Saying the Unthinkable
Published in the IHT on November 10, 2007
There's a deep-seated and superstitious refusal to name what we fear. Believing "Macbeth" to be unlucky, Shakespearean actors refer only to "the Scottish play." Harry Potter's fellow students of witchcraft and wizardry refer to the dread Lord Voldemort only by the euphemistic "He Who Must Not Be Named."
The trouble is, anxious evasion of a problem can help to bring it on.
Or so it is after the gloomy reaction in Britain to the report last month from the Financial Reporting Council on possible relief for the accounting profession (here). Attention is now over to the United States, where wise heads are gathering, under the auspices of the U.S. Chamber of Commerce and the Treasury secretary, Henry Paulson Jr.
Despite the threat to the survival of the Big Four accounting firms, none of the players - not the Big Four leaders, regulators or politicians, or the community of financial information users - will say it straight out: The large auditors' business model is broken, and their risks are unsustainable. The next large-firm failure will take down the other Big Three as well, just as fast as Arthur Andersen crashed in 2002, leaving large companies unable to obtain the current form of audit report from any source.
And why is nobody willing to ask what life will be like after the Big Four?
For that, I had a long talk recently with a senior accountancy regulator, who acts in a large country vital to the global capital markets and the future of the auditors. We found ourselves agreeing on the unappreciated necessity to confront a Big Four collapse and on the essential impotence of regulators or politicians.
We also had complementary approaches to the possible form and look of post-collapse assurance: In his world, beefed-up internal audit departments would report, with as much independence as they can muster. Audit committees would review and endorse the internal audit reports. And outside auditors would assess and report on the sufficiency of the internal auditor's resources, competence and scope of work.
Importantly, this latter report - well within the audit profession's capabilities, thanks to the experience gained under the requirements of Sarbanes-Oxley - would not require the scope of resources or the cost models of the current large firms.
In my world of the future, company reporting would be done by finance directors, on the basis of work done by outside firms, engaged from among the local and industry-based practices that would emerge from the wreckage of the Big Four. These firms would target their audit procedures and report on specific company areas ripe for attention - like a complex treasury function, a portfolio of risky assets, a troubled company operation or a first-time product or process.
From these two models, merged together, would emerge new forms of reporting and assurance, testable in the capital marketplace for value and utility to users.
And how would this all work, in a post-Big Four world?
First, internal audit departments would readily attract qualified personnel, out of the rosters of the late large firms, at compensation packages attractive to experienced accountants who would prefer the stability of corporate life over the uncertain risk and reward of the current fragile partnerships.
Second, the niche practices that held together after the large practices split up would also thrive in a new competitive environment. Their offerings would include the accounting expertise on which large enterprises will continue to depend, the new reports on internal audit departments, and the specific industry and geography-based assurance that finance directors will outsource and sell onward to the financial community.
Restructuring the current staffing models of the large firms, after the disintegration of their networks, would take one single recruiting cycle. The newly emergent practices would then operate with leaner resources, reduced costs and a profitable revenue model no longer hostage to failed attempts at pricing for the risk of unbearable litigation.
Third, and the driver for the first two, none of this reporting would ever claim to be in compliance with today's liability-ridden securities regimes, whose reporting requirements would have fallen to ineffectual disarray along with the firms themselves.
Instead, reports would be issued under strict limitations of liability to companies and their book of shareholders - not to the investor community and exploitation by the plaintiffs' lawyers. Reporting auditors would neither have nor claim independence in its now outmoded form. A truly competitive environment for assurance solutions, valued on a market-led basis, would replace the model that today is past its time.
Whatever the fear of speaking the unthinkable about the next era of large-company assurance, it is now on the table. There is a broad-based symposium, waiting to be convened by a top global regulator, under the title, "The Future of Auditing After the Big Four." If the boy wizard Harry Potter could name, face and overcome his nemesis, a group of adults should be able to do no less.
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