Re:Balance -- Jim Peterson

The PCAOB's Concept Release: What Might a Truly Useful Auditors' Report Actually Say?

First reaction to the Public Company Accounting Oversight Board’s Concept Release of June 21 (here), which puts on the table a buffet of possible revisions to the long-standing commodity language of the standard auditors’ report: 

It’s like Bob Dylan’s observation on the twelve-string guitar – you spend half your time tuning the damned thing, and the other half playing out of tune.

Thanks to readers for asking – more will be coming, through the comment period ending September 30.

A second reaction should be positive, since the project puts the US regulator’s stamp on a vital question, posed by Chairman James Doty during the public meeting (here), “how audit reports can be more useful to society?” 

But optimism should be carefully tempered. This is only the latest in the cyclical spasms of user dissatisfaction, going back to such barely-remembered efforts as the Cohen Commission of 1974 and the Treadway Commission of 1985. Vision and will have consistently turned to failure, over-taken by the return of bubbly investor enthusiasm, and this spring’s exuberant reception of the new media IPO’s (here), during which rational attention to the boundaries of quality accounting and reporting has been blinkered by investor frenzy, does not bode well.  

Researchers in group psychology have long known that human attitudes are asymmetrical towards rewards and detriments: people are risk-seeking on the upside, but risk averse on the downside.

Which means that the pain of a losing investment will more than outweigh the pleasure of a similar gain.

And therein lies the fallacy behind the traditional “pass-fail” audit report. As shown by recent behavior, investors will ignore all cautionary limitations within a clean report on such recent bubble companies as LinkedIn or Pandora – or the sketchy accounting proffered ahead of the upcoming launches of Facebook or Groupon. But on the other hand, they will never be satisfied – whatever the PCAOB staff may think they have accomplished with their “outreach” – absent an advance “fail” signal on a company poised to fall – Lehman, Bear, Countrywide, AIG, Fannie, and so on – not because the real desire is for a coherent and comprehensible articulation of a business model destined to failure, but to avoid the failure itself, at all.

What this “second-order” disconnect means, then, is that the auditor is truly at one remove from the core issue in today’s world of short-term score-keeping -- financial reporting is, essentially if emotionally, only a proxy for investors on the ultimate future success of the reporting enterprise. So it misses the point to keep belaboring the messenger.

Resolution is ready to hand, right within the framework of the Concept Release itself. But radical adjustment will be required, both to the reporting by issuers themselves and in the auditors’ report language.

That is, it must be for the company, not the auditors, to fully satisfy the regulators’ disclosure goals regarding, for example, the achievability of results dependent on management’s judgments, critical estimates, and difficult choices among permissible or alternative accounting policies – all of which contain and reflect the company’s business, operational and strategic risks, on which actual results depend.

The accountants then have two socially useful but limited roles:

First, to provide the necessary technical and professional competence to assist issuers in navigating through their many politicized and judgmental reporting choices – a process, by the way, which brings to the fore the many irrationalities involved in the unending fables of “convergence” among standards and the essentially irreconcilable inconsistencies between and among IFRS and the various versions of GAAP (for which, as always, see The Accounting Onion).

Second, the assurance role: to support – to the extent possible -- the clarity and transparency of the representations made in the financial statements to the community of users.

And that’s it – so much, and no more.

What may this mean for legitimately useful audit report language? Messages are required like, “We don’t know …. we cannot tell from the evidence …. we cannot test or provide a meaningful comment ….”  These, with some work on the drafting, can be properly articulated under several of the Concept Release’s rubrics -- whether Auditor Discussion & Analysis or Emphasis Paragraphs or Clarification of Language.

The profession’s leaders have been leery of any such rationalization of their role – a fear driven by economic self-interest and their unwillingness to confront the fragility of their business model.

Staying the present course to nowhere, however, risks their being revealed, like the Wizard of Oz, as little figures behind the curtain, puffing smoke and noise of no value or significance.

It needn’t come to that. Stay tuned – the upcoming months may tell.

 

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Mandatory Auditor Rotation -- Further Thoughts on PCAOB Chairman Doty's Bad Idea

 Why Chairman James Doty of the Public Company Accounting Oversight Board keeps pressing mandatory auditor rotation, neither useful to the capital markets nor achievable for large global companies (see his latest, June 2), remains beyond sense.

Doty, hands full with the challenge of an official re-think of the standard auditors’ report (here), is supported by blogger Tom Selling, whose Accounting Onion provides lucid and incisive commentary on the politicized and intellectually incomprehensible inconsistencies of global accounting standards.

Much as I value Selling’s work, I would be reluctant to call a “disagreement” my inability to share his enthusiasm (here). Instead, some “additional thoughts”:

The context for rotation – especially the long tenure and duration of auditor relationships among large companies – reminds me of the loyalties in the farming community of my youth.

There, partisans of the trucks made by Ford or Chevy passed their abiding devotion along from fathers to sons, while on each farmstead along the rural roads, the tractors and combines glowed exclusively in bright Farmall red or the deep green of John Deere.

These intense affinities were debated non-stop in the village café and the adjoining pool hall, by sunburnt advocates wearing baseball caps branded to proclaim their choice of machinery. The system was stable -- client service was dependable if unimaginative, the cartel of dealers prospered, and it would have been thought foolish to sacrifice decades of accumulated knowledge, relationships and bins of technology and spare parts for no identifiable advantage.

Out in the fields of corn and soybeans, meanwhile, there was no rational performance difference between the competing commodity brands. Cosmetics were immediately obscured under the prairie dust, and a dirty red tractor worked not any better or worse than a green one.

In today’s audit market, to which the metaphoric characteristics of farmyard equipment extend, Selling’s endorsement of mandatory rotation omits a number of considerations.

To start, while correct that “audit failures … are small potatoes” below the mega-level of Lehman or AIG, Selling misses the stumbling block of international impossibility.

Which is, for example, that American rotation would impose on such global-scale but US-listed companies as Deutsch Bank or Total or Banco Santander or Nokia. Would the regulators in Germany or Switzerland or Spain or Finland adopt and enforce the obligatory sacking in their countries of, in these cases, KPMG or E&Y or Deloitte or PwC? And if not, how do those parent-level firms possibly coordinate and perform their locally-contracted statutory engagements?

No way -- given the halting steps of the PCAOB in the nine endless years of its aspirations – reflected in its still-complete exclusion from China (here) and the twenty-page list of large companies outside the US where, as of last year, its auditor inspection access was denied (here and here).

Second, where does the wheel of rotation turn for these companies? Where are alternatives to be found? It is not appreciated that the malign effects of independence and scope-of-service restrictions, and the uneven distribution of Big Four resources in the large economies, have squeezed or eliminated any viable rotation opportunities. Back to the study for the Financial Reporting Council in 2006 (here), and instances in the UK where “companies may have no effective choice of auditor in the short term” (emphasis added).

Third, Selling too gently observes that, “we don’t have a lot of evidence that audit firm rotation is going to work.” Truth is, we have none – the only experience being Italy, where rotation has contributed to greater Big Four concentration, and figured not least in the divided-audit environment at Parmalat. 

Fourth, Selling’s attribution of significance to the AICPA’s lobbying against rotation, back when the Sarbanes-Oxley law was passed in 2002, misses the irrelevance of that body to today’s market. That’s because, at the big-company level (the segment that matters, as he and I agree), rotation would be a pass-the-parcel exercise among the Big Four. Their dominance in the scope and coverage gap with the smaller firms has only grown over the last decade; rotation would if anything likely further squeeze the smaller firms out of the top-tier market.

Finally and most important, Selling asserts that the overhanging prospect of rotation would improve performance – in his hypothetical, “the fifth year of a 7-year relationship” – “some yet-to-be-disclosed successor auditor will have every incentive to examine each page of the old working papers with a fine tooth comb.”

This is backwards, and the incentives go the other way. A successor’s incentive and mandate are to examine old work only to lay a foundation for the current year’s engagement. To do otherwise, recalling that the successor is not an agent of law enforcement or regulatory oversight, is to pry for skeletons in old closets on a gratuitous basis.

Consider the hindsight judgment that a prior error might require correction. The company is in no position to force the now-dismissed prior auditor back onto the job of re-issuance. Yet the successor is in no position to re-perform old and stale work – at least not without inflicting massive time and cost on the current job.

To sum up: the case cannot be made at the large-company level that mandatory auditor rotation confers any benefits or justifies its costs. It is particularly impractical at the global level in any event. And requiring rotation only for smaller companies would be expensive, ineffective and politically impossible.

The proposition that rotation deserves a try, only because “every other device for loosening the bond between auditor and client has been tried and fallen far short of the mark,” is not a strategy, but a wish – and a wistful one at that. Better to focus on ideas that are both justifiable and within the range of practicality, than to continue lobbying for one that is neither.

 

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What Should Be In the Auditors' Report? Would Users Know When They Saw It?

 I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it ….”

       -- United States Supreme Court Justice Potter Stewart, on pornography, Jacobellis v. Ohio (1964).

A host of different interests are calling for a re-think of the standard auditors’ report.

Believing that its familiar commodity language has long given no value, except to satisfy the self-interest of the securities regulators, I fantasize a shared project between the International Auditing and Assurance Standards Board – which has the expertise to make it happen – and the Public Company Accounting Standards Board – which does not, but which must lead the American effort if there is ever to be success (here).

Essential would be this determination: what form of assurance is really desired -– what do users value, and what will they pay for?

Available pronouncements are unhelpful – neither such slogans as in PCAOB Chairman James Doty’s May 5 speech, that “the audit embodies core societal value and relevance”(here), or this month’s hyperbole from the European Parliament’s Committee on Legal Affairs, that the statutory audit is “an absolutely fundamental component of the democratic economic and political system” (here).

Two more helpful but ultimately depressing generalizations may be made:

The first, addressing the tumult of the last four years, is that users emphatically do not want the “clean” assurance that was delivered within weeks or months of an issuer’s demise – the unqualified opinions on such casualties-in-waiting as Bear Stearns, Lehman Brothers, Merrill Lynch, Citigroup, General Motors or AIG.

The palpable annoyance in London of the House of Lords Economic Affairs Committee, at the UK banks escaping “going concern” qualifications only through closed-door sessions between their auditors and banking supervisors – the Bank of England or the Financial Services Authority (here) -- makes the point.

The other unreality -- the re-emerging credibility gap between the traditional one-page report and the market behavior of investors – reprises the roller coaster of the late 1990’s in the current IPO wave of “new media” and other darlings – where stock prices, enterprise valuations and near-hysterical crowd behavior give every indication of a new bubble well inflated.

The poster child must be LinkedIn, with its IPO on May 19 at an upwardly-adjusted $45 and its first-day explosion to $122 – and its gradual post-offering descent back in the general direction of reality, now around $ 74, leaving all after-market purchasers under varying depths of water. 

LinkedIn’s indicated post-offering enterprise value -- $ 4 billion-plus -- pales next to the mooted $ 15 billion for Groupon and the staggering $ 50 billion for Facebook – figures bearing no terrestrial relationship to the companies’ available financial data.

Illustrative is the straight-faced ability of Groupon to base its offering on results that should exclude its sky-rocketing marketing expenses and acquisition costs (here). Flouting five centuries of accounting theory under which double-entry bookkeepers have recorded and reported everything on both sides of a ledger, the company would spin Luca Paccioli and his successors in their graves, while spinning the enthusiasms of investor credulity.

Elsewhere the valuation landscape is no less fanciful. Glencore’s launch at 530 pence on May 19 was well over-subscribed, but slipped to this week’s 480-ish – reasonably attributable to the over-heated state of the commodities markets at the core of its business, even ahead of its rumored (and now disavowed) targeting of ENRC to extend its mining activities into those havens of business and political stability, Kazakhstan and Congo (here).

More illustrative of the wild variability are Yandex – Russia’s clone of Facebook, offered on May 24 at $ 25 and lofting to almost $ 39, now at $ 31, or its Chinese opposite, RenRen -- launched at $ 14 on May 4 with a first-day pop to $ 19, but presently slumped to under $ 8. No surprise, the latter, while a cavalcade of failed Chinese companies after American “reverse-merger” listings has amply illustrated the opacity and distress at the heart of Chinese accounting, reporting, governance and over-all business legitimacy.

Or, right down to date, the June 14 offering of music-streaming Pandora at $ 16 per share, twice raised since its initial filing – an indicated company valuation of $ 2.6 billion, despite a consistent and unbroken loss-making history -- came out of the gate of open public-trading today to climb above $ 23 before starting to slip.

By way of these two central themes, it is knowable both what financial statement users do not want at all, and what they will completely ignore.

For what that teaches about new forms of assurance, unfortunately, the news is not good. As baseball sage and philosopher Yogi Berra would have put it, “If investors don’t want to act sensibly, you can’t stop them.”

 

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Can Value Be Brought Back to the Auditor's Report? A Tale of Two Systems

 Is it the best of times, in the struggle to re-introduce value into the traditional auditor’s report – or the worst of times? The age of wisdom or the age of foolishness?

Latest to join the Dickensian-length of characters is the International Auditing and Assurance Standards Board, which on May 16 released its consultation paper, “Enhancing the Value of Auditor Reporting: Exploring Options for Change” (here).

Compared to the others, whom to list takes up three full pages of its appendix, the IAASB brings the essential combination of intelligence and technical skills. Well it should, charged with the promulgation of international standards on auditing (ISA’s), thus conversant with such abstruse but centrally relevant topics as the auditor’s responsibility for published information other than financial statements (ISA 720), and use of “emphasis of matter” and other paragraphs in an auditor’s report (ISA 706). 

Among the most prominent of those heard from, and least likely to offer substantive contributions, is the United Kingdom’s upper legislative chamber, whose Economic Affairs Committee has this spring gotten its lordly knickers in a twist over the bogus suggestion of a malign influence of international accounting standards on the crisis-era reporting of the British banks (here), and also prodded the UK’s Office of Fair Trading into an inquiry as to the market dominance of the Big Four (here) – yet another tedious exercise destined to yield neither surprises nor constructive suggestions. 

Joining the Lords in fullness of volume and emptiness of ideas has been EU markets commissioner Michel Barnier, whose “green paper” consultation served mainly to remind anyone interested of the capacity of European bureaucrats to sacrifice forests of trees to document the lowest-hanging fruit on a fragile bush (here). 

The Americans arrived on May 5, when the chairman of the Public Company Accounting Oversight Board, James Doty, promised a “concept release” this summer “to consider how the auditor’s report can be changed to provide more useful, relevant and timely information” (here).

Where the IAASB suffers a gap between competence and authority, of course, is in its lack of muscle to carry out its aspirations. Sponsorship and support of senior regulators are required, led by the Americans, for a legislative re-engineering of the liability landscape, because assurance in any innovative area can only be designed and delivered if relieved from the devastating exposure to hindsight second-guessing that today shackles the auditors to their obsolete model.

Fantasize, for a moment, an “age of wisdom” in which the IAASB and the PCAOB actually made common cause. What might be accomplished?

The IAASB release makes the obligatory musings on possible adjustments to the current report itself – whether to move the opinion paragraph to the top, or to push the explanatory language to a footnote. But cosmetic niceties are inconsequential, as the grown-up technicians surely realize; knowledgeable readers would be neither confused nor influenced by this syntactical re-arrangement of the deckchairs, and others simply would not care.     

Once past political correctness, however, the IAASB does press into important new territory, recognizing “the demand for additional, and more pertinent, information about entities and the processes that support the quality of their financial information.”

Its delicate suggestion of “perceptions that auditor reporting is not meeting the needs of financial statement users” is a rhetorical bow to the tensions among competing constituencies and the understandable retreat into euphemism – where what is called for is removal of this barrier to clear thinking and precise articulation.

Teasing the blunt inference out of the IAASB’s sensitivity, today’s audit report is obsolete and, beyond compliance for which Doty and the other regulators are acutely self-interested, delivers no real user value.

If it were an old horse, it would be given due respect for its decades of good service -- then the worn-out old nag would be led off to the knacker’s yard and given the humane dispatch its dumb loyalty deserves.  

Within the scope of the IAASB’s standard-setting, it lists readily identifiable subjects for auditor contribution:

• “Corporate governance arrangements.
• “Business model, including the sustainability thereof.
• “Enterprise-wide risk management.
• “Internal controls and financial reporting processes.
• “Key performance indicators.”     

The release further tables the desirability and value of auditor insights in such financial reporting issues as:

• “The quality of the entity’s internal controls and financial reporting processes.
• “Qualitative aspects of the entity’s accounting policies, including the relative conservatism or aggressiveness reflected in management’s selected policies.
• “The auditor’s assessment of management’s critical accounting judgments and estimates, including where each critical judgment or estimate falls within a range of possible results.
• “The quality and effectiveness of the entity’s governance structure and risk management, and the quality and effectiveness of its management.”

 Here lies real opportunity. The IAASB solicits comments until September 16. Disinterest, silence and the retention of the status quo should not be tolerable options.

 

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IASB / FASB "Convergence" Postponed Again: Tweedie and Seidman March Back to the Future

In a late pre-retirement hurrah, outgoing International Accounting Standards Board chairman David Tweedie has made a bequest to his successor: last week’s agreement with Leslie Seidman, his opposite number at the Financial Accounting Standards Board, to extend by “an additional few months” the already elastic June 1 date for completion of the decade-long aspiration to converge international and American accounting standards (transcript here or here).

Is there a sentient being on the planet who is so benighted as to claim surprise?

Long predicted (here), the continued slippage in this always-distinct possibility – hardly deserving to be credibly described as a “target,” much less a “deadline” – continues to recede into the distant future.

Which was inevitable, for two reasons, purely aside from the dubious substantive merits (no better addressed than by Tom Selling’s acerbic Accounting Onion).

First is that the still-unfinished workload of four pending priority projects – the individually challenging topics of leasing, revenue recognition, financial instruments and insurance – had long been recognized as impossible of accomplishment within the resources of the two bodies and the politicized obligations to their antagonistic constituents (here). And that’s even if there had been agreement between the bodies themselves, which on these highly-complex subjects, there is not.

Second and more fundamentally, the tediously-reported proclamation of real convergence commitment has never been more than a smokescreen behind which the divergent interests of the Americans and the Europeans have knocked heads to the point of insensibility. (For which, recall the continued fudging of the SEC as to whether, if ever, that agency is even going to confirm a date certain on which to decide if to weigh in or not (e.g., here and here).)

Why no-one has called the question on this endless charade reflects the two-level fantasy in the dialog: the IASB and the FASB both pretend to believe in the desirability of fully-converged accounting standards, and the community of financial statement issuers and users pretend to believe them.

At the same time, the complexity of standards within either IFRS or US GAAP expands apace. The example is the latest annual report from HSBC, which achieves a stunning 392 pages (here), thereby vying in both bulk and opacity with such legislative monstrosities as the Dodd-Frank law or the EU rules defining chocolate.

There is a striking and pertinent observation, in academic studies of breakdowns and failures in large-scale strategies: once a project starts to go over time and budget, each of the successive series of further delays and over-runs is typically longer and more costly than the last.

Public works projects are notorious: the Sydney opera house was completed in 1973 for A$ 102 million, nine years late and 15 times over its initial A$ 7 million budget. Finally completed four years late in 2003 for $ 14.6 billion, Boston’s “big dig” harbor highway tunnel tripled its initial estimate. The Eurotunnel was a happy contrast, only one year late in 1994 and a mere $ 3.6 billion over budget.

Military and political conflicts are equally instructive. President Bush’s May 1, 2003 speech under the “Mission Accomplished” banner, two months into the conflict in Iraq, is now at eight years and counting. The continuing escalations of American commitment in Vietnam for a victory supposedly just around the corner still have tragic resonance. The broken promises of peace in the land of Abraham’s children date not just to the founding of Israel in 1948 but at least back to the Balfour Declaration of 1917.

In Joseph Heller’s darkly comic 1961 war novel “Catch-22” – still the best manual in print on the absurdities of dysfunctional organizational management (see my January 2004 review in the International Herald Tribune) – the sycophantic lieutenant Scheisskopf secured his reputation and his promotion by the strategy of announcing that the much-despised weekend parades would not be held. 

(Anyone missing the scornful locker-room epithet is invited here for his name’s translation from the German.)

Tweedie and Seidman having picked their low-hanging fruit, they now confront the reality of a tree too tall to climb. So the virtue of their other modest accomplishments being acknowledged, their adoption of the Scheisskopf technique of perpetual postponements invites skepticism and ridicule in kind.

 

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Two Obsolete Models: Global Financial Reporting and Audit -- And Pimping Spam Viagra With AOL's Rogue E-Mail

 

Last week came a very peculiar e-mail, from an old and trusted friend whose judgments I have long valued and whose recommendations are informed by insight and experience.

There was no text – just a link. It led to the web site of an enterprise in Canada, offering remarkable discounts on an extensive array of exotic pharmaceuticals – mainly those promising cut-rate prices for exceptional enhancement in male potency and performance.

The note had multiple addressees, so it was evidently not a well-intentioned if gratuitous extension of concern for my personal functionality, satisfaction and well-being.

To pursue my second thought, I wrote my friend to ask if the site was being flogged as an outburst of his own endorsement and enthusiasm. His reply identified the third and real possibility – his long-standing AOL e-mail account had been high-jacked, and under hostile influence was engaged in stealth marketing beyond his control.

I have deliberately kept my distance from AOL for some years – first because a company capable of so thoroughly bungling its tie-up with Time Warner must suffer a fatal infection in its vision and its maladroit execution. But right at home, AOL’s long history of service lapses had finally ended with its sudden and irretrievable termination of my whole family’s portfolio of accounts, without so much as a word of explanation or a hint of assistance or apology.

So I have had a definite lack of interest in the recent kerfuffle over AOL’s bleeding of its declining but remarkably durable dial-up customer base to fund its $ 315 million acquisition of Huffington Post – a project of great enrichment to Arianna Huffington herself, if not to the cadre of free-lance bloggers who toiled without for years without compensation, to enable a generous pay-day redounding to her benefit alone.

On all this background I wrote my friend again, suggesting it was well past time he acted on his long-held awareness, that monthly AOL subscription fees were a wasteful expense drain for an inferior product that had long since been over-taken in the marketplace, and also that he had just experienced the last-straw disruption and inconvenience commonly inflicted by an outmoded service, pernicious in its obsolescence.

As for extending the metaphor -- where have we heard this before?

The answer of course is that for the last twenty-five years, nothing but in-bred regulatory inertia and supine user acquiescence have propped up the standard auditor’s report on a financial reporting model that is no less obsolete than that of AOL.

Nobody reads an audit report – nobody attends to its commodity language. No transactions of significance turn on its content, which can be purchased without qualification by any company short of bankruptcy, no matter its dubious reputation or parlous condition. No candid banker or institutional investor, claiming to act in other than a herd-oriented role, will admit to laying value on a document behind which individual due diligence is obligatory.    

While on the contrary, retail investors lack the time, tools and expertise to de-construct the arcana of financial reporting standards too complex and multifarious for the comprehension of mere mortals. 

Finally, the costs to consumers are indirect, buried far from view and only moderately painful. And with self-interested players having their own reasons to prefer a system subject to their gaming, the indifference of the sluggish acts like gum in the gears of evolution and innovation.

The death of AOL’s dial-up business has been an inevitability ever since it became common knowledge that the cost of internet connectivity would approach zero. So came the recognition by CEO Tim Armstrong, that evolution for the sake of survival was least expedient. Whether achievable, time will tell -- although the immediate post-merger firing of 900 AOL employees suggests an imminent re-play of the old maxim that a strategy of “shrinking to greatness” is next to impossible.

As for the equally obsolete model of financial reporting and assurance, the spam being broadcast to user communities in the form of traditional annual reports and auditors’ opinions remains unchecked, if only for the moment.

To paraphrase the health warning on my friend’s inadvertently intrusive Canadian web site – seek immediate medical relief for any audit report that generates excitement lasting more than four seconds.

 

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Accounting Standards: Rules or Principles? Lessons From the UBS Dress Code

Goldman Sachs has snatched from its US clients the windfall chance to front-run Facebook's IPO, by limiting access to the potential of its $1.5 billion special-purpose fund to foreigners -- while professing no influence from the fuss-budgets at the SEC (here). So it seems a good time to ask:

Should regulatory compliance and accounting standards be expressed as detailed codes of precisely-drawn rules? Or as broadly-articulated principles?

There are lessons to be taken from the 43-page dress code issued by Swiss bank UBS in December (here).

The debate needs help: endless, pointless and fruitless, it feeds the conclusion that much-touted but never progressed “convergence” between international accounting standards and country-level codes in Europe, the UK and the US is as distant, elusive and unlikely as ever.

Popular reaction is that only a Swiss mentality could perpetrate the obsession at UBS, with its meticulous prescriptions on suit fabrics, cosmetic colors, collar points and hair care both facial and cranial.

Although, a dress code did appear late in my own corporate life – no less ridiculous but also raising non-trivial dissonant issues about the boundaries and effectiveness of guidance.

I was the senior member and titular head of a team based in Paris – an expatriate American amongst colleagues from the major European countries. To a man and woman, all were immensely talented and hard-working. They were also urbane, stylish and beautifully attired.

Global headquarters in the US published its requirements for the new “business casual.” It was only six single-spaced pages, compared to the fulsome 43 pages of UBS – but who’d have expected better from the sartorially challenged Americans?

It went into gruesome detail on necklines and sleeve styles and degrees of elasticity; it proscribed denim and gym gear and athletic branding; and it forbade flip-flops and open toes and footwear of any aerobic provenance.

On a given day, probably one-third of our Paris team would have been out of compliance. But, making their own individual decisions about skirt lengths, or pantyhose in July, or whether to match an Armani T-shirt with a differently-branded suit, my young charges were always impeccably turned out and appropriate for client premises and boardrooms anywhere.

For the purpose, they were capable of proper judgments under the lightest of guidance. At our annual group party our solicitor from Edinburgh was elegant in his formal tartan kilt, dirk and sporn – but for court he was always in proper dark grey suit. On warm spring days the length of limb on display among our lanky cadre of legal assistants was a substantial percentage of their average 1.8 meters – but they all donned decorous trouser suits when the visiting firemen arrived from America.

Which has what to do with the challenge of setting international accounting standards? The answer starts with the extent of mutual trust and confidence shared by a community seeking for mutually-acceptable guidance and limits.

Our Europeans rightly expressed derision and ridicule for the US code, just as most of the world feels for the pathetic efforts of UBS, because of our expectations for what was important: discipline, dedication and execution of first-quality work. Under broad principles of professionalism and good taste, their public face was virtually one of self-regulation.

Whereas if constrained by punctilious trivialities, they would have wasted both their morale and my goodwill, along with countless hours of productive time, on manipulation of the rules in rebellious search for boundaries and exceptions.

It’s no different with financial reporting standards and regulations. History teaches that bright-line limits are pushed to excess by the creative and the aggressive: the depreciation lives of mainframe computers in the 1970’s, the elastic retained ownership requirements for special-purpose entities exploited by Enron in the 1990’s, the investor limits skirted by Facebook under the counsel of Goldman Sachs.

It is the human condition that some deviance from codes of behavior is inevitable – society decides the amount, by voting its willingness to allocate resources to law enforcement and sanctions.

The range across cultures can be vast – from the de facto legalization of recreational drugs in urban America at one end, to the use of flogging in Singapore to punish the consumption of fast food on the public streets.

At the extreme, drunken driving among teen-agers could be eliminated: raise the driving age to 25 and impose capital punishment on first offenders. No less, accounting manipulations could be wiped out – by outlawing commercial transactions in more than one currency or that fail to settle for cash within 48 hours.

But the compromises required of society would never go so far. Instead, the certainty of occasional lapses and excesses is accepted. Limits are broadly defined, and enforcement mechanisms are calibrated -- for both better andworse -- in both the capital market’s use of financial information and the fashion decisions of a business office.

Judged by my experience in the latter, a global environment is far more seemly and operates with more success without the heavy hand of excess regulation.

That will soon be learned, I wager, in the halls of UBS. Whether the new leaders of the Financial Accounting Standards Board and the International Accounting Standards Board will agree is a matter of greater doubt.

 

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The Audit Model Is Broken -- "Re:Balance" Has Its Third Birthday -- And The Message Hasn't Changed

And lo, it came to pass in the dark time of winter, that there was a grand convergence. All the scribes did their scribbling, and the soothsayers said their sooths, and the stars came into alignment. There was loud wailing, and an anguished chorus sang in unison, and a great outcry was heard in the land:

“The model is broken.”

All the major voices of concern over the unsustainable state of the financial reporting and audit model sang the same year-end theme.

For the academics, Dave Albrecht was most terse (December 15):

“The audit model is broken.  Everybody knows it. … Therefore, financial reporting is broken.”

The best critic of the dysfunction in reporting standards, Tom Selling, said (November 9):

“none of the (proffered) solutions fix the root causes of the problems with the auditing profession…. the sad irony is that nobody is as happy as they could be with the current state of affairs.”

Expect to hear from a plaintiffs’ lawyer? Jake Zamansky obliged (January 5) with a shout-out for Andrew Cuomo’s suit against Ernst & Young over the repo accounting at Lehman Brothers:

“Lehman Bros’ actions, and Ernst & Young turning a blind eye to them, stink to high heaven. … As the financial and subprime crisis unfolded, where were the auditors who were the “gatekeepers” charged with protecting shareholders?”

Francine McKenna could be counted on – re-cycling a prior piece (also January 5):

“I’ve said throughout the subprime crisis that morphed into the financial crisis that fraud played a role and the auditors were, at least, negligent and potentially complicit in that fraud."

On the UK side of the Atlantic, both Ian Fraser (December 21) and Richard Murphy the next day resurrected the 2008 interview in which Charlie Munger likened the state of accounting to a “sewer” and asserted that:

“a majority of the horrors we face would not have happened if the accounting profession were organized properly.”

And the ever-opinionated Dennis Howlett rang in (on the solstice itself):

“Francine, myself and others have for years been saying that audit is broken….(O)ne thing that any self respecting professional must look at and wonder. What the hell is going on with our profession?”

So what’s to make of this convergent outbursting? First, the chorus may be louder, but the lyrics are not new.

“Re:Balance” celebrates its third birthday this month – with my thanks and appreciation to all those who do me the privilege of their interest and involvement. From its earliest days, the message has been consistent; in its first month (here), I took up a reader’s question: “How much of this sub-prime thing is related to the accounting?”

As I put the answer then, and still today:

“Subprime and the credit market turmoil are all about the accounting, and nothing else. Fundamentally flawed assessments were made – whether out of venality or ignorance – about the quantification, timing and transferability of the risks associated with uniquely complex financial derivatives, and the collapse in their values as knowledge and experience eventually caught up.”

But attention goes back much further, to this blog’s antecedent, my column in the International Herald Tribune in Paris – where in April 2002, in my second piece,* I warned that, “what has been absent is a debate on how much longer the audit function, as it has been known for 150 years, can survive in its present form:”

“Companies will push the ‘rules’ of accounting beyond the edge. And unless the corporate audit changes in nature and in value, the Big Four auditing firms – down from the Big Eight in the last dozen years – will read their own obituaries well before another dozen.”

This is where Charlie Munger and those who focus their spleen only on the auditors go astray, and do real harm to the potential for constructive debate.

Munger has his history wrong, despite being closer than all of us to the Victorian-era birth of the audit function. Independent audit – voluntarily created by company owners -- was not born to bear a “public duty,” but acquired that appliqué in the decades after it saw off government take-over in England in the 1860’s and America in the 1930’s.

As a consequence, he gives an inappropriate pass to the central parties – the issuers and other players who really like the system as it is.  Which is understandable, because Munger as wheel-man for the legendary Warren Buffett is, unlike the average investor or shareholder, a member of that very circle who give no respect or regard to audited financial statements, precisely because of their ability to both grasp and exploit the inadequacies and obsolescence inherent in today’s model.

It’s as if – using Munger’s “sewer” analogy – blame for an antiquated and overflowing drainage system were inflicted not on the engineers and designers responsible for its shortcomings, or the politicians who refuse support for the renewal of the public works, but on the subterranean workers in boots and gloves, struggling in futility to shovel against a tide of dark and filthy muck.

As I put it three years ago:

“In the end, … the quality of accounting is an effect, not a cause – the level of its virtue and integrity is observable in a mirror held up to commercial society.

"Or as first put in the early 1970’s by cartoonist Walt Kelly’s swamp philosopher, Pogo the possum, “We have met the enemy, and he is us.”   

 

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---

* No available reference, I am sorry to say. The New York Times as sole owner of the IHT has managed not only to suck both the soul and the circulation out of that once-vibrant resource that served the overseas Anglo community so long and well, but also to consign its web archive to the same closed and inaccessible limbo to which the newspapers themselves are rapidly headed.

 

The House of Lords Looks at the Role of Auditors: And Then Everyone Went for Tea

 Here’s a good way to increase the chances for satisfaction: start with very low expectations.

That was my approach, anyway, in dialing up the broadcast by Parliament TV of the House of Lords Economic Affairs Committee session of November 23, billed as a look at concentration in the audit market and the role of the auditors in the financial crisis -- here.

As a soporific, it was a decent substitute for televised football as a way to sleep off the after-effects of the Thanksgiving feast – watching the heads of the Big Four practices in the UK bat away slow-pitch questions that ranged from the naïve and misinformed to the incomprehensible.

Plainly, the intractable challenges to the viability of the large-company audit model are at no risk of being solved at the hands of the British legislators, whose depth of inquiry ran the gamut of complexity from A to B.

Examples:

• “Are you happy” with the degree of market concentration? Well, what’s not to like -- although it can hardly be admitted, when the Big Four control the entire large-company audit market with no prospect of competition.

• What about a threat to withdraw from the audit market? Oh, not us, your lordships – audit is at the very core of what we do!

• If that’s so, “are you uneasy” that the large firms would go from four to three?

• With a straight face, “we don’t see that on the horizon.” Of course not – while at the same time conceding that although the events of the credit crisis were “unprecedented,” there are “lessons to be learnt” for everyone.

Sometimes the unthinkable does happen – as the events of the last three years have made clear. So where was their lordships’ follow-up question: 

What would you do – what would any of us do – if despite your intentions, one of the firms incurred what was described with wonderful British euphemism as an “Andersen moment”?

And for this, there was no suggestion of an answer from either side of the tables. 

In the middle third of the proceedings, their nobilities were able to become better informed, if not wiser, as their invited guests gave a concise run-down of the irrelevance to audit concentration of a list of unachievable ideas -- namely:

• Break-up of the Big Four would add nothing to global-scale competition, since – against the breadth required because 80% of the revenue of FTSE 100 companies is generated outside the UK -- the resulting fragments would lack scale, coverage and investment capability.

• The current restriction on scope of services to audit clients – where last year no FTSE 100 company paid consulting fees to its auditor – is claimed to be working well: an assertion which, considering the unsolved nature of the survivability threat, means that if the current environment represents success, what would failure look like?

• The arguments for joint audits or mandatory rotation founder on the examples of degraded quality – the likes of Parmalat in Italy and BCCI in the UK itself.

• And the howler of the day: if audit is “implicitly a form of insurance,” why does that industry not ride to the rescue? – a proposition so discredited that even the committee chair hastened onward.

The hearing wound down to a clearly rehearsed and well-choreographed five pm break for tea, but not without an “Alice in Wonderland” go-round on the question of the auditors’ issuance of unqualified opinions in the months before the failures of such British institutions as Royal Bank of Scotland, HBOS and Northern Rock.

At the assertion that the auditors actually “performed well” in light of the complex events of 2007 and 2008, adjectives such as “astonishing” and “misleading” were tossed around both in the hearing and amongst subsequent commentators – here.

But why should anyone be surprised?

The pointed observation by one of the Big Four that the auditor does not assess the risk of a business, but renders a report in identical language, whether the leverage of the enterprise is 100 times or none at all – starkly contrasted with a plea from the questioners that an assessment of the “dangers" in a business is precisely, if simplistically, the assurance sought by a wishful user community.

In that context, the fact that the technical reporting requirements were satisfied, to avoid a going-concern qualification – if only through closed-door communications with the Bank of England and the Financial Services Authority – finally exposes the raw insufficiency of the current audit model.

As was equally the case in the 1980’s when the American auditors trailed the emerging catastrophe among the savings-and-loans, the profession lacks satisfactory tools when the regulatory regimes put them to the choice -- whether to qualify their opinions and generate a self-fulfilling prophecy of disaster, or to rationalize a demonstration of the emptiness of the report that constitutes their core product.     

If that much could be taken as established once for all, before everyone went off for tea, then unlike the case with most such posturing displays, the day was not a complete waste.

 

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The SEC's Mary Schapiro on the Myths of GAAP/IFRS Convergence: The Lady Doth Protest Too Much

            Local news item: “Last night the high school drama club played Shakespeare. Shakespeare lost.”

 Last week, SEC Chairman Mary Schapiro played the 2010 annual conference of the chartered financial analysts. Her speech is here.

Credibility lost.

Her ambitious list of messages included a major tilt at four “myths” about the SEC’s lukewarm attitude toward GAAP/IFRS convergence and globally merged accounting standards.

In protesting that “you can’t always believe what you hear,” Schapiro’s pushback suffers the inductive fallacy that opposition to your critics is not the same as proof of your own position.

Whether or not the agency’s own “commitment to international standards has flagged,” Schapiro either could not face – or is still denying – the implacable international antagonisms to convergence that her agency lacks the capacity to resolve.

 There is, indeed, no more eloquent concession of the “convergence gap” than Schapiro’s own admission that “US GAAP and IFRS are currently not converged in a number of key areas,” including “the accounting for financial assets (the very types of securities at the center of the financial crisis), revenue recognition, consolidation principles, and leases.”

 Any other problems, Madame Chairman? These on her list are so comprehensively grave that they will keep the international standards standoff alive until the end of time. 

 It’s not necessary to believe Schapiro to be as malign as Shakespeare’s Queen Gertrude, or to fault the bona fides of her commitment to the “fundamental principle” of “comprehensive and neutral accounting standards.” Because on the prospect of core-level GAPP/IFRS convergence, she is committed as were the pre-Copernican astronomers to the “fundamental principle” of an earth-centric solar system.

 It’s just that while good faith is fine, eventually it must yield to reality.

 In assessing the feckless attitude of America’s chief securities regulator, it helps to keep at hand a glossary of trans-Atlantic euphemism. That is:

•  ·      When a Frenchman says, “We need to be pragmatic,” what he means is, “Agree to do it our way – or there’s no deal.”
• ·      When an Italian says, “You don’t understand how things are done here,” the unspoken message is, “You have no chance – cut your losses and head for home.”
• ·      And when the typical balls-out American attitude gives way to Schapiro’s concession to “understand the importance of process to a successful conclusion (her emphasis, not mine), it means “We know we’re screwed for now, so we’ll kick the can down the road and try to sell it as success.”

The targets for Schapiro’s spin were not clear, as she advanced the assertion that discussion on accounting principles “is often limited to specialized journals and a handful of websites for the kind of people that can tell a repo 105 from a 401(k).”

As if her pimping would be seductive. Weighing in from his base in Minnesota, academic blogger Dave Albrecht (here) made it clear that he did not just fall off the turnip truck, with a trenchant Twitter message that the intelligence level of Schapiro's constituents other than the mainstream brown-noses is entitled to more respect: “Ridiculous comments, sad that some might believe her.”

Also counting against Schapiro’s credibility is that, despite building her speech on the three obvious pegs of the SEC’s mission, initiatives and priorities, she gave not a single reference to a most basic issue – the continued viability of the global assurance function.  

Anyone still thinking that the life-threatened auditors have “had a good crisis” over the last three years (here) has not spent recent time around the courthouses – the latest bullets added to the Big Four firms’ deadly game of Russian roulette being Ernst & Young’s inclusion in the Lehman Brothers litigations (here) and the two-billion dollar claim against PwC by the winding-up board of Iceland’s Glitnir Bank (here).

On the very day of Schapiro’s speech, with its bare one-phrase reference to her “overseeing … the PCAOB,” that agency published a list of some 400 non-US companies whose auditors could not be inspected because of obstacles under their home-countries’ laws (here).    

The PCAOB claims to be “currently prevented” from its mission – as if the issues of non-US confidentiality, data protection and privilege have not been readily knowable since before Sarbanes/Oxley birthed the agency birth back in 2002.

A good index of global-scale companies, whose audits are out of reach of the PCAOB, could be built from that list: a quick sample of household names from around Europe includes AB InBev, Nokia, Total, AXA, Daimler, Deutsch Bank, SAP, Ryanair, Luxottica, ArcelorMittal, ING, Ericcson, ABB, Credit Suisse, Royal Bank of Scotland, WPP, BP, AstraZeneca, Pearson and Unilever. 

To be really transparent, the internationally toothless PCAOB might publish its short list of those companies for whom audit inspection did not present obstacles (a sub-set whose total market capitalization would not make a flyspeck on the windshield of the world’s economic engine). Or, perhaps, the far longer list of those companies for whom auditor inspections have not even been attempted.

Schapiro claimed that “investors – from anywhere across the globe – come under the SEC’s umbrella of protection. ” 

She might more candidly confess to all investors, “bring your own foul weather gear – you’re on your own.”

 

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Repo 105: Was Lehman's Accounting Only Ticking Boxes? Or Is It A Ticking Box?

I’m not often inspired to take issue with my colleagues in the ink-distribution trade – mainly because the antics of regulators, politicians and senior leaders of business and the professions are usually more tempting targets. 

But the analyses of the bankruptcy examiner’s report on Lehman Brothers, released on March 14 (here), show a number of serious shortcomings in reasoning or conclusions – none so difficult to have gotten right as to be tolerable without comment.

Take the misperception repeatedly put forward by the Financial Times, that the “rules-based” nature of accounting principles in the United States, ostensibly contrasted with the broader principles as articulated in the United Kingdom, are effective to mitigate the large accounting firms’ litigation risk (see here and here).

Simply -- wrong. That a “culture of box ticking … helps firms defend themselves against law suits” is both unsupported and contrary to the accounting profession’s exposure to devastating claims in the American courts.

Empirically, first: the large firms have no track record of successful trial outcomes in the billion-dollar US cases that threaten their survival – precisely because their leaders cannot tolerate the risk of actually going to trial in a bet-the-firm contest before a jury.

Which, secondly, is for good strategic reasons: there is no legal defense or “safe harbor” in American law based on proof of compliance with professional standards – box ticked or otherwise – a proposition established in a criminal prosecution over forty years ago. 

The lightweight insight of the salmon-colored London press could be attributed to the appearance, as a matter of comparative jurisprudence, that British legal standards of liability might be more stringent. Superficially comparing the two forms of auditors’ opinion language on audited financial statements reveals a non-trivial difference: a UK report delivers the unmodified opinion of a “true and fair view,” whereas the American version speaks of “fairly presented in accordance with” applicable standards. 

But the difference is elided, and the far lower level of UK-based exposure is significantly explained, by the absence of an auditor’s duty to the general population of UK investors – where by contrast, auditors of companies issuing US-registered securities are exposed to the world, under its securities laws, for publicly-accessible statements determined to be false either affirmatively or by omission.

So the assertions of the Financial Times, that auditors’ reports are of “diminished authority” or “less valuable as due diligence,” must find their credible support elsewhere than in the professional standards. 

As they do – but which the FT does not grasp: the vulnerability of the profession’s core product – the assurance it delivers on its clients’ information -- is not reinforced by such legalistic assessments as are advanced in Ernst & Young’s letter regarding Lehman to its clients’ audit committees, quoted at length in Re: The Auditors for March 20.

Charlie Green’s Trusted Advisor goes a good way toward the reason why spin does not yield substantive relief: “’wrong’ is a moral concept, ‘illegal’ is a legal concept.” Yet – and this takes the last and necessary step – the conflation of the two can be deadly.

That is, the problem for Dick Fuld, Lehman and its gate-keepers including E&Y, is that the Valukas report is not the end of the process, but only the beginning: because there is no other forum for public moral accountability, the law courts are the venue of last resort.

And there, unfortunately, although E&Y’s last audit of Lehman was for fiscal 2007, its reports on Lehman’s first two quarterly resorts for 2008 (here) put it on the scene of the conflagration. Even if not full audits, they are all that will be necessary to underpin a nightmarish litigation exposure.

In other words, “not illegal” suffers a two-fold shortcoming in persuasiveness – being both irrelevant to and missing the point of a disturbed public moral sense, and requiring vindication through the trial process to be effective at law – a process for which in recent years the large accounting firms have shown neither the fortitude nor the resources. 

With the depth and complexity of its challenges posing issues of viability and survival, the accounting profession deserves better treatment in the mainstream media than it typically receives, including now under the Lehman spotlight.

Responsibility for typical press coverage that is both superficial and simplistic would not readily be laid at the auditors’ door, however, but for the profession’s own contribution through its reluctance to address with candor and clarity the unclosed gaps between its aspirations to a sustainable future and its role in an unsatisfactory current dialog.  

 

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GAAP/IFRS Convergence: The SEC's Roadmap is a Highway Leading Nowhere

For two reasons I’ve taken a while to step into the fray about the prospects for convergence between Generally Accepted Accounting Principles in the United States and the International Financial Reporting Standards.  

First, it was an honest and necessary but also dreary and time-consuming task to plow through the entirety of the SEC’s statement of February 24, “In Support of Convergence and Global Accounting Standards” – here.

Second, it was a toss-up which was more enervating: to slog through all 68 pages of the SEC’s turgid and repetitive bureaucratic prose, or to contemplate whether anyone thoughtful in that agency really believe in a highly-uncertain timetable that at its most optimistic extends more than halfway through this decade. 

Although the G-20 declared in Pittsburgh last September that global standard setters should complete their convergence project by June 2011 (here), the SEC gives itself all of next year even to be positioned to consider a determination whether to give more support to convergence, much less when or how. Depending on a new staff-level Work Plan that supplants the famous “Roadmap” of 2008 (here), the SEC projects that presently-undefined steps in implementation may be taken no earlier than 2015 or 2016.

The merits of convergence are debated across the spectrum, from industry sycophancy (here and here) to David Albrecht’s professorial patriotism (here) to Tom Selling’s sour challenges to its lack of intellectual substance (here) to the playful irreverence of Going Concern (here).

For me – I am agnostic on this point. First, the whole issue of whether convergence ought to happen is largely academic – because the complexities and judgments within either GAAP or IFRS themselves render the outcomes too challenging and non-comparable for any users except the dedicated experts.    

But second, there are understandable reasons, based entirely on process, why the SEC’s program for convergence has more qualifiers than this month’s NCAA basketball tournament. 

On the European side of the Atlantic, conspicuous on the personal roadmap of IASB Chairman David Tweedie is the stop sign of his June 2011 retirement. Now a lame duck, Tweedie has combined intellectual rigor and prickly Scottish wit, but his ability to achieve harmony among his constituents has been frustrated by the evident limitations on his diplomatic skills.

Disparate nationalistic players in Europe have shown the ability to evade, frustrate and maneuver around attempts at cross-border unification and cooperation at many levels:

• ·      The French bankers, abetted by no less an accounting expert than President Jacques Chirac, led years of lobbying to prevent the applicability of a single international auditing standard on derivatives accounting (here).
• ·      The Swiss judiciary continues to provide home-court advantage in frustrating the on-going efforts of the American IRS to obtain personal data on alleged tax evaders (here).
  
• ·      And eight years on from the passage of Sarbanes/Oxley, the SEC has officially permitted the PCAOB to bail for another three years (here) on its supposed mandate to inject itself into the inspection and oversight of ex-US accounting firms, unable to penetrate the European rules on privilege, privacy and confidentiality.

While on the American side, the SEC’s guidance-writers did not have a great winter:

• ·      Their late-January pronouncement on disclosure of the implications of climate change (here) was a cheerleading exercise in vacuity – see here.
• ·      On the subject of short-selling, the SEC voted 3-2 on February 24 to re-instate an uptick rule (here), but only for shares dropping more than ten percent – a debatable exercise in cosmetics at best, that will impose obnoxious compliance costs while substituting the vacillations of motion for the reality of progress. 
  
• ·      And on the subject of convergence, the flabbiness of a schedule measured in geological time makes clear that compared to a real roadmap, the agency’s navigators couldn’t find first base with a compass and a guide dog.

So on one side, the Europeans can waffle and jawbone the convergence process for as long as it suits – while the SEC's political dithering only kicks the can down the road, far past the tenure of any present office-holders. Which means that the absence of accomplishment half-a-decade from now will become the responsibility of a whole new set of map-readers.   

It’s all enough to speculate how Robert Frost’s 1916 poem, “The Road Not Taken,” would sound, if written by an observer of the GAAP/IFRS process:

Two roads converged in a wood.

And sorry I could not see the forest for the trees,

Long I stood in the undergrowth.

……

I shall be telling this with a sigh

Somewhere ages and ages hence:

Two roads never converged

And that has made absolutely no difference.

 

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The SEC Turns Up the Heat on Climate Change -- Or Just More Gas?

The Securities and Exchange Commission in Washington voted by 3-2 last week to issue an “interpretive release” aimed at public company disclosures of the impact of climate change – ranging from new regulations and legislation, to changes in economic trends or physical risks (here).

Yet another layer of mandated environmental platitudes?

In her announcement speech, Chairman Mary Schapiro disavowed any intent to “create new legal requirements or modify existing ones,” and stated (her emphasis) that the Commission is “not making any kind of statement regarding the facts as they relate to the topic of ‘climate change’ or global warming’.” 

Further pounding down another nail of obvious banality, she noted that “it is neither surprising nor especially remarkable for us to conclude that of course a company must consider” possible events which “under our traditional framework” it must evaluate and disclose if material.

So the SEC’s cheerleading on climate change will be right there with the influence of the pom-pom girls on the outcome of the Super Bowl.

The SEC has been in rehabilitation mode since the prior administration, for everything from being caught out by Bernie Madoff’s spectacular Ponzi scheme to its virtual absence during the credit crisis. (see Andrew Ross Sorkin’s thoroughly engaging “Too Big To Fail” (Viking Penguin 2009), for the shared view that the then-Chairman was a clueless and ineffectual lightweight.)

The agency’s October 8, 2009 strategic plan has been followed by an outpouring: creation of a division for Risk, Strategy and Financial Innovation (November 5), borrowing of “cooperation incentives” from the toolkit of serious criminal prosecutors (January 13), and re-shuffling of bodies and titles within the Division of Enforcement (also January 13). Here then, the appearance of another release du jour. 

Or so it seems – because it can hardly be justified on the substance. Rather than real regulation, it’s the Potemkin façade of illusion – animated by the same optics-oriented spirit that inflicted on the user community the costs, disruptions and distractions of the Sarbanes/Oxley law. 

With details still to come, the SEC’s release offers four so-called “triggers’ whose impact could lead to disclosure – legislation and regulation, international accords, indirect consequences of regulation or business trends, and physical impacts of climate change – each of which would already have been unexceptionally viewed as an appropriate disclosure category under pre-existing guidance.

It offers a fair question: where the carbon set-offs will be found, for the acres of forest and tankers of jet fuel that will be consumed and emitted, to support all the round-tables, seminars and symposia, expensive legal opinions and auditor box-ticking, that will enable registrants to react to this latest burst of regulatory hot air.

What might be some of the new language, on top of disclosures that are already vaporous enough?

•  “The company safeguards its portfolio of exotic derivatives in an eco-friendly black box, which is regularly re-valued by marking to a market that is completely organic.”
• “While the company’s internal control structure may not prevent our shopping-addicted CFO from stealing us blind, we are pleased that our corporate credit card accounts are now settled by paperless invoicing.”
  
• “Any facilitating payments made to public officials by our off-shore subsidiaries will be delivered in brown paper bags made of no less than 60% recycled material.”

Kidding aside, validation of the importance of climate change is plain from its prominence in the marketing of each of the Big Four (here, here, here and here) – so nearly identical and undifferentiated as to be products of the same publicity shop.  

The accountants had best be ready, because the financial and reporting issues around climate change will become real – from the complexities sure to arise when the inventive wonks in the derivatives markets develop exotic ways to re-package emissions permits for speculative purposes, to the management and audit issues of identifying and controlling pollution sources for purposes of permit measurement and compliance.

But for now, with the SEC already fully occupied with credibility-stretching issues, it is hard to see its exercise in non-substantive flag-waving as anything more than a needless contribution to the already-elevated level of Washington’s noxious fumes.  

 

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Previewing 2010 -- And a Note of Thanks

As the old year winds down to the winter solstice and all those rituals by which we mark the holiday season, a brief look ahead.

Depending on reckoning, the New Year will either end an old decade or begin the next one. Whichever, here are a few events that will feature in 2010 among the on-going challenges to the global structure of large-company assurance:

• The Supreme Court in the US may well declare the PCAOB to have been illegally constituted (here or here). If so, predictable spasms of re-enactment and ratification by the SEC cannot successfully encompass such issues as the viability of pending investigations, the legitimacy of past inspection reports, or the need to re-register all the foreign accounting firms.

In the context of those issues of contention, the legislative mischief to be wrought by a Congress offered a blank page on which to re-debate the Sarbanes/Oxley law can scarcely be imagined.

• The fits and starts of accounting standards convergence will have no more traction than a pig on roller skates. The announced retirement of Sir David Tweedie as head of the IASB (here) will take one prickly personality off-stage, but will not solve the antagonisms among competing country and industry level interests. And as the scope of complexity and judgments within both GAAP and IFRS figure to be as significant as those between reporting systems, the achievability of comparability and comprehension will remain as elusive as ever. 

• Attempts to impose liability on the large accounting firms’ international structures will continue apace. The success of BDO International in confining the Bankest verdict in Miami to the Seidman firm alone (here) means that if that $521 million exposure becomes enforceable, BDO may need to find a new US member firm – a tactic painful enough for that organization but which none of the Big Four could achieve under like conditions.

Flashpoints for structural threats will include the Madoff-related feeder funds litigations, concentrated in the US but also spread around the world, and PwC’s exposure on Satyam.  And with PwC’s Indian partners on Satyam about to observe their first full year of local imprisonment, that network's attempts to extract itself from class action exposure in the American court system (here) raise the interesting question whether submission to Indian justice is really a preferred strategy.

• Tempting as it might be to be lured into the speculation about identifying which of the Big Four firm is most likely to disintegrate under the combined pressures of litigation and government threat, in 2010 or otherwise (here), I will decline – since the determining factor is the unpredictable timing of the cases themselves. Specify the judges’ scheduled trial dates for the 25 biggest cases hanging in Damoclean fashion over the large firms – and only then would I be able to offer a view.

• More broadly, strategic decision makers in the world of financial information will continue to confront the volatility of government conduct – an under-recognized factor in their overall risk assessment methodologies.
  

The reactive nature of public officials has been marked in recent years by an ad hoc cascade of unpredictable and unintended consequences – ranging in scope and scale from the back-of-envelope bank bail-out schemes to the bonus supertax in the United Kingdom to the first-ever invention in Dubai of a default-driven debt reorganization scheme of uncertain application or reliability.

So life in the forthcoming year will not be boring. 

Meanwhile, in this space, Re:Balance observes its second birthday. Launched in January 2008, this venture was the evolution from “Balance Sheet,” the column I had the six-year privilege and good fortune to write for the International Herald Tribune.

The challenges have been fascinating, starting with the anxiety-inducing migration from old-style print. No less than the accounting firms, the IHT itself -- like the other newspapers -- pursues its fading struggle in search of a sustainable niche business model. While in the world of rapidly mutating media platforms, the near-term impact of the likes of Twitter, Facebook and Kindle will continue at a dizzying pace to re-define the information landscape.  

It has been most gratifying over these two years, both to participate in community with an expanding group of smart and incisive commentators, and to experience steady growth in readership and especially in subscribers.

For these opportunities, I thank you all for your interest, your insights and your inputs.

Merry Christmas -- best holiday wishes -- and a healthy, peaceful and prosperous New Year to all. 

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Global Convergence of Accounting Standards? In Whose Lifetime?

A senior member of the fraternity of pundits touchingly spoke, recently, about one effect of the passage of time: “The older I get,” he said, “the more care and respect I have for the phrase “not in my lifetime…’.”

There’s a grain of sense -- however frustrating it is, that decent respect for the elderly means that we have to pay attention to the superannuated, however unwilling they are to surrender their microphones. Truth to tell, there is usually an inverse relationship between advancing age and advanced intelligence -- examples would be gratuitous but readily available on request – suggesting a requirement that pontificators come with staleness warnings or prominent display of a sell-by date.

That said, there is a recent media flurry around the long-dated estimate for convergence to a single set of global accounting standards – centering on the dialog between the Financial Accounting Standards Board in the United States, responsible for GAAP in that country, and the International Accounting Standards Board, responsible for IFRS as now mandated in the European Union and adopted to varying degrees in 100+ countries around the world.

The recent G-20 meeting in Pittsburgh was the context for a leaders’ statement by the great and the good, calling for completion of a convergence project in 2011 – a date also targeted for the US SEC’s decision to require IFRS adoption (for a helpful review of the state of play, see Edith Orenstein’s FEI Blog.)

Meanwhile in furtherance of the accounting profession’s party line, Ernst & Young’s global chief Jim Turley is quoted (in the Going Concern blog), flogging a single set of standards as “imperative.”

The chorus for convergence is not singing in unison. No critic is more trenchant or persistent than Tom Selling (The Accounting Onion) – although in an era of commentators’ ranting for ratings, sound reasoning and intellectual rigor have limited weight.

It matters much more that the reluctant Europeans will likely have their way. The Financial Times reports – here – that Henri de Castries, chief of French insurance giant AXA, views the setting of standards as “a matter of political sovereignty” and that French finance minister Christine Lagarde has put it to EU financial services commissioner Charlie McCreevy to “’ensure the safeguard’ of European public interest.”

Which sounds entirely like dressed-up cover for another version of the European capacity for protracted refusal to yield up national autonomy – foreshadowing a de facto continuation of country-based “mark to management” accounting, however pious the leaders’ pronouncements in favor of convergence.

Not that it may matter all that much, in a financial reporting world where comprehension and comparability are already elusive.

A generation ago, one of my then-colleagues – the world’s expert on accounting for complex financial instruments – maintained a list, on which he always included one entirely fictitious product. His standard wager of a full year’s bonus was that even a knowledgeable practitioner would not find the bogus item – and he never found a taker.

In practice today, he would say that there is already so much slack, judgment and overnight obsolescence in the tough issues of recording and reporting, even within single systems – whether the best-in-class among the major countries’ local GAAP or under IFRS itself – that the prospects for true convergence at any level of detail will remain perpetually elusive.

Add in the politically-motivated local vetoes being retained by the likes of the recalcitrant French, exemplified by the spirit of M de Castries and reflected in the measurements of European progress over spans of geological time: the deeply-embedded antagonisms and resistance recall the lesson from high-school geometry, that parallel lines only converge at infinity.

If only for these purposes, how delicious it would be if Ernst & Young were AXA’s auditors in France. Armed with the opposing attitudes of their bosses, if the client’s chief financial officer and the audit engagement partner were put to a debate on convergence, which one would emerge alive?   

One thing for sure – considering that the footnote in AXA’s 2008 annual report that sets out its choices and description of accounting principles already runs to sixteen pages (here): for anyone tempted to estimate a future date on which AXA might issue financial statements under a single converged set of globally-applicable accounting standards, it would be a safe bet to go with “not in our lifetime.”

 

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