Grant Thornton and Refco - Small Favors

Refco is a favorite case of mine, since it is a Chicago case and also the first time I used the expression "big swinging 'sticks'."  I try to keep it clean on this blog, but occasionally I can't resist wordplay that implies my visceral reaction to the true rogues that pepper my posts.

As I mentioned earlier, guilty pleas by Refco's top three rogues helps the case of all other defendants, and there are more than a few suing and being sued in a money-fueled circle jerk the likes of which are unfortunately still all too common post- Sarbanes-Oxley.  

Does that mean Sarbanes-Oxley is ineffective?  

Au contraire, mon frere.

My contention is that Sarbanes-Oxley has at least raised the tone and tenor of the conversation about internal controls and about common sense, tried and true, reasonable practices for financial reporting to shareholders and other stakeholders.  Sarbanes-Oxley has raised the expectations, to an appropriately high level, of corporate governance and ethical, non- self-serving behavior of corporate executives.  Sarbanes-Oxley has given stakeholders the tools to bring the hammer down on irresponsible, non-responsive, fat headed, cigar chomping, belligerent, insular, seemingly untouchable "big swinging sticks."  The Tone at the Top as improved in most major corporations and their professional advisors, if not by design then by default - the fear of prosecution.

Whatever it takes...

From Securities Law 360 (subscription required, 7-day free subscription available)

Refco-Related Claims V. Grant Thornton Tossed

Equity Firm Battles Grant Thornton In Refco Fraud Suit

 A lawsuit claiming Grant Thornton LLP is responsible for an investment firm's massive losses in connection with the collapse of Refco Inc. was partially thrown out Wednesday.

A federal judge tossed Thomas H. Lee Equity Fund V LP's claims of negligent misrepresentation and professional malpractice but allowed a claim of aiding and abetting fraud to go forward against the auditing and consulting firm.

The suit...alleges Grant Thornton knew about the now-defunct Refco's fraudulent loan transactions in April 2004 — during the time Thomas H. Lee was considering a $450 million investment in Refco in the form of a leveraged buyout.  The lawsuit alleges that Thomas H. Lee lost more than $245 million after making the investment in August 2004 and blames Grant Thornton for making “numerous misrepresentations” regarding Refco's dire financial state.

Judge Gerard E. Lynch ruled Wednesday that “defendant's motion to dismiss is granted with respect to plaintiffs' negligent misrepresentation and professional malpractice claims, and denied as to all other claims.”

Lynch's ruling says the complaint failed to prove that Grant Thornton had “any duty of reasonable care” to make sure the plaintiff knew about the fraudulent loans because, among other things, the audits were not performed with Thomas H. Lee's specific investment plan in mind.

However, the judge, in upholding parts of the case, ruled that Thomas H. Lee was right in asserting that Grant Thornton was aware that Refco was making the now-infamous round-trip loans and that the auditors knew the loans were “suspicious.”

The judge added that Grant Thornton's claims that it was never provided with documentation sufficient to discover the fraud are “belied by the complaint's allegation ... that [Grant Thornton]” discovered a $545 million suspicious transaction between Refco and a third party. Such a loan should have been a red flag for any auditor, the judge said.

Counsel in this matter for Grant Thornton is Bradley E. Lerman, Winston & Strawn LLP. The company and counsel, contacted Thursday, had no immediate comment. Counsel for Thomas H. Lee could not be determined Thursday and the company had no immediate comment.

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More FAS 5 - More Transparency or More Shilling

Edith Orenstein has a very extensive summary on the FEI Blog of the latest in potential changes to FAS 5 disclosures. The proposal is causing a significant amount of consternation and wrinkled brows for the corporate lawyers. 

For the uninitiated, here's a quick summary of how disclosure of legal contingencies currently works.  

Now, I usually like lawyers.  I've even complimented the ones that defend the partners and the Big 4 firms. 

When they're very, very good.

And I admire the ones that really know their stuff, guys like Jim, Jake, Broc, and Tom.

Ok, I like guys with really big brains and a bad-ass attitude.  I'm busted.

But in this case, the corporate lawyers are going all out to defend their corporate clients and their bias shows like a tattered slip under a cheap floozy's summer wrapper.  

Consider one of the most vocal ones.  Mike Young is always good for a good quote about how any and all disclosure is bad for his clients' (company management, certainly he's not thinking about shareholders) position vis a vis their defense and negotiation with those that sue them.  

He's a (big) talking head for the audit firms, too.  But he's also afraid of the auditors. 

Which side are you on, Mike?

From Mr. Young's comment letter:  

...It is to the Board's credit that it seeks to mitigate these concerns through the possibility of aggregation.  While that attempt is commendable, however, it doesn't really solve the problem. The prominence of large litigation often cannot be disguised by aggregation, and both large and small litigation would presumably be the subject of robust discussion with the outside auditor in disaggregated form, thereby making highly prejudicial information potentially available to adversaries through loss of the attorney-client privilege... 

Read more here about the corporate defense lawyers who are afraid of the external auditors (or internal auditors) having access to any real strategic business information. 

Yeah.  He makes a great case for me to agree with squelching disclosure.

Not.

Let's take a look at a recent case of lack of disclosure: Nokia-Qualcomm.

As I wrote in a blog post back in October, 2007, Nokia and Qualcomm had some significant litigation going on and there was nary a mention of it in their most recent annual reports at the time, per FAS 5 current rules.  PwC was on all sides of this conflict.  Hmmmmmm. 

The litigation was recently settled.

A reader who had been following that case much more closely wrote:

...I speculated [back in October when I wrote the original post] that it may have something to do with the ever-boastful Nokia's true status with regards to their pending litigation with Qualcomm. At the time I predicted that Nokia would cave and settle within 12 months, for terms that perhaps would be less favorable to Nokia than they might have led their shareholders to expect. 

Well, the above played out true to form this past Wednesday, as Nokia raised the white flag on the courthouse steps, just as the trial was to commence. While there have been quite a number of prominent articles the past 48 hours stating that Nokia "got the best of Qualcomm", I would submit to you that the share price action the past 2 days indicates otherwise.

A "short" Nokia/"long" Qualcomm strategy has worked rather well the past 6 months, and I suspect this will continue to be the case going forward.

As for poor Carl........................I suspect he and/or his employer saw this day coming all too well.

Without sufficient disclosure, how could either side's shareholders been able to gauge the impact of pending litigation accurately in order to make proper investment decisions?

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H1-Bs and Student Visas

I've had a lot of questions in the past from students and H1B visa holders about their options if they're recruited by the Big 4 and then cut.

Here's some news from Dice.com, home of Jobs In The Money Blog.

Go to their site and answer the poll to voice your opinion.  Current results are shown. My answer is in bold.

The Department of Homeland Security recently extended the amount of time foreigners on student visas can work in the U.S., from 12 months to 29 months. What's your reaction?

It's a great decision. It helps the labor pool without a big change to the H1-B visa rules.
23%

It may be controversial, but it will help companies get more ROI from foreign workers.
6%

It won't cause much change. Workers may stay longer, but it's still only temporary.
 9%

It's just a quick fix. Instead the government should help more Americans learn IT skills.

62%

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Ernst & Young Mucks Up Independence

It's not a lot of money but, oh, the stupidity of it.  I have actually been rather impressed with EY lately, both for their ability to stay out of trouble, to take on the staff shed by other firms,  and for their bold moves on the business model front.  

But this is just not good, especially given their prior transgressions in the same area that resulted in their being barred from taking on new audit clients for six months.

As I have mentioned before with regard to the rest of the Big 4 firms, in particular PwC of whom I have the most knowledge:  The Independence Offices are fighting against the entrenched attitudes of the partners and the firm leadership that tell them, "Business comes first."  

They also have no idea how to create alliances and partnerships, such as the one that was the subject of this EY issue, without mucking up.  The partners go off on their own and do something they think is sexy, don't ask anyone until it's too late, but by then it's perceived to be too "big" for anyone to say no.  With fines as paltry as $2.9 million, they have a point:

Ask for forgiveness rather than permission.

When is the SEC or someone else (??) going to let the firms know they mean business? How much more of this amateurish approach to alliances, without regard to the rules they must adhere to as an audit firm first, are the regulators willing to accept?

And Mark Thompson?  Is he barred from serving on a Board, in particular on an Audit Committee, for life?

Update from a great new source, a lawyer, of course.

 

Tom Gorman at Porter Wright:

By April 2004, shortly before the relationship ended, E&Y’s policies required that matters potentially relating to independence be reviewed by its independence office and disclosed by the relevant coordinating audit partner to the audit client. After reviewing the relationship between Mr. Thompson and the firm, E&Y concluded that the relationship did not impair its independence because it fit within the “consumer in the ordinary course of business” exception to the independence rules general prohibitions.

The Commission rejected E&Y’s claim that its relationship came within an exception to the rule, finding that, in fact, the firm’s independence had been compromised and that Mr. Thompson was a cause. According to the Ernst & Young Order, “[b]usiness relationships with persons associated with the audit client in a decision-making capacity, such as audit client directors, officers and substantial stockholders” are prohibited by the independence rules. 

This conclusion is based on Rule 2-01(c)(3) which provides that “[a]n accountant is not independent if, at any point during the audit and professional engagement period, the accounting firm … has any direct or material indirect business relationship with the audit client, or with persons associated with the audit client in a decision making capacity, such as an audit client’s officers, directors or substantial stockholders.”

Here, Mr. Thompson was a member of the boards of three E&Y audit clients and on the audit committee of one. Mr. Thompson was well aware that E&Y was the auditor of the three firms since he signed filings for each and, as a member of Company A’s audit committee, participated in the retention of the audit firm...

And now the news article:

SEC Sanctions Ernst & Young

Ernst & Young LLP, one of the so-called Big Four accounting firms, agreed to forfeit more than US$2.9-million to settle U.S. regulatory claims it compromised its independence while auditing three companies.

The firm "engaged in improper professional conduct" after agreeing in 2002 to create an audio series of recorded interviews with industry leaders in collaboration with Mark Thompson, a board member for three of its clients, the Securities and Exchange Commission said in a statement on Wednesday. It didn't identify the companies.

Best Buy Co., the largest U.S. electronics dealer, announced plans in 2004 to drop Ernst & Young as its auditor after learning Thompson, a member of its audit committee, had a separate relationship with the accounting firm. Thompson earned about half his income by coaching Ernst & Young partners to conduct talk show-style interviews for its "Thought Leaders Series" of compact discs, the SEC said.

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The SEC Meets The Web: "We Likey!"

On July 30, 2008, the US Securities and Exchange Commission (SEC) published its interpretive release explaining how companies can use their websites and blogs to meet their requirements for public disclosure under Regulation FD.

Dominic Jones at IR Web Report says,

"...I don’t expect a flood of companies ditching their wire services overnight and cranking out new investor relations blogs. It will take time for companies and their legal counsel to gain confidence that they can use their websites rather than the traditional methods without exposing executives to potential SEC action under Reg. FD..."

Dennis Howlett takes the issue down the road to the not so distant future and declares, while quoting me twice, that this change means the end of audit as we know it.

What this new guidance does is add fuel to the regulatory oversight fires. The Big Four audit companies have successfully put the fear of prison front and center in the minds of C-level officers, reaping the increase in fees that go with it. However, they have been almost derelict in their updating of testing services for today’s complex ERP. 

What possible hope they have of providing guidance in this area is beyond my comprehension... If, as has been argued elsewhere, one of the Big Four collapses and this guidance is fleshed out to be meaningful, then the whole question of corporate public disclosure becomes a major talking point.

Imagine this: the entire value of traditional audit comes under question. What replaces it? A carefully orchestrated stream of transparent information that can be parsed through links. There will, in other words, be no place to hide.

Well, as much as it may seem that just putting disclosures on the corporate website or a blog could allow a Wild West scenario to emerge, where companies will start willy-nilly disclosing data without running it past their auditors and lawyers, it's just not going to happen.  

Yes, mistakes will be made, because the disclosure controls will need to be significantly tightened.   If I were you, I would focus more on the dramatic impact on information overload and ready accessibility to all the dirty details that's coming from XBRL mandates.  Now that's where everyone really needs to be very careful.  

But the rules are clear.  No interim reporting that is intended to comply with Reg FD without the auditor's review.

In December 1999, the Securities and Exchange Commission (SEC) adopted a rule that requires a company's independent auditor to review the company's interim financial information prior to the company filing its quarterly report on Form 10-Q or Form 10-QSB. In the SEC staff's view, this rule makes it a clear violation of the securities laws for a company to file such a quarterly report without having its auditor perform the review in advance of the filing. The rule was effective for all fiscal quarters ending on or after March 15, 2000...

The professional standards and guidance for conducting interim reviews are set forth in Statement on Auditing Standards No. 71, Interim Financial Information (SAS 71)with only minor modifications for conforming changes by the PCAOB. The objective of a review of interim financial information is to provide the auditor with a basis for reporting whether material modifications should be made for that information to conform with generally accepted accounting principles...

In practice, a review report typically is not issued on interim financial information, although SAS No. 71 provides that a report may be issued. The SEC does not require, and most companies do not request, the issuance of a review report. However, the SEC does require that if a company includes a representation in their filing that the auditor has performed a timely review, the auditor's report on the review must accompany the interim financial information...

There's also the quarterly requirements for Section 302 certifications under Sarbanes-Oxley. I don’t believe (although I could be wrong) that there is any explicit requirement in SEC rules for the auditor to review the certification. However, reading the entire filing, in a manner consistent with SAS 8 requirements, is the first procedure noted in the PITF I linked to. You can see all SEC filings now on almost any corporate website, most of which now reproduce several different versions of all SEC filings using a direct link to EDGAR or some other investor relations reporting third-party service.

Although I agree with Dennis that this new guidance on Reg FD disclosures puts more pressure on companies to produce better information, faster, more accurately, and with more polish, it doesn't change what hoops they have to jump through first.  

Or else the penalties are clear.

A company that files its quarterly report without having its auditor perform a quarterly review is, in the SEC staff's view, in violation of the securities laws, and an auditor with a client who does this should consider discussing the matter with the company's audit committee and the company's legal counsel. Guidance for conducting such reviews can be found in the SAS No. 71.

One of the primary reasons the SEC has mandated the above requirement is to minimize large year-end adjustments to quarterly financial statements that historically have been uncovered in the annual audit process...

What does change dramatically are the opportunities for deeper, richer, fuller use of company websites, in an interactive social media way.  One good example is an Investor Relations Blog.  These new tools can engage investors and rebuild trust in both companies' financial statements and the auditors that audit them.  

Before it's too late.

Update:

Business Wire's response.  Of course they'd say that.

Business Wire Announces That Standalone Webposting Runs Counter to Spirit of Reg FD

Broad, Simultaneous and Real-Time Distribution is Key to Ensuring Fair and Equal Access for All Market Participants

NEW YORK--(BUSINESS WIRE)--Business Wire believes that the SEC's Interpretive Guidance release on web-based disclosure clearly falls short of the investor relations industry's best practices standards, and that simultaneous, real-time distribution of material news to all market participants is the key to ensuring the "level playing field" that is the intent and spirit of Regulation Fair Disclosure...

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PS.  Thanks to my favorite Chicago SEC expert for confirm on facts here.

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PwC's CYA re: Northern Rock

PwC has started to draw the bright line on its involvement with Northern Rock by almost giving the bank a "going concern" qualification.  As many of you know, that qualification is pretty much a death knell for any other kind of organization, causing companies to be in non-compliance with bank covenants and experience a credit and, therefore, a liquidity crisis. But as we know, liquidity crises never just happen overnight.  There is always an underlying weakness that all have been unwilling or unable to acknowledge, including auditors.

But since the lender is the government, maybe it just doesn't matter.  Like with Bear Stearns.  And Fannie Mae, Freddie Mac...

The company executives get away with plunder and so do the auditors who stood by, either by design or default, and watched it happen.

PwC red flags Northern Rock 'uncertainty'
Rock auditor says disclosure in the troubled banks accounts do not provide adjustments which would have to be made if the bank collapsed

PricewaterhouseCoopers has raised concerns about Northern Rock's interim report disclosures, warning that there was no guarantee the bank will be able to continue as a going concern unless a key approval is secured from Europe.

The troubled bank's auditor did not qualify the bank's half-year numbers, but said there was a 'material uncertainty' hanging over Northern Rock because the government's £25bn bailout had not been endorsed by the European Commission...

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Another Day, Another Opportunity To Shape The Future of Accounting

Yikes! Some of you might be saying, "She's really gone over the edge now." Did that 400th feed giver her delusions of grandeur? Maybe it was the people at the ISACA conference in Toronto, not just from the US, that came up after she asked a question and couldn't believe it was really the Francine McKenna, author of re: The Auditors, at an ISACA conference. 

"I read you every day and so do all my co-workers!"

I'm getting a lot of crap from close friends and family here about The Book.  The Book was the reason for the blog in the first place. I saw how some folks in New York had done it... Start a blog, get a book contract, become famous, have everyone buy you drinks instead of the other way around. 

And then, around this time last year, I started to think: Maybe a hardcover, old media book is not the "be all and end all" of what's possible. I'm still thinking about it and still planning to finish the book. But I've also been thinking about other ways to use the tools available nowadays to do more in different ways. 

Blame the wild and crazy "social media" types I've been meeting lately. And Dennis Howlett. He's always good for a few ideas. And then I see folks like Andy Sernovitz of WOM still writing books. For credibility. And I'm back full circle.

And then there's the students and folks at the beginning of their careers with the firms. Another great dinner last night with a smart, honest, hardworking guy that wants a little more and deserves a little more and knows he should give a little more because he has been blessed with extra brains and a family that encourages him. 

I have the good fortune to correspond and sometimes meet in person many, many young people and they keep me moving at 60mph. I never tell anyone, "Don't join the Big 4." Or, "Quit, now, while you're still human." Because, as I said to José last night... If you graduated at the top of your class, and have already done an internship at one of the firms, have multiple offers from Big 4 firms and/or have already joined one, then you have already signed up for most of the program. In other words, you are already an accountant and Big 4 material. The question now is, "Do you want to develop and become what it takes to succeed in the Big 4, much of it good for you and some of it not, or do you want to use your talents in another way?"

I cannot presume that anyone who has already joined a firm and had that opportunity wants to live the way I have. I've worked lots of places, changed jobs, not always on my own terms, been on my own, now for the second time, lost and regained contact with family and friends a million times because of all my traveling, and gotten divorced. It's not the American Dream. But in any event, I am happy. It's all led to this, whatever this is, and followed a thread, not a straight line, but a path that's continuous and meaningful. 

But it's not for everyone. So when someone asks me for advice, and they do all the time now, I just tell them my version and hope that their brains are big enough for them to see it for what it is: More information they should process but not take as gospel. (Note to Big 4 Partners: If you want this to happen to you, and you should, and you must, it's not hard. Just be sincerely open and willing to share. They really appreciate it.)

After all, I'm just a girl.

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Having Some Fun

Abject apologies I just got a bajillion whiny emails saying I have not updated this since people stopped clapping and Tinkerbell died...(The day before yesterday) You would not believe the fairy dust I have to clean up. But I'm sorry you'll just have to take my word for it..

I am hopped up on caffeine, with an obsession with saving money, selling my soul to Google, just generally being a biatch to various lawyers I met recently, and my day drinking from the first cockadoodledoo from the rooster until I run out of alcohol. I am putting money aside so I can run away. I wish you could go with me.

I declare solemnly I will get online again after this next Lolla set. You have my word! I really, truly promise!.


(Having some fun thanks to Rohit and this site.)

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Plugging In - One Post At A Time

Lately I've been getting to know more folks and more groups here in Chicago that are involved in "Social Media."  People like Barbara Rozgonyi, Andrew Coffey, Liz Strauss, and Daniel Honigman. "Social Media" is a term that accountants and lawyers may know but only from, perhaps, their experience with Facebook or Linked In or similar connectivity tools.  I wrote recently about Deloitte's foray into Social Media, both as a consulting firm advising clients and as a company trying to respond to the need of their own employees to talk about their firm, both positively and negatively.

For me, it's like many other things I become interested in that are outside my own area of experience.  I look with a detached, outsider's eye and try to psyche it out since I am not, after all, part of the group that is dependent on belonging.  And so I have come to realize that I am doing things and accomplishing things with this blog that some charge good money to talk about and that others are starting to think is pretty neat.

I was invited to a workshop here in Chicago called Word of Mouth Crash Course.  It's run by Andy Sernovitz, who is famous in his area of expertise and has many of the marketing gods, like Seth Godin (???), in his corner.  Andy kicked off a local, stay at home version of his crash course yesterday to a mixed group of corporate professionals, social media mavens at companies like Yahoo, bloggers, and the already converted like me.  

Why "Word of Mouth" marketing versus traditional marketing?

1)You can replace paid marketing with "free" marketing

2)Word of mouth is sustainable, renewable

3)Leads acquired are cheaper as your word of mouth impact expands geometrically

4)Grassroots impact translates into more creative press coverage

5)According to Andy, it works!

Well, you don't have to tell me.  I realized that I was already doing many of the things Andy was talking about in my small way in the blog, mostly because as a non-monetized venture, I try to spend as little as possible.  The site is free.  I do all the work.  I mostly write from home and from existing sources.  I do my own PR.  The only things I spend money on are travel, expensive hotels, champagne, and shoes (for when I go to Washington DC and New York.)  But I would do that anyway, so the marginal cost to the blog venture is minimal.

I would highly recommend Andy's book and seminars to anyone looking for new ideas, a new way of looking at simple activities in light of their marketing potential and a crash course in what kinds of tools and technology are currently available to make it happen.  All of this is at least helpful if you still end up hiring an agency to help you with "interactive marketing communications."  At least you will know that they're talking about.

One great example that came out of the day went like this:

Andy was talking about the thoughts behind his choices for the course goody-bag takeaway.  We received a small transparent zippered pouch, suitable for airline travel, filled with two small bottles for liquids, a big chocolate bar, a mini funnel for filling the bottles, and an orange electrical plug with three outlets for those travel situations where you need to charge your phone, your laptop, and help a fellow traveler. 

Eric Rochow, creator of the Garden Fork and Real World Green Social Media empire, says, "Yeah Andy, that's great, but you should have branded that plug somehow with your logo."  

And Jamie Goren, President of Plastic Decorators Inc., a Quebec Canada company that prints all kinds of things (and brother of Mark Goren) says, "Hey I can do that!"  

And the impact is that Jamie will earn back his fee for the course from new business for Andy and Andy will tell the story of Jamie's company every time he talks about the plugs in future seminars and workshops.  

This is the essence of Andy's message.  Make an impact.  Make the impact the old fashioned way:  Get your customers to talk about you rather than have your advertising talk at your customers.  Multiply that impact.

My take away from yesterday was something Andy calls the "Matchbook effect."  He lamented the fact that since smoking was losing favor in some many places, many restaurants and bars no longer printed matchbooks with their name, address, and sometimes a very creative logo to help customers remember them.  That really hit me,  since I collect matchbooks, even though I do not smoke.  I have traveled all over and to many unusual places.  I have returned to many places more than once but not always frequently.  I collect matchbooks so I remember great restaurants and bars and can find them the next time I'm in town or recommend a place to a friend who is going to that city.  I have many unique ones, in particular from Latin America and Paris.  I have some from all the way back to 1987 when I made my first trip to Brazil.

I am thinking about how I can generate the matchbook effect with this blog.  How can I leave you with something you'll remember so you know how to come back to me and know how to tell a friend about me?  

I did make one immediate change during the class.  I added a line to my RSS feed to thank you for reading, ask you to tell a friend, and give you a way to get in touch directly if you like.  In the days ahead, I may be testing out some other ideas on you, things like communities, forums, events and other ways that anyone who is interested in these topics can keep talking about them.  We'll see....

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Enron Stripper Lover Charged

The guy who was probably one of the bigger Enron swinging sticks, has been charged by the SEC. Thanks to the Daily Caveat for the tip.

SEC ANNOUNCES CHARGES AGAINST CHAIRMAN OF FORMER ENRON ENERGY SERVICES
Enron... The name just makes me nostalgic. Probably less so for Lou Pai, formerly Chairman and CEO of Enron Energy Services, who the SEC recently charged with insider trading, circa May to June 2001. Pai immediately settled, accepting a hefty ($30 million plus) financial penalty and a to a five-year bar from serving as officer or director of a public company. Pai's settlement did not require an admission of guilt...

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The Hits, They Keep On Coming

I'm at a seminar today sponsored by local media guru Andy Sernovitz on Word of Mouth marketing.  I'm coming late to this party, but I'll be coming on strong. Watch for more.  I'm wearing the Prada brown strappy sandals with the four inch bamboo heels.  (Picture is a likeness not exact image. )

Party later.

In the meantime, the audit industry just keeps on giving.  Here's a potpourri of litigation updates for your bemusement until I'm back at the blogging ranch later:

Cast Art Industries, LLP v. KPMG, LLP

For those of you who watch such things, I caught this email last week announcing that a judge had found sufficient evidence for a jury trial in a case involving KPMG. The suit alleges that the auditors failed to detect a fraud worth approximately $50 million at Papel Giftware, a firm bought by the plaintiffs, Cast Art Industries...

BDO global network posts double digit growth as demand for forensic and anti-money laundering services increases

BDO Seidman, the US firm appealing against a $521m (£261m) damage claim, has posted a 12% increase in its revenues.

The firm said its had made $659m for the year ended 30 June, compared with $589m in the previous year, citing more activity in the areas of forensic services and anti-money laundering.

The revenue increase will come as a boost for the firm after Portuguese company Banco Espirito Santo successfully argued that BDO Seidman was negligent in its audits of factoring company Bankest, leading to the massive penalty...

PwC face probe into failure to detect €21m fraud
(To get the most from this post, please read this first: Money Laundering: Are accountants and lawyers potentially just as guilty as the criminals themselves?)
PricewaterhouseCoopers are the external auditors for several large businesses in Barbados including FirstCaribbean Bank International. It is my understanding that PwC is also the external auditor of FCIB (Belize)...

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SOx and ERPs - Where Are The IT Auditors?

Given all the issues we're seeing with botched Deloitte ERP implementations that result in Sarbanes-Oxley issues, at LAUSD, Levis, and others, I have to ask, "Where are the IT auditors?"

To PwC's credit, they seem to have brought the hammer down on their audit client Levi Strauss at least after their shipping was held up a week and their results this past quarter compared to last quarter dropped 98%.  Better late than never....If  it was really the fault of the SAP implementation that their profits suffered.  

But it looks like, in any event, there are issues with this implementation and they are big.

It should finally be time for corporations and their auditors, internal and external, to be able to focus more on IT and the role of ERPs in ensuring the integrity of financial reporting controls as required by SOx.  Most large, modern companies are, after all, run by ERPs, or at least a number of automated systems both new and legacy, connected by band aids, string, duct tape, manual processes, lots of uncontrolled spreadsheets and fingers crossed whenever anything significantly changes.

Instead, because of the pressure on the Big 4 to reduce audit fees and SOx related fees, in particular via Auditing Standard 5, the Big 4 is laying off auditors, and IT auditors in particular.  Firms are feeling pressure from their clients to charge less, which may or may not translate into less work immediately.  But fees on external audits are going down.  Don't take my word for it.  Compliance Week says so.  However, Compliance Week would like to believe, as Chris Cox smiles down on us all, that it's because of Auditing Standard 5.

Sarbanes-Oxley testing is both a component of the external audit and a service sold by the Big 4 separately either under internal audit co-sourcing agreements or as a separate Sarbanes-Oxley internal assistance program.  One interesting variation that developed as the pressure started to build on Sarbanes-Oxley projects two years ago is the performance fee.  Sometimes the Big 4 has promised cost-saving process improvements form SOx work, meant to offset the resentment that high fees for SOx assistance engendered.  As part of a consulting engagement, a Big 4 firm promises process improvements from SOX documentation and testing activities of a certain dollar amount or if not found, a discounted fee equivalent to the promised savings.  

The hard part is setting up the metrics and measuring the savings sufficient to satisfy the client so they won't deduct the money anyway from their invoice before paying.  But when done well, it's a great thing.  I won't go into now the conflict presented by a supposedly competent and objective, independent, internal Sarbanes-Oxley tester (co-sourced from the non-auditor Big 4 firm) being pressured by their managers and partners to redesign a process that they are testing as management's proxy and then retesting and approving the same process that they have redesigned.  All so that their firm does not have to discount fees to the client...  That's a post for another day or something for the PCAOB to look into.

Nevertheless, even well documented savings will still result in clients taking the implied discount anyway.   Once you say you can lower your fees, clients will never pay more for the same thing.

In addition to grudgingly accepting haircuts from their clients, when fees for external audits and outside consulting on Sarbanes Oxley go down, where are they getting cut?  

On the IT side.

It's unfortunate, since as we have seen, companies have not stopped having problems with IT controls. In fact, in banks and trading companies, weaknesses with IT controls are an epidemic. When it comes to implementing ERPs like SAP, poor controls over the use of these applications will have a financial impact, as Levis and SocGen showed us. 

Why aren't the Big 4 pushing the IT audit component more?

Well, during all of this Sarbanes-Oxley bonanza, they have never had enough IT audit staff and now they have less.  So they can't do the work as well as they'd like even if they should.

And then there are the internal firm political issues.

The Big 4 client partner in charge of either a big company financial audit or a Sarbanes-Oxley assistance engagement most often comes from the financial side.  The Big 4 partners responsible for the Risk Advisory or IT audit and security component of external audits or SOx support engagements are leading specialist practices, still most often most closely aligned with the audit practice, and act as supplements to the larger financial piece.  The IT Audit partners get revenue credit for as many people as they have on someone else's engagement but the financial audit partners are calling the shots.  The IT external audit engagement would never be sold separately. IT audit co-sourcing or SOx assistance for solely IT audit is engaged separately only on special occasions.

Now that companies are putting pressure on their auditors to reduce fees, client relationship partners on the financial side of the house are cutting staff on the audit engagements in the areas that hurt them the least, IT audit.  The total fee to the client can be reduced, but the revenue and margin to a financial partner in charge of the engagement can stay the same or maybe even increase if he cuts some of those pain in the ass, expensive IT audit and security folks from the engagement.  

It's called leverage, baby.

Which is a shame.  The biggest "bang for the buck" or "bang-up avoidance" that can come from good Sarbanes-Oxley work is improved IT controls.  When a company and their auditors do focus on IT controls, as is being done in one of the most notorious recent bankrupt companies that also happens to be an SAP customer, you can get great results.  Companies can reap process improvement cost savings that can pay dividends for a long time down the road by implementing SAP and other ERPs as intended, with all the controls configurations thoroughly addressed.  In addition, tight automated controls means less testing of manual documents at Sarbanes-Oxley and internal audit time, even under the worst circumstances.

Here's two examples:

Testing three way match - When ERPs like SAP are configured properly for automated three way match, not only do companies see staff reallocations and reductions in previously manually intensive functions like Accounts Payable, but they also see expedited testing at SOx time.  Testers do not have to pull a sample of receiving, invoice, and PO documents and make sure payment rules were followed and exceptions approved.  They only have to test configuration and, if the automated controls can be depended on, are able to bypass time and money intensive document sampling.

Testing approval workflows for journal vouchers - If a company has special approvals needed for journal entries hitting certain accounts or when they exceed a certain dollar amount, manual testing includes identifying those entries via transaction reports, finding a sample, and testing paper copies of journal vouchers for handwritten approvals against an approval hierarchy chart.  When configurations for proper approval workflows are established in ERPs like SAP and tested as effective, this time and money consuming detail testing can be bypassed.

Moral of the story - If a company can depend on their automated ERP controls, they will save a lot of money and headache, with or without SOx.

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In The Agenda

I was quoted this morning in the Financial Times subscription only publication, Agenda.  It is directed at members of Boards of Directors.  

The title of the article, "Fate of SOX in Hands of One Judge" is quite ominous.   By Tony Chapelle

My quote:
Would public companies keep improving their financial reports were both the PCAOB and Sarbanes-Oxley to be closed down even temporarily?

Probably, says an internal audit and corporate governance consultant. While a temporary vacuum in regulations “would be a huge advantage” for firms, says Francine McKenna, president of McKenna Partners, they would still enforce high-quality internal controls to stay clear of shareholder lawsuits.

Meanwhile, McKenna explains that even when an auditing client switches its accounting firm, the new auditor usually requires the manager to make the same changes in accounting treatment or restatement that the previous firm had required.

Thanks, Tony.

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Embracing Change - Day by Day

I often think of my career as having had at least four parts, so far:

1.  The first nine years I was, first, an internal auditor and financial analyst in a bank and then a financial accounting executive in two different B2B industrial distribution companies.  (Many of my best "what not to do" stories are from those years and it was during this period that I passed the CPA exam.)

2.  The next eight years I spent with KPMG Consulting, JP Morgan, and then returned to BearingPoint as a consultant, the last half of which was spent in Latin America 100%. (It was during this time I became a consultant in mind and body, met many wonderful people who are still my friends, perfected my Spanish, and changed my life irreversibly.)

3.  The post 2001 years, until recently, were spent at two firms, Jefferson Wells, part of Manpower, as a Regional VP for the Midwest including Toronto, and at PwC.  I was on my own for two years in between, but I allowed two men, a PwC partner who had been the #2 Auditor at CINB, my first employer, and the National Partner in Charge of Internal Audit at PwC, to entice me back to working for someone else.  

(It didn't take much, only a large salary that helped me out of the financial challenges I had created for myself in being on my own for two years and the flattering comments of the National IA Partner: 

"You are a renaissance woman.  We need you to inject consulting experience and a global view into our flat, insular, internal audit culture."  I'm a sucker for an Italian man who looks up to me.)

4.  I've been on my own now again since October 2006, writing the blog and doing client work that infuses that writing, while staying close to only whom and what I want to spend time with.  I call it professional convergence.

Some people I know now only know me as a writer and blogger.  Many people who know me now didn't know me as a married person. (I haven't been for ten years.)  They only know me as a Jefferson Wells executive or PwC employee and don't know I speak Spanish and didn't know me when I was in Latin America or when I was a Controller, General Ledger Manager and Internal Auditor.  Some people only know me from my Latin America days and will forever see me as Francisca the "gitana", living a life filled with travel, tequila, and task-oriented, technology focused, cross-border project management.

So when I show up at the ISACA Leadership Conference in Toronto, as the Vice President of the Chicago Chapter, people are surprised to find I am not really an IT auditor or security professional.  I write a blog about the Big 4.  I consult on strategy, sales and marketing, operations and Web 2.0 issues for professional services firms in the internal audit, corporate governance and compliance space.

I was never one to load myself down with a lot of designations and certifications.  I passed the CPA exam, but I have never been licensed or practiced public accounting.  I have been in the public accounting firms but in technology consulting and internal audit practices and most famously, thanks to my PwC colleagues, auditing the strategy, operations, compliance and governance of that firm.  

I am not an internal auditor, nor am I a super technical technology consultant.  I do think of myself as a writer now.  I use that term often when introducing myself.  And I do have my own firm, however small and beautiful I keep it for now.

I thought of all these things when I sat and talked for hours with Krupo and Neil last Thursday and since.  They are both 26 1/2 or so, at the beginning of their lives, and yet they feel so much older in their actions and insights.  Is that good or bad?  Well it's better than being flaky, and it made it so much easier for an old lady like me to talk with them. But I worry that they won't be able to keep up the pace for as long as I have.  It takes a lot of energy and pure resilience to do what we are all doing now for another twenty years, at least in my case, and another forty in theirs.  

I hope they have it in them.

 

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