“Hic Sunt Dragones”
--Map inscription supposed by medieval cartographers to warn of dangers in uncharted waters
Auditors realizing the hazards of fee-paying business? Hell freezing over!!
Perhaps the wintry bomb cyclone of this holiday weekend in the eastern United States signals a convergence of unlikely events.
With the spectacular flame-out of Sam Bankman-Fried’s crypto exchange FTX, the Armanino and Prager Metis firms have been sued over their audits of its US and international operations; Mazars pulled its “proof of reserve” report on Binance and cut ties with other crypto clients; BDO displayed its anxiety over its crypto client work; the Big Four sit in the background with little show of appetite for crypto’s possibly terminal disruption.
That the crypto sector could be revealed as so toxic as to repel the gate-keepers of the capital markets might once have been beyond imagination –- it long having been an insiders’ wry one-liner that the short wording of a Big Audit engagement letter was, in its entirety, “Will work for food.”
Yet the profession’s retreat from crypto's trackless wilderness suggests two propositions:
- There actually are activities beyond the auditors’ capability to provide assurance within the standards developed since the invention of independent audit in the Victorian era.
- There actually are enterprises whose plans, strategies and operations, and their management competence and ethos, are so deviant as to make them unsuitably risky as clients.
It's scarcely ever been thus. A rare exception arose in my time as in-house counsel at a Big Eight firm –- olden days, very long ago, well before the company that became Enron mutated from a middle-America network of gas pipelines, and before “generally accepted” professional guidance was imposed by Washington functionaries.
(Apologies -- only with both reluctance and prudence am I still obliged to mask identities.)
One of the Big Eight was offered the first-ever audit of a global-scale cartel –- a massively complex, multi-national enterprise with pervasive presence and influence. There was no proposal process or competition –- no questions or limitations –- instead a gigantic potential fee, with no negotiations, and the work was for the taking.
The firm’s senior risk manager for the industry laid down a short, blunt, and non-negotiable refusal. “It can’t be audited. We know there are undiscovered nooks and crannies. We could never penetrate the hiding places and the dark corners. No fee is worth either the political exposure or the catastrophic risk of litigation.”
Had only that experience been more widely applied –- how might have differed the last decades of “where were the auditors?"
Today, the audit firms that have put crypto work out to the public are already exposed and should expect to pay a price. Some number of their “proof of reserve” and actual audit reports are bound to attract the plaintiffs’ lawyers. Despite the Armanino firm’s position that its digital asset practice generated a mere one percent of its revenues, it is hostage to the “one and done” ligation impact that Enron inflicted on Arthur Andersen.
It would be encouraging to think that the profession is acting on a recognition, however belated –- like the coyote chasing the road-runner over the cliff –- that it’s a long fall to a rocky crash.
Where to from here?
Little enough should be expected from the regulators, who as usual are a day late and a dollar short. That's despite both the bold position of SEC chair Gary Gensler that, for crypto companies’ compliance, “the roadway is getting shorter,” and the speed with which the agencies of American law enforcement swooped down upon SBF, flipping his two top lieutenants and snatching him from the Bahamian authorities to face US-style justice under a $ 250 million bond and electronic monitoring in his parents’ home. There’s a fulsome discussion to be had, as Francine McKenna takes up this week at her substack, The Dig, as to how the regulators were watching the store while fictive crypto entities were allowed to grow like alien invaders into the legitimate capital markets.
Meanwhile in the marketplace itself, both the accounting firms and their clients may be choosing a cleansing re-appraisal of their activities.
It would be cause for cautious optimism if the large firms’ charting of the crypto map led them -- rather than acting as cosmeticians willing to apply lipstick to a pig -- to a simple veto message: “neither crypto nor anybody else has an entitlement to our work, name, or reputation.”
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