Re:Balance -- Jim Peterson

Audit “Reform” in the UK – the Government Finally Speaks, and Says Little

On March 18, the UK government weighed in with its long-promised consultation paper (the “Consultation), “Restoring Trust in Audit and Corporate Governance.” Ninety-eight questions, spread over 232 pages, contain much that is cautious and little that is innovative. The problem is, what is cautious would not innovate, and what would innovate is not cautious.

For another day, the Consultation’s fulsome treatment of such worthy topics as the re-purposing of the UK’s audit regulator, the performance and accountability of corporate directors, and the very purpose of corporate information assurance. On the central topic of public concern since the failure of Carillion back in January 2018 -- the structure and performance of Big Audit itself -- the Consultation offers on only two items.

These are the “operational separation” of the Big Four’s audit and advisory practices, and the threatened imposition on FTSE 350 companies of “managed shared audits” – a novel concept unknown to either professional standards or actual practice.

The first is easily disposed of, as an insubstantial exercise in optics. The second, to be further discussed, is ill-conceived and deeply flawed.

“Operational separation” should have been recognized as a trifling matter the instant it was mooted (see § 6 of the April 2019 Final Report of the Competition & Markets Authority on its Statutory Audit Market Study).

That’s because the UK critics have neither the will nor the authority to force the Big Four networks to expel either of these core UK components from their global structures – disruptions that would disable them from the breadth of services demanded by the complex auditing of the world’s large public companies. Attempted “full legal separation” at the UK level, in other words, would be either or both legally impossible and globally inconsequential.

Moreover, it’s no surprise that the Big Four would accede to the Financial Reporting Council’s quest for public display of their audit leadership, governance and financial reporting. The simple reason was that they already had such structures and metrics in place -– essential tools for managing these four large businesses -- audit practices having published 2019 revenues of between £ 453 and £ 713 million.

Back to “managed shared audits” -- the Consultation contemplates (¶¶ 8.1.15-.16) that a FTSE 350 client of the Big Four would be obliged in its audit tender process to identify a “meaningful proportion” of its statutory audit -- not less than 10% and desirably closer to 30%, by metrics including audit fees, group revenues, assets and profits – to be performed by one of the so-called “challengers” – that is, a firm below the Big Four in size, yet brave enough to deem itself qualified to propose.    

Whisper who dares: in a triangular relationship among an issuing company, its lead auditor and a “challenger,” such an arrangement could satisfy none of the three.

Because the Consultation would not allow for joint bidding (¶ 8.1.17), a Big Four firm preparing to take the lead would start from an untenable position –- not even knowing the identity of the smaller firm, much less its qualifications, reputation or resources by either industry or geography. Despite which, that lead auditor would, under applicable professional standards and the liability regimes to which its global-level work and overall opinion would be exposed, bear full responsibility for the results of the group audit including the work performed and up-streamed by the “challenger.”

Passing for the moment whether such inhibitions would implicate a scope restriction on the lead auditor’s acceptance and planning (see International Standard on Auditing 300), a lead firm’s risk manager would have cardiac arrest at any lesser level of involvement than essentially 100% re-performance of the work of the “challenger.”

As for the company under audit, its management and audit committee could scarcely with comfort identify between 10% and 30% of its operations to be devolved for audit by a “challenger” whose capability and experience at the FTSE level would range from untested to non-existent.

Complicating the risk assessments of both the company and the lead auditor are two issues that inhere in the globalized nature of the large-company environment. First, a recent study estimates that 62% of the sales of FTSE 100 companies (and 35% for the FTSE 250) are generated in locations and operations outside the UK – beyond the geographic scope of a UK-based audit team. That means either that a “challenger” would be obliged to bring its own global resources to bear at the same level of multi-national scope and scale as its putative client – as the Big Four do now -- or that a company would essentially devolve what it could of its UK-based operations, leaving the lead auditor to carry out the ex-UK work and perform the eventual audit and reporting on the consolidation.

Also on the global front, affecting each leg of the triangle is the FTSE 350’s trading of their securities not just in the UK but in other major markets – especially the US where, as put in a recent cautionary article, American Depository Receipts are offered to investors “for over 200 UK companies including most of the country’s large cap companies.” The long US history of high-cost shareholder and other lawsuits presages liability exposures for which the “challengers” are woefully unequipped, and for which the Big Four would have no appetite to carry the burden of their smaller brethren.

Finally there is the unavoidable but compelling matter of the scale and capability of the “challengers” themselves – who audit none of the FTSE 100 and but ten of the next smaller FTSE 250 (see Figure 38, p. 48, of the Financial Reporting Council’s “Key Facts and Trends in the Accountancy Profession,” October 2020).  

In a 210-page Impact Assessment accompanying the Consultation, a model is cobbled together to support an aggressively optimistic position on the growth potential of the “challengers.” Using historical audit fee income for the five largest, ranging from 1% to 4% (page 127), a “conservative assumption (is made) that annual capacity growth of 2-4% can be safely sustained by challenger firms.”

Two problems – one of method and one of supply – are fatal.

For the first, the model disregards the Big Four-dominated growth of overall FTSE audit fees, as shown by two relevant data points: the 2018-2019 growth in Big Four audit fee income of 6.9% (page 46 of the FRC’s “Key Facts and Trends”) and the UK audit practice growth figures for 2020 reported separately by the Big Four, ranging from 3% to 8.7%.

Bluntly put – at the “challenger” growth rates assumed by the Consultation model, and the faster rates actually achieved by the Big Four -- the “challengers” would be losing market share, not gaining. Not assumed, but indeed omitted, would be the inability of the challengers in this zero-sum environment to grow relatively, enough faster than the Big Four to achieve an actual shift in their market share.

To which must be added a further and final point -- the supply side problem of the “challengers” to grow their necessary rosters of experienced partners. Within the Consultation’s timetable, their only available recruitment sources are the Big Four themselves, where individual partners would understandably question a poacher’s overture: reduced profitability and lower compensation, lesser industry experience and technical support, and uncertain financial resources in the face of expanded liability exposure.

The “managed shared audit” proposal would exacerbate those concerns -- because the partner-level obligations and responsibilities at a lead firm would expand in the execution of an engagement involving a “challenger.”

That is, in a single-firm engagement, a signing partner (and the other partners on a complex job) have the benefit of the coherence, cohesion and efficiency of working with a team of subordinates sharing a common set of methodologies, documentation, vocabulary and communications. Delegations can be made, and expectations set, in the relative confidence of shared membership in a common enterprise.

Not so, where that lead partner would be obliged to receive, review, and accept ultimate responsibility for ten to thirty percent of an engagement as staffed and performed by strangers – for which there could be no solution but to increase dramatically the level of partner time, energy, and attention.

At the broad market level, such a shared-audit concern would anticipate major partner-driven fee increases at the lead firm. At the personal level, Big Four audit partners would expect to see their value enhanced, not diminished, by the forced carving out of portions of their FTSE company portfolios – with a concomitant further reduction in a poacher’s attractiveness.

Shot through as the Consultation is with other failures and short-comings of vision – to be addressed here anon – it is earnestly to be hoped that its proposal of “managed shared audit” will promptly and deservedly be dismissed as impractical and unachievable, lest it crash in unintended consequences if an attempt is actually made to put it in place.

 

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Remembering Bernie Madoff -- His Character Was Provable on the Golf Course

Bernie Madoff, the Ponzi schemer who died in prison yesterday while serving a 150-year sentence, provided great wealth for this blog, if not to the broad array of credulous customers from all levels of society,  from whom he extracted over $ 17 billion. One of my favorites, from March 27, 2009, is re-offered here in full, lest the memory ever fade of an irresistible pedagogic moment for my graduate students in Risk Management and Decision Making:

Teed Off at Bernard Madoff?

Bernard Madoff was observably crooked, and his long-running swindle could easily have been stopped, early on. Except that those in the know either didn’t care, or had their own interests to be served.

Calling a halt to his scheming did not require a wake-up call at the soporific SEC, so thoroughly outed after the fact by whistle-blower Harry Markopolis, or performance of the due diligence that the feeder funds promised their customers, for which they and their gatekeepers will now pay the litigation cost.

Instead, it was as simple as the questionable honesty of Madoff’s golf game – and the mutually corrupted readiness of his country-club set of investors to subvert the integrity of that ancient sport.

Deep in “Madoff’s World,” Mark Seal’s delicious piece in the April 2009 edition of Vanity Fair, Seal observes that in the catalog of Madoff’s obsessive-compulsive mannerisms, his golf game was as tightly managed as the rest of his life. He quotes Donald Trump: “Out of hundreds and hundreds of rounds, he never shot lower than 80 or more than 89.”

Although the former guy may not top everyone’s list of character witnesses, there’s an unmistakable clue to Madoff in his throwaway line, “Experts say he’s either the most consistent golfer in the world or he’s cheating.”

In golf as in most other endeavors, whether recreational or professional, there is simply no way to avoid the occasional bad day. A weekend duffer with no hope of approaching par will still have the rare round where the gods smile, drives are straight and every putt drops. Still, there are two tails to every bell curve. Symmetry teaches that there are days when the sand traps eat up approach shots and the cup seems to have a lid – and an honest scorecard shows it.

So the only way Madoff could have shown his reputed consistency would have been through all the available manipulative devices: improved lies, do-over shots and disregard of the whiffs and the penalties for landings in the water.

Golf being an activity where integrity relies crucially on self-reporting, that brings up the role of Madoff’s interested enablers -- the playing partners who would have seen his doubtful conduct in the bunkers and on the greens – but who if they called him, stood to lose their privileged access as early beneficiaries of his Ponzi scheme.   

Regular readers know that I have neither aptitude nor appetite for golf (here), choosing instead to keep the game safer for everyone by staying in the clubhouse. For its culture and protocols I rely on my friend Joe, who played scratch in college and still posts a handicap in the single digits.

He tells of a now-retired professional athlete of epic dimensions, who receives a guest's celebrity welcome on courses worldwide, but who will never be invited into serious club membership – because he is known to fiddle his scores, stiff his caddies and welsh on his bets.

That measure of the seriousness with which the game’s code is taken, and the apt phrase from the fractured Latin of the law schools – falsus in unum, falsus in omnibus – point the finger of accountability at Madoff’s companions. Facing the disrepute of Madoff’s violations, they evidently elected to accommodate their source, lest the promised stream of their investment returns be closed off.

Joe taught me that the dour Scots who invented the game called it “golf” because the more pungent four-letter words were already taken – “hell” or “damn” or the stronger alternatives, muttered or shouted in exasperation at the shanked drive or the malignly placed tree branch.

Would that Madoff’s blind-eyed followers had had the honesty to call “foul.”

 

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Bernie Madoff, the Ponzi schemer who died in prison yesterday while serving a 150-year sentence, provided great wealth for this blog, if not to the broad array of credulous customers from all levels of society,  from whom he extracted over $ 17 billion. One of my favorites, from March 27, 2009, is re-offered here in full, lest the memory ever fade of an irresistible pedagogic moment for my graduate students in Risk Management and Decision Making:

Teed Off at Bernard Madoff?

Bernard Madoff was observably crooked, and his long-running swindle could easily have been stopped, early on. Except that those in the know either didn’t care, or had their own interests to be served.

Calling a halt to his scheming did not require a wake-up call at the soporific SEC, so thoroughly outed after the fact by whistle-blower Harry Markopolis, or performance of the due diligence that the feeder funds promised their customers, for which they and their gatekeepers will now pay the litigation cost.

Instead, it was as simple as the questionable honesty of Madoff’s golf game – and the mutually corrupted readiness of his country-club set of investors to subvert the integrity of that ancient sport.

Deep in “Madoff’s World,” Mark Seal’s delicious piece in the April 2009 edition of Vanity Fair, Seal observes that in the catalog of Madoff’s obsessive-compulsive mannerisms, his golf game was as tightly managed as the rest of his life. He quotes Donald Trump: “Out of hundreds and hundreds of rounds, he never shot lower than 80 or more than 89.”

Although the former guy may not top everyone’s list of character witnesses, there’s an unmistakable clue to Madoff in his throwaway line, “Experts say he’s either the most consistent golfer in the world or he’s cheating.”

In golf as in most other endeavors, whether recreational or professional, there is simply no way to avoid the occasional bad day. A weekend duffer with no hope of approaching par will still have the rare round where the gods smile, drives are straight and every putt drops. Still, there are two tails to every bell curve. Symmetry teaches that there are days when the sand traps eat up approach shots and the cup seems to have a lid – and an honest scorecard shows it.

So the only way Madoff could have shown his reputed consistency would have been through all the available manipulative devices: improved lies, do-over shots and disregard of the whiffs and the penalties for landings in the water.

Golf being an activity where integrity relies crucially on self-reporting, that brings up the role of Madoff’s interested enablers -- the playing partners who would have seen his doubtful conduct in the bunkers and on the greens – but who if they called him, stood to lose their privileged access as early beneficiaries of his Ponzi scheme.   

Regular readers know that I have neither aptitude nor appetite for golf (here), choosing instead to keep the game safer for everyone by staying in the clubhouse. For its culture and protocols I rely on my friend Joe, who played scratch in college and still posts a handicap in the single digits.

He tells of a now-retired professional athlete of epic dimensions, who receives a guest's celebrity welcome on courses worldwide, but who will never be invited into serious club membership – because he is known to fiddle his scores, stiff his caddies and welsh on his bets.

That measure of the seriousness with which the game’s code is taken, and the apt phrase from the fractured Latin of the law schools – falsus in unum, falsus in omnibus – point the finger of accountability at Madoff’s companions. Facing the disrepute of Madoff’s violations, they evidently elected to accommodate their source, lest the promised stream of their investment returns be closed off.

Joe taught me that the dour Scots who invented the game called it “golf” because the more pungent four-letter words were already taken – “hell” or “damn” or the stronger alternatives, muttered or shouted in exasperation at the shanked drive or the malignly placed tree branch.

Would that Madoff’s blind-eyed followers had had the honesty to call “foul.”

 

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Vax Populi: A Dispatch From the VA

Yesterday morning, volunteering at the COVID vaccination center in the hulking Veterans Administration hospital on our city’s south side, I offered a supporting arm under the elbow of a bent and broken warrior.

“Vietnam” on his cap, oxygen tank in a camo backpack over his stooped shoulders, cane in a trembling hand -- he was so wracked with COPD that he could not shuffle unaided the twenty feet to the check-in desk from the arrival door – his determination to get the vaccine having brought him only that far.

Here for context:

Back in early February, the only side effect after my own first Pfizer shot was a full-body wave of relief, optimism and gratitude.

Among the very few benefits of advancing age, my priority group was right behind the first responders. That, along with the privilege of readily available medical care, put me well up the queue. After my no-wait, no-pain jab, came an emotional challenge: since we are not all safe until everyone is safe, how in good conscience could I not put some of my discretionary time into support for the broadest and fastest distribution?

A quick web search led me to the coordinator of volunteer services at the VA, where the vax site was up to speed at around 600 doses a day, and expanding its initial access for the 80-year-olds down to age seventy.

I’m now six weeks as a member of a red-shirted team of volunteers. Working in shifts of six to eight, we take stations at the corners and the corridors that are points of confusion. We answer questions, relieve anxieties, and mainly manage the traffic flow from curbside to paperwork, onward to the actual shots, the necessary recovery/waiting area and eventual discharge.

It is affecting, to be with these vets. Nearly all black and brown men, they fully display the grim array of their conditions – service-sustained as well as the obvious weight, both literal and figurative, of lifetimes of economic, educational and life-style inflictions.

They know the VA. It’s a familiar venue, for which they come fraternally dressed. Most wear caps, jackets or insignia that identify their branch and era of service; the others sport the gear of a local team. Accustomed by their military training and culture to stand or sit with patience in the inevitable waiting lines, they pass the time establishing with total strangers the instant comradeship of their shared experience.

From my first day, helping the process of disciplined but slow and painful steps, I was struck to estimate that well over a third come with canes, walkers or wheel chairs, or on the arm of a spouse or child or caregiver – a proportion of mobility impairments unknown in my own daily bubble.

My puzzlement was schooled by a fellow volunteer – a steely veteran of the first Iraq war. Army Airborne, she said with pride, backing her claim of 26 jumps with a display of scars and attitude that left no room for doubt. “Unless you’ve been there, you can’t imagine,” she said. “The training alone ruins your body. Deployment in the desert—you breathe 24/7 a combination of sand and poison from the oil fields sabotaged by Saddam Hussein. These guys’ lungs and hearts are devastated.”  

The contrast was striking. In my own zip code, physical exertions at the gym or tennis court or ski slope are the antidotes to life at a desk. Orthopedic worry is whether a knee replacement induced by one too many Sunday 10K runs would be reconditioned in time for the paddle tennis season at the country club; with age-rated vax rates approaching 90%, a leading source of pandemic anxiety is the availability of a landing slot for the private jet escaping to the vacation home at the beach.

Not so at the VA, where tired and hurting heroes come for succor, having been put into uniform and harm’s way to make body-and-spirit breaking sacrifices for the sake of our country and its ideals.

They are not only our nation’s deserving – they are the exposed. Their working days are over, but their daily support is provided by children and grand-children -- themselves the central strands that weave our social and economic tapestry: the nurses and orderlies, teachers and waiters and truckers and bus drivers who put their own lives and safety on the front lines of the pandemic campaign.

The VA’s site, now open to all ages and including spouses and widows, is scheduled through the spring. By that time America will have acted according to our national character – corruptly mis-led and inept early on, roaring back with energy and commitment at an over-whelming level, only to tail off into dosage over-production and vast empty delivery sites.

As for the long process of recovery, we will by then finally reach what Winston Churchill called “the end of the beginning.” Except there will linger an unreached percentage of the population whose resistance will inflict a residual level of infections and fatalities, avoidable in theory and aspiration but tragically to be suffered out of a toxic and politicized combination of ignorance and bigotry.

The enfeebled veteran with whom this story started, along with his health-blasted comrades, placed on the altar of patriotism their youth and their healthy adulthoods, to defend principles both precious and complex -- including the right to persist in selfish disregard for the wondrous accomplishments of medical science and the collective good practices that would ameliorate our still-running miseries.  

We are obliged to respect that right – but neither its legitimacy nor those who assert it.

The good pandemic news is that not all the news is bad. Real spring has arrived in our region. Baseball is back. Six-figure vaccination doses are delivered in the state every day. At the VA, at-risk veterans are being cared for in their latter, pain-ridden years.

If you haven’t yet got your shot, you have no excuse – if for no other reason than the safety of your family and friends, colleagues and clients.

And if it’s been a while since you bumped elbows with a veteran and said “thank you,” now would be a good time.

 

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Book Review: Tim Harford, "The Data Detective"

Released today, by Riverhead Books -- "The Data Detective" -- so titled in its American edition, the latest book from Financial Times economist Tim Harford. 

Here in the United States it is Groundhog Day. As a Brit, Harford might not appreciate my sense of deja vu. Not quite two months ago, I had written a review of the earlier version, released last May in the UK by Little Brown under the title "How to Make the World Add Up." 

As an unambiguous fan of Harford's ability to bring both clarity and entertainment to the challenges in wrestling with quantitative information, I re-publish it here for interested US readers, under the new title so as to be relieve any confusion, mis-direction or concerns about finding it.

Enjoy. I did.

 

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Is Audit Reform Truly a UK Priority? Good Luck With That

Kwasi Kwarteng wasted no time, upon taking office on January 8 as the UK’s new Secretary of State of Business, Energy and Industrial Strategy, in asserting that audit reform was “one of his initial priorities.”

The sounds of earnest innocence might be rather touching, from a government servant, freshly elevated from his Energy remit to become chief minder of the entire sprawling BEIS portfolio. Forbearance for a learning curve may be indicated, as reinforced by a CV that does not reveal experience with the issues afflicting Big Audit.

For the moment, however, and presuming good in Kwarteng’s intentions, queries on his earliest signals are in order. See his first Twitter message, following one of appreciation for his appointment – shouting out a £ 10 million investment to support carbon emissions reduction by the whiskey distillers (@kwasikwarteng), as “something we can all raise a glass to.”

Unfair to compare -- few glasses have ever been raised to salute the auditors, in the centuries since the invention of double-entry bookkeeping. But neither did audit reform rate a mention in the BEIS coverage of Kwarteng’s January 11 telephonic discussion of his priorities with five different British business organizations.

Post-Brexit trade relations with the EU and the state of the COVID vaccine roll-out naturally headed that list, on which audit reform did not appear – these having pre-occupied Kwarteng’s short-lived predecessor in office, Alok Sharma. Which said, the realities underlying the intense criticism of Big Audit in the UK that erupted with the collapse of Carillion in January 2018 now confront the anodyne language of the new Secretary’s introduction.

Government response is awaited to a quartet of reports – Sir John Kingman (December 18, 2018) on the manifold inadequacies of the Financial Reporting Council; the Competition & Markets Authority (April 18, 2019) on the Big Four’s audit market concentration at the FTSE 350 level; the BEIS select committee chaired by MP Rachel Reeves (April 2, 2019); and the extended inquiry by Sir Donald Brydon (December 2019) on the purpose of audit.

While the critics’ array of proposed “solutions” are shelved pending official response, further outbreaks of financial scandal and irregularities, litigation and regulatory impositions have added to the intensity of public interest – both in the UK (e.g., Thomas Cook, NMC Health, Patisserie Valerie, Autonomy) and globally (e.g., Gupta, Steinhoff, Wirecard).

What confronts the prospects and the credibility of Secretary Kwarteng, unhappily, is that he brings to the battle a distinct lack of weapons. As explored in detail in my 2019 book – “DOA: Can Big Audit Survive the UK Regulators?” (Amazon) – there is quite simply nothing in the legislative or regulatory armory that can be deployed to effect fundamental change in Big Audit as presently configured.

In summary:

• Re-engineering of the FRC, decried as “toothless and useless,” into the new Audit, Reporting and Governance Authority, is hostage to necessary legislation, and in any event is aimed not at auditor performance itself but at a regulator whose impact is at best secondary and retrospective.
• Attempts to expand competition with the Big Four, by injecting the so-called “challenger firms” into either joint or shared engagements or by actual forced re-distribution of audit mandates – neither ever justified on the basis of audit quality impact – more importantly confronts the reality of the smaller firms’ limitations in size, resources, geographic scope and risk-taking capacity and tolerance.
  • Auditor changes for troubled companies, in the post-Carillion era, do not indicate optimism that those limitations are subject to relief. The replacement of Grant Thornton by RSM as auditor of Sports Direct (since re-named Frasers Group) in October 2019, after weeks of non-compliance, and the December 2020 replacement by Boohoo of PwC with the much smaller Littlejohn firm of the PKF network, do not signal endorsement that the capacity of the “challengers” is adequate to the task.
• As for the ability of the Big Four to house the ancillary skills necessary to perform audits for the world’s complex companies, in the face of calls that they should be “broken up,” the UK regulators retreated to a process of “operational separation” of the audit practices – not only because full legal separation would have been a reach too far for the UK authorities, but because the negotiated optics-oriented adjustments to the large firms’ branding, governance and internal resource deployment were readily within reach.   

To emphasize – the impotence of Kwarteng and his fellows in the face of Big Audit’s intractable issues does not counsel either cynicism or despair. The world’s capital markets will continue to seek financial information assurance that is both relevant and dependable.

The Brydon report points the way, although not without heavy lifting, as Sir Donald understandably declined to wrestle with several fundamental challenges – notably the audit firms’ presently limited financial and structural stability and the related limitations of archaic rules on independence and permissible scope of practice.

One way or another, those will be solved. Perhaps by another litigation-driven collapse, as with Arthur Andersen in 2002, and replacement of the current model with newly organized and emergent suppliers. Or, desirably but much less likely, by the collective and collaborative efforts of all the relevant players to make the deep and necessary changes.

But not, it must be said, by Secretary Kwarteng. To him, as his day of reality and reckoning awaits, the best and only offer is “good luck.”

 

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RIP Senator Paul Sarbanes

Former United States Senator Paul Sarbanes (D-Md) has died, age 87.

No notice of his passing fails to lead with his co-sponsorship with the late Michael Oxley (R-Ohio, 1944-2016) of the legislation bearing their names that was passed in the summer of 2002.

With its creation of the Public Company Accounting Oversight Board and the far-ranging intrusion of government into what had for 150 years been a profession-led model for the content and issuance of corporate financial information, the Sarbanes/Oxley law fundamentally altered the relationships among US public companies, their auditors, users of their financial information including investors and other sources of capital, and the standards-setters and agencies of law enforcement.

My meetings with the man were occasional, brief, and correct. As for his signature legislative accomplishment, I have never had reason to modify the view, as put in my July 20, 2002 column, "Balance Sheet," that I had the privilege of writing for the International Herald Tribune (itself sadly RIP), that "any legislation receiving the bipartisan margin of 97-0 is bound to be fundamentally defective...."

As I put it in my blog post of August 7, 2012, commenting on the vigorous rounds of mutual self-congratulation on the law's tenth anniversary:

"...the challenge remains that the cyclical nature of market bubbles makes inevitable a post-scandal period of cleansing and temporary return to virtue – political dynamics notwithstanding.  

"Put another way, the storm of both scandal and outrage after Enron and WorldCom was bound to clear, no matter what. So instead of the wrong question, whether post-Enron corporate behavior is now improved, under both the Sarbanes-Oxley law and the law of unintended consequences, the proper operative question should be:

'Would financial reporting and assurance not be better if Sarbanes-Oxley had not been passed at all?'"

Approaching another decade later, all the issues I catalogued in 2012 still persist, and have only continued to deepen and spread world-wide -- ranging from the glowering dissatisfaction with the inadequacies in the basic form of large-company assurance represented by the traditional auditor's report to the on-going outbreaks of large-scale instances of financial malfeasance now globalized in such examples as Carillion in the UK and Wirecard in Germany, despite the inability of earnest but out-gunned regulators to achieve their deterrence.  

So in recognizing the passing of Paul Sarbanes, a man known for decency in his extended years of public service, the question I posed eighteen years ago remains unexplored, much less unanswered.  

 

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Book Review: Tim Harford, “How to Make the World Add Up"

“Two aristocrats are out horseback riding and one challenges the other to see which can come up with the larger number. The second agrees to the contest, concentrates for a few minutes, and proudly announces, ‘Three.’ The proposer of the game is quiet for half an hour, then finally shrugs and concedes defeat.”

 -- Professor of Mathematics John Allen Paulos, “Innumeracy” (Hill and Wang 1988)

There is no better go-to source of wisdom and insight in our complex and data-overloaded world than the weekly column in the Financial Times by economist Tim Harford. His latest book, “How to Make the World Add Up” (Bridge Street Press 2020, 294 pp.), now joins his others on my reference shelf.

Harford has accomplished the remarkable – delivering, under the guise of a work on coping with the complexities of statistics and quantitative information, accessible guidance grounded in principles of human psychology and behavior.  

Sympathy for his project is in order. It would have been on the verge of completion, early in 2020 when the pandemic broke out. Frustration would have been matched by opportunity – necessary re-writing in context of a quintessential case for the necessity to gather and assess best-quality data.

It would have been his challenge that, even as the world struggled to contain the virus, issues of incomplete and unreliable information were from the outset and continue to be pervasive – on the numbers of infections, hospitalizations, and deaths; the demand and provisions for testing and protective equipment; and the scope and magnitude of job losses and business failures. Data failings in all these areas continue to confound the design and application of strategies for mitigation, containment and recovery.

Credit to Harford that his book survived a Black Swan’s fly-over. Sympathy too, for the pressures of last minute revising to preserve the book’s structure while addressing a global crisis evolving on a daily basis. There are the occasional faint palimpsests of red-pencil attention -– imagine “note to self -- insert COVID reference here.” Happily for readers, they do not impede his narrative arc -– a set of behavioral “rules” by which readers are invited to gain confidence in their ability to penetrate the confusion that otherwise beclouds complex statistics-laden situations.    

Not a math geek? Intimidated by the difference between mean and median? Fear not. Harford writes in a non-technical vocabulary, advocating the importance of disciplined means to avoid conclusions or decisions that are hasty, under-evaluated or overconfident:

Be curious – be skeptical – recognize and manage the impact of your emotions – be aware of your fallibility.

Neither is his set of tools unfamiliar:

Beware the wrong metrics – avoid jumping to hasty conclusions – do not be led by such biases as survivorship or over-confidence – insist on the integrity of both data and their presentation.

In our time these appeals go back to the 1970s and the pioneering work of Daniel Kahneman and Amos Tversky, and such antecedents as Michel de Montaigne’s self-searching essays in the 16^th century.  

And those standing on the broad shoulders of Kahneman and Tversky have seen far in many fields. Their insights inform successors such as Philip Tetlock and Richard Thaler – also “big data” explorer Viktor Mayer-Schönberger, physicist Richard Feynman, sociologist and systems researcher Charles Perrow, and information design genius Edward Tufte.

Point of disclosure: I did not come to Harford’s work without a perspective of my own. The influential thinkers just mentioned figure in my advice to clients, and populate the syllabus of my graduate-level course in Risk Management and Decision Making. That raises the possibility of a self-reinforcing prejudice in Harford’s favor – the very emotional response that he himself takes pains to warn against.

I feel no need to confess error and recant. Some time ago I forswore reviewing books I would not recommend, and my enthusiasm for Harford is openly declared. Inconsistency with his advice would be both unironic and so minor as not to impair this proposal -- that as a primer for those seeking assistance, or as reinforcement for those already engaged, Harford’s very appealing book does a favor and is worthy of attention.

 

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Merci pour “Le Grande Thanksgiving” – As Art Buchwald Explained It To the French

Even with the many and perplexing challenges that seem out of control and continue to inflict deadly harm upon populations, economies, and social and political environments around the world, the American holiday of Thanksgiving presents much for which we should be grateful.

Vaccines are on their way – for which we appreciate the skill and dedication of their developers, give thanks to the medical and other care-givers and workers who have been tireless in their dedication and support since the onset of the pandemic, and offer prayers that the suffering and losses still to come may with activated and responsible leadership be at a minimum.

The arrival of a new political era cannot come soon enough – desirably with a recovery of the capacity to engage each other in dialog, strategies and actions for the common good in which we are all, for better or worse, responsible and accountable.

In the meantime, on a lighter note, it’s interesting to receive messages from friends in Paris, with whom we shared expatriates' versions of this special day during our years in residence there – suggesting that there may be a universality to the search for communal expressions of thanks.

We always found it difficult to explicate the legend of Thanksgiving to the Parisians – not least because they look down turkey as hopelessly déclassé and inferior to their better-regarded poulets and canards. We were grateful for the version supplied by Washington Post humor columnist Art Buchwald -- first appearing in the International Herald Tribune in 1953, and an annual staple for many years thereafter. It may serve as an invocation -- here -- whether your Thursday observation is by ZOOM, a local grab-and-go, or a traditional family gathering (in which case, for the sake of those you care about, please be properly masked and distanced).

As neither Buchwald himself nor the IHT remain available to be thanked, I can do no better than to wish for all a hearty chuckle; a safe, healthy and well-distanced holiday celebration; and the coming of better times.

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Audit Regulation After Wirecard – Germany Marches Backwards

In French it’s déjà vu -- adopted in English, for lack of an equivalent.

The same in German, and aptly describing the behavior of the German government, dazed and confused in the fall-out of last June’s crash of erstwhile market darling Wirecard.

Confronting the familiar question -- “Where were the auditors?” –- German officials are pursuing the imperative in the DNA of regulators under stress, hoping to be seen as “doing something.” That is, heedless of the ineffectiveness or unintended consequences, they are re-cycling proposals already attempted and no more effective in other countries.

I carry no water here for Wirecard auditor EY, as it defends the enforcement scrutiny and investor lawsuits that center on the hole in the company’s cash accounts of an apparently fictitious € 1.9 billion.

Rather, as aired out in the Financial Times of November 16, a menu of German proposals have the air of familiarity and futility displayed elsewhere over the last two decades: mandatory auditor rotation, further rules on services to audit clients, tinkering with the structure and authority of the regulator, and adjustments in the standards for auditor liability.

We’ve seen these movies before. They were weak in earlier screenings, and are unimproved in this latest re-run.

In the US, Enron and WorldCom brought forth the Sarbanes/Oxley law of 2002 – which influenced neither financial reporting throughout the crisis of 2007-2008 nor such later-exposed scandals as the Ponzi scheme of Bernard Madoff or the corporate fictions of Elizabeth Holmes at Theranos.

In the EU, neither the constraints on auditor’s ancillary services to clients, the infliction of mandatory rotation, nor the introduction of extended auditors’ reports avoided the money-laundering at Danske Bank or the goodwill puffery at Steinhoff.

Mandatory ten-year rotation in Germany might be a wrinkle on the existing EU timetable – although suffering no less the absence of any credible demonstration that extended auditor tenure is in any way associated with audit quality. And the challenges to engage replacement auditors in a supply-challenged market are already on display in the region – see the compliance difficulties of Sports Direct in the UK and the pending default of Plaza Centers NV in the Netherlands.

As for further constraints on services to audit clients, those are already effectively foreclosed by existing EU rules, and in any event do not address the nature or quality of performance of the basic assurance function itself.  

In the UK, the list of recent scandals is headed by the collapse of Carillion in January 2018, with additions including Patisserie Valerie, Thomas Cook, and NMC Health among others. But Brexit and the pandemic have tossed into the ditch the perfervidly critical reports on the Big Audit model, even as the cries for disruption of the Big Four’s structures and market dominance remain untested against the inexorable impracticalities of any alternative. [1]

Broader powers are mooted for the German financial regulator – itself well deserving the opprobrious characterizations of the UK’s shambolic Financial Reporting Council as “toothless” and “useless.” Well and good, but irrelevant to concerns for actual audit performance – because it is in the very nature of a government agency to be resource constrained, limited in vision and initiative, and consistently in reactive mode after-the-fact to the speed, agility and superior imagination of new generations of white-collar malefactors.

Finally, the proposal to raise or eliminate the current auditor liability cap under certain German legal theories raises for two reasons the problem of “be careful what you wish for.”

First, given the relatively immature body of auditor liability jurisprudence in Germany compared with the major Anglo jurisdictions, there is no reason to think that a German court, if convinced that auditor malfeasance in a multi-billion euro scandal was sufficiently grave, would not readily over-ride the damages cap currently set at a negligible four million euros.

Second, the possible consequences of a “worst case” judgment in a case on the scale of Wirecard include the disintegration of the audit firm itself – it being plain, even if not widely recognized, that the Big Four lack the financial resources and organizational stability to survive claims of the magnitude of the Enron collapse that brought down Arthur Andersen in 2002.[2]

Not that any of these observations mean that the German government will find a path out of the mire. To paraphrase baseball guru Yogi Berra on those fans reluctant to visit the ballpark of a loser, “if the audit regulators don’t want to apply good judgment, you can’t stop them."

 

[1] Please see my book of last spring, “DOA: Can Big Audit Survive the UK Regulators?” (Amazon 2019).

[2] For the particulars, please see my book, available on Amazon, “Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms” (Emerald Books, 2d ed. 2017), pp. 56-60.

 

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Voting in America – Lessons at the Polls

 “You can observe a lot by watching.”

       -- Philosopher and baseball legend Yogi Berra

I have views on the still-airing resistance to the called outcome of our recent presidential election. For today I forbear – instead with some non-partisan thoughts on my Election Day opportunity to be an on-the-ground participant in our country’s massive suffrage exercise.

With the eventual result a certainty, it’s a relief to take a break from the chattering heads and their maps and charts. Rather, this is to recognize and give respect to the hundreds of thousands of workers in their recording, tabulating and reporting over 150 million individual preferences, during an on-going pandemic that is expanding out of control.

I volunteered as a “poll observer” -- as I’ve done often over the years. My assignment was in a working-class suburb of a small city, once heavily industrialized and now down-at-heels. The political leanings of the residents were doubtless predictable, but it wasn’t for me to ask, nor have I gone back post-election to inquire.

It was just sunrise as I reached my site – a large high-school gymnasium hosting the apparatus for three precincts. Some 25 county staff had already laid out sanitizers, marked waiting queues in colorful tape, and carefully separated check-in tables, voting stations, and tabulating machinery.

Well over a hundred citizens were on line before the 7.00 a.m. opening, to perform their civic ritual on the way to work – a backlog that held into mid-morning and foretold a record turnout.

The day turned out to be calm and orderly, defined by its lack of drama – belying all the outcries of chaos and conspiracy, before and since. Spacing and mask wearing were almost universal; the official position was that the right to vote over-rode mandated masking, so the handful of violators were tolerated with no more than dark looks.

A scattering who displayed partisan hats and sweatshirts were gently persuaded to remove or cover, and the candidate advocates beyond the doors kept their banners and literature at the required distance.

Not least, nobody pushed the policy, litigated in advance, that the state’s right-to-carry law permitted firearms inside the polling places.

One small encounter confirmed the wisdom of legendary Massachusetts legislator Tip O’Neill that “all politics is local”:

My prior experience was that diplomacy of observers is key, being basically interlopers on the fringes of the authorized workers’ demanding tasks. Well-prepared, I introduced myself to the crew chief with the offer of a large bag of donuts – it being conventional that copious quantities of coffee and sugar are the fuel for the energy demands of the entire operation.

Her initial reaction was bright and cheery. Not only did my offering fulfill the traditional protocol -- at the personal level also, her apple-cheeked profile confirmed her close and intimate familiarity with baked goods. But it was not to be. “I’m so sorry,” she said. “You’re generous to offer. But with the pandemic, we’re not allowed to take in any food from the outside.”

No harm done, and on to work. I checked back later in the morning as the rush eased, to observe turnout figures and ask about issues. “All good,” was her report, “and thanks again for the offer of donuts.”

“Actually,” she said, “the county clerk’s rule on food was that it could be brought in, if you had gone to their office in advance and registered your food and got their permission.”

Pre-registration and a permit requirement for a bag of donuts! Tip O’Neill’s maxim was on full display -- hometown political culture that no stranger could possibly have imagined.

Driving home after my eight-hour shift, and having scrolled the observers’ notes posted to our overseeing state-wide chat room, I pondered several take-aways:  

• Our country’s dispersed, diverse and locally-run voting structure is clunky and inefficient and – like any operation designed and run by fallible human beings – it is subject to a non-zero rate of low-impact errors.

• But the national operation in the aggregate – barely deserving the label of a “system” – is, in the lingo of the scholars of industrial process, “loosely connected.”

• That is, it contrasts with the tightly linked systems that are subject to catastrophic failure when a breakdown of one critical component triggers a cascade of failure – such as a fatal flaw in the launch sequence of a space shuttle, or an intelligence lapse that mistakenly aims a drone attack at a children’s hospital.

Our collective voting methodologies run separately in the individual states, operated locally and staffed by reasonably trained and well-intentioned citizens. The likelihood of widespread and pervasive corruption of that loosely linked aggregation, on a scale significant to affect the overall outcome, is on a pure systems basis so small as to give confidence in its basic integrity and reliability.

Or so I told myself, on my ride home, and as I keep repeating now while waiting for the noise levels to diminish.  

 

It’s not that my usual topics here are dormant -- involving large-company financial information. Concerns there remain widespread and threatening, but are of understandably lowered public priority under the pre-occupying concerns of the pandemic, economic distress and political unrest.

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De-Listing Chinese Companies – American Policy is “Ready, Fire, Aim”

The American securities regulators have a problem with China, expressed in their hand-wringing laments (e.g., here and here): their counterparts forbid inspecting the work and accessing the work papers of the auditors of Chinese public companies whose securities trade on America’s capital markets.

“Why so?” is the mystery. The SEC and the PCAOB have the effective means by which to relieve their frustrations, which – whether lacking vision, will, or coherent policy -- they have been unwilling to deploy. Instead, a “President’s Working Group” led by Secretary of the Treasury Steven Mnuchin reported on July 24 a proposal that is muddled in concept, inefficient in structure, and destined to be ineffective even if eventually put into place.  

It’s an exercise in “Potemkin regulation” – to create a façade of legitimacy, like the faux villages supposedly built by Grigory Potemkin to impress Empress Catherine II on her visit to the Crimea in 1787. Here’s why:

Empowered by the Sarbanes-Oxley law of 2002, the SEC and the PCAOB have been packing, but have kept securely holstered, a double-barreled weapon:

• Auditors of public companies whose securities trade in the US can be de-registered (Sarbanes-Oxley § 105) for failure to submit to PCAOB inspection including the obligatory production of working papers (§ 104(a)).

• Companies reporting to the SEC that fail to file accounts bearing the opinion of a registered auditor (§ 102(a) and SEC Reporting Manual § 4115.1) are subject to exclusion from issuance or sale of their securities in the US.

Only if used, these would combine in a swift and efficient two-step: the PCAOB de-registers a non-compliant auditor, then the SEC bars a company failing to file compliant financial statements. QED.  

Not so simple, in the Potemkin village. For unknown reasons, rather than break out the available armaments, the PWG proposes:

Instead of a straight-forward trading ban imposed directly by the SEC, rule-making would invite the American securities exchanges to pursue their own de-listing process (PWG report, p. 9) – an awkward and unnecessarily complex “solution” that would, among other inefficiencies, not reach the possibility that companies would simply retreat to non-exchange trading in the over-the-counter market.

To supplant a Chinese audit firm beyond the reach of PCAOB inspection, a Chinese company would obtain its audit report from the Chinese auditor’s US affiliate, deemed a “co-audit firm” – a term unknown in the professional vocabulary and having no defined scope or meaning (PWG report, p. 8). Such a process would fail, for two separate reasons:

• First, risk managers in the American firms should be aghast. Their firms are not licensed to practice in China, nor do they have the language, local technical knowledge nor cultural and political awareness to perform there. The extent of a US firm's necessary reliance on the personnel, work and documentation of its Chinese brethren would render it a “letter-box,” by which it would offer up its name, reputation and financial resources to unknown and unmeasurable exposures.

• Second, the PWG blithely assumes that in fulfillment of the PCAOB’s inspection process, the American “co-audit firm” would obtain and produce the work papers evidencing the actual work performed in China – a notion both mis-placed and naïve, given the long-standing access refusal of the Chinese regulators who would view such a ruse as risibly transparent.

To the contrary, for two decades the consistent Chinese have swaddled the American regulators in blankets of woolly rhetoric, which in their credulous diplomatic ineptitude the Americans have believed to be real and dependable promises. There is no reason to expect a fundamental change in the Chinese position.    

Nor does the PWG’s construct address the key political issue, namely the collateral effects of threatening the US listings of a roster of Chinese companies estimated at a market capitalization of $ 1.7 trillion (PWG report, p. 7).

That is, while the Chinese themselves might welcome the opportunity to capture the exchange listings of such global giants as Alibaba, PetroChina and China Life, the panjandrums of the American capital markets and the managers of the investment funds holding those companies in their portfolios might feel otherwise – as would those who believe in the desirability of promoting rather than antagonizing the enormity of the Sino-American trading relationship.

Put briefly, there is no perspective from which the PWG[1] proposal can be wrestled into rationality. Not surprisingly, it has perplexed commentators literally around the globe, from Paul Gillis’s China Accounting Blog to the Financial Times in London.

It is not impossible, of course, that Secretary Mnuchin is cranking a fog-making machine as cover for the inconsistent and unpredictable POTUS –- or that the administration is simply vamping for time through the up-coming election.

Either way, the interests of effective operation of the capital markets deserve better.

 

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[1] As a side observation for the language geeks, this body’s label joins a short list of rare three-fold oxymorons. The classic has long been “Holy Roman Empire” – a polity deserving none of those descriptions. My own offering has been “Italian justice system,” as my work experience up and down that congeries of ancient trading states showed their jurisprudence to be neither just nor systematic. Here, there is no evidence of substantive presidential guidance, and the PWG as a “group” oddly does not include the chairman of the PCAOB, the agency most involved and affected; readers are left to conclude as to the fitness of its report under the rubric of “work. ” Submissions of other such triplets are invited.    

Baseball Is Back -- Dr. Fauci Brings Some Joy to Mudville

This was drafted and ready this morning; as the footnote explains, because I paused for lunch, events overtook its prediction:

You win a few, you lose a few.

Some get rained out.

But you got to dress for all of them.

-- Satchel Paige

Dr. Anthony Fauci gave the country a lift and a smile last Thursday, when he threw out the ceremonial first pitch to open the abbreviated baseball season at Nationals Park in Washington.

Looking every inch his five-foot-seven, he shot-put an effort that at least bounced close to the first-base foul line.

A confessed Nats fan, Dr. Fauci displayed sports energy going back to his basketball days in New York, as Regis High’s plucky point guard and team captain. While his errant lob immediately earned a collectible baseball card – if not yet a Wheaties box – a grateful nation will prefer he stay focused on his day job, as America’s face of science and intelligence during the COVID-19 pandemic.

The game ended at five innings under lightning, thunder and torrential rain, with the Yankee’s own # 45, Gerrit Cole, pitching for the win. Earlier that day in Washington, even as “Fireball Fauci” was preparing to take the mound, POTUS 45 clutched for his own first-pitch publicity – a visit to Yankee Stadium on August 15.

Dr. Fauci was masked under his informed policy guidance, while also muffled under the official forces of unmasked ignorance and hostility. Here he is, sportingly enjoying himself, a picture of genuine boyish enthusiasm:

 

The same day, here is the handcuff of Mariano Rivera’s underhand toss into the ample Presidential breadbasket. Defended as if a hostile alien -- instead of a routine double-play ball, it would score an error, first-and-third, and nobody out:

 

Will August 15 actually happen? There are reasons for doubt. As heard from this White House so often and with such little effect, “We’ll know … in about two weeks.” Three seasons into this administration, the incumbent is the first non-participant in the baseball tradition started by President Taft in 1910.

On the political side:

• If not for the empty seats under the pandemic, the predictable reception by fans in New York -- the home city he forsook for Florida and one of the “Democrat” (sic) “hellholes” he so denigrates and disrespects – would have loudly reciprocated the hostility.

• Ardent animosity to Colin Kaepernick’s pre-game kneeling and bigoted militaristic reaction to all aspects of the Black Lives Matter movement would confront the banners, the ribbons and the players themselves – actions he’s claimed to mean “the game is over.”

• The mound can be even more lonely than the Oval Office. For someone eager to claim all credit but deflect all blame, there will be no subordinate or surrogate to demonize for a gaffe, nor a manager to pull him for a reliever.

• Performance anxiety will be raging under the red MAGA cap and the orange comb-over. Comes to mind the scene early in “Bull Durham,” after Crash Davis (Kevin Costner) gets into the thick head of Tim Robbins’s Nuke, whose wild throw shatters the window, and Crash calmly announces “ball four.”    

Further to the narcissistic personal vanity, POTUS would be at serious risk of being shown up by Dr. Fauci’s bouncy authenticity:

• The current major league mound was lowered years ago but is still built to the intimidating height of eight full inches – a slope that, unlike the platform at West Point on June 13, will offer neither a handrail nor a guiding elbow.

• That deteriorated frame shows scant evidence of enough shoulder rotation to launch a baseball the full 60’6” from mound to plate – neither two-handed water drinking nor awkwardly choppy golf swings inspire confidence.

• On my Little League team, anyway, an adolescent displaying the pain and clumsiness pictured in that close-distance game of catch on the White House lawn would have been banished to far right field and the eight-spot in the batting order.

Put another way, generously (if skeptically) accepting the claim of one-time high school level ability, decline is now on display. By comparison, Tony Fauci’s mound performance looked like Don Larsen against the Dodgers on October 8, 1956.

As a Cubs fan – anxiously noting that at this writing they have split their first two games – I have learned to my sorrow not to make predictions. Here however I hazard that by the morning of August 15, some intervening excuse will emerge to scuttle the much-ballyhooed event.

Certainly not a flair-up of the once convenient but lately unmentionable bone spurs. Nor would it be tasteful to invoke golf-induced muscle spasms.

Inclement conditions would be handy. Threats of moisture sufficed to cancel both a visit to a military cemetery outside Paris in November 2018, and the July 11 campaign event in New Hampshire. Rainout-ready Sharpies will be poised over the New York weather maps.

Or, more than likely, some staffer on the White House fringe will have gone rogue and taken a virus test with a positive return – despite the steadfastly illogical proclamations that fewer tests would mean fewer cases. That would offer an out, and finesse the prospect of an ugly and embarrassing debacle.

As often said, “We’ll see.”[1] 

[1] At 3.44 pm EDT this afternoon, POTUS tweeted a vacuous trio of reasons why he will be “unable to be in New York to throw out the opening pitch for the Yankees on August 15…” As Casey Stengel put it, “You could look it up.”     

     

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COVID-19: Florida’s Inexcusable Fiasco Goes National

 “There are no words” is not a default available to those presuming to take a public platform. Today, though, I struggle to express my anger and dismay over an experience with the corona virus – one that both strikes close to home and exposes the multiple consequences of the cascading failures of our country’s office-holders.

It falls specifically on Florida governor Ron DeSantis – incited as he has been by the abject failings of the bunkered White House, whose occupant from the emergence of the pandemic has confirmed on a near-daily basis his apt if vulgar characterization in July 2017 by then Secretary of State Rex Tillerson as a “f***ing moron.”    

It’s about an elderly friend in Chicago – a woman both indomitable in her fortitude and among the world’s most caring, sensitive and empathetic – always accessible, wise and perceptive with friends, clients and all who know and love her.

While bravely bearing a lifetime of severely compromised immunity, this gentle soul undertook in early June to fly to Florida. She was generously motivated by the desire to give care and support to an even-older relative. Regrettably too, she was credulously enticed by the attitude and messaging of DeSantis.

By then the consequences had long been evident of the blinkered failure of the Trump administration to appreciate the intelligence widely available – the literally vital necessity to stock up, close down, and take seriously the certain aggression of a novel virus that cared not the slightest for the disrespect and denial shown by the comprehensively ignorant. It was unleashed and spreading, to be affected only by drastic measures with social and economic consequences unknown to modern societies.

Sadly, she bought the governor’s blind-eyed optimism. Despite compelling evidence in the data and the science, DeSantis – along with his minions and enablers in Florida and his cretinous coevals in other states -- had resolutely opposed and resisted calls to close churches, parks and beaches. His wildly premature phase 1 re-opening in late April covered indoor dining, and his June 5 phase 2 extended to bars, theaters, and most retail.

For all of which, as wryly put by the Los Angeles Times, where that state too “for a brief moment … returned to bars, beaches and botox,” the still-developing extent of DeSantis’s tragic recklessness has been thoroughly validated as ill informed and deadly in its consequences.

So it falls on DeSantis, that my friend in all her innocent misapprehension spent three weeks in Florida within the scope of his misbegotten policies – nurturing her relative, and in close social contact with his community of the aged including a now highly suspect birthday celebration.

From which, there is this horrific added complication: My friend was robust and asymptomatic as she left to return to Chicago – taking a flight last Saturday evening. The next day she was immediately overcome with classic indications of COVID-19. Promptly hospitalized and tested positive, she is as I write released and isolating at home with her quarantining spouse – feeble, depleted, and barely able to speak.

At this point -- like the many other states that were too late to close and far too hasty to open, and which as of July 6 will be subject to the emergency order announced by Chicago’s mayor Lori Lightfoot that imposes fourteen-day quarantine requirements on travelers to our city -- Florida is over-whelmed. Under the incompetence of the DeSantis administration, there is no chance of tracing the source of my friend’s infection, or calculating the extent of its spread among the groups of at-risk elderly with whom she shared contact – not to mention the likelihood that she herself could have been a virulently infectious spreader on her airplane and in the airports she traversed.

Up to this week I had already been managing proximity with three early-stage cases – a college student, a millennial of world-class athletic stature, and a previously robust, marathon-qualified Gen-Xer whose very survival was at risk and who likely confronts long-lasting adverse pulmonary effects. These suffice to confirm that the virus has no respect for age or politics, or for the wishful thinkers or the deniers who would cry “hoax” or wish that it should miraculously “disappear.” They are instead enough to raise my anger level that even these cases could have been mitigated by competent policy-makers prepared to respect the intelligence and pay attention accordingly.

With that, what additional reaction is possible now, to the multiple threats in my beloved friend’s situation, both to herself and to all those to whom she was exposed due to the compounding negligence of DeSantis and his fellows? Frustration and outrage are insufficient, that she and others are sacrifices to the ignorant political optics of elected officials and their devotees.

Last night I made a no-contact delivery of a get-well card and a bouquet of flowers. That -- along with my heartfelt wishes for her recovery and this telling of her story, which I invite you to share – is what I can do, for my friend and for us all.

Because nobody who has bought into the hoax and conspiracy theories will have stayed to read this far, I need not advocate for changes of views; if there is a message to the sympathetic from this pulpit it would be one of simple encouragement:

Pay attention – be cautious – keep distances – keep wearing your masks. Brave people are putting their lives on the line for us. Respecting them and each other is the least we can do.  

 

 

Wirecard Crashes – And Everything Old Is New Again

German payments processor and DAX market darling Wirecard AG has been revealed to have a € 1.9 billion hole in its balance sheet. Erstwhile superstar CEO Markus Braun found himself both out of a job and into police custody.

The company’s catastrophic implosion would have been no surprise to those alert to the depth of its problems as publicized over the last 18 months – not among them the credulous at German regulator BaFin, deeply interested DeutschBank, or a group of groupies among the executive team at SoftBank.

As for the missing cash? It appears never to have been there in the first place, suggesting that the inevitable up-coming forensic exercise may not be all that complex, to unpack an extended course of malfeasance.

Professors of literature teach that there are but a handful of great plot lines. So too, there are just a few basic financial fraud schemes, repeated with minor updating variations from one decade to the next. Among them, falsified operations and fictitious assets are persistent and recurring themes – tweaked in their sordid details by each new generation of white-collar criminals.

Two examples go back a half century – the first accounting scandals on which I cut my teeth as a rookie lawyer: the Salad Oil case, in the tank farm near Newark airport where Tino De Angelis used light-weight soybean oil to top off huge tanks filled with heavier water, fooling the auditors who climbed the ladders to open the lids but neglected to tap the valves at the bottom; and the Ponzi scheme at Equity Funding, where Stanley Goldblum’s minions falsified customer ledgers to create fictitious life-insurance policy holders who went undiscovered because not directly confirmed.

Back in those old days, fraudsters did real work to cover their tracks. Barry Minkow of ZZZBest tricked up dummy customer locations to pass as real work sites. Sam Antar at Crazy Eddie dissuaded the auditors from descending into the creepy basement vaults under his boutique-sized New York shops – never large enough to hold the bulky cartons of projection televisions shown on the fanciful inventories. Head counts of phantom cattle herds were inflated by multiple cycling of the same calves through corral gates, under the noses of naïve city-bred staffers, perched on fence rails and eager to escape the dust and noise.

The evolution over five decades means that such fabrications are of less need to the malefactors. Even the revelation in 2009 that one-third of the revenue of Indian software company Satyam Computer Services was bogus involved only non-existent customer contracts, although the inexplicable absence of physical evidence for 13,000 ghost employees – such as canteen turn-over and transport allowance cards and desks and telephones – remains a puzzlement.

In the case of Wirecard, the concentration of its business in a mere three shadowy “acquiring partners” and the ostensible location of its cash in two banks in the Philippines will figure. With their mission in hand, fraud examiners should not take long, peering at Wirecard’s business model through the guiding lens of hindsight, to reverse-engineer the plot line. Any treasure hunt is eased by having in hand a map with a large “X”.

William of Occam’s reductive principle applies no little to inform the design of a large-scale financial scam. In Wirecard, “the simpler, the better” is likely to have found a new application.

 

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For Chinese Companies -- “Double Secret Probation”?

With appreciation to my friend and colleague Francine McKenna, this guest contribution is up today on her newsletter, The Dig -- to which readers here are enthusiastically invited -- and contact her at TheDig@Substack.com.

 

 

When in need of street wisdom, legendary Chicago columnist Mike Royko called on his bar-stool pal Slats Grobnik.

Not even Slats could explain what has possessed the United States Senate – which on May 20 passed the Holding Foreign Companies Accountable Act – which would expel Chinese companies from the American capital markets because their auditors are shielded by the Chinese regulators from the oversight and inspection program of America’s audit regulator, the Public Company Accounting Oversight Board.

As the world’s greatest deliberative body – so goes the cliché – the fractious Senate can barely muster bi-partisan agreement on the time of day – so passage of the HFCA by unanimous resolution must elicit skepticism about whether there are adults minding the playroom.

The Act first plays to the chest-thumping China hawks – Trade Representative Robert Lighthizer and economic advisers Larry Kudlow and Peter Navarro. It would require a Chinese company seeking access to the American capital markets to certify that “it is not owned or controlled by a governmental entity….” That provision -- so susceptible to gaming that Slats would guffaw over his beer -- pictures a trench-coated character out of John le Carré, peddling a fistful of “no control” certificates -- facially valid and untraceable in provenance.

For two reasons, though, Slats would truly slap his forehead over the Act’s second bit: a Chinese company would loose its US listing and its shares would be barred from US trading, if the PCAOB were unable for three years running to access its auditor and its working papers under the auditor inspection program put into place by the Sarbanes Oxley law of 2002 and activated by extension to ex-US auditors in 2005.

For starters, even though since first requested the Chinese have consistently forbidden PCAOB auditor inspection, the enforcement armory of the American securities regulators has long had the necessary weapons locked, loaded, and zeroed in. Launch of the inevitable Chinese/American diplomatic and trade apocalypse has – at least on paper -- needed no more to pull the trigger than the order of an authorized zealot – one of the noted hawks or, even and perhaps better in these over-heated times, theocratic and rapture-ready Secretary of State Mike Pompeo.

Here’s the short guided tour through the existing arsenal:

• Sarbanes Oxley § 102(a) and PCAOB Rule 2100 require auditors reporting on an issuer’s financial statements to be registered.

• Under Sarbanes Oxley § 104(a), auditor registration includes and requires a registered firm to submit to the PCAOB’s inspection process, including access to personnel and working papers.

• Sanctions for non-compliance include revocation of a registration, under Sarbanes Oxley § 105 (see the PCAOB’s orders relating to PKF (Hong Kong) (January 12, 2016), Crowe Horwath (HK) CPA Limited (July 25, 2017), and Anthony Kam & Associates Limited (November 28, 2017).

• Audit reports by a de-registered firm may not thereafter be included in an issuer’s SEC filings (see the SEC’s Financial Reporting Manual § 4115.1).

• The obligations of a principal auditor using or relying on the work of another audit firm – whether or not that firm is referred to (Manual § 4104.1-.5), or must itself be registered (under the “substantial role” threshold of Rule 1001(p)(ii)) – include the production of work papers and other documents related to that firm’s work (see PCAOB Staff Questions and Answers on Audits of Mainland China Issuers By Registered Firms Outside of Mainland China, December 30, 2016).

• Further, a non-US firm on which a principal auditor relies, whether or not registered, must under Sarbanes Oxley § 106(b)(2) produce its work papers on request and designate a US agent for service of PCAOB or SEC process.      

• Finally, because the financial statements of an issuer in the US may only be reported upon by a registered auditor (Sarbanes Oxley § 102(a)) – the consequences are as summarized in a recent blog post from the Columbia Law School (emphasis added):    

“Companies that fail to file within the allowed grace period are subject to a variety of costly penalties, including deregistration by the SEC, delisting by stock exchanges, the inability to raise capital through issuance of public securities, and potential debt covenant violations.”

With all that authority already in place to bar Chinese companies from US trading of their securities, the questions Slats Grobnik would press—caring no more about the grimy details of the law-making process than he would the ingredients in a classic Chicago hot dog – would be:

• What could they be thinking -- against the immediately predictable blowback from the Chinese securities regulator to a proposal “directly targeted at China…(that) … politicizes securities regulation”?

• Why now, having welcomed for fifteen years the listings of some of the world’s largest companies – the likes of Alibaba and PetroChina and China Life and China Telecom – while the inevitable emergence of a scandal on the order and scale of Luckin Coffee has been predictable the entire time?

• And has anyone the moxie to do it?

That last is not to be ignored -- the question who would do the dirty and disruptive work of de-registering auditors and stripping Chinese companies of their US listings. The weapons exist and are at the ready -- not so the boots on the ground. This administration’s lack of confidence in the PCAOB was manifest in its clean sweep of all five board members and the gutting of its senior staff, and this March, a budget proposal to eliminate the PCAOB altogether and roll up into the SEC whatever remaining modest scope of its politically permissible activities might survive.

Nor does SEC chairman Jay Clayton have standing as the fire-breathing regulator needed and committed to wage the hawks’ holy war. In his background is the record-breaking $ 25 billion IPO of Alibaba in 2014, featured among the big deals of his pre-SEC life as a partner in the heavyweight firm of Sullivan & Cromwell – while in his current position, he offers only frustrated reminders to investors of the limits of his agency’s timorous reactions to the on-going Chinese rebuffs.

The search for coherent thinking behind the HFCA becomes even more muddled, in looking for consistency in the justification by Senator John Kennedy (R.-La.), the bill’s principal sponsor, in the Congressional Record: “We are excruciatingly transparent. We like investors throughout the world to know what they are buying.”

Slats again – Izzat so? Then what do investors know about the operations in China of, for two quick examples:

• Caterpillar, which shows seven manufacturing and distribution locations in China in its Form 10-K for 2019, is estimated to derive some 5% of its $ 53.8 billion in global revenue from that country.

• Apple, which for the first quarter of 2020 rang up revenue in China of $ 13.6 billion -- 14.8% of its total global revenue of $ 213 billion.

High-ranking American companies – audited respectively by the US firms of the PwC and EY networks. Neither auditor explicitly shows use or reliance on the work of their colleague firms in Hong Kong or China, although both would be subject to the legal and regulatory obligations noted above – to maintain and produce information – but only if “on request.”

How long would we hold our breath, waiting to know whether Chairman Clayton’s foot soldiers might “request” access to the audit work scrutinizing those billions of China-based revenue? Slats’s lament for his beleaguered Chicago Cubs – the perennial and off-putting “just wait till next year” – extended a fulsome five score and eight years.

A long political step too far, for Senator Kennedy to extend what consistency of logic there may be in his HFCA, to benefit the investors he claims to favor, by reaching for access to the China-based audit work supporting the American firms’ reporting on the financial statements of ex-Chinese companies that include their large operations there. Nor, presumably, would it suit the China-bashers. Audits covering the operations in China of Cat or Apple are no less opaque to PCAOB inspection than those of Alibaba or PetroChina – but where would the sponsors of the HFCA see the pay-off in picking that fight?

The Senate’s headlong rush portends a reprise of the enactment of Sarbanes Oxley itself. As I wrote in the now-lamented International Herald Tribune on July 20, 2002, about that law’s equally lamentable passage, “any legislation receiving the bipartisan margin of 97-0 is bound to be fundamentally defective.”

That assessment has been well vindicated, by two decades of small-bore and ineffective behavior by a body whose mission would have been at least as well executed under existing laws, regulations, and behavior modification by the sector itself. As Slats would say, “here we go again.”

It does not inspire confidence that a version of the Senate-passed HFCA was promptly introduced in the lower chamber. The warning from Will Rogers is stark:

“Ancient Rome declined because it had a Senate. Now what’s going to happen to us with both a House and a Senate?”

Might good sense intrude? Elected officials definitely have the authority to inflict the HFCA – otiose and pernicious as it would be. But a strategy of “ready – fire – aim” cannot repeal the impact of the still-valid Law of Unintended Consequences.

 

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