Re:Balance -- Jim Peterson

Around the Media – “The Economist” Gets A Good Deal Right

Recognition should be given where deserved. Mainstream media reporting on the grave challenges to the viability of the Big Audit model is typically so uneven and ill-informed that generosity favors freely extended tips of the hat.

Perhaps especially to express appreciation for the pick-up of a few choice words of my own.

So please do read the piece in the current issue of the Economist – “Accounting scandals - The dozy watchdogs”.

I had spoken at length with its author, Dan Rosenheck – with whom I am in considerable alignment, especially on our shared view that the historical “pass-fail” auditors’ opinion is sadly deficient to provide value to the complexity of today’s demanding capital markets.

Rosenheck quotes me thus:

“An auditor’s opinion really says, ‘This financial information is more or less OK, in general, so far as we can tell, most of the time’, says Jim Peterson, a former lawyer for Arthur Andersen, the now-defunct accounting firm that audited Enron. 'Nobody has paid any attention or put real value on it for about 30 years.'"

Where next? With the “expectations gap” so glaringly wide, and the perception of inadequate auditor performance so widely expressed, where does the dialog need to go?

Regular readers here will know my attention to the unachievable nature of the “magic bullet” solutions put forward by those who combine their passion for the subject with their ignorance of how Big Audit actually operates – for examples of which, see the reader comments reacting to the Economist piece as representative.

In this, I admit lack of success in calling off Rosenheck from two glaring examples:

• Selection or actual performance of audits by agencies of government – suggested by the New York Times but which I have discussed (August 20, 2014) as being so impractical as to attract and deserve nothing but howls of derision.

• And the fantasy of “audit insurance” – a long-discredited notion from academia that not only fails both the basic principles of insurability and the capacity of the market to provide coverage for the multi-billion dollar failures that threaten the lives of the Big Four accounting firms, but which is conclusively shown to be impractical by the simple fact that if realistic, it would already have been put in place by the insurance industry itself (see my posts going back to May 5, 2008, and July 15, 2008).    

Which does not take away from this central point:

If the dialog on the survivability of Big Audit is not treated as important and worthy of candid engagement by all the interested players, then its very viability is threatened by the kind of “Black Swan” event that would require re-design of large-company audit out of the wreckage after a catastrophic collapse.

And that threat should be appreciated as far too disruptive to be tolerable. 

 

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Deloitte's Audit Ban in Saudi Arabia -- And Its Global Effects?

This week’s report that the Capital Market Regulator in Saudi Arabia will ban Deloitte’s firm from auditing public companies there as of next June 1, on account of its work for the targeted loss-making company MMG, will not be going down well for the largest of the global Big Four accounting networks.

Much more ominously, a collateral outcome of the Saudi black-ball may be the long-feared destabilizing of the Big Four’s trust-based franchise to audit the world’s largest companies, by a disruptive event in a location mistakenly assumed to be peripheral.

It has been well-enough recognized, since 2002 when Arthur Andersen’s leaders fatally failed to placate the US Department of Justice over conduct related to Enron, that it hurts to be on the wrong side of angry life-or-death power. Conversely, there are ample examples of the Big Four’s escape from scrutiny in settings too small to be consequential.

It’s the combination that is dangerous: an authority without a mature history of regulatory predictability, but with enough influence to unsettle the Big Audit model.

For some illustrations:

• In 2000, the Italian antitrust authority had the then-Big Six firms dead in its sights, with charges of price-fixing and other coordinated anti-competitive conduct. Lacking either the will or the motivation to push for practice prohibitions or other changed behavior, however – and who knows about “Italian justice” -- the agency was content to tap the firms gently on their wrists.

• PwC’s firm in Russia spent several years in litigation over its 2002-2004 audits of Yukos, under potential threat to its license to practice. But as now reported, PwC having remitted its fees to the government in settlement, it is comfortably persona grata, as shown by its engagements for Gazprom and Sperbank.

• PwC also suffered the inconvenient protracted incarceration of two of its Indian partners and their lengthy criminal trial, over the billion-dollar “ghost employees” scheme confessed in 2009 by Ramalinga Raju, founder and CEO of Satyam Computer Services. Results of the trial are expected at the end of this month. But it would seem unlikely that PwC‘s global chief Dennis Nally would have travelled to Delhi last month to head up his firm’s vigorous pimping a Goldilocks view of the country’s economy under Prime Minister Modi, unless he was thoroughly comfortable that the expected outcome would not disturb his firm’s presence there.

What is important is that none of these countries are large and important enough to matter. The Big Four’s global networks could survive worst-case exclusion from local practice in Russia or Italy or India.

It could have been a different and life-threatening story, by contrast, if in 2006, the sanctions imposed on PwC in Japan for its work on Kanebo had not been so flexible. With the size and global connectedness of the Japanese economy, PwC dodged a fatal bullet, permitted to survive the forced closure of its local firm by organizing a new local affiliate – which came to absorb many of its personnel and, vitally, by which it was able to continue both local work for foreign clients and ex-Japan work for its clients there.   

Which comes back to Saudi Arabia – where, incidentally or not, Deloitte also audits the Saudi-listed telephone provider Mobily, another investigation target after profit cuts, a stock price collapse and the suspension of its chief executive officer.

What is now unknowable is how far abroad the Saudi sanctions will run. In mature regulatory environments, official enforcement would not cascade into private sanctions across a Big Four client list. Leadership of a CalPers or PIMCO or Vanguard would resist imposing a ban on one of the Big Four that would cause self-inflicted disruption to the companies making up their massive fund portfolios.

Could the same be said of the global holdings of the Saudi royal family?

Demonstrably sensitive to any suggestion of lack of transparency, Prince Alwaleed Bin Talal is the chairman of the Kingdom Holding Company. On his watch, Deloitte’s consignment to pariah status in his country must be of concern, for example, to Deloitte’s firm in the UK, as auditor of one of the Kingdom’s premier real estate holdings, the massive Canary Wharf development in London.

More’s to the point, it might safely be predicted that, if the Prince has any say in the matter, only if Riyadh freezes over will Deloitte compete successfully against the incumbents for audit engagements of such prize Saudi holdings as Citigroup (KPMG), EuroDisney (PwC) or News Corp (EY).

The rippling effects of Deloitte’s Saudi-originated punishment may be grave enough. Further, with the acute pressures on auditor choice and replacement arising from mandatory re-tender requirements in the UK, and the rotations mandated under new legislation in the European Union, the structural impacts beyond a single unpredictable country can only be … well … unpredictable.

 

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