Re:Balance -- Jim Peterson

Managing the Scale of Deadly Risk -- Of Planes, Batteries, Cars and Guns

 

“Ignorance is the softest pillow on which a man can rest his head.”

            -- Michel de Montaigne

It is good to be back in the classroom again – a seminar of bright graduate students in Risk Management, searching for wisdom among the host of examples where business, the professions and policy-makers have botched up in large and highly consequential ways. 

Relevant to the current news cycle is this syllabus topic: among the shared lessons from such disasters as the Costa Concordia, MF Global and H-P/Autonomy, is the realization that harm and damage increase exponentially as events “scale” in size.

That is, a huge hurricane is more than ten times as destructive as ten small windstorms; a car crash at 100 mph is far more deadly than twenty fender-benders; urban pathology in a city of a million people is more than ten times as complex as in ten towns of one hundred thousand. 

Of immediate relevance: no number of over-heated personal computer batteries in the internet cafes could match the potential for incendiary catastrophe of a single lithium-ion meltdown in a Boeing 787 (here).

Nor could all the saloon fist-fights and domestic arguments in a whole police precinct generate the grief of a fatal drive-by shooting. And however impactful to the victims and their families, all the dispersed one-off weekend homicides lack the societal impact of the 26 deaths in the Newtown massacre.

What follows, by way of lessons?

First, there is no “average” harm among a set of events – whether natural disasters or vehicular accidents or civil violence – that are distributed for frequency and impact not on a bell curve but on a graph shaped like a hockey stick.

And for the same reason, the very rare, front-page events are inherently beyond precise prediction, identification or prevention on a “top-down” advance basis.

Instead, risk identification and mitigation of potential catastrophes can only occur at the lower levels of the “pyramid of close calls,” where symptoms of potentially deadly problems can be teased out and nipped in the bud.

As Boeing may be learning -- under whatever belated enlightenment emerges from the realization that its Dreamliner quality program apparently came “batteries not included” – the weakness in its deficient design approach escalated exponentially. By separately outsourcing the lithium-ion batteries and their chargers to different suppliers (here), Boeing forfeited the “bottom-up” quality testing needed to reveal battery flaws far back at the pre-assembly stage.

Other examples abound. The standard commoditized auditors’ report, widely derided for its obsolete and limited message that financial information is “mostly right, most of the time,” proves less and less valuable either to identify, warn of or avoid the large, rare but too-common outbreaks of global-scale corporate chicanery and abuse.

Likewise, providing weapons to every school teacher can be no more effective against the threat of an unidentifiable deranged shooter – but would be just as wastefully costly and fraught with unintended consequences – as the mandating of universal mammograms or colonoscopies above age forty, or the construction at public cost of an individual apartment for every single member of the urban homeless.

As for the challenge of reducing gun violence in America – it cannot reside with the futile attempt to isolate or disarm specifically dangerous individuals – who, like the potentially harmful white-collar criminals or breast cancers or faulty batteries, are too dispersed and lurking beneath detection in the general population.

It is, rather, to act on as many of the “close-call” factors as possible, across the entire spectrum of contributing factors: bans on non-recreational assault weapons and high-capacity magazines, registered transfers with universal background checks for issues of criminality or mental health, mandatory licensing and training as with automobiles, buy-backs and turn-ins, and required insurance and liability for manufacturers, sellers and users.   

To achieve the elusive next “massacre that doesn’t happen,” none of these alone is a certainty. Nor can they all add up to perfect elimination of risk. As with the catalog of other examples, that is impossible in a complex and humanly fallible environment. The achievable goal instead is the accretion of incremental opportunities to interrupt the chain.

Just as it took an iceberg to “failure test” the complacency of the Titanic’s design flaws, the slaughter at Newtown illuminates society’s obligation to re-engineer its approach to gun violence, from the ground up.

 

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Happy New Year -- What's On the Accounting and Assurance "Worry List" for 2013?

For the financial information community – issuers, users and gate-keepers -- what looms ahead for 2013? Now that we have survived the end of the Mayan calendar, crawled back from the edge of the year-end fiscal cliff, dodged briefly the threat Greece poses against the Euro, and crowned Alabama as the champions of college football? 

For starters, in a very target-rich environment, three potentially malign influences may be in retreat:

First, on the everlasting postponement of converged international accounting standards, the combination of political antagonism and absence of a sensible rationale desirably signals the end of the endless charade.

IASB chairman Hans Hoogervorst did temper his usual bellicosity at the AICPA’s annual December knees-up with the SEC and the PCAOB – not that his sabre-rattling had ever done the cause any good. The SEC lacks a head cheerleader, being populated these days by lame ducks, ghosts and placeholders – so with newly-designated chief accountant Paul Beswick’s deputy Julie Erhardt the nearest to a champion, the diffidence in her understatement amounted to a punt from the regulatory end zone.

While across the Atlantic (see the always-informative Edith Orenstein for the FEI), the ICAEW in the UK bailed out. Its report, The Future of IFRS, calls for non-adopters with “strong national GAAP” to take their own convergence “option” – an unmistakable message to the US to go its own way.

Second -- if finally game-over for convergence, it’s no less so for mandatory auditor rotation – never more than an unachievable notion in futile search for evidentiary support (here). Reality has taken hold in Europe in a climb-down from proposed six-year rotations and “audit-only” firms, despite a fervid pro-rotation residue unrelieved by the complete lack of factual basis. And an important voice of reason is heard in the US -- PCAOB member Jay Hanson – conceding at the AICPA conference that he “doesn’t know” what a “reliable study … would conclude with respect to audit tenure’s effects on audit failures and deficiencies…” and expressing skepticism “as to whether we would ever be able to make that connection.”

Third – the always-fraught issue of auditor liability remains challenging, if unlikely to be existential.

The manipulators of short-term statistics did nobody a favor by asserting in December that “things have changed” for the better from the post-Enron wave of auditor liability claims – a hostage to fortune disprovable at the time and subject to immediate invalidation (see below).

On the contrary, the Big Four in the UK fell all over themselves to emphasize their litigation exposure, in resisting the Competition Authority’s suggestion of a benign environment. True enough, that official proposition dangles from two illusory hooks – that short-term calm portends a longer-lasting trend, and that the large firms have available insurance remotely adequate against potential claims measured in the billions – neither of which is sustainable.

The real problem is that the large firms have never succeeded in carrying the burden of their message – dating back to 2008 and the embarrassing inability of the US Treasury’s fractious Advisory Committee on the Audit Profession even to agree that life-threatening litigation was an issue.       

In this tangle among the confused, the perplexed and the unpersuasive, three recent items are informative:

First, Ernst & Young’s agreement to pay C$ 117 million to settle civil litigation in Canada relating to its work for the failed Chinese company, Sino-Forest, does not approach the calculable limit of E&Y’s financial tolerance. But it is amply big enough to exceed either E&Y’s local Canadian resources or its global-scale nuisance value. And an upward re-set of the liability record in any developed economy cannot bode well in the hands of aspirational plaintiffs’ lawyers.

Second, the slow-moving litigation machinery in Iceland has ground out not only prosecutions and now jail sentences for senior members of its renegade banking sector, but also new claims against PwC in both Iceland and the UK, on the non-trivial order of $ 490 million, relating to its audits of Landsbanki, added to a prior claim for $ 2 billion over its work for Glitnir Bank, commenced against the firm in the US in 2010 and re-started in Iceland in 2012 (here).

Third, the HP-Autonomy fiasco in the UK saddles the Deloitte firm with years of runaway defense costs and disruptive diversion of senior management. Even if Autonomy CEO Mike Lynch’s robust defense of his company’s accounting proves entirely vaporous, however, or substance emerges in the announced investigation by the US Justice Department, Deloitte’s exposure is wrapped in several layers of insulation:

• The reluctance of the UK system to impose death-threat damages.
• HP’s reluctance to proceed adversely against its own alliance partner.
• The high threshold facing HP shareholders attempting to sue Deloittte derivatively in the company’s name.
• And the hostility of American courts to claims having a foreign nexus and one step removed from HP’s own financial reporting.

Auditor regulators in the United Kingdom not having a record of aggression, timeliness or ferocity, the Autonomy debacle is unlikely to tar Deloitte, either at all or at least within a time span occupied by anyone currently in positions of authority or responsibility.

So much for what may pass as good news. There’s a good deal more of concern, in this new year – but not today – so please watch this space.

 

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