• Satyam, SocMed, BDO International, and Sunshine

    By • Jun 26th, 2009 • Category: Latest, Pure Content, The Big 4 And Globalization

     

     
    It’s been a very hot few weeks here in Chicago.  After last weekend’s thunderstorms, we’ve had temperatures between 85-90 F or so all week. (That’s 30-32 C for you metric folks.)

    Needless to say, Rosie Rott and I have been drinking a lot of liquids. I feel like a broken record telling everyone at an event last night, “It’s about time we had hot weather. Wasn’t that a lousy winter we had, worst ever?  I blew five tires from potholes.  Oh, how I wished I was in Mexico. Better sunshine than snow. I just turned off my heat on Memorial Day weekend…”

    Such is the nature of chit-chat.

    It’s been a busy week for me, in spite of the fact some of you may complain about the lack of a new blockbuster post.   First there’s the comments about layoffs and the general management malaise in Big 4 firms.  I made the unthinkable mistake of stopping comments on the latest post for pundits and poseurs before we reached 500.  Was just trying to give you a clean slate. Mea culpa, Mea culpa.

     “Deloitte – The Worst May Be Yet To Come” is back open.  I’m trying not to get in the way of this spontaneous outpouring of content and commentary.  Please post comments wherever you feel it makes sense.  I will keep 500 as cutoff so you all know when that is approaching.  Follow comments on the front page of blog to see the latest in each thread. 

    I did post a few interesting things based on my travels last week.

    My speech on careers at the Maryland Association of CPAS Business Expo:

    Managing Your Career: Turning Uncertainty Into Opportunity

    And info about my participation in a panel at this same conference on Accountants and Social Media.

    I also interviewed Steven Thomas, attorney for Banco Espirito Santo, on the status of the litigation and judgment against BDO Seidman and BDO International  and what it portends for future litigation against the Big 4 global networks. Mr. Thomas, you may recall, is also the attorney for the plaintiffs in a case against KPMG International and KPMG LLP on behalf of the New Century Trustee.  That post should be up early next week.  I am currently re-reviewing all trial footage and getting some new clips.  In the meantime, take a look here at the clips provided early on by Courtroom View Network for a flavor of the trial and the issues discussed.

    Next up in my live auditor trial coverage (this access will be real-time to me) is the Schein v Ernst and Young trial. CVN is streaming the trial live, and making it available for on demand viewing. Superior Bank is the one that caused so much trouble for Cabinet hopeful Penny Pritzker during and directly after the Obama candidacy.

    A three-week accounting fraud jury trial in Broward County Circuit Court’s complex litigation division. Plaintiffs Alan Schein and Result Technologies, Inc. brought the claim, alleging they were damaged by Ernst & Young’s failure to conduct proper audits of Illinois-based Superior Bank F.S.B. The FDIC took control of Superior Bank in 2001 after declaring it insolvent. 

    The case calls into question consulting fees given by the banks to Ernst & Young. 

    From BNET News: “Feb. 8–Ernst & Young LLP, the auditing firm accused of inadequately overseeing the books of now-failed Superior Bank FSB, also received consulting fees from the bank which totaled at least twice as much as the fees it received for its accounting services, a federal regulator said.  “It was a direct conflict,” said Gaston Gianni, inspector general for the Federal Deposit insurance Corp., in testimony to the Senate banking committee Thursday. “

     

    There’s been some hubbub in India over my post, How Satyam Supported PwC’s Schizophrenic Strategy To Reenter The Systems Integration Business.” 

    Not here.  Not with me.  In India.  It seems that both Gartner and PwC have contacted the journalist at The Financial Chronicle of India complaining about their article, which was based entirely on mine and on the Gartner report which I linked to.  The Financial Chronicle did their own due diligence, contacting PwC India and International, and ran the story after getting no response.  

    I also had contacted both Gartner (prior) and PwC (day of publishing) about my story and got no response regarding its content.   But now PwC seems to want to rewrite the history of their leadership’s arrogant sales pitch and unwise choice of two projects that involved audit clients to showcase their big push to get back into systems integration/implementation consulting.

    Price Waterhouse’s Indian PR representative writes the Financial Chronicle:

    “…We have read the Gartner report in detail and find no justification for the comment that “the Gartner report indicates that PwC was in a strategic partnership with Satyam”.

    We also find no reference to Satyam as PwC’s “system integration partner” in the report.
    In our response to our letter dated June 2, you admitted that “The part of ‘strategic partnership’ was our interpretation” (your interpretation). This is precisely the point that we are making — you had drawn a wrong and unsustainable inference.

    No PwC firm has ever sought or created a joint business relationship with Satyam Computer Services. The only relationship PwC had with Satyam was as an audit client of Price Waterhouse. In the specific case that your report cited, the company seeking the services contracted with Satyam separately and directly, and not as a result of a joint business relationship between a PwC firm and Satyam….”

    Really?

    The journalist, Ritwik Mukherjee, confidently replies:

    “The Gartner report that we quoted said the opposite of what Price Waterhouse now contends — that “No PwC firm has ever sought or created a joint business relationship with Satyam Computer Services.” The report, which was extensively quoted in our story of May 28, quoted PwC’s US advisory strategy leader Joe Duffy at the PwC’s analyst day, as stating: “We are full scale in the implementation and integration business.” According to Gartner, “PwC clarified that its implementation stops short of coding for large-scale customisation of business applications. The firm offered an example wherein its India-based operations performed the coding for a client’s financial data warehouse, but a system integration partner coded the business application customisation.”

    To demonstrate the range of its capabilities, PwC offered two case studies with clients and engagement teams: One was Idearc, a $3 billion Verizon spin-off and the other Microsoft. “With Idearc, PwC was engaged through the full project life cycle leading to the one-day flash cutover to Idearc’s new systems. Much of this engagement occurred while PwC was still under the IBM non-compete agreement, and Satyam Computer Services did much of the system integration work,” the Gartner report said.

    In our report, we called into question the propriety of PwC having any business relationship with Satyam while its arm was auditing Satyam. The Gartner report pointed to a business relationship between PwC and Satyam, whatever name one may give it….”

    Go Ritwik!  I support you.  Especially since it was my story to begin with.  PwC obviously is more worried about its reputation in India than about anyone in the United States reading my blog or forming any opinion on this issue.  Maybe it’s because some major media here are saps, still giving PwC the benefit of the doubt and ignoring all other aspects of the story that are negative to PwC. They gave the imprisoned PW partners, whose remand was extended once again,  a forum to cry crocodile tears about their treatment and the injustice of it all.  

    For shame.

    How wrong PwC is in thinking they can control everyone!  I have not only been contacted by journalists in the US and the UK who are working on in-depth stories on this issue but I know that regulators on both sides of the pond have read my stories.

    Oblivious?  In denial?  Or just plain stupid, as they were to let Joe Duffy choose the Idearc case study for the Gartner dog-and-pony show last July when PwC International leadership must have already known of the problem-child nature of Satyam and the India practice by then.  After all, the PCAOB had been to India in early 2008. Satyam had been, as reported by the Financial Times, included  as one of the Price Waterhouse India clients to inspect, and had already formed an opinion that everything was not right with the world there. Did the PCAOB team not start telling PwC what they had seen and found while there as soon as they got back home?

    By the way, the PCAOB report on this Spring 2008 India inspection is still not final.  Because it shows there was a problem?  Because it says there was not?  Because PwC is still trying to negotiate out any reference to these issues from the public report, if not from the private report too, given almost certain future litigation?

    Inquiring minds want to know.

    I hope Dennis Nally has his super diplomat hat on as he repeatedly goes to visit the Indian politicians during these next few months. It’s reported that PwC wants to grow India by leaps and bounds.  It’s strategic for them. Are there Foreign Corrupt Practices Act provisions against private professional services partnerships paying off government officials to make it all go away?  Maybe someone like our FBI should keep a close eye on PwC International.  They are in deep here and scrambling to do damage control.  

    And they seem capable of anything.

    Photo Source (Aansu Lake, Tears of Shiv Devta)

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    37 Responses »

    1. Francine:
      I have no confidence in the PCAOB’s competence or integrity. I suspect it is rewriting its PWC India report as the original said “A-OK”. The PCAOB, which may be on life support if the Supremes kill it, figured it must criticize PWC-India lest the PCAOB be revealed as the Big 87654’s cartel enforcer. I don’t see what PWC-India need “negotiate” with the PCAOB. Anything the PCAOB found amiss at PWC-India was likely amiss for years. The question: Why didn’t the PCAOB find it before? Why didn’t the SECPS, remember that, find the problems? Because all of these CPA regulatory arms are scams. The PCAOB is between a rock and a hard place. It can’t be very critical of PWC-India, because it has been reviewed before. It must say something critical to retain some aura of respectability. Until it can “strike the right balance”, do what bureaucrats do. Stall.

    2. @Independent Accountant

      This was the first inspection of Indian firms, if you can believe it. The PCAOB is way behind in inspecting foreign firms because of resource constraints and because of resistance in some cases from foreign countries to allowing their inspections – something that was not anticipated or planned for in the legislation.
      http://www.reuters.com/article/BROKER/idUSN2527506120090625

      “WASHINGTON, June 25 (Reuters) – The U.S. audit watchdog voted on Thursday to defer its first inspection on 49 foreign auditors in areas such as the European Union, China and Switzerland for up to three years. Under the Sarbanes Oxley corporate reform law, the Public Company Accounting Oversight Board (PCAOB) is required to inspect the bulk of the registered public accounting firms once every three years. But cross border confidentiality issues and lack of agreements between the United States and other countries have hampered the PCAOB’s ability to review the foreign firms.”

      PwC is negotiating, potentially, the contents of the report because that is how it is done. Although this is pretty long for a report to not be final and issued, it is not unprecedented even for the domestic reports. In the beginning it was almost two years before any reports were issued. I have a post about that. http://retheauditors.com/2007/02/when-the-private-becomes-public/

      At this point PwC has probably gone back and forth with PCAOB on drafts and refused to agree to anything that will harm them later in litigation, which is ridiculous. It is not unprecedented for info that is truly embarrassing to be put in the private report along with all the other information about the firms quality controls, compensation practices, risk management and other “management of the firm ” issues. Recall the recent Deloitte report where they publicly complained about what was in the public report and said it should not have been in public but private report. http://www.cfo.com/article.cfm/13524221
      Deloitte is the only Big 4 to ever be sanctioned by Big 4. http://www.pcaob.com/News_and_Events/News/2007/12-10.aspx

      So they are trying to be tougher, but they have no teeth. The ability of the firms to be able to criticize and effectively ignore repeated failures cited in the reports such as those related to cash and receivable confirmations, fair value, http://www.cfo.com/article.cfm/9355231/2/c_2984378?f=related
      and general audit evidence and testing standards is tantamount to impotence on the part of this regulator.
      http://retheauditors.com/2008/01/pcaob-a-lapdog-not-a-watchdog/

      Francine

    3. It appears to me that the PCAOB’s impact on the firms is more about what the documentation looks like rather than the quality and content of the audit. The firms appear to be afraid of the PCAOB, and as such they focus on writing as little as possible so that no evidence of any kind (good or bad) can be found… and this hinders quality communication that would, IMO, lead to a higher quality audit. The fear of law suits, PCAOB, etc leads to the firms need to focus on the appearance of quality work rather than the delivery of quality work.

    4. Francine:

      It may come as a surprise that everything is not a conspiracy and the leaders of the Big 4 do not spend all day trying to figure out how to be unethical. The system we have in place today for public company audits is problematic for many reasons. The extremely low failure rate of public company audits is a reflection of the substantial cost of such failures to the auditing firm. You may be surprised to find out that many of the partners in these firms actually got into the business because they believe in the public mission.

    5. @Terry Fox

      It may come as some surprise to you that more of what you see going on in the Big 4 that is negative for investors and shareholders of public companies is a conspiracy or an example of collusion between the largest firms in order to protect the franchise. The Big 4 leadership do not have to spend all day trying to figure out how to be unethical because for some of them, after spending 25-35 years in the firms, it comes naturally, like brushing your teeth in the morning. They know no different any more. It’s how they survived this long and rose to the top.

      “…extremely low failure rate of public company audits…reflects the substantial cost of such failures…”

      That’s a fun one to debate. Unfortunately it’s not a fair fight, because I would have one hand tied behind behind my back and be hopping on one foot. Why? Because we do not have the actual data publicly available in order to measure the failure rate or the cost. Do you count as an audit failure the large number of cases where the audit firm denies having done anything wrong and settles, under secrecy, with no publicity (except for what I am now providing) for an amount that we don’t know was their last dime or their umpteenth one? Do we look at the cost of the audit failures that we know about from their perspective of a total cost per firm or at an aggregate cost of litigation for the top six firms and a total exposure number provided last year to the Treasury that now, thanks to the financial crisis, needs to be updated each day? Do we measure by the public disclosures of both litigation exposure and capital reserved against these contingencies on a firm by firm basis? Unfortunately no, since that information is not publicly available.

      Almost every major failure of a financial institution in the last five years and the failure of GM and the Big 3 automakers’ suppliers is an audit failure to me. Is the cost high to the firms? Yes. Have they weathered it thus far? Yes, dribbling dollars out in settlements or in the case of BDO Seidman, soon via a record judgment. Will Madoff and subprime litigation add additional pressure on the Big 4 strategy of settling everything ? Yes, there is, in reality, a finite amount that is available at any point in time. The largest threats are already on the table or coming soon. Billion and multibillion dollar threats. How much can the Big 4 endure? Only The Shadow knows.

      I’d love to see your data. Do you work for CAQ, one of the firms, or a public relations firm?
      Francine

      PS. I watched a great interview with Oliver Stone yesterday on Bill Maher’s show. Maher asked him if it hurt to be called a conspiracy theorist, given his military service to the country and his overall success, critical and financial, as a director and writer.

      I’m proud to be put in the company of “conspiracy theorists” because we put ourselves in the category of those providing more information, more knowledge, where there is very little in order to change minds, change behavior, and change important structures/organizations for the better.

      The question and his answer are found in part 2 at 5:18

      http://www.youtube.com/watch?v=Eogp2Xpgpkw&feature=related Part 2
      http://www.youtube.com/watch?v=LWie9X6miac&feature=channel Part 1

      fm

    6. Going to have to object a little bit here. I agree with the general gist of your post FM. What i don’t think you touched on is the concept of audit failures that are never caught because they “fix” themselves (i.e. grossly overstatign revenue in one year and the next year it corrects itself). As long as the company doesn’t go bankrupt a case like that would never come to light.

      But, GM? where is the audit failure? Last year they received an unqualified opinion. There has been no restatement. They have reported the massive losses they they have been incurring. This year (a year from last years opinion) they received a going concern qualification. And shortly thereafter declared bankruptcy (which is what the going concern warned about). I just don’t see the failure.

      If you feel audits should protect investors from losses that’s fine and a valid view point. But your gripe should be with the current laws/regulations, not the audits. Your argument is akin to saying an ump should rule a player on the juice out when he steals a base a base in baseball, because sooner or later he’ll get caught, go off the juice, and the be slower. Sorry, that’s not the rules (as nice as that would be). If the player gets there before the ball, he’s safe. The ump has to make a decision based on the rules in place. That’s the same as an auditor (yes there are differences, but this is an analogy).

      An auditor is not an analyst who is reporting future prospects of a company. An auditor is not a credit rating agency, whose job it is to judge the risk in certain securities and let the public know about those risks through its ratings.. There are analyst and credit rating rating agencies for both of those jobs, so if they don’t do them well, your gripe should be with them (if you ignore them and instead rely on an audit opinion, your gripe should be with yourself for ignoring the available info).

      Auditrs are accountants. They judge past transactions and whether how they are reported agree with certain rules. That is all they do and are permitted to do (under current rules).

    7. @#6 Anonymous

      The concept of audit failures is a very interesting topic worthy of its own post or series of posts. I agree, another category are the ones that are never identified and that “correct” themselves over time. That doesn’t mean that they do not harm investors, both inside and outside the company based on inaccurate financial reporting and therefore information reported to regulators, the public and others at any point in time.

      As far as GM, well, you are right about the unqualified opinion. But you must agree that all those unqualified opinions are horse-hockey given the fact that GM has had a material weakness in internal control over financal reporting (amongst others) since their first SOx review. The one that lingers has to do with inadequate, incompetent, entirely lacking in GAAP knowledge financial and accounting staff.

      “Material weakness previously identified at December 31, 2007 that continues to exist at December 31, 2008:
      Controls over the period-end financial reporting process were not effective. This has resulted in a significant number and magnitude of out-of-period adjustments to our consolidated financial statements. Specifically, controls were not effective to ensure that accounting estimates and other adjustments were appropriately reviewed, analyzed and monitored by competent accounting staff on a timely basis. Additionally, some of the adjustments that have been recorded relate to account reconciliations not being performed effectively. A material weakness in the period-end financial reporting process has a pervasive effect on the reliability of our financial reporting and could result in us not being able to meet our regulatory filing deadlines. If not remediated, it is reasonably possible that our consolidated financial statements will contain a material misstatement or that we will miss a filing deadline in the future.
      Based on our assessment, and because of the material weakness described above, we have concluded that our internal control over financial reporting was not effective at December 31, 2008. The effectiveness of our internal control over financial reporting has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein….

      Actions implemented or initiated to address the material weakness described above that exists at December 31, 2008:
      1. Actions to strengthen controls over the period-end financial reporting process include: (i) improving period-end closing procedures by requiring all significant non-routine transactions to be reviewed by Corporate Accounting; (ii) reinforcing the requirement that account reconciliations and analyses for significant financial statement accounts are reviewed for completeness and accuracy by qualified accounting personnel; (iii) implementing a process that ensures the timely review and approval of complex accounting estimates by qualified accounting personnel and subject matter experts, where appropriate; (iv) developing improved monitoring controls at Corporate Accounting and the operating units around account reconciliations and complex accounting estimates; (v) enhancing pre and post-closure communications processes to facilitate early identification, resolution and conclusions on accounting treatment of business transactions; (vi) increasing Regional Controller’s Staff responsibilities for consolidation and elimination activities; (vii) implementing several new accounting policies clarifying roles and responsibilities over such areas as account reconciliations and review and approval of journal entries; (viii) continuing, on an on-going basis, to utilize over 100 external technical accounting resources both at headquarters and in the regions to ensure large and complex transactions are appropriately accounted for; and (ix) began implementing a re-design of our consolidation process. In addition to the efforts which are already underway, we expect to further address the existing material weakness by: (i) implementing a new consolidation system which will improve the quality and availability of data to both the Regional and Corporate Accounting staffs; (ii) designing and implementing enhanced balance sheet and income statement analytical procedures on a quarterly basis; and (iii) further enhancing monitoring controls at the Corporate and operating unit level relating to timely and complete recording of transaction activity.”

      SO what has GM been doing? Buying that expertise from Deloitte, their auditor. That’s hilarious and close to a major independence violation if I ever saw one. The external auditor is not supposed to be opining on accounting standards and GAAP that they themselves advised the client to adopt. $11 of the $54 million GM paid Deloitte for audit and audit related services was for consultation on these issues.

      “Audit-Related Fees: $11 million for assurance and related services that are traditionally performed by the independent auditor. More specifically, these services include employee benefit plan audits, due diligence related to mergers and acquisitions, accounting consultations and audits in connection with proposed acquisitions, internal control consultations, attestation services that are not required by statute or regulation, and consultation concerning financial accounting and reporting standards.”

      This info can be found on Part III, Item 14, page 304 of their annual report.
      http://phx.corporate-ir.net/phoenix.zhtml?c=84530&p=irol-SECText&TEXT=aHR0cDovL2NjYm4uMTBrd2l6YXJkLmNvbS94bWwvZmlsaW5nLnhtbD9yZXBvPXRlbmsmaXBhZ2U9NjE4Mzk4OCZhdHRhY2g9T04%3d

      Francine

    8. @6 is correct the auditors are like the police officers… we should also take into consideration the laws, the criminal and the courts. It seems to me that the cops have the least ability to fix anything. Cops who ignore the law or feel they are above the law are a problem. Is that what FM’s basic stance is? I have never gotten that impression. I feel FM should be looking at the regulations and the criminals themselves.

    9. @8

      When the “police” condone, look the other way, take bribes and favors, ignore/thumb their nose at their responsibility to the public, socialize with criminals, and bend over backward for them because they are more glamorous or have the money, they are no worse than the criminals. They are corrupt and should be held responsible.

      The unending string of fraud, failure and fake financials we’ve seen just since Enron (!) tell me some of these things, maybe all of the them, have occurred at hundreds if not thousands of companies. Where are the auditors? Where are these supposed watchdogs for investors, shareholders, other stakeholders and the capital markets?
      In the back room counting their money.
      That’s what I’m saying.
      Francine

    10. @fm – those things can and do happen. But to draw the conclusion your seem to have drawn, you must have first ruled out that the regulations are sufficient and adequate if performed properly. The evidence you provide — the number of frauds we’ve seen — is not indicative of the cause or those to be blamed. Just because something happens often doesn’t mean there is a single failure or that the failure is with the people who are the last in line of those that might be expected to uncover the failure.

      Fraud requires three things:

      1) a misrepresentation that is relied upon by someone else — you would argue that the audit opinions are misrepresentations relied upon by the shareholders
      2) harm to the person(s) relying upon the information — you would argue the shareholders have been financially harmed
      3) intent — here in lies the tricky part. Have the auditors shown intent to harm the shareholders

      Are you arguing that the auditors are part of the fraud(s)? Where is the evidence of intent?

    11. @10. I completely agree. Many seem too eager to convict an arsonist (auditors) before putting out the fire (changing regulations)

    12. Anonys @ 10 & 11 —

      The problem with your point, Anony @ 10, is that the courts have a decently long history of saying that “deliberate ignorance” and “reckless disregard” are tantamount to intent to defraud … at least in other civil contexts at the Federal level. Now, some defendants might successfully distinguish those cases from audit failures based on different statutes, different facts, or whatever. But I think it is worth mentioning that “intent” doesn’t necessary mean what a layperson might think it would mean. That’s well-settled law as I understand it, not being one of the guildmembers.

      The other issue I’ll take with you and Anony @ 11, is that the Supreme Court has stated that auditors don’t just audit. SCOTUS has ruled that the law of the land in the the USA is that auditors “certify” the financial statements of the companies they audit. Let me be clear: an audit opinion is a certification that the F/S not only comply with applicable GAAP, but also are accurate in all respects. Period. That SCOTUS “opinion” is a fact (pun intended). I wish Fran would publish the salient parts of that AY opinion so that we could put to bed, once and for all, that sob story about how auditors aren’t responsible for the numbers they audit ….

      Forget “changing regulations”. It ain’t the regulations who cut audit budgets and then staff audits with the wrong competencies at the lowest available levels. It ain’t the regulations who create “check the box” audit methodologies, where form kicks the ass of substance, and meeting budgets is more important than digging out the truth. And it ain’t the regulations, nor is is the regulators, who give audit work to sycophants and local staff, when others (better qualified) are on the beach/bench wondering when the axe is going to fall. Among other peccadillos we are all familiar with.

      The fact is that every single audit failure we know about was preventable, and the root cause has always been incompetence masked by greed. You may not agree with Fran’s conclusions, but the facts from which she draws her conclusions aren’t really arguable.

      Deal with it.

      — Tenacious T.

    13. Tenacious T:
      I agree with you. Auditors concern themselves with valuation issues in: receivables, inventories, oil and gas assets, pensions, and other accounts. Auditors are not just bookkeepers reporting on “past transactions”. About 10 years ago, GM set up Delphi. In my opinion it was a scam. GM set up a VEBA a few years ago, as I recollect. I think it too was a scam. What no substance? Yes. Look at KPMG and BDO selling tax shelters without substance. What else is new.
      FM:
      PWC Is negotiating? What? Would the PCAOB “negotiate” with a non Big 87654 firm? I don’t believe any of this. The PCAOB, which is full of “former” Big 87654 partners, is trying to figure out how to protect PWC. I hope the Supreme Court kills this useless monster. If it hasn’t “inspected” the foreign firms it should revoke each’s registration. Tomorrow. Period. Let PWC US audit Satyam.

    14. @TT

      This excerpt comes from this academic paper. Has citations if anyone wants to read whole case. It’s United States v. Arthur Young.
      http://papers.ssrn.com/sol3/papers.cfm?abstract_id=303181

      “The 1980s saw continued, increased scrutiny of auditor independence and the accounting profession, including the Supreme Court case, United States v. Arthur Young & Co., and the high profile congressional hearings chaired by Representative John Dingell which questioned much about the accounting profession, including its ability to self-regulate itself…

      IV. THE FUNDAMENTAL TENSION IN THE STATUTORY AUDIT SYSTEM, CHANGES IN THE ACCOUNTING PROFESSION, AND FOUR ALTERNATIVE SYSTEMS

      A. Tension in the Current Statutory Audit System.

      As discussed supra, the fundamental tension in the statutory audit system is that auditors get hired by, fired by, and must work side by side with, the corporate client – be that some combination of management, an audit committee, or the full board of directors – while legally required to take the interests of shareholders, creditors, and the public as their primary responsibility and allegiance. This peculiar bifurcation of interests will not remedied by yet more Byzantine independence rules. Instead, interests must be re-aligned. In the one Supreme Court case that addresses this issue, United States v. Arthur Young & Co.,372 the Court unintentionally reinforces the dilemma that the Securities Laws have placed auditors in:

      ‘By certifying the public reports that collectively depict a corporation’s financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public. This “public watchdog” function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust.’

      This sounds good, but who is the client? And are stockholders’ and creditors’ interests viz. a certain company always aligned? If not, then who gets the greater allegiance of the auditor? And, finally, does it even make sense to talk of the interest of the “investing public” as if it were of single mind and unitary interest? There may be times when the interests of shareholders – say, to drive up the price of their shares to sell at maximum value in the secondary market regardless of the actual fiscal health of the company – are contrary to the interests of the general “investing public” – say, to have the most accurate information regarding the fiscal health of the company to determine whether to buy its shares in the secondary market.

      The Young Court outlines a mechanism by which the statutory audit system polices corporate malfeasance regarding any temptation to misstate tax accrual reserves to its auditors and the public.

      ‘. . . the independent certified public accountant cannot be content with the corporation’s representations that its tax accrual reserves are adequate; the auditor is ethically and professionally obligated to ascertain for himself as far as possible whether the corporation’s contingent tax liabilities have been accurately stated. If the auditor were convinced that the scope of the examination had been limited by management’s reluctance to disclose matters relating to the tax accrual reserves, the auditor would be unable to issue an unqualified opinion as to the accuracy of the corporation’s financial statements. Instead, the auditor would be required to issue a qualified opinion, an adverse opinion, or a disclaimer of opinion, thereby notifying the investing public of possible potential problems inherent in the corporation’s financial reports. Responsible corporate management would not risk a qualified evaluation of a corporate taxpayer’s financial posture to afford cover for questionable positions reflected in a prior tax return.’

      This description entails some fairly adverse relationships between corporate management and the corporation’s auditors. Yet, at the same time, the actual incidence of qualified opinions has been relatively small – 24% in one study – with most of those carrying no adverse connotation anyway because they were based on restatements, leaving only 14% of all audits reviewed being qualified with negative connotation. Thus, the “risk” undertaken by management in these cases is not that great. There is also the problem of “opinion shopping” that prompted the SEC to require that company boards institute audit committees and disclose any disagreements with, or changes in, their statutory auditors. Thus, the question is whether the incidence of qualified or adverse opinions is low because most corporations actually present accurate financial statements, or because corporations do what they need to – whether through opinion shopping or coercing their present auditors – to obtain an unqualified opinion.

      But, the latitude which corporations and their auditors have to depict the financial state of the company represents arguably an even greater challenge. One might suspect that both GAAS and GAAP are well established sets of guidelines with something approaching a one-to-one correspondence of guideline to accounting situation – i.e., there is only one acceptable way to record or audit a particular transaction. But instead, the accounting profession and its regulators have become increasingly tolerant of multiple “generally accepted” practices for a specific transaction and auditees can pressure the auditor to follow the alternative that best suits the company’s earnings management goals rather than the one the auditor believes most accurately presents the transaction. But this problem feeds on itself: companies now see their stock pummeled in the public market where earnings expectations are missed by even a small amount because the marketplace expects earnings management and any company that misses estimates at all must be in serious trouble.

      All of this clouds the environment in which auditors work. Rather than black and white situations where we might imagine an auditor sweating through a mini-morality play, confronted with doing the clear “right” or “wrong” thing, we instead have auditors threading their way through a complex field of gray where application of one principle over another – both “generally accepted” – will lead to dramatically different outcomes for the company. And even where each such choice yields a less dramatic shift in outcome, the cumulative effect of a number of these small decisions can still yield a substantial shift in overall outcomes. The Young Court recognized a version of this when it asserted that…

      ‘the characterization of the proceeds of a sale as capital gain instead of ordinary income, the claiming of an investment tax credit, and the attribution of a transaction to a future tax year are decisions requiring judgment calls in gray areas of the [Internal Revenue] Code, any one of which might result in a recantation of the corporation’s outstanding tax liability.’

      The severity and complexity of the foregoing has been greatly exacerbated over the past few decades by sea changes in the accounting profession and its marketplace…”

      fm

    15. […] re: The Auditors » Blog Archive » Satyam, SocMed, BDO International, and Sunshine […]

    16. Fran,

      Let’s highlight the SCOTUS quote from the paper.

      Quoting SCOTUS at U.S. v. Arthur Young:

      “By certifying the public reports that collectively depict a corporation’s financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public. This ‘public watchdog’ function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust.”

      Let’s be very clear here — this is the audit standard to which the firms are held accountable. (Pun intended.) This is the standard, this is the bar, this is the mark of professionalism. So let me ask you all, how well is YOUR firm doing at hitting this mark?

      — Tenacious T.

    17. Nice writing. You are on my RSS reader now so I can read more from you down the road.

      Allen Taylor

    18. @TT – I cannot answer your question regarding audit as I am not in audit. But I do not find anything specific in this quote giving real direction to the audit. It indicates independence — we all agree that should be there and we all disagree as to the degree to which it is there. This quote says the auditors attest to a corp’s “financial status” — at a point in time. It does not say anything about the ability to maintain that status and for how long. It does not mention the methods by which an accountant is expected to look for fraud… and more importantly – it doesn’t discuss the fact that one might look well and hard and deep but still not be able to uncover it.

      I suggest that the regulations are vague. I suggest that the oversight of these regulations gets stuck in a quagmire of documentation standards which encourages auditors to NOT document as much as possible. This environment of fear of the regulations (because they are unclear) means that communication within teams is blocked (e.g., some audits do not allow email communication), this environment is focused on not pointing things out in writing but telling someone verbally and passing the buck on to them. Because it isn’t written down, it may often get forgotten or dismissed. Auditors are fearful of honest communication that may lead to better audits. They develop a check-the-box methodology as a result of this fear.

      I for one have raised issues to an audit partner based on lack of cooperation from the CFO, irregularities in the data that the CFO could not explain, and other issues. The CFO was terminated. That time it worked. In another situation I raised questions to the audit partner regarding the sampling methodology. I was removed from the audit/investigation and a more senior statistician brought in to address the situation. I do not know the result — it may have been a better result, but having my comments in writting forced a response and did not help my personal career at that time.

      Regarding your comment on intent — that is a debate for the lawyers to have — not the accountants. It is not clear at all. Intent will be based upon different measures in each case. Forensic accountants look for the evidence of harm and for the misrepresentation. Lawyers argue over who relied up on the misrepresentation and whether there was intent. Can intent be proven based on ignorance and negligence — possibly, but I honestly do not know. Does intent differ from premeditation?

    19. Francine:

      I enjoy your blog very much but increasingly you seem to be more angry than thoughtful. Your view of the audit profession has become unbalanced and some of your comments in the dialogue to this blog are not to be taken seriously. You do not want to be in the same category as Oliver Stone.

    20. @Terry Fox

      Thanks, I think. I’m not sure how to react to your comment. I have always been very clear that my writing about the audit/accounting industry is not intended, deliberately, to be balanced, is biased to my point of view based on my experience, and presents the other side of the coin not available typically in the mainstream media.

      I also moderate these comments which are an informal forum and I welcome alternative views. I also welcome rebuttals, guest posts, and responses from official firm spokespersons and their lobbyists and affiliates such as CAQ and AICPA. As you can see, that happens rarely.

      It is what it is. I hope you enjoy it as complementary to whatever else you read about the industry.
      Francine

    21. Posting a link and article from Times of India. Answers by PWC on Satyam to the investigations team.

      We didn’t audit Satyam: PwC

      http://timesofindia.indiatimes.com/Business/We-didnt-audit-Satyam-PwC/articleshow/4718155.cms

      The questioning of Ramesh Rajan, chairman and CEO of PricewaterhouseCoopers, India (PwC) by CBI last week, has revealed that the Satyam balance sheets were in fact audited by Lovelock & Lewes and not Price Waterhouse (PW). It is also learnt that the auditing fees, though deposited in the name of Price Waterhouse, Bangalore, was later transferred into the account of Lovelock & Lewes. “It is from here that the partners S Gopalakrishnan and Srinivas Talluri withdrew the money,” sources involved in the investigation of the case told TOI.

      Apart from Rajan, other senior partners of PW, from Delhi and Kolkata, were also summoned by the CBI last week. The partners denied any association with PW, Bangalore and said that Gopalakrishnan and Talluri were not entitled to sign any balance sheet on behalf of PW. “So as it turns out, the auditors who are partners with PW, Bangalore, wrongly signed under the name of PW, and also outsourced the work to Lovelock & Lewes,” said sources adding that investigations confirm that the entire auditing team at Satyam is from Lovelock & Lewes.

      On being questioned by CBI about this “outsourcing” of work , Rajan, who is also a partner with PW, Bangalore said that the firm has no manpower and, hence, as part of an internal arrangement gives out their work to Lovelock and Lewes. “But this is not acceptable, considering that the two firms are completely different entities,” said sources.

      An India-based auditing firm, Lovelock & Lewes, though is a network firm of the international consulting body PwC, has no authority to audit under PwC’s name. The CBI is now in the process of recording Rajan’s statement and also plans to summon other partners of PW, Bangalore for questioning, later this week. “CBI officials are hoping to be able to interrogate some partners of PW, Bangalore who are not attached with any other firm, so a to get a clearer picture about the functioning of this Bangalore unit,” sources told TOI adding that if need be, appropriate action would also be taken against this particular firm.

      However, for now, the investigating body has decided to write to Sebi asking it to ban the two tainted auditors from signing balance sheets of any listed company, in the future. “Even if they are released they should not be allowed to audit the books of any listed firm ever again. The financial fraud they have committed is of huge magnitude,” said sources.

    22. @ 21. ExDeloitte

      Great find! A lovely little morsel for the PwC International lawyers to get their teeth into!

    23. ExDeloitte @ 21,

      Fascinating information. It appears that —

      1. Satyam pays audit fees to PW India and, in return, gets a Big 4 signature on the F/S.

      2. PW India, who “has no manpower, and hence, as part of an internal arrangement gives out their work,” outsources the audit hours to Lovelock & Lewes.

      3. Lovelock & Lewes, who is a “network firm of the international consulting body PwC,” apparently “has no authority to audit under PwC’s name.” That sounds like a bit of hair-splitting spin to me. PW India may have been responsible for the audit opinion, and chose to outsource the work to a member firm. That doesn’t necessarily mean that Lovelock & Lewes “audited” under PwC’s name.

      4. Satyam pays PW India its fees, the PW partners book the fees and revenue under their names, then subsequently transfer the payments to Lovelock & Lewes. The metrics have been satisfied. If Lovelock & Lewes’ rates were significantly lower than PW’s rates, then engagement margins could have been quite nice, indeed. High revenue, high margins, no performance reviews — sounds like a dream engagement!

      5. PW India, completely relying on the work of the other firm’s staff, signs the F/S. I wonder how they determined they could rely on the others’ work?

      The more I learn, the more I just shake my head in bewilderment….

      Thanks for the info.

      — Tenacious T.

    24. Fran,

      Dennis H. had a nice post on this latest turn of events, and some nice things to say about you.

      You should post a link, if you haven’t already done so.

      — Tenacious T.

    25. @TT
      Dennis and I talk 24/7. Skype, Twitter, phone (which jacks up both our phone bills because the bugger is in Spain.) On these issues we confer. Excessively. He does his thing and I do mine and we don’t always agree, but we always discuss. In detail. Excruciating detail. :)

      I am working on my own post to update on new stuff. I also Tweeted both articles last night and got quite a few replies and re-tweets on them. You should check my Twitter more often. It’s where I address breaking news until I can do a longer post.
      http://www.twitter.com/retheauditors

      My post out later today. Not too much later.
      Alwayas something new…They keep giving and giving.

      Francine

    26. In India it is illegal for a partnership to have more than 20 partners. It is also illegal for a partnership to operate under a “foreign name” unless that name was registered in 1948. Coopers & Lybrand’s name did not exist until 1973 and as a result it operated in India under the name of its network firm, Lovelock & Lewis. Price Waterhouse was registered in 1948 and as a result could operate under that name. After the merger in 1998 PwC dropped the use of the name Lovelock and Lewis and utilized just the Price Waterhouse name. None-the-less, as with the other Big 4, PwC has many firms in India because of the 20 partner rule. Each firm is legally separate as required by India law. Satyam litigants will have a very hard time getting past this because it would undermine Indian public policy with respect to partnerships if the Indian courts permitted it.

    27. @26 Terry Fox

      Slight correction but an important one.

      Price Waterhouse holds a special place in the Indian business community due to their long presence in India, more than 100 years. They are grandfathered in to many of the rules that have been established more recently for others. In particular, Price Waterhouse can audit under the Price Waterhouse name in India, an exception to Section 190 of the Chartered Accountants and Regulation Act.
      In addition, partners who retire from other firms are not permitted to hold positions in boards of companies that are audited by their former firm. Price Waterhouse India has done exactly the opposite. As soon as Amal Ganguli retired as a senior partner in 2003 and immediately he joined the boards of the companies he himself audited : HCL, NIIT,NDTV and Maruti –just to name a few.
      Similarly Satyabrata Ghosh another retired senior partner joined the board of Global Trust Bank while his protégé Amal Ganguli signed the accounts. In the last year just before Global Trust Bank collapsed, Satyabrata Ghosh was a director of the bank while his own nephew Partha Ghosh a partner of the firm signed the accounts of the bank.
      PwC Global performs lucrative non-audit work through an “independent” company called Pricewaterhouse Coopers Private Ltd. but the fig-leaf of independence falls off on two counts:
      1) The three legal entities that conduct external audits of clients and are registered with the PCAOB in the United States, Lovelock and Lewes, Price Waterhouse and Co Bangalore and Price Waterhouse & Co Kolkata, are all licensed by the same parent PwC International, London, and
      2) Ramesh Rajan is the Senior Partner of Lovelock & Lewes and Price Waterhouse and the Chairman of PricewaterhouseCoopers Private Ltd.

      Francine

    28. @26 Tery Fox

      Slight correction but an important one.

      Price Waterhouse holds a special place in the Indian business community due to their long presence in India, more than 100 years. They are grandfathered in to many of the rules that have been established more recently for others. In particular, Price Waterhouse can audit under the Price Waterhouse name in India, an exception to Section 190 of the Chartered Accountants and Regulation Act.
      In addition, partners who retire frm other firms are not permitted to hold positions in boards of companies that are audited by their former firm. Price Waterhouse India has done exactly the opposite. As soon as Amal Ganguli retired as a senior partner in 2003 and immediately he joined the boards of the companies he himself audited : HCL, NIIT,NDTV and Maruti –just to name a few.
      Similarly Satyabrata Ghosh another retired senior partner joined the board of Global Trust Bank while his protégé Amal Ganguli signed the accounts. In the last year just before Global Trust Bank collapsed, Satyabrata Ghosh was a director of the bank while his own nephew Partha Ghosh a partner of the firm signed the accounts of the bank.
      PwC Global performs lucrative non-audit work through an “independent” company called Pricewaterhouse Coopers Private Ltd. but the fig-leaf of independence falls off on two counts:
      1) The three legal entities that conduct external audits of clients and are registered with the PCAOB in the United States, Lovelock and Lewes, Price Waterhouse and Co Bangalore and Price Waterhouse & Co Kolkata, are all licensed by the same parent PwC International, London, and
      2) Ramesh Rajan is the Senior Partner of Lovelock & Lewes and Price Waterhouse and the Chairman of PricewaterhouseCoopers Private Ltd.

      Francine

    29. […] can save their consulting business at least and not get PwC kicked out of the country. They’re badgering journalists, pressuring analysts like Gartner and generally mucking things up in a futile attempt to salvage their professional life, stay out of jail, and avoid being thrown on […]

    30. […] from the various mischiefs committed by the common partners that you have already reported -here is the evidence that partners are running lucrative computer training businesses with […]

    31. […] the link to my posts on PwC/Satyam, go here, here, here, here, here, here, here, here, here, […]

    32. What is going on with RSM and M&P? Any insight you have?

    33. […] claimed to be victims themselves, made several appeals to the Indian media including trying to squelch my reports, set up an internal “advisory board” with foreign partners and reorganized more than […]

    34. […] claimed to be victims themselves, made several appeals to the Indian media including trying to squelch my reports, set up an internal “advisory board” with foreign partners, and reorganized more than […]

    35. […] is actually 84th.  My reporting of the Satyam scandal is unfair […]

    36. […] claimed to be victims themselves, made several appeals to the Indian media including trying to squelch my reports, set up an internal “advisory board” with foreign partners and reorganized more than […]

    37. […] PwC’s Schizophrenic Strategy To Reenter The Systems Integration Business, May 26, 2009 Satyam, SocMed, BDO International, and Sunshine, June 26, 2009 PwC Global Board: Risk And Quality Top Priorities, June 30, 2009 Dreaming of India: […]

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