Government Assignment and Financing of Audits? The New York Times Offers a Poisoned Bouquet

“Full many a flower is born to blush unseen,

And waste its sweetness on the desert air.”

 -- Thomas Gray, 1751

 There are three good reasons to be both optimistic and thankful that the New York Times editorial of August 15, 2014 – calling for “a revamped system in which audits are paid for not by company management, but by fees that companies pay to a public entity for the purpose of financing audits” – will fail to achieve traction.

These are, in ascending order of significance:

First, any print release at the absolute nadir of the annual news cycle, on a Friday in the dog days of August – and on the widely-observed holiday of the Feast of the Assumption at that – is bound to be ignored as inconsequential.

Second, two key people are distracted and not listening. The Chairman of the Securities and Exchange Commission, Mary Jo White, has shown no more interest in the accounting profession than her predecessors. And in any event, White herself is teetering on her back foot; as the NYT itself only two days earlier put it, “she has disappointed a wide swath of would-be allies … whose opinions of Ms. White’s performance range from dissatisfied to infuriated.” 

While over at the Public Company Accounting Oversight Board, chairman James Doty is fully tied up with deciding whether or not audit partners should sign opinions for their firms or in their own names – a long-perplexed but basically trivial matter not worth the years of wasted effort. Meanwhile, Doty’s latest feat is an inspection protocol announced on July 18, 2014, with the audit authority in Denmark. A pleasant little country, Denmark, but so insignificant to the global capital markets that it has only five PCAOB-registered firms in all, including but three of the Big Four, while the list of countries where the PCAOB remains stymied is headed by the 46 registered but uninspected firms auditing the massive economy of China – where successfully evasive politics continue as slippery and entangled as a bowl of ramen.

Third, the NYT’s endorsement of government-administered audit assignments reflects either breath-taking naïveté or an incomprehensible and unworthy lack of understanding of the audit services market – one that has operated exclusively on the “client pays” model since privately-provided assurance was invented in the 1850’s in England and Scotland.

Not that the accountants are or should be free from critical scrutiny. Examples of legitimate current concerns include:

• The very acceptability of the accounting by Lehman Brothers and its auditors, EY, cited by the NYT editorial itself.  

• The personal conduct of a very small handful of their partners (e.g., here and here).

• The settlement announced on August 18 by the New York State Superintendent of Financial Services with PwC, imposing a $ 25 million fine and a two-year ban on certain consulting for New York-regulated banks, summarized by the NYT as a “watering down” of a report on money transfers for blacklisted companies by Bank of Tokyo-Mitsubishi (and for a considerably contrasting description, compare Matt Levine’s Bloomberg View).

The large-company audit market continues under the near-total dominance of the Big Four – whose aggregate 717,000 personnel in fiscal 2013 generated $ 114 billion in global revenue for their 38,000 partners. For a government agency to assume the administration of the greater part of that sector of professional services – hardly a mere “revamping” – would present a catalog of challenges unexamined by the NYT and unaddressed by even the profession’s most rabid critics:

• What single-country government agency could evaluate and compare the global competence, resources and freedom from conflicts of auditor candidates in every one of the several dozen countries where a global-scale company operates and would require audit services?

• What costs and disruptions would the audit networks have to incur, to tender their credentials and proposals to such a government body? And how would their business model mutate, by way of talent and audit performance, if forced to deploy their resources to such a business-seeking process.

• Because government agencies are by their very DNA unable to resist political pressures, what would be the impact of the inevitable lobbying on behalf of small and minority firms, lower-tier accounting school graduates, and population groups under-represented in the profession?

• Would auditors bid for appointments? And if so, what pricing mechanism could be functional to provide transparency and integrity?

• Or would engagement assignments be dispensed like government permits? And if so, what public confidence could be reposed in light of historical experience with the awards of broadcast licenses, mineral exploration rights and cable and mobile franchises?

• How would the constraints of government-dictated budgets and liability exposures be reconcilable with the need for engagement cost changes in light of judgmental decisions to modify or expand audit scope?

• In light of these and a host of other questions, how could a government-run process of auditor proposal, selection and monitoring possibly function on a schedule that would enable the delivery of audit reports both timely and informative to the community of interested users?

In short, what possible public legitimacy could an agency achieve, operated under the aegis of a government that has inflicted on its citizens such administrative monstrosities as the Internal Revenue Service, FEMA and healthcare.gov?

A robust public dialog has long been needed on the structure and the future of privately-provided large-company audits. Happily, with the overhang of issues like the above, if it does take place, it will not be in context of last week’s proposal by the New York Times.  

 

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Comments

[Robert F. Kelley]

Only an hungry, auditor with low IQ would think this was a good idea.

RFK

[Richard Brodsky]

Jim, you mouth the words about the need to hold auditors accountable, but you balk at every suggested remedy: firm rotation, payment by users, government conscription. What would you do to prevent auditors from failing to do proper audits, agreeing to financial double-talk, or worse?

[TMU]

Sure, let the government take over assigning audits/managing payment. It has worked out so well with Medicare and Social Security, the Post Office and everything else the govt has gotten its incompetent hands on.

[Jim Peterson]

Richard -
Thank you for your thoughts, and for your expression of frustration, which I share.
As some time with the archives and topics of this blog will show, I have been exploring the so-called "solutions" since the 2002 launch of its predecessor, my column in the International Herald Tribune -- see, for example, August 7, 2011.
What emerges is the consistent unresponsiveness of these "solutions" -- including those you mention -- to the basic viability of a sustainable and useful assurance services model. The causes range from political impossibility (liability reform), marketplace limitations (new entrants, insurance), anachronistic or short-sighted regulation (scope of practice, independence, government take-over), to a combination of all of them (rotation).
Along with these barriers to achievability, the large firms remain exposed to the deadly shock of litigation, lacking either structures or capitalization to resist the forces that broke up Arthur Andersen in 2002 and Laventhol in the 1990's (see my post of November 30, 2011).
My desire is and has been for a "robust public dialog" -- which to be productive would require confronting deeply entrenched attitudes on traditional professional practices, organization and oversight.
Unfortunately, all of the interested parties retain their separate reasons for resistance to disturbing the status quo. But if it should happen, I would be eager to occupy any seat in the room.
Thanks again.
Jim