Re:Balance -- Jim Peterson

The Great Maple Syrup Caper -- A Sticky Mess in Quebec

While bidding farewell to the old year and welcoming the new, this Christmas Eve story out of Canada should not be lost in the holiday news cycle: 

“Over a one-year period during 2011 and ’12, some 6 million gallons of maple syrup – about $ 18 million worth – were stolen from the ‘strategic maple syrup reserve’ controlled by the Federation of Quebec Maple Syrup Producers (FPAQ)…. Last week, three men were arrested in connection with the heist.”

The Mounties have ridden to the rescue, the arrest total reportedly has reached 18, and weightier issues can now be on the table than a supply threat to the breakfast calorie count. Namely:

Producers around the world closely protect their strategic assets – whether Middle Eastern petroleum (OPEC), Japanese agricultural products (Nokyo), Colombian narcotics (Cali and Medellin) or American professional football and basketball players (NCAA). So it should not be surprising that the question is debated about Quebec, why our typically mild-mannered northern cousins maintain a government-run cartel to promote market stability in the supply and pricing of gourmet pancake toppings.

A better question, though, is just how fully one-quarter of the national stock – the equivalent of 16,000 barrels of syrup – could have been siphoned out of a warehouse described in the FPAQ’s own press release as “secured by a fence and locks, and visited regularly.”

The question must inevitably be asked, in short, “Where were the gate-keepers?”

Fortunately for the appetites of the world’s luxury crepe-and-candy consumers, the thieves were undone because they chose the hard way, working their felonious little scheme on the liquid commodity itself. Their sticky footprints left a trail, because to monetize their scheme required a disposition infrastructure – trucks and warehousing, a processing facility in neighboring New Brunswick and a sales pipeline through which to channel their slippery merchandise into the sweets-addicted US market. 

In this, they suffered the detection risks of scams like that of India’s Satyam in 2009 – where maintaining a roster of 13,000 phony employees would arouse the curious to wonder about the absence of ancillary evidence – the ghost workers’ non-existent desks, telephones and withholdings and remittances for health care and benefits.

Simpler, harder to detect and far less messy, would have been the time-honored creation of inventory that was fraudulent and fictitious from the outset. Consider these classics:

• The great Salad Oil Scandal of 1968, by which Tino DeAngelis floated only enough vegetable oil on bulk tanks of water to fool auditors who looked and tasted from the top rather than tapping the tanks at the bottom.

• Equity Funding in 1970’s Los Angeles, with over-stated death benefit liabilities under fictitious life insurance policies turned into cash through a Ponzi scheme of cessions to reinsurers.

• The South American coffee shipper, showing tons of stock on its balance sheet and available for collateralized borrowings, in reality comprising only camouflaged piles of sand under thin layers of beans.

• Over-stated Texas cattle herds, sold to unwary urban tax-shelter buyers – it being no great trick to run the same calves repeatedly through a maze of corrals, past the clip-boards of credulous city slickers unwilling to dirty their suits to exercise the control of chalk-marking the forehead of each passing animal.

• Or the related German scheme by which a fleet of trucks was over-counted in their repair sheds by auditors distracted from the back parking lots, where the vehicles were re-cycled by simply switching their license plates and dashboard bar codes.

The examples are as endless as the ingenuity of the criminal mind. Had the light-fingered Canadians only thought through the vulnerabilities of their targeted provincial cartel’s control system, they’d have kept their hands far cleaner while moving phony paper rather than hot syrup.

And they’d have made their illegal fortune while avoiding not just the brown sticky stuff, but what will now be extended stays in government custody, where the pancakes in the prison cafeteria will not be flavored with so much as a drop of down-market Aunt Jemima’s.

 

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Congratulations to a New Chicago Cop! Now -- How Do We Support You?

 My nephew Rory Oliver was sworn in this morning as a new police officer for the City of Chicago. So the usual topics are put aside, so I can say “congratulations,” and offer my respect and admiration.

Marine veteran, number one for fitness in his academy class, ridiculously fit – he’s worked for this goal with focus and intensity, both physical and mental. Loving father of a handsome son and a daughter on the way this winter -- devoted husband with the caring support of his marvelous wife -- parents and brothers and grand-parents and in-laws pulling for him – he exemplifies all we can hope from the first responders of whom society asks so much.

So how will we respond, to Rory and his class of fellow rookies -- ready to answer the call, and to put on the line for us all that they love and value?

Surely it’s time in our national discourse to act on these core truths:

• That there is no place in civilian life for weapons designed only for warfare, for armor-piercing bullets or for high-capacity magazines.

• That if we can license and regulate and restrict access to the rights to drive a car or give a haircut, we can design reasonable safeguards around the constitutional right to bear arms. 

• That while access to mental health care should be part of our commitment to care for those in our midst least able to care for themselves, there is no discernible difference between the deeply disturbed in America and those in other countries where the ability to wreak homicidal violence is impeded by effective limits on gun access.

• That the same liability system that puts responsibility on the sellers and distributors of other dangerous means of harm and injury can work effectively to constrain the supply chain of gun-related death and destruction.

As a matter of priority we must start there, because suicidal “outliers” will always slip through any cracks, undetected and unpredictable – no system for deterrence or counsel will stop those crazed enough to act. But it makes the wrong point, looking at the foreign killer with a knife, to say, “See, it happens there too.” The right question is, “What do we learn, of how many were spared, because he could not get a gun?”

Or, for that matter, the deadly feedstock of ammunition. For a gun without bullets is no more than household décor, unusable to inflict deadly harm on spouse or sibling or self. As a weapon, an unloaded firearm is only a club, and an ineffective one at that. So cutting off the means to damage, especially large clips and belts, must be one of the many fruitful ways to start rendering more safe our schools and theaters and homes and public places.

I was raised in rural America, where gun ownership and the safe, respectful use of firearms was part of every household, including mine. Skill with a gun determined whether there was meat on the table, and bragging rights accrued to skill on the target range. I need no persuasion on the diverse scope of our national culture.

But the accommodation to hunting and sport and the rights contemplated by our nation’s fathers should not extend to the failure to assure the freedom from wanton slaughter of our first-graders.   

So we salute you, Rory Oliver. We are proud of your calling and your ambition to serve. We will rely on your strength and your dedication. We will pray daily for your safety and that of your brethren in uniform. And we are dedicated to help you, in the quest to free our land from its course of senseless mayhem and to make it instead a place of peace and safety for all. 

 

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Foreign Auditor Inspections? "China Syndrome" Strikes the SEC

 

Confidence in the American securities and accountancy regulators was not raised, when a press release on December 3 announced -- under the headline “SEC Charges China Affiliates of Big Four Accounting Firms …In Refusing to Produce Documents” – a proceeding against the five largest global networks.

For the first time in its eleven-year history, this column calls upon a graphic to illustrate the folly of a gang that couldn’t count straight:

 

   The PCAOB has been stymied for a decade in its futile attempts to enforce in China its asserted mandate under Sarbanes/Oxley to inspect and obtain working papers from auditors, including those in foreign countries, which audit more than twenty percent of a registrant’s assets or revenue (here). And the SEC itself has been piddling along with company-specific subpoena enforcement and administrative proceedings against Deloitte and its Shanghai affiliate.

So now they have called in the heavy artillery, in the person of Robert Khuzami, director of the SEC’s Division of Enforcement, who says that non-complying firms “face serious sanctions.”

Khuzami cannot be faulted for zealotry. He arrived on the scene of an agency whose Cox-era somnolence had missed not only Bernie Madoff’s predations on the domestic front but the internationally destructive tsunami of “reverse mergers” by which Chinese companies gained access to the world’s capital markets. That scorecard, a decade late and billions short, now includes more than 50 de-listings by the SEC and 40 fraud actions – and, elsewhere, a flurry of civil litigations, and most recently an agreement by Ernst & Young to settle civil litigation (but not a disciplinary proceeding) relating to Sino-Forest, by agreeing to pay C$ 117 million, the largest auditor settlement in Canadian history.  

(As an aside, those disposed to see darkly conspiratorial revolving doors in the place of Chinese fire drills will note that this is the same Khuzami whose predecessor at SEC Enforcement from 1998 to 2001, Richard Walker, thereafter went in-house at Deutsche Bank, where he hired Khuzami in 2002. So the latter, before becoming the top American securities cop in 2009, was on-scene at DB when the bank – as now reported – according to three whistle-blowers concealed losses of up to $ 12 billion for failure to “mark-to-market” the exposure gap on a notional $ 130 billion of exotic derivatives known as “leveraged super-seniors.”)  

Calling in Khuzami’s troops may look like the last act of desperate regulators – but it will actually play as the next act in “The Comedy of Errors.”

That’s not because it’s so little so late. Or because frustration of the PCAOB’s aspirations to access Chinese auditors and work papers would attract retaliation against their own ambitious plans to re-structure the global audit market by building and unleashing global-scale Chinese audit firms – an ambition otherwise unachievable both for want of competence in personnel and standards but also because, in reciprocal hostility, other countries will be no less protective of their local prerogatives.

It’s mainly that the US regulators’ only weapon of significance – banning Chinese affiliates of the large global accounting networks from qualifying to work on audits of American-listed companies – would ripple far beyond the toxic roster of China-based companies.

There are potential consequences for global-scale companies with significant operations in China that go far beyond the inability of the PCAOB to inspect their local audit firms, whether or not maneuvered to keep below the 20% threshold.

Consider just two examples: Caterpillar, whose annual filing with the SEC does not set forth results by geography but discloses total 2011 sales of over $ 60 billion and elsewhere reports its China sales to be 3% of its total. Or HSBC, which does report by region including $ 3.6 billion in profits from China in 2011 and whose mainland Chinese operations include 133 outlets including 27 branches, even after the announced sale of its interest in giant insurer Ping An.

A barrier to the use of Chinese audit firms would make it impossible for those companies to include audited results from their Chinese operations in their global accounts. The result would be top-level consolidated financial statements with a huge unaudited portion, and auditors forced in their opinions to confront the professional standards for limitations on their audit scope.

Across the globe from KPMG in London and its top-level opinion on HSBC, to PwC in Peoria, Illinois for Caterpillar – unable to rely on their excommunicated Asian brethren – auditors would have no choice but to use the dread “qualify or disclaim” language -- never seen for a public company because anathema under the rules of the SEC itself.

Or, in extremis, PCAOB de-registration of the whole of an audit network deemed non-compliant would render a company’s entire financial filing unacceptable.

Restoration of adult-level expectations and the pursuit of a non-litigated resolution process is essential, although a fading hope – since calling in the police as a last resort means an escalation of hostilities due to the one-dimensional DNA of their approach to problem-solving.

For good reason, then – under the latest blows from SEC Enforcement – the large accounting firms must feel like a bunch of nails in a hammer-testing factory.  

 

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Thanks for joining this dialog. Please share with friends and colleagues. Comments are invited and welcome, and subscription is easy and free, both on the Main page.

 

 

 

Re-Posting: Foreign Auditor Inspections? "China Syndrome" Strikes the SEC

Confidence in the American securities and accountancy regulators was not raised, when a press release on December 3 announced -- under the headline “SEC Charges China Affiliates of Big Four Accounting Firms …In Refusing to Produce Documents” – a proceeding against the five largest global networks.

For the first time in its eleven-year history, this column calls upon a graphic to illustrate the folly of a gang that couldn’t count straight -- here.

The PCAOB has been stymied for a decade in its futile attempts to enforce in China its asserted mandate under Sarbanes/Oxley to inspect and obtain working papers from auditors, including those in foreign countries, which audit more than twenty percent of a registrant’s assets or revenue (here and here). And the SEC itself has been piddling along with company-specific subpoena enforcement and administrative proceedings against Deloitte and its Shanghai affiliate.

So now they have called in the heavy artillery, in the person of Robert Khuzami, director of the SEC’s Division of Enforcement, who says that non-complying firms “face serious sanctions.”

Khuzami cannot be faulted for zealotry. He arrived on the scene of an agency whose Cox-era somnolence had missed not only Bernie Madoff’s predations on the domestic front but the internationally destructive tsunami of “reverse mergers” by which Chinese companies gained access to the world’s capital markets. That scorecard, a decade late and billions short, now includes more than 50 de-listings by the SEC and 40 fraud actions – and, elsewhere, a flurry of civil litigations, and most recently an agreement by Ernst & Young to settle civil litigation (but not a disciplinary proceeding) relating to Sino-Forest, by agreeing to pay C$ 117 million, the largest auditor settlement in Canadian history.

(As an aside, those disposed to see darkly conspiratorial revolving doors in the place of Chinese fire drills will note that this is the same Khuzami whose predecessor at SEC Enforcement from 1998 to 2001, Richard Walker, thereafter went in-house at Deutsche Bank, where he hired Khuzami in 2002. So the latter, before becoming the top American securities cop in 2009, was on-scene at DB when the bank – as now reported – according to three whistle-blowers concealed losses of up to $ 12 billion for failure to “mark-to-market” the exposure gap on a notional $ 130 billion of exotic derivatives known as “leveraged super-seniors.”)

Calling in Khuzami’s troops may look like the last act of desperate regulators – but it will actually play as the next act in “The Comedy of Errors.”

That’s not because it’s so little so late. Or because frustration of the PCAOB’s aspirations to access Chinese auditors and work papers would attract retaliation against their own ambitious plans to re-structure the global audit market by building and unleashing global-scale Chinese audit firms – an ambition otherwise unachievable both for want of competence in personnel and standards but also because, in reciprocal hostility, other countries will be no less protective of their local prerogatives.

It’s mainly that the US regulators’ only weapon of significance – banning Chinese affiliates of the large global accounting networks from qualifying to work on audits of American-listed companies – would ripple far beyond the toxic roster of China-based companies. There are potential consequences for global-scale companies with significant operations in China that go far beyond the inability of the PCAOB to inspect their local audit firms, whether or not maneuvered to keep below the 20% threshold.

Consider just two examples: Caterpillar, whose annual filing with the SEC does not set forth results by geography but discloses total 2011 sales of over $ 60 billion and elsewhere reports its China sales to be 3% of its total. Or HSBC, which does report by region including $ 3.6 billion in profits from China in 2011 and whose mainland Chinese operations include 133 outlets including 27 branches, even after the announced sale of its interest in giant insurer Ping An.

A barrier to the use of Chinese audit firms would make it impossible for those companies to include audited results from their Chinese operations in their global accounts. The result would be top-level consolidated financial statements with a huge unaudited portion, and auditors forced in their opinions to confront the professional standards for limitations on their audit scope.

Across the globe from KPMG in London and its top-level opinion on HSBC, to PwC in Peoria, Illinois for Caterpillar – unable to rely on their excommunicated Asian brethren – auditors would have no choice but to use the dread “qualify or disclaim” language -- never seen for a public company because anathema under the rules of the SEC itself. Or, in extremis, PCAOB de-registration of the whole of an audit network deemed non-compliant would render a company’s entire financial filing unacceptable.

Restoration of adult-level expectations and the pursuit of a non-litigated resolution process is essential, although a fading hope – since calling in the police as a last resort means an escalation of hostilities due to the one-dimensional DNA of their approach to problem-solving.

For good reason, then – under the latest blows from SEC Enforcement – the large accounting firms must feel like a bunch of nails in a hammer-testing factory.

 

My apologies for the re-posting, especially to subscription readers to whom the intended video clip did not feed -- a lesson learned in attempting to reach beyond competence with technology.

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HP - Autonomy: How Might the Auditors Survive the Fall-Out?

The toxic cloud spreads, from the implosion of HP’s $ 11.1 billion Autonomy acquisition, and the $ 8.8 billion write-off announced on November 20 by CEO Meg Whitman: 

• Whitman’s claims of pervasive accounting fraud have been vigorously denied by Autonomy’s ex-CEO Mike Lynch, and derided by critics as a mask for HP’s own faulty due diligence, gross over-payment and post-transaction mis-management.

• Prompt lawsuits followed, derivatively on behalf of HP and by shareholders as a class, against the usual targets including Deloitte as Autonomy’s statutory auditor in the UK and KPMG in its role for HP. 

• Referrals have been made to authorities in both the US and the UK, the scope of whose interest and enthusiasm has yet to be made public.

As to the various Big Four firms, pointed questions arise -- beyond those expected about Autonomy’s revenue accounting and HP’s due diligence – going to the structural heart of the traditional auditor-client relationship:

• Floyd Norris in the New York Times: “’Where were the auditors?’…They were everywhere.”

• Francine McKenna, “Re: The Auditors: “’To the victor’s auditor go the audit spoils’…is not how the Big Four audit industry is played now that consulting is again King.”

• Tom Selling, “The Accounting Onion”: “If Autonomy’s accounting practices were too aggressive, would Deloitte’s staff have had the gumption to push back given the stakes?”

Meaningful discussion of these issues, which unfortunately have proved intractable for decades, requires confronting two essential issues: 

First, because Autonomy’s accounting and reporting and Deloitte’s issuance of the standard commoditized auditor’s report are targeted as unsatisfactory, just when critically important, the question is raised yet again: what good are models having the appearance of utility, only up to the point of their unexpected exposure as insufficient, when suddenly they don’t? 

Second, the finger-pointing at Deloitte’s alliance relationship with HP and the scope of its non-audit services for Autonomy raise again the unresolved obsolescence of the notion of “appearance of independence.”

Regulators have the large accounting firms’ expansion of non-audit services in their sights – most recently at the recent AICPA’s SEC-PCAOB conference:

Acting Chief Accountant Paul Beswick: “I question whether accountants' expanding practices into areas unrelated to their primary competencies weakens public trust.”

PCAOB Chairman James Doty: “Audit practices have shrunk in comparison to audit firms' other client service lines — not all of which are schooled in, or depend upon, the fundamental exercise of skepticism. This threatens to weaken the strength of the audit practice in the firm overall.”

If the accounting profession is to survive what will otherwise be another generation under this radioactive rhetorical cloud, fundamental adjustments are in order. 

The first would be a robust defense of the “client-pays” model: however much criticized, it dates to the invention of independent assurance in the 1850’s, and is the only approach ever to stand the test of actual adoption and use.

“Client pays” being irreconcilable with “independence in fact,” however, the HP-Autonomy fiasco is a reminder of the profession’s long-standing inability to articulate intellectually stable support for “independence in appearance.” 

So it is time to renew the proposition I have advanced for years (see my March 24, 2006 column in the International Herald Tribune) -- that, “the sacred cow of auditor independence should be led off and humanely put out of its misery.” What I said there remains vital:

“The concept of auditor independence does not serve the interests of investors.

“Audit performance - and more immediately, the survival of the large firms to serve their global clients and the capital markets - would be better achieved if the current independence requirements and constraints were scrapped altogether.

“Auditors should be free to provide their clients with any services within their skills. The only thing that should be required is comprehensive disclosure of all relationships, to be evaluated and decided by the voting power of the marketplace.”

At the same time, clearance of the radioactive debris of independence inhibitions would free the marketplace once for all from the entire sterile debate over permissible services by auditors.

The community of financial information users is capable of defining, engaging and valuing the scope of services available from its gate-keepers -- whether bankers, lawyers, rating agencies or auditors.

If the trade-off for the large accounting firms, for release from a system of constraints that has long lost its value, is a downward re-assessment in the value of their traditional core product – which would only acknowledge a reality long suppressed or denied in any event – that is an exchange worth making. 

For their future as legitimate participants in the world’s capital markets may well hang in the balance.  

 

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