On the troubled state of the large audit firms, it has perhaps been wrong of me to be so critical of the attention given by the various committees and think tanks, for their general failure to grasp the truly serious issues and the vacuity of their discussion – examples here.
Because – from a recommendation given by the US Treasury Department’s Advisory Committee on the Auditing Profession – when they do advance a substantive idea, it is so breath-taking in its misguided impracticality.
On April Fools Day that group put forward, in all apparent seriousness, the notion that the partners in the large audit firms, anticipating the possibility of a catastrophic threat – that is, a fatal litigation or prosecution – should voluntarily modify their agreements to trigger the replacement of their leadership. Or failing such a step, the Securities and Exchange Commission should be authorized to apply in court for a trustee.
The text of the recommendation – and, for the masochistic, the webcast of the Treasury committee’s March 13 discussion meeting – are available here.
As Oscar Wilde described his reaction to a plot by Charles Dickens, only the truly hard-hearted can read this pathetic work without breaking into hysterical laughter.
First, who’s to decide? In the history of leadership, the concept of anticipatory abdication is a complete non-starter. Especially under challenge, leaders believe they can work through their crises, and will fight to stay in office. In the political sphere, leaders from Louis XVI to Richard Nixon to Robert Mugabe have shown the inability to anticipate their own downfall.
Business professionals are no different. Is it any more likely that the large-firm partners would willingly turn over their careers and their fortunes to an outside stranger, than that the shareholders or directors of Bear Stearns or Northern Rock – or, for that matter, of Enron or WorldCom – would have enacted advance terms for the displacement of their executives?
But if not done by leaders themselves, who would pull the trigger? An external decision-maker would have to be credible to all constituents, at least as informed as management itself, and presciently ready to act decisively at a moment’s notice.
But the corporate world does not keep world-class crisis managers stocked in reserve. Anyone meeting those job requirements already has his energy and talents fully committed elsewhere.
Nor, paying respects to the grey eminences who populate the advisory committees themselves, is this a function to bolster the resumes of the retired. The learning curve of a real-time audit firm survival crisis would be too steep to be climbed by those for whom robust knees and lungs are the memories of youth.
As for the notion of timely SEC intervention, the Treasury Committee’s members themselves grasped at least two among the fatal flaws:
• First is the issue of timing. The Andersen firm disintegrated in a matter of weeks in 2002, following the tardy but eventual capitulation of its CEO and an aborted effort to bring in outside leadership. Even the provisions of the US Constitution for the temporary transfer of presidential powers contemplate a timetable of four weeks or more.
• Second, who is to recognize the need? The Public Company Accounting Oversight Board, regulator of the profession in the US, disavows responsibility for audit firm viability as outside its remit, and rightly so. The timing and scope of that body’s practice quality sampling program is already all it can handle.
Which leads to the unrecognized crux. The supposed rationale for a rehabilitation process is that new leadership might preserve a firm by dealing more successfully with its litigation adversaries or prosecuting authorities than those on the scene of the wreck.
But such a view, while real, entirely misses the broader point.
Namely, as should have been learned from the Andersen experience – or those recently of Bear Stearns or Northern Rock – the franchise value for those selling commodity products rests entirely on the preservation of trust, and not just on fresh negotiating positions or the appearance of new faces. Once the fuse is lit and a credible challenge to that trust has started to run – whether doubts about the “safety and soundness” of a regulated bank or eroded “client confidence” for an audit firm – it’s too late, and an explosion is inevitable.
Finally, it is argued that the SEC’s power to apply for a trustee – even if “in the pocket” and never expected to be used – would be an incentive to the firms to improve.
But again, that naïve view defies reality. The audit firms’ managements already know that they face death-threat exposures today. So if at the brink they would not be saved by SEC intervention – and when existing leadership will have been cashiered in any event – a regulatory tool that is both inutile and ineffective would, if anything, create a disincentive to constructive change.
There’s value to wild and unworkable schemes – they can focus attention on what really can and needs to be done. This one has served its purpose – and can now be scrapped as it deserves.
Jim, As usual, brilliant. Even Paul Volcker couldn't save Andersen. The whole proposal assumes the audit firms agree that they are actually regulated and that the regulators have some power over them. Only a potential indictment for criminal activities seems to scare the dickens out of them, a la KPMG and the tax shelter mess. The audit firms are to the PCAOB as the airlines are to the FAA - customers not entities to be monitored.
Posted by: Francine McKenna | April 06, 2008 at 09:21 PM