In the logging camps north of my little home village, lumberjacks teaming up on a two-man crosscut saw would admonish each other, “Either push or pull – just don’t drag your feet.”
Which on first glance would apply to last week’s report from the US Government Accountability Office, on the continued tight concentration in the market for audit services (here).
Despite re-affirming what has long been obvious -- namely, that almost all large public companies are audited by one of the Big Four firms, that audit fees have risen significantly in recent years, and that for global-scale companies, the option to choose among auditors is all but non-existent -- the GAO’s phlegmatic conclusion is that no compelling need for immediate action appears to exist.
So how well-deserved in the criticism of Comptroller General David Walker, head of the GAO – ranging from Paul Boyle, head of the UK’s accountancy regulators (here) to blogger Francine McKenna (here)? Can Walker really be expected to resolve the absence of client choice among the Big Four tetrapoly? Or to re-write fee levels, or to eliminate the threat to audit firm survival from ruinous litigation?
The concerns about large-firm fragility and performance do not lack for substance. The GAO’s sanguine view that audit quality has improved is already under challenge in the rapidly-growing population of subprime-driven litigations – a courthouse rush of new lawsuits marking a return to Enron-era levels (here), that to date sweeps in at least three of the Big Four along with clients of them all.
But to criticize Walker for foot-dragging is to mis-analyze the reasons for his diffidence.
The GAO makes a common but crippling error in its view of the impact of another large firm failure, on which more shortly. But its passivity is based in reality: it has available no achievable solutions, so its rational acknowledgement at least deserves recognition as credible.
That is because the critics of the current regulatory paralysis have no effective rebuttal to the GAO’s recital of the impediments to new entrants to the large-audit market:
First, the smaller accounting networks, suffering shortfalls in capacity, expertise and qualified personnel, lack either the interest or the risk appetite to take on audits at the Fortune 1000 level.
Second, proposed changes to allow outside investors in the accounting firms, with fresh capital to supplant the limitations of the private partnership model, cannot be shown either effective or beneficial. The firms don’t need, don’t want and couldn’t use the money, even if the bankers were prepared to take the risk, which they aren’t.
And, third, while the private market participants show their indifference to any initiative to help the auditors’ plight, beyond their own whining about limited choice, the menu of possible government actions is no more appealing.
That is, proposed official actions such as breaking up or spinning off parts of the Big Four, or requiring mandatory auditor rotation, or placing caps on auditor liability in hope of assuring their survivability, are all politically infeasible and potentially pernicious in their own unknown and unpredictable effects.
With the prevailing American political zeitgeist defined by populist cries for change, there is no chance of traction for either legislative or market-based relief in favor of a small cadre of high six-figure audit partners.
If the GAO stopped there, with its reputation behind an admitted inability to alter current conditions in any managed way, its shoulder-shrugging would at least advance the public discourse.
But its failure goes deeper – the same recurring flaw that runs through officialdom worldwide -- in the erroneous claim that the impact of another large-firm failure would be ameliorated by the relevant federal agencies. All three -- the SEC, the Public Companies Accounting Oversight Board and the Department of Justice -- are said by the GAO to be prepared to take various actions to help minimize the disruption to the market.
Walker and the GAO are wrong. There are no such preparations. The agencies are impotent. Out-going PCAOB chairman William McDonough admitted it in September 2005: “none of us has a clue what to do if another of the Big Four failed.” Unless there is a double-secret codicil to the GAO report, concealed somewhere in a bunker in a Washington file drawer, the same remains true today.
So the Comptroller General is merely acting out the bureaucrat’s classic rationalization of inactivity, in accordance with his basic genetic make-up: if nothing can be done, selling inaction as the best course becomes the strategy.
Or as baseball philosopher Yogi Berra would have put it, if the accounting regulators don’t want to solve the problems of large firm concentration and survival, nobody’s going to stop them.
Comments