Re:Balance -- Jim Peterson

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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The Big Four Accountants and the Specter Bill to Reverse "Stoneridge": Please Don't Throw Me in that Briar Patch!

Because “dumbed down” education is a poor trade-off for political correctness, it is unfortunate that the Uncle Remus stories no longer flow through children’s literature into popular culture.

A favorite from my childhood involved the wily Br’er Rabbit, who was caught up by Br’er Fox’s tar baby, but duped his nemesis by imploring, “Please, don’t throw me in that briar patch.”

Even though my father’s rural twang made strange work of the concocted plantation dialect of Joel Chandler Harris and his 1880’s adaptation of African-American folktales, the didactic moral in the rabbit’s witty strategy was clear – the briar patch was where escape and safety lay.

It’s the same today for the large accounting firms in the United States, who confront a dilemma in the legislation proposed by Senator Arlen Specter (D-Pa.) to overturn the January 2008 decision of the Supreme Court in the Stoneridge case (here), so as to broaden and extend civil liability claims against gate-keepers and other secondary actors for violation of the American securities laws. (For a very nice and concise summary, see Kevin LaCroix’s D&O Diary.) 

The auditors’ position is particular. Despite blizzards of careless commentary, their litigation risk in the classic big-ticket shareholder actions was unaffected by Stoneridge, since the public availability of their reports distinguished them from the equally essential but backroom roles of the bankers and the lawyers -- for whom the Specter proposal offers a clear and present threat of massive new liability.

So the lobbying will be focused and furious. But like Br’er Rabbit, if the auditors are well advised they will recognize the opportunity that lies in amendments suggested by Columbia Law Professor John Coffee (here) – offering the auditors a briar patch within which they might at last find relief for their threatened survival.

As a bone to the considerable influence of the lobbies of potential new defendants, Br’er Coffee suggests liability limits for secondary actors – a concept that for the auditors is essential (if not sufficient – see here) if they are to attain survivability in the face of their over-hanging and potentially ruinous litigation exposures.

Not that Professor Coffee has his dollar formula remotely within politically achievable limits. With the recent generation of schemes and corporate failures measuring well into the hundreds of billions, investor representatives will rail that damage ceilings of $ 2 million for individuals and $50 million for corporations are off by at least two orders of magnitude. 

Coffee does go on to suggest a “wealth ceiling” of ten percent of income, net worth or market capitalization. This is a test that the Big Four accounting firms could survive – if based on the $ 10 billion that is the roughly-averaged 2008 income of their practices in the US-dominated American region. (And interestingly, a $ 1 billion damages ceiling for US exposure would also be consistent with Big Four survivability under research done for the European Commission – here. ) 

Could the Big Four persuade Br’er Specter to throw them into that liability patch? Several reasons would indicate skepticism:

There is the challenge of vision. Leadership of the profession has been notoriously squeamish, and several vials short of the testosterone level needed to propel them forward in support of a holistic legislative program for their own survival.

Further, the complex political calculus in Washington suggests that the administration of President Barack Obama will toss something to its left side. If so, lobbying dexterity will be tested to the extreme to insert and maintain liability limits into the Specter plan. In this process the accountants will need to align forces with the other gate-keepers – a logical if historically rare occurrence.

Put another way, there is the simple matter of legislative effectiveness, at which the accounting profession’s dismal track record is perhaps best cited to the description given by Crash Davis (Kevin Costner) in the 1988 baseball classic, Bull Durham: “Couldn’t hit water if they fell out of the (freaking) boat.”  

Inaction and passivity will leave the large firms where they are -- stuck to the tar baby of their litigation exposure. Initiative, subtlety and cunning may not be in long supply, on the other hand – but in the animal kingdom of Washington, they offer a best hope.

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Happy Times for the Big Four Accounting Firms? It's All in Whom You Read

The familiar formula for measuring forward-looking attitudes has an update:

The optimist sees a glass half full.

The pessimist sees a glass half empty.

Whereas -- the consultant sees a glass that’s twice as big as it needs to be.

Varying spins are given to the report just issued by the flagship firm of PricewaterhouseCoopers in the United Kingdom, for its year ended in June – 72 pages of sunshine about its £2.25 billion in revenue, profitability that works out to a 34 percent profit margin, and £770 thousand average profits per partner.

The Lex column of the Financial Times cheerily bought in – here. The pink color of the FT’s pages infuses the lenses through which it sees two themes:

“First, firms and their auditors have become more conservative since the Enron and WorldCom debacles. Second, Sarbanes-Oxley in the US and harmonized reporting standards elsewhere have forced greater disclosure requirements.”

The always-acerbic blogger Dennis Howlett begs to differ – here - with a link to the PwC report itself. His focus is on the structural impact of the decline in PwC’s audit and tax revenues, as offset by its rise in advisory practices, with notable emphasis on the £100 million derived from PwC’s work on the Lehman administration: 

“PwC UK may be doing very well at the moment but you can see where it is going. I anticipate that over time, it will continue to reduce its dependency on assurance services as the engine for growth but with it will come renewed criticism of its conflicted advisory position.”

The FT manages with a straight face to say that “the most important asset the accountants have maintained in this recession is their reputation” – a rosy view, not even shared by Floyd Norris of the New York Times (here), and suffering two-fold difficulties:

First, it is hard to see the recent years as a Goldilocks era for the accountants, post Enron and Sarbox, with the lengthy list of financial institutions that have fallen to collapse, shotgun mergers or government control – all of them flagging clean reports on their financial statements and their controls even as they plunged over the cliff to ruin.

It is more likely proved once again that the capacity for scandal-driven public outrage is both limited and finite, the only variable being the number of targets at which insults are sprayed.

That is, the energy and attention demands of the various stimulus and rescue efforts, and the related demonizing of the institutions and their high-bonus leaders – screeched by politicians, regulators and media alike – have in effect given the auditors at least a temporary pass from hostile scrutiny.

Second, there is the FT’s remarkable proposition that “the downturn has not notched up a big accounting scandal.” That’s as may be, but only if from its London base the vision stops at the shores of the sceptered isle.

Because the rest of the world will not disregard the inclusion of auditors in claims directly associated with the collapsed financial institutions (tracked and summarized by Kevin LaCroix at the D&O Diary), the massive claims involving the audits of the Madoff feeder funds (here) or the existential threat posed by the Satyam fraud in India to PwC’s practice in that country or the on-going criminal prosecution of its personnel there – the last flagged by Howlett although ignored by the FT and indeed by the PwC UK report itself.

Solutions to the multi-faceted antagonisms that ensnare the Big Four and put their survivability at risk will not be brought forward under the dewy pandering of the Financial Times. But it’s not that Howlett gets a complete pass either.

Howlett may be signaling that PwC is his entry in the commentators’ pool on the next of the Big Four to catch a fatal bullet – here. The near future will test the marker he puts down, to “watch for a potential breakup a la Arthur Andersen in years to come. Especially if they get nailed on Satyam.”

But he is experienced, skeptical and critical enough of the large firms’ exposed position to contribute above the unhelpful one-dimensional finger-pointing ordinarily delivered by the profession’s usual cast of critics. The sharp point of his pen could constructively jab at an issue much more challenging than the Big Four’s public relations exercises – such as this:

“If the large-company audit structure collapses, what takes its place?”

That’s a discussion yet to start.   

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