Can Another Audit Firm Collapse? Absence of Evidence is not Evidence of Absence

Sitting out these balmy summer evenings, I have a clear look at my neighbor’s corroded and rusty front porch, which is diagnosed as a clear hazard, at risk of collapse at any moment.

He stubbornly refuses to replace the rotten ironwork, despite the dual exposures: the lawsuit when it falls, perhaps under his visiting grandchild or the postman, and the disclaimer of coverage by his insurance company based on his willful inaction.

“It’s stood there for thirty years,” he rationalizes. “So there’s no problem.”

Wrong. Just because it hasn’t happened doesn’t mean it can’t. Or won’t.

It’s so commonly mis-apprehended: absence of evidence is not evidence of absence.

The towers of the World Trade Center stood tall and firm – until the morning of 9/11/01. John F. Kennedy was a vital and glamorous president --until November 22, 1963. Bear Stearns was a maverick Wall Street success -- until the spring of 2007, when the failure of its models and its products made it the poster child for an industry floundering without control or direction.

The past is an unsatisfactory measure for the proof of a negative today.

Look at the Australian airline Qantas, with its a unique and admirable record – never a passenger fatality, over its entire history. Does that mean it can’t happen?

Qantas surely enjoys a favorable comparison with commuter carriers in rural China or the flag carriers of African despots. But the recent news photographs of the Qantas fuselage mangled by an exploded oxygen tank make this graphic point: any system designed and run by human beings is subject to a non-zero risk of large-scale breakdown and terrible consequences.

On these pages, not surprisingly, that comes around to the survivability of the current model for the delivery of audit services to the world’s large companies – the franchise dominated by the Big Four firms.

There is a sterile unwillingness in the public dialog to acknowledge and act on the real existence of a catastrophic threat. The committee convened by the US Secretary of the Treasury is due to issue its final report next month on the sustainability of the audit profession – here -- and there is every indication that this group of wise persons will not even reach a consensus statement on the credible existence of a threat to the firms’ survival.   

My neighbor’s mis-guided rationalization about the safety of his porch, that “it can’t happen here because it hasn’t so far,” is severely undercut by the porch collapse two doors down the street – another house of identical age, design, construction and weather exposure.

And what are those blithe about the threat to the audit firms learning from the speedy disintegration of the Arthur Andersen firm in 2002? Unthinkable as it would have seemed in advance, reality struck within a matter of weeks, despite Andersen’s 90-year history as a robust and stable enterprise, a leader of the profession, with both profitability and cohesion that were the envy of its peers.

How is it possible, either for my short-sighted neighbor or for those professing concern for the future availability of a sound and stable large-company assurance function, to avoid leading any discussion agenda with this reality: “Collapse can happen. And we had better call in the safety engineers before somebody really gets hurt.” 

But then, who is there to answer to call? Where the leadership on this vision might be found is a matter for discouragement, if not for despair.

The regulators? Not in the closing months of the Bush administration. Treasury Secretary Paulson has his pre-departure plate full with the credit markets and a rescue for Fannie Mae and Freddie Mac. When a typical bureaucrat’s idea of “long-term” strategy means avoiding an issue long enough to foist it onto a successor, no more can be expected of the Paulson Committee than the very low expectations threshold of a politically correct assembly of antagonists.

The financial statement users? If the recent letter to European Markets Commissioners Neelie Kroes and  Charlie McCreevy from the International Corporate Governance Network is any indication -- here -- the investor community is still fixated on such quaint if unworkable notions as small-firm competition and distaste for liability caps.  

And what about the leadership of the large firms? Here is the challenge to private sector leadership, where innovation in the free-market system should be expected to reside. It will take courage beyond that shown so far, for a Big Four chief executive to inform his partners that their business model is broken, and requires replacement for the sake of future survival.

If not, hindsight will charge the profession’s current leaders, whose state of public denial still avoids that difficult step, with a dereliction of their stewardship obligations to their younger generation. Because nobody else is going to rise to the occasion, the question is whether it matters enough today that they will. 

Comments

[Steve Coleman]

Hear, hear.All we can do is warn and regulate. Neither of which can prevent collapse caused through human action or non-action as the case may be!