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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