Another large firm will fail soon.
Soon, to me, means in 1-3 years, not 5-8 or 10-13.
Jim and I had a long talk about a week ago over pancakes and waffles. We usually have a nice leisurely lunch, replete with more than one choice of wine and strong espresso and dessert to cap it off. But we knew the subject was “failure” and so we planned a breakfast, with plenty of carbohydrates and caffeine.
Jim is very strongly a “blank sheet of paper” kind of guy when it comes to devising solutions to the problem of audit scandals, audit firm catastrophic litigation and poor audit quality. When I think about it, I tend towards the “we can fix it if we all try hard enough” perspective. It comes from my experience as a “blank sheet of paper entrepreneur.” If I have to do the work, I’d rather start with something, however broken, and fix it, than start from scratch.
Can the firms be fixed?
Well, I think the model is certainly broken and the objectives, goals, and incentives on cross-purposed, contradictory and opposing sides. My usual rallying cry is, “Make the firms step up and meet their professional obligations. Take away the oligopoly protection (hence my opposition to liability caps.) Let some fail in order to clean house and bring market discipline to the firms. ”
Yeah, capitalism and market discipline. That’s the ticket. What rationally self-interested Ayn Rand
follower can disagree with that?
We should bring the questions back to investors:
What do you need in the way of financial reporting assurances, audits, due diligence, attestations? Does an audit and its useless, boring boiler plate make a hill of beans difference in your investment decisions, or do you all, analysts, sophisticated investors and other stakeholders, make your own decisions based all publicly available information assuming it’s timely and accurate? Can we find a way to uncover fraud, punish fraud and warranty the financial information that is distributed to the public so that financial statements are a tool rather than a throwaway?
I offered you a chance last week, via the blogger survey tool, to voice your opinion on the next firm to fail. I was surprised and pleased with the results. First, I was pleased that so many took the time to respond. There were 173 responses over a five day period. The choices were:
(Primarily due to the judgement against them in Florida)
(Primarily due to Refco and Parmalat litigation pending)
(due to New Century potential litigation primarily given their still fragile state)
Testimony from the Big Four and the insurance industry provided the count of death-threat litigations: 27 cases with damage exposures above $1 billion, of which 7 exceeded $10 billion – with the estimated total between $100 and $140 billion. The large firms cling to their tactically sound but politically tone-deaf refusal to offer comprehensive data on their own financial condition, but the litigation potential to overwhelm their partners’ limited capital is unrebutted.
I was surprised at the result of my survey, since I believe BDO is the closest to death’s door. I received an email from a source recently that said, “…the vultures are hovering”:
Heard yesterday from an insurer that BDO will likely pay some amount. This person works for a leading insurer of accounting firms. The company does not insure BDO, but other mid-tier firms. Take it for what it is worth, an educated guess from someone in the industry.
He also told me that other firms, most likely mid-tier firms, have made inquiries about hiring BDO employees in the case of its failure.
So it was a surprise when reader opinion said something different:
KPMG (New Century case)
PwC (Northern Rock and AIG)