Re:Balance -- Jim Peterson

“Count Down” – The Second Edition Is Published

The second edition of my book -- “Count Down: The Past, Present and Uncertain Future of The Big Four Accounting Firms” -- is, to my pleasure, just released by Emerald Books.

Deliveries are available – see Amazon. Up-dated, revised and extended, this trade edition is now designed -- and priced --  for readers in accounting and other professions, corporate management and governance, finance and investing.

The new “Count Down” brings into its updated narrative important developments since publication of the December 2015 first edition, affecting the Big Four and the threats facing their business model:

The Big Four’s growth to collective global 2016 revenue of $ 128 billion, and the structural implications of the continued growth disparities between their Audit and Advisory practices.

The imposition and implications of mandatory auditor rotation under legislation and regulation in the European Union; and in the US, the PCAOB’s requirement to name lead partners on public company audits.

New examples of corporate financial malfeasance, regulatory and law enforcement proceedings and potentially disruptive auditor litigation, involving each of the Big Four and their large global clients – of which a partial sample here:

• Deloitte’s Brazil firm in December 2016 incurred an eight million dollar penalty, the largest ever imposed by the PCAOB, and practice bars and other sanctions against twelve partners and employees, over confessed alteration of documents, false testimony and lack of cooperation with the PCAOB’s inspections and investigations.
• EY in September 2016 was the target of two SEC enforcement actions, involving censures, fee disgorgements, fines and practice bars against its personnel, over charges of loss of independence based on “close personal relationships” between engagement partners and client personnel -- in one case a romantic relationship and in the other, significant expenses paid for travel, entertainment, sporting events tickets and family vacations for the client CFO and his family.
• KPMG in April 2017 fired five partners and an employee, including its Vice Chair of Audit and its head of Audit Quality and Professional Practice, over its receipt and handling of advance inspection information leaked by an employee of the PCAOB.
• PwC’s delivery of the wrong “best picture” envelope, and the resulting tumultuous ending to the February 2017 broadcast of the Academy Awards, evoked public ridicule -- although the significance of the debacle was pale compared with the potentially fatal financial impact of two multi-billion dollar lawsuits, relating to its audits of Colonial Bank and MF Global, where jury trials in process in August 2016 and March 2017, respectively, were discontinued in favor of settlements for confidential amounts.

This new edition also expands in scope and detail on the required re-engineering by which – with the necessary but unlikely mutual cooperation among financial statement issuers and users, the accounting profession, legislators, regulators and agencies of law enforcement – a sustainable structure for financial reporting and assurance might emerge -- that is, a Big Audit model truly fit to serve today’s global capital markets.

The issues here have meaning and impact not only for professionals in the Big Four and the smaller but no less affected firms, but also for those working with and for public companies and their clients, and investors who rely on robust audited financial statements, as well as individuals and institutions holding the securities of public companies in their savings and retirement funds, Keoghs and IRAs, pension and endowment funds.

The story of the fragility of the business model of the Big Four retains its importance. In that spirit, I hope it is worthy of your attention. I invite you to order -- read -- enjoy (or at least be stimulated). Reactions are invited. Comments on Amazon are welcome and encouraged -- as are "likes," "shares" and RTs on Facebook and Twitter, messages on LinkedIn, and especially, recommendations to friends and colleagues. As for any disagreements or criticisms -- feel free to write me directly at [email protected].

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Ukraine’s Bank Regulator Whacks PwC – As For The Broader Messages?

The 103^rd anniversary on June 28 of the assassination of Archduke Ferdinand in Sarajevo, with the consequent world-wide descent into the maelstrom of warfare, should remind that under aligned conditions, “distant and obscure” does not mean “benign and inconsequential.”

 It was reported in the Financial Times on July 20 and the KyivPost on July 21, 2017, that the National Bank of Ukraine – the country’s banking authority – has struck PwC’s firm from its bank auditor registry. The alleged failure:

“to highlight the credit risk faced by PrivatBank PJSC, which led to the bank being declared insolvent and nationalized, with substantial recapitalization costs borne by the state.”

To the charge of failing to identify a $ 5.5 billion balance sheet hole, PwC issued the expected statement of disappointment: “PwC performed its audit of PrivatBank’s 2015 financial statements in accordance with international auditing standards” – typical language in private litigation, but of cold comfort as the firm faces loss of its Ukrainian bank audit franchise.

PrivatBank starkly displays the “Expectations Gap,” at its worst. That is, even a GAAS audit assumed to be immaculately compliant with professional standards would not remotely satisfy the hindsight pique and anguish of an immature small-country regulator, forced to hoover up the droppings of a political crony’s quasi-private piggy bank.

My response to a media inquiry on the implications in Ukraine, and more broadly for the Big Audit model, gathered these notes, here at more length than a broadcast soundbite permits:

First, as hostage to the NBU, PwC’s plight illustrates the accounting profession’s hazard where government as enforcer also has a client’s direct financial interest. That is, whatever PwC’s virtuous claim to good work, the firm cannot simply dig in and litigate, as it would against a private plaintiff, because its adversary controls its very right to practice.

Examples abound. From bygone days was Arthur Andersen’s travail with its Belfast audit client DeLorean Motor Company – because the major investor was the British government. There, HMG not only sued the audit firm when DeLorean collapsed in 1982, but it also black-listed Andersen from auditing British government enterprises and agencies, inflicting the crippling loss of a portfolio of actual and potential future work. (Full disclosure – I was a senior in-house counsel at Andersen at the time, with involvement in the unpleasantries.)

Second, there are potentially disruptive consequences to Ukraine’s banking sector – depending on the extent of PwC’s market share and the availability of replacements. (While the website of PwC Kyiv states that among its industry services, it is “particularly focused on the banking sector,” a table as of 2011 shows PwC in a fairly distant third place among the Big Four.)

Even if not an issue in Ukraine, a harbinger of potential larger concerns is the uneven distribution of audit expertise in the major economies. Consider, that is, the disruptive impact on available auditor choice in Germany if KPMG were to lose its license there, as it audits almost half of the country’s DAX 30 companies, or if PwC in the United Kingdom were excluded from auditing its 40% share of the FTSE 100.

Third, there are operating implications for PwC beyond Ukraine. It will lose whatever cross-border work it does for the subsidiaries and affiliates of home-country institutions outside Ukraine; and it will also be challenged to conduct audits for foreign banks with Ukrainian operations requiring audits under the NBU’s authority – needing to seek out the resources in-country either from the other Big Three or among whatever cross-border banking expertise may reside in other, smaller firms.

Finally, there is the large-scale question of the stability impact on the Big Audit model. In the bigger picture, Ukraine is not big enough to matter – PwC could simply shut down there without significant impact on its global business. Not so, however, if a regulator in a seriously large economy were to do the same – because loss of license in a G20 country -- on the scale of Spain or France or Italy, or surely Germany or Japan or the UK or the US – would mean a network-wide failure of client service capability. That would speedily disintegrate an entire Big Four network – with disruptive impact on the entire Big Audit model, incapable of functioning with only Three members.

Andersen’s virtually overnight downfall in 2002 is illustrative – to serve its large-company clients on a global basis, a Big Four network cannot operate anywhere if it cannot operate everywhere.

The scale and gravity of PwC’s issues in Kiev should not be under-stated. The writing on the wall may be devilish hard to read, being in Ukrainian, but its meaning is both clear and ominous.

 

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