Re:Balance -- Jim Peterson

Should Trump Have Testified? A Tale of Two Trials

Should Donald Trump have testified in his own defense?

Would his performance as a witness have turned the New York jury who on May 30 found him guilty of 34 felony counts of falsifying as legal expenses the hush money paid to quash the threatened publicity of his one-off with porn performer Stormy Daniels? 

 Or was it a preferred strategy to avail himself of the unambiguous right to keep silent? 

It’s a good time to pursue the question, while Trump awaits sentencing and runs out his string of appeals. The debates are lively, even though now with hindsight the question lacks a meaningful answer. Its complexities will be assessed both by doubtfully qualified commentators and courtroom groupies, gassing around on the media platforms, but also by serious observers of trial tactics - defense counsel, academics and students. They will all try to slice and dice the nuances of the common if opaque cliché that while a jury wants to hear a defendant’s first-hand story, a choice to testify risks worsening an already difficult situation.  

Over a career involving a significant catalog of large-scale white-collar criminality, I have worked on, watched and studied enough trials to believe that, while prosecutors and defense counsel alike will do all they can to shape their best case, it is a fool's errand to predict a jury result. Every criminal trial has its own dimensions, every trial team its own quirks and quiddities, and every jury its own dynamic – partially knowable at best and then only to the first-hand participants.

Which said, my admittedly limited sample suffices to put forward a recent outcome where the jury came out the other way, as a comparison with Trump’s decision not to testify.

On June 6 in San Francisco, a federal jury acquitted UK tech entrepreneur Mike Lynch of multiple counts of wire fraud and conspiracy, arising out of his role as chief executive of software company Autonomy. The charges were that under Lynch’s leadership, the company used backdated contracts, round-trip deals to entice customer purchases, and software revenues mis-allocated to unprofitable hardware sales. With its financial reporting so manipulated, it was claimed that American company Hewlett-Packard’s 2011 purchase of Autonomy for $ 11 billion, led by Silicon Valley veteran Meg Whitman, for which HP took a write-off one year later of $ 8.8 billion, involved an overpayment that exceeded $ 5 billion. 

Lynch took the witness stand at his trial. As reported, his “calm and confident performance in his own defense on the witness stand appeared to have turned things in his favor.” 

By contrast, in choosing not to testify, Trump is unique among American presidents. Whatever the course of his future appellate strategies, he is a convicted felon – a label hung on him by a jury of twelve ordinary citizens.

While the American notion of the Monday morning quarterback seems not to have a colloquial British equivalent, Lynch has a prominent public profile there, and his acquittal has been well covered in the UK media. Both the similarities and the differences invite comparison.

The two defendants brought to their trials a common reputation of domineering and autocratic executive styles. Both professed disinterest in the details under their watch, left to subordinates in favor of attention to their avowedly higher callings.

The readiness to evade responsibility for the conduct of their minions invoked what one of my early mentors, a former federal prosecutor, called the “pure heart and empty head” defense – asserted by CEOs who claim to be above attending to the granularity of quotidian particulars. In Trump’s case, responsibility fell to Allen Weisselberg, his longtime financial wheelman who for his complicity earned both a two-million-dollar severance payoff from the Trump Organization and a five-month sentence for his guilty plea to charges of tax and other frauds. For Lynch, it was his chief financial officer Sushoven Hussain, who had earlier been convicted and served a five-year prison sentence for his role in Autonomy’s malfeasance.

Both defendants brought to their trials the baggage of collateral litigation exposures. Arising out of his personal and business affairs, Trump faces adverse judgments in New York in the actions brought by E. Jean Carroll for defamation relating to what a New York jury found to be his sexual assault, and by the state’s attorney general for his organization’ corrupt manipulation of its real estate valuations; related to his tenure in office are the three pending but stalled cases - for conspiratorial vote-rigging in Georgia, purloining and concealment of confidential government records documents in Florida, and the January 6, 2001, insurrection in Washington.

Lynch’s situation is rather simpler - he confronts the damages phase of civil claims by HP in the London courts, seeking recovery for the debacle on the back-breaking if implausible scale of four billion pounds.

Commentators have suggested that the prosecutor’s case against Lynch was over-complicated and confusing for the jury. As a non-participant and therefore unqualified to opine, I note only that juries are fully capable of following even complex financial and accounting narratives – as shown not only by the Trump verdict but also by the November 2022 convictions of Elizabeth Holmes for financial fraud based on the fictitious blood-testing technology of Theranos, and Sam Bankman-Fried’s November 2023 conviction for the wild excesses of crypto exchange FTX.

A challenge for any defense counsel – assessing how a client defendant’s testimony may be perceived by a jury, for better or worse - is not just a hard call. Sooner or later as any litigation of consequential scale reaches its inflection point, whether criminal or civil, defense lawyers must make plain to their clients a highly simplified proposition – “You could lose this case.” It may happen on the eve of trial, as with the last-minute agreement by Fox News to settle the defamation claims of Dominion Voting Systems for $ 787 million. Or when a plea bargain is offered. Or when there is no further postponement of the binary decision whether to take the tactically risky but legally justifiable choice not to testify.

Mike Lynch may not have needed the lawyers’ speech. Trump, schooled by über-fixer Roy Cohn and pursuing for decades the tactics of “delay, deny and deflect,” may even now not have registered the reality.

Lynch may have dodged conviction by his act of courtroom salesmanship. Whereas if credence is given to Trump’s relentless self-promotion and unrestrained self-confidence, it would be fair to ask how he could resist the opportunity for a theatrical first-person courtroom display of his ability to market his own brand and his long-cultivated image of superior intellectual skills and behaviors both innocent and virtuous.  

Would the outcome of either trial have been different, if their choices had gone the other way? One reason the inquiry and the comparison are so tantalizing is precisely that we cannot and will not ever know.   

 

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EY’s Project Everest and Stockton Rush’s Titan –- A Comparison of Two Wrecks

"The Defense Department regrets to inform you that your sons are dead because they were stupid.”

            Goose to Maverick, Top Gun, 1986

 An exam essay for my graduate-level course in Risk Management and Decision-Making, out of this spring’s two catastrophic implosions:

• Stockton Rush’s submersible Titan, crushed in a nano-second on its descent to take an expensive porthole peek at the disintegrating wreckage of the Titanic, lying 2100 fathoms deep on the floor of the North Atlantic.

• EY global chief executive Carmine DiSibio’s aborted Project Everest, by which he sought but failed to split and separate the accounting and consulting practices of the Big Four network.

Here it would be:

As an exercise in “failure study,” compare and contrast the attitudes and behaviors of Rush and DiSibio, and the sources of bias, error, mis-judgments and other factors contributing to the collapse of their ambitious aspirations.

This course seeks lessons for business, professional and personal choice-making. The semester has just ended and my terrific student cohort has scattered on their summer holidays, so here’s what I would have expected from them –- a comparative exercise in how central themes in human behavior are found and recur across a broad range of examples.

While the literature on flawed decisions is rich with guidance, it converges on the deadly combination of arrogance and ignorance. Over-confident commitment to a triumphal goal –- a visual close-up of the historic wreck site, or the cascade of riches anticipated from the EY separation –- would suppress any appeal to proceed with caution, prudence and counsel with the available expertise of others in the sector: hull design, incremental trouble-shooting, and inclusion of safety and emergency capabilities, on the Titan –- and for Everest, coherent strategic planning, globally functional leadership, and resolution of organizational inadequacies in governance and infrastructure.

Innovation, evolution and boldness of vision lie at the heart of great plans, to be sure. But not even unlimited financial resources can purchase a repeal of the inexorable laws of physics and metallurgy and marine engineering –- nor can boundless hubris and grandiosity evade or bypass the basics of economics and organizational dynamics.

The comparisons extend. The hydrostatic pressures on the hull of the Titan were calculable in terms of the water’s depth and density (P = pgh, for those interested) –- predictably catastrophic forces on a vessel of sub-optimal shape, inadequate testing, and fatigued by multiple descents.

As turns out, the formula has application, by analogy at least, to Project Everest –- the depth of its problems went unmeasured and untested, and the density of its leadership created destructive forces beyond recovery.

There’s one further comparison, grisly in its nature, in an expert engineer’s analysis:

• The Titan’s malfunction and loss of power, de-stabilizing and tipping it out of control to “fall headlong towards the seafloor,” meant that its five passengers –- helplessly piled in the nose of the cabin without lights, communications or workable emergency measures -- likely had about a minute of terrified awareness before its fatal failure.

• Likewise, the plain take-away for Carmine DiSibio in the failure of his head-to-head with EY’s American leader and deal skeptic Julie Boland was that the lights were out on Project Everest, a crash was imminent, and there was no available rescue plan or exit strategy.

Stockton Rush’s mis-adventure in “tourism porn” –- charging obscene ticket prices for a reckless project having no legitimate purpose within the protocols of real science, but induced by incentives lying elsewhere in egoism, emotion or ambition –- will be no more than a blip on the future of deep-water exploration. Further analysis is to come, but early post-mortem reporting on the recovered remains already indicates that the causes of the Titan implosion are well understood in the surfeit of flaws in its design and execution.

The same for Project Everest, and DiSibio’s frustrated conflicts as the would-be leader of a new, publicly-listed consulting enterprise. The debate will continue about the desirability of alternate models for professional services, as across the spectrum from integrated, full-service firms to “audit only” assurance practices completely separated from the expanding array of consultancies in Sustainability, cyber security, artificial intelligence and otherwise. But because history’s best example of the latter is the mixed outcome of the Arthur Andersen divorce of 2001 –- the immense success of the Accenture IPO and that company’s powerhouse growth thereafter, contrasted with the death spiral of the Andersen accounting firm in less than a year –- the next entrepreneur tempted to dive into these cold waters will be wise to study with care the uncharted hazards beneath the surface.

“What will kill you is ‘not knowing what you don’t know’” -- the maxim is captured by the academics as the Dunning-Kruger effect. Critically for lessons to be learned, any complex situation with a non-zero possibility of potentially fatal problems calls for pauses and consultation, analysis of emergent quality issues, and careful attention to dissenting views and disaffirming evidence.

Which apparently did not figure for either Rush or DiSibio –- meaning that the outcomes of both projects were fore-ordained. Titan and Everest are now reduced to rubble and mourning, for reasons traceable to the conduct and behavior of their sponsors and advocates. Further efforts in either area may benefit from their unhappy experience.   

 

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Accountants and Their Biases: Human Nature Will Not Be Denied -- Part I

Updating the syllabus and reading list for my graduate-level course this spring in Risk Management and Decision-Making provides a reminder: the members of the accounting profession are just as susceptible as anyone else to the kinds of bias and error that, if avoided, allow for better performance and results. Here the first of a three-part series I am pleased to have written for Caleb Newquist at Gusto:

 

“You can’t expect to improve, if you can’t tell whether you’re good or not.”

Maxim of consultants in decision-making

Trustworthy, high-quality service lies at the heart of the accountants’ claim for public confidence and professional legitimacy. Rigorous standards and high expectations are set for independence of judgment, skepticism, and ethical behavior. 

Yet, to the frustration of the profession, its leaders, and its public critics, undesirable behaviors continue to erupt:

• Large-scale financial failures and scandals that prompt the popular outcry, “Where were the auditors?” –- revealing problems that have been repeated for decades. 
• Corruption of regulatory inspection and oversight through falsification and back-dating of documents and misuse of confidential agency information. 
• Answer-sharing and other cheating on professional examinations.
• Individual violations of trading rules, use of inside information, and breaches of independence rules.  
• Doubts over the profession’s ability to recruit and retain a growing number of properly qualified and skilled personnel, in the context of concerns for academic preparation and workplace environments. 

This despite intense attention and massive investments of time, money, and energy in education, training, messaging from senior leaders, and the development of tools and methodology 

The challenges may seem intractable. But if issues that extend over judgment, skepticism, ethical behavior, and operating priorities are really so hard, are there ways to improve? 

Although the search for simple solutions to complex questions can lead down the road of faulty analysis and wrong answers, a more optimistic perspective is proposed here. Fortunately, we have a half-century of research in the cognitive sciences to open a window into the complexities.

The premise is that accountants share common characteristics with all other fellow humans –- for better or worse. They are not unique or special, differently equipped, or uniquely skilled. They are no less subject to all the influences and pressures that affect and expose the human condition with its frailties and weaknesses.

Which means the news is not all bad. The very opportunities identified in that research have adaptations to the accounting profession’s particular needs. 

Biases, Pressures, and Human Frailty

A rich body of relevant literature sets the stage. A sampling for those interested: 

• The ground-breaking 1974 essay of Daniel Kahneman and Amos Tversky, “Judgment Under Uncertainty: Heuristics and Biases” (Science V. 185)
• Kahneman’s own encyclopedic book, “Thinking, Fast and Slow”(2011)
• Contributors such as Philip Tetlock, “Super-Forecasting: The Art and Science of Prediction” (2015) and Richard Thaler – with Cass Sunstein, “Nudge” (2009 and later editions), and his own “Misbehaving: The Making of Behavioral Economics” (2015)
• A generation of sharp economists, including Steven Levitt and Stephen Dubiner of the University of Chicago, e.g.,”Freakonomics” (2005) and the UK’s Tim Harford, e.g., “The Undercover Economist” (2005) and “How to Make the World Add Up” (2021). 

Greatly simplified, all modern humans carry the legacy of our prehistoric ancestors’ DNA. An early hunter, armed with a spear and hearing the rustling underbrush, faced a critical moment that required an instant reaction: if it were an animal he could kill, the tribe would eat that day, but if a tiger or a wild boar, he was at deadly peril. A stranger emerging from the forest with outstretched hand –- was it in friendship or with a weapon? 

For our ancient predecessors, the fast instincts of “fight or flight” and “friend or foe” were essential to the tribe’s safety and survival, whether against hostile adversaries or vicious predators. Their judgments carried life-or-death consequences for the hunters, although the tribe survived provided they were mostly right, most of the time. 

Those same triggers serve today in many simple cases. When a traffic light changes from green to yellow, no analytic energy goes into a driver’s non-rational “go or no” reaction. Likewise, quick and low-salience consumer choices at a Starbucks counter or a grocery shelf are mostly simple, fast, and non-demanding. 

But these examples show that our DNA has not evolved. The very simplicity of our ancestors’ instinctive reactions means they are maladapted to complex modern challenges. Decisions such as how to allocate an investment portfolio, calculate a reserve provision, where to open a new office, or which candidate to hire are better made with research, deliberation, and consultation.

Like the ancient tribes, today’s society still operates, for better or worse, as programmed for overall survival under normal conditions. This means that decision-making often defaults to oversimplification or resists recognition of the consequential exceptions:

• The very essence of the long-standard auditor’s report, expressed in non-technical terms, conveys a message filled with multiple qualifications — that the client’s information “is generally right, for the most part, over this time period, so far as we can tell within the limits of our work.”
• Likewise, practices and programs for personnel hiring, evaluation, promotion, and management are designed on the assumption that those affected will behave as expected. They act honestly, in good faith, and respond appropriately to guidance and leadership. 

For both of these, the general rules work just fine. Until, under conditions that may seem unusual or unpredictable, they don’t.

The dissonance emerges in both performance and management, because it is the exceptional cases, not the normal and expected ones, that cause the problems (e.g., the white-collar fraudster for whom an audit is an inconvenience to be evaded, the abusive supervisor, the rogue employee).

And that’s when the consequences kick in. Reactions to this bad behavior –- from the profession, its clients, the general public –- can be put in the terms used to discipline unruly children, “when you do right, nobody remembers; when you do wrong, nobody forgets.”

The Ubiquity of Human Bias

The literature has cataloged an entire vocabulary of human bias and error that pervades the accountants’ environment as much as any other area of business or professional services. The irresistible human impulse to simplify complex problems leads to narrowed questions that, by default, are often answered with little time and energy –- and too frequently answered incorrectly. 

Examples from a long list will illustrate.

                                                     In General            In the Profession

The Induction Fallacy (Mistakenly believing that past experience is a complete guide to the future)	It’s only the flu	The CFO has never misled me before
The Planning Fallacy (Over-confidently disregarding the likelihood that unforeseen changes will affect a project’s execution)	The opera house will be finished on time and on budget	Our report is on schedule –- we don’t expect any disruptions
The Anchoring Effect (Over-weighting quantitative information that is visible although not complete or relevant)	“Buy three tires, get fourth free” -  bargain	Receivables  look light–bump of 5% should do it
The Optimism Bias (Ignores evidence inconsistent with desired outcome or narrative)	Our troops will occupy Kiev within two weeks	Client growth 15% last year, so 20% this year is a lock
The Inertia Effect (Continuing past practice, whether or not in a changed environment)       The Bias of Representativeness (Extending an assumption based on limited information)	NASA shuttles launched for years –Challenger good to go     Dressed like that, he surely doesn’t belong here	Scope was fine last year -- SALY     We don’t send recruiters to schools with that ranking

These examples — illustrative and by no means comprehensive -– are common throughout the profession, as they are in society as a whole. And they share a common theme. They all arise out of the natural default to quick, simple, and intuitive reactions inherited from our ancestors that are ill-suited for modern life’s complexities.  

The guidance of the research is best summarized by Richard Thaler (Misbehaving, pp. 355-56): 

"It is time for everyone –- from economists to bureaucrats to teachers to corporate leaders –- to recognize that they live in a world of humans and to adopt the same data-driven approach to their jobs and lives that good scientists use.

"Good leaders must create environments in which employees feel that making evidence-based decisions will always be rewarded, no matter what outcome occurs. The ideal organization encourages everyone to observe, collect data, and speak up."

A word of caution: perfection is not within the grasp of fallible humans with our in-built limitations. “Zero defects” is not achievable, nor does the awareness of our sources of bias assure consistent use of the tools available. But the deliberate aspiration to improve, being the best we can do, has promise.  

Installments to follow will suggest some means to take these thoughts forward to practical application.

 

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Crypto-Land –- The Accountants Discover That It’s Terra Incognita

“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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Ave Atque Vale: What I Learned by Riding in John’s Old Jeep

I am hurting at the loss of a dear friend. John was large in girth, spirit and personality, and his death leaves a hole in my heart.  

Make of this what you will, readers who believe in transcendent energy connections or that nothing is accidental or coincidence: while digging this weekend in the disorder of my files, I turned up a pencil draft, two decades old.  

Here are those old notes, with little change, in salute and farewell to my friend, who would grasp the lesson I took from riding around in his world.

 

I made a recent visit to the car culture of Los Angeles, and came away with an increased appreciation for the value of small and subtle sources of knowledge and expertise –- which need not be complex or exotic to be valuable, only focused and specific. 

My friend John might have been typical in southern California, although to this taxi-dependent resident of an Eastern city, his freeway life was as foreign as his garage was full: matching Porsche 911s as the couple’s separate commuting cars, a sizable Mercedes sedan to haul the luggage for weekends in the country, a marshmallow-shaped Plymouth coupe that went back to his boyhood, and a baby-blue MGB soft-top nestled in the corner, so cute you wanted to pat its rear as you walked by.  

There was also his go-shopping vehicle, in which we set off for wine and other weekend necessities -– a civilian version of the English-built WWII jeep, vintage late 1940s. Right-hand drive, olive-drab, canvas roof and otherwise open to the elements. Its short wheel base made the kidney-thumping ride hellishly uncomfortable.

Parked at a busy market, it attracted stares. I was puzzled. “How do you lock it? Isn’t it an inviting target?”

I was met by scoffs. John did not suffer fools.

“Not another person in all of LA County could get it out of the parking lot. First, there’s no ignition key. A thief wouldn’t know about the off/on toggle under the dash. And the ignition is separate, with a starter switch on the floor above the accelerator.”

I had visions of early lessons on the farm trucks and tractors of my rural youth. To drive the hay fields and the feed lots required a contortionist’s flexibility to manage a foot-activated starter tucked up obscurely between the two main pedals.

“The shifter is floor-mounted under the driver’s left hand. There’s no chance an American could find the R in the pattern. It’s the same lay-out as in this country, just like the pedals, but a Yank would think ‘mirror image,’ hit 2^nd gear, and lurch right into the curb.”

“Last, the old crash-box transmission. If a thief did manage to get out of the parking space, he’d be stuck in low gear and stall within twenty yards.”

There are times to believe in the “wisdom of crowds.” But the instincts of the herd only serve for conventionally available knowledge and experience. The advantages of small information gaps open up when nobody else has the facts.

Put another way, a model based on commodity-scale knowledge has weaknesses that create opportunities in either of two ways: first, because everybody wrongly thinks they know it -– like the dubious worth of bitcoin or a no-advantage business plan -- second, having a unique niche, as with an armor-plated portfolio of intellectual property, or a unique license, or as here, a foreign post-war jeep.   

Neither need it be complicated. British soldiers were trained and knew exactly how to handle the simplicity of their camo-decorated workhorse. In America, John’s jeep was fully theft-proof, for reasons as hidden in plain sight as its inscrutable old technology.  

 

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The Accountants Are Toasting ESG -- With Loving Cup or Poisoned Chalice?

The accounting profession is joining in the broad-based enthusiasm for a future of greatly expanded attention to corporate reporting in the areas of Environmental, Social and Governance / Diversity, Equity and Inclusion. Whether the stampede is toward a new promised land of useful information, or a cliff-edge of hazard -- that remains to be seen.

My own recent contribution appears in this winter's special edition of the International Journal of Auditing (V.26, Issue 1), published by Wiley in the United Kingdom at the initiative of Dr. Ilias Basioutes, senior lecturer in Accounting at the Aston Business School in Birmingham, as an extension of the annual Audit & Assurance Conference under the auspices of the school and the Audit Group of the British Accounting Association.  With his kind permission it appears here:

THE FUTURE OF EXTERNAL AUDIT: ISSUES AND QUESTIONS 

Introduction

Prediction is very difficult, especially if it's about the future!

- Attributed most reliably to Danish physicist Niels Bohr

What does the future hold for ‘Big Audit’—the function that emerged in the Victorian era 1 to offer third-party assurance on company-provided information, valued and used by the world's capital markets?

Audits of public company financial statements, leading to the all-too-familiar ”true and fair view” opinion, are at the core of a formidable professional services franchise.2

Pressures on the model are multidimensional:

• The traditional ‘pass/fail’ opinion is criticized as simplistically inadequate to address the complexities of modern business reporting.
• The firms are stressed to embrace rapid developments in technology, big data and artificial intelligence and to cope with staffing and employee issues under the COVID-19 pandemic and the work/life concerns of younger generations of their workforce.
• Despite decades of attention to audit quality, costly corporate collapse and white-collar malfeasance persist—in recent years spanning from Carillion in the UK to WireCard in Germany. Highly publicized scandals generate both the expected question, “Where were the auditors?” and litigation at levels posing existential threat to the firms' survival.3

Little should be expected from the politicians and regulators. The consultation initiated by the UK government in March 2021, “Restoring Trust in Audit and Corporate Governance,” portends extended attention to the mission, scope and structure of a reconstructed UK audit regulator but is essentially silent on changes to the basic model of the firms themselves.

Driving real change, however, will be the loud and demanding calls for expanded corporate transparency in a multitude of areas— loosely gathered as Environmental, Social and Governance (ESG) and lately extended to the rubrics of Diversity, Equity and Inclusion (DEI).

Under the imperatives and opportunities of the capital markets, new corporate disclosures may be supported by third-party assurance from sources still to be determined. In that new landscape, where would the accountants find themselves? What might or could they do? Prudently considered, what should they do?

The Accountants Should Be There

The accounting profession has a prima facie claim for a seat at the table. Evidence that assurance providers were “counting the stuff’ goes back to the Sumerian era, when clay tablets were inscribed to record quantities of grain and livestock. At the meta-level, the auditors have provided assurance process innovation and application for 170 years.4 Whether that history supports a claim for primacy may be another matter.

Along with the accounting firms themselves, bodies including the International Federation of Accountants, the ICAEW in the United Kingdom and the Center for Audit Quality in the United States are tub-thumping advocates of a presumptively leading role for the profession.

Observers such as Sir Donald Brydon are more measured. His report of December 2019 on his “Independent Review into the Quality and Effectiveness of Audit” expresses the desirability of a new professional designation—the corporate auditor—contemplating a remit well beyond that of statutory auditors, “to encompass today's auditors and others with appropriate education and authorization” (¶ 6.0.11).

The Brydon report's salient observations suggest that the range of subject matter expertise and competencies required to put flesh on the auditors' process skeleton may be more extensive than is presently available or as envisioned in the self-regarding eyes of the profession itself (all emphasis added):

“... It is far from clear that an accountant is best placed to opine on many of the variables involved (¶ 6.0.13).

“Whilst in this new environment there may be environmental auditors, cyber security auditors and financial statement auditors, only some would need to have an accountancy qualification as known today” (¶ 6.0.14).

Some Threshold Questions

There are threshold questions in the ESG/DEI discussion, answers to which are still on the far horizon. They start with the challenge of articulating the “standards” against which companies will report and under which auditors may provide some form of assurance.

Simply, what is a “standard,” and how is it to be interpreted, applied and enforced?

Ad hoc communities of the great and the good are vying among themselves to proclaim both virtue and competence in standards setting. Self-designation carries no real weight, however; history teaches that stature and credibility are only achieved, and legitimacy bestowed and maintained, through public acceptance, when and if value is demonstrated and responsibility is accepted and enforced.

There is some inchoate understanding, visible among the players, of the uncertainties involved:

• The merger of the International Integrated Reporting Council and the Sustainability Accounting Standards Board into a newly launched Value Reporting Foundation reflected the reality that streamlining and convergence are essential.
• On 3 November 2021, the IFRS Foundation Trustees announced the long-awaited and much-promoted launch of the new International Sustainability Standards Board, one approach to the ultimate need for broadly endorsed official standards recognition and sanction.

Complete global convergence is unlikely, however, as already signaled by separate efforts of the SEC in the United States on climate disclosure and unilateral movement in the European Union toward mandated assurance.5

The Overhanging Issues of Liability 

The skunk at this otherwise optimistic and congenial garden party is that of legal liability. While the prospect of major exposures looms on the horizon, there is no likelihood of short or medium term change in the liability exposure for auditors offering ESG/DEI assurance:

• Barring the unlikely adoption of “safe harbour” protection for assurance in whatever form, inevitable lawsuits will assert liability based on the broad association of the provider's name and brand, whatever the ostensible limitations of its report language. Under the particular conditions of each individual case, it will be asserted that the “standards” were unsatisfactory or deficient to protect the interests of users, or that if the standards had only been properly understood and applied, an allegedly deficient report would and should not have been issued.
• Engagement contract provisions between auditors and clients, to cap or otherwise mitigate potential exposures, have failed to attract widespread or indeed any significant adoption. Public companies in the United States are prohibited by the SEC from using such provisions in any event. Future adoption cannot be anticipated.
• There is no public appetite to relieve the auditors of their generally unlimited liability to investors and others; no realistic expectation exists of liability “reform,” caps on damages or other relief.

Some Nightmare Examples

When an assurance engagement thought to be low risk does go wrong, as some number surely will, the consequences can be wildly disproportionate to a firm's approach to its risk assessment or to the quality of resources and performance actually delivered.

It requires little enough to hypothesize a menu of situations that would spawn serious litigation against ESG/DEI assurance providers, whoever they may be—auditors or others:

• Hard on the heels of an opinion on the controls and governance of a dealer in precious metals, a whistle-blower reveals the entity to be engaged in systematic gold smuggling and money laundering.
• Within a year of an environmental safety report, offering assurance on a global energy company's procedures for controlling the completion of its offshore oil wells, a new blowout occurs on the scale of the 2010 Deepwater Horizon. Weeks are needed to bring it under control; it causes unquantifiable ocean pollution and damages in the billions to regional businesses, fisheries and wildlife, resorts and tourism.
• Directly after a “reasonableness” opinion on a global clothing manufacturer's disclosures of the structural safety of its factories, a high-rise sweatshop in a developing country collapses. Building and contents are a total loss, along with extensive fatalities among the trapped workers.
• An assurance report is delivered on a company's compliance with its country's standards for the number of vehicles necessary for timely evacuation of a factory's workers in an emergency. Unfortunately, a massive accident destroys the facility, with an 80% fatality rate among the workers. Subsequent investigation reveals that while the number of vehicles on site was in compliance with the minimum set by the standards, one third were inoperable and awaiting maintenance; in any event, even the total number could at most have accommodated no more than half the number of workers on site at the time of the evacuation order.

The Profession’s Own Perspective

Optimism and “success bias” are deeply embedded in the DNA of the accounting profession. Well they should be, to meet the complex needs involved in building and leading large organizations in fast- evolving conditions.

But—a personal perspective—in dealing for nearly 50 years with the threats against auditors in their most difficult and dangerous situations, I have long seen their continuing desire to focus on “all the things we do right, that we never get credit for.”

That is especially true for assurance other than statutory audit— whether compilation or reviews, agreed-upon procedures or opinions worded in “limited” or “reasonableness” language. For these, the default attitude is “they're low risk, and people have to understand our role.”

Both of which are true, most of the time. But not always. To invoke the maxim for the occasional discipline of unruly small children, “When I do good, nobody remembers; when I do bad, nobody forgets.”

As For Possible Future Directions?

So what might the future hold? Assuming medium-term formalization of standards and reporting for ESG/DEI, either voluntarily or by official mandate, and the publication of a critical mass of assurance reports, there will follow a small but non-zero number of corporate breakdowns that involve and implicate the performance of the providers.

Some number of accountants and other assurance providers, convinced to accept engagements to provide “limited” or “reasonableness” opinions, will find their work challenged in the courts. Defenses against asserted damages at potentially catastrophic levels will be required. Litigation outcomes being unpredictable, at minimum those firms will incur and expend extensive time, expense and settlement costs.

Other providers, in their exercise of risk assessment, will have foregone the acceptance of ESG/DEI assurance engagements, unless protected from exposure to potentially ruinous liability. It may be expected that such decisions will predominate both in the US and for ex-US companies whose US-traded securities open the door to litigation under that country's legal system.

There is a third scenario for the accountants, if allowed to chart their own course over an uncertain ESG/DEI landscape that lacks dependable signage and is fraught with hazards. By analogy to the tax consulting services that the firms have delivered for decades, they would have a consultative role, both valuable and manageable, bringing expertise and discipline in support of their clients' disclosures, while refraining from extending their own opinions where the value is uncertain and the risks are increased, unpredictable and beyond quantification.

Two factors could complicate such a strategy. The first is that zealous regulators could attempt to mandate ESG/DEI assurance, despite or without adequate assessment of the limitations and complexities.6

Second, the scope of technical competencies and expertise required to support broadened ESG/DEI reporting and assurance has potential to clash with the rules of independence and permissible scope of services that constrain the accountants, particularly in tension with their statutory audits.

That is, because ESG/DEI assurance is likely to be viewed by regulators as insufficiently related to statutory audit to be a permissible service to those clients, firms could be deterred from investing to build that practice in the first place. Further, attempts to house these ancillary non-audit resources inefficiently in separate parts of their organizational structures may not satisfy narrowly read prohibitions. At worst, the competitive tensions between separate practices could renew and exacerbate the dynamics that led to the divorce between audit and consulting that split up the Arthur Andersen organization in the late 1990s.

Conclusion

It should surprise nobody that the concerns in this rapidly evolving area are real and complex. Absent full and robust attention, constructively addressed at an early stage, adverse consequences can be expected; because they are identifiable now, they will not in the future honestly qualify as “unintended.”

 

1 Research in the archives of the British National Library for my book,  Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms (Emerald Books 2d ed 2017), pages 28–34, shows what may be the first modern independent auditor's opinion, dated and signed by William Welch Deloitte on 8 February 1850, on the financial statements of the Great Western Railway for the half-year ended 31 December 1849.

2 Together, the dominant Big Four international networks—Deloitte, EY, KPMG and PwC—have over 1.1 million employees and generated 2020 global revenue of $157 billion.

3 For calculations of the shockingly low litigation “tipping points” that would drive a Big Four firm into the death spiral that was fatal to Arthur Andersen in 2002—never publicly disputed or contradicted—see pages 56–64 of Count Down.

4 This was Mr. Deloitte's description of his scope for Great Western in 1850 (see Count Down page 31):

“Every item has been minutely examined by the Auditors, the vouchers and receipts have been inspected, and the purpose to which the payments were applied has been ascertained. “

5 A close-by context confirms that view, by analogy: The widespread adoption of the International Financial Reporting Standards for financial statement reporting has not overcome some local authorities' retention of their own reporting frameworks.

Broader still, as if confirmation were needed that there will be no arrival at a Nirvana of fully converged ESG/DEI standards, consider the impact on the global economies of the costs and inefficiencies of such competing national choices as between left versus right-hand driving, or the use of imperial versus metric measures of weights, volumes and distances.

6 If so, it would not be the first instance of such overreach. The consequences are still developing on the EC's misguided imposition of mandatory auditor rotation. Meanwhile, in the United Kingdom, only an outbreak of good sense stands in the way of the government's consultation proposal for “mandated shared audits” for FTSE 350 companies.

 

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Big Audit Leaves Russia – Or Does It?

Rapidly as world events are moving, it’s my pleasure to share my guest post of today on The Dig, my friend Francine McKenna’s always sharp-pointed substack, with her incisive sub-head:

“Ties were severed with an ease and speed that suggest the auditor global networks may be more fragile than advertised.”

"We should go" -- Chris Woolf (Ben Affleck), The Accountant (2016).

We’ll only know with the judgment of history whether the large global accounting networks’ readiness to separate from their member firms in Russia had any impact whatsoever on the political and economic outcome of Russia’s invasion of Ukraine. For now, as Churchill described the actions of Russia in 1939, “it is a riddle wrapped in a mystery inside an enigma.”

Two-plus weeks into the increasingly bloody morass of Vladimir Putin’s “special military operation,” however, there can be these observations:

• The largest six networks (as of this writing) have acted to join an ever-expanding list of firms and companies, public and private, choosing the right side of history by withdrawing from Russia.

• Which said, the accounting networks’ structures and the nature of the Big Audit model –- both differing fundamentally from those of the world’s largest corporations and the lawyers, consultants and other professional service providers – mean that in actual practice the impact is likely to be minimal.

• Once beyond the immediate optics and a modest amount of house-keeping, the ease and speed with which these amputations were carried out suggest that future distress scenarios should be seen as dire.[1]  

Grant Thornton led on March 1, and then the terminations came raining down –- PwC and KPMG, EY, Deloitte as the last of the Big Four, and BDO on March 9. The pack of red cards lagged business cessation announcements by McKinsey, Apple, Nike, and a partial but growing list of the large law firms, although ahead of giants in the consumer sector — McDonalds, Coca-Cola and Starbucks — and lately even bankers Goldman Sachs and JP Morgan Chase.

Their public face was one of collegial amiability; if couched as divorces, they would anticipate future reconciliation or re-engagement. EY’s press release offered comfort that the “EY global organization assured that it would provide assistance to Russian employees.” PwC Russia put it that, “This transition is expected to be smooth and the PwC Global leadership team has stressed that it would make every effort to support our Russian colleagues and firm through the process.”  

Looking ahead, the tone of the announcements fairly brimmed with confidence:

• PwC stated that, “The principles and rules of working with clients in Russia will remain unchanged.”

• Over at EY, “EY Russian practice is providing and will continue to provide services to all its clients in accordance with high quality standards based on international methodologies developed by the global organization, which will continue to provide methodological support to Russian practice.” 

The basic organization of the large networks portended the up-beat tone. As well enough known but seldom scrutinized, they are assemblages of distinct and separate legal entities, organized and providing client services at the local country level to comply with the local nature of the profession’s regulation. They are, for the most part, various types of private partnerships, owned by their local partners who share profits and losses at that level. They do not have outside third-party capital, a corporate “parent,” or a top-level “holding company,” although most have some form of non-practicing administrative entity that is inserted into a complex web of inter-firm contractual agreements to facilitate the handling of intellectual property, methodology sharing, quality oversight, personnel transfers and the like.

Very little need change to maintain the status quo. Daily life at both the newly-outcast Russian firms and their quondam colleagues ex-Russia will evolve in ways that are both marginal and limited. That’s especially as compared to the disruption being caused by outside forces, as the array of Western sanctions on companies and individuals both Russia-based and doing business there looks expansive, targeted, and significant.

Those effects, however, would befall the accounting networks and firms whether the Russian members were in or out.

• Employees of the newly-isolated Russian firms will continue to work the same jobs, at the same locations and under the same leaders as before.

• The fortunes of the Russian partners will continue to depend on their on-going local practices –- although as noted, impacted by Western sanctions –- but not radically different from under the large networks’ localized compensation ethos of “eat-what-you-kill.”

• Change management will be trivial. Clients and other interested parties will have received the news of the Russian firms’ status almost instantaneously. With marginal effect in the marketplace, the firms’ publicity resources will be occupied briefly with revised branding announcements, re-labelled publications, website re-designs and the issuance of new business cards.

Nor is there any reason to doubt the limited nature and scope of the impact on the execution of Big Audit engagements. For these, there are two aspects:

• An audit firm in Russia, engaged by a client based there and having international operations, would always have relied on its collegial network member firms to perform any necessary non-Russia work. That need will continue, although under the global-level assurances of on-going cross-border amity, it will be uninhibited by the cosmetics of separation (while, as noted, very possibly affected by the sanctions regimes).

• Symmetrically, the auditor of a non-Russia company with operations in Russia will have relied traditionally on its member firm there to audit and report on the local results. Again, going forward (and noting that the audits of companies exiting or halting their Russian business may now have to address the accounting for operating losses or discontinued operations), the local Russian firm would presumably be available to be engaged at arm’s-length — deploying its personnel and relying on the non-Russia referring firm to provide technical consultation and methodology guidance, just as a large network has always done to secure services in a country where it might not have its own network member. 

So far, very likely all well and good, if lacking in drama — save for this: when the violence has ended, and the dust of the Russo-Ukrainian conflict has settled, both literal and figurative, a dark and subtle message lurks beneath the surface.

Consider that the large audit networks have thrived on messages emphasizing the scope and strength of their international structures, and their capacity at scale to deliver seamless and efficient services to the participants in the global capital markets.

Those messages have persisted, despite an emphatic signal delivered in 2002, when the Arthur Andersen network collapsed in a matter of weeks. This occurred even though it was the most profitable and tightly-organized, with its partners enjoying the only globally integrated results-sharing model in the profession’s entire history. 

Which is to say — the largest six networks have now shown the capacity to surgically excise their Russian member firms, voluntarily and in a matter of days. That suggests — under-cutting the messaging of network unification as robust and tightly-bound (and shifting metaphors) — that the “ties that bind” may only be attached with slip-knots, or are spun of gossamer, able to being broken or snipped in an eye-blink by the scissors of exigent events.

I have long argued that the under-appreciated lesson in Andersen’s precipitous fall was that, far from being “too big to fail”, the surviving Big Four tetrapoly is “too fragile to survive.”[2]

That every one of these large networks was able to cut loose a member firm of significant size, swiftly and without obvious discord or repercussions, does not inspire confidence that a similar fate would not befall an organization under the stress of a government sanction or a litigation judgment at a level — easily foreseeable, given the size of recent well-known corporate failures — that would threaten the limited depth of its capital structure and its individual partners’ resources.

Modifying network structures that have included Russian member firms, over to on-going relationships with now free-standing Russian local firms, should work smoothly enough, considering the size of the Russian economy in an overall global context. Tightly knit as are the activities of the companies and the sources of capital that make up the large western economies, however, the case would be far different should a large network be forced to lose a local firm in, say, a G-7 country or a handful of others.  

That prospect is worthy of a discussion, when a post-wartime context allows, that deserves to be held explicitly and in full public view.

 

[1] By way of disclosure, my legal practice has for five decades been focused on the accountants. I was a partner in the Arthur Andersen worldwide organization and a senior member of its in-house legal group until the spring of 2001, and continue with on-going relationships both personal and professional.

[2] Please see, for example, my book, “Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms” (Emerald Books 2d ed. 2017, pp. 45-64).

For more about this subject see an excellent summary of the issues, “Why the Big Four’s Russia Pullout Isn’t a Clean Break: Explained,” by Amanda Iacone and Michael Kapoor.

 

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Book Review -- “Noise: A Flaw In Human Judgment”

For those making group or individual judgments or decisions, on the job or personally: when Danny Kahneman has something to say, listen and learn.

His latest book, co-authored with Olivier Sibony and Cass Sunstein, is “Noise: A Flaw in Human Judgment” (Little Brown Spark, May 2021) –- deservedly long-listed by the Financial Times for business book of the year.

“Noise” extends a history of scholarship that goes back to Kahneman’s ground-breaking essay with Amos Tversky, his long-time and much mourned colleague, “Judgment Under Uncertainty: Heuristics and Biases” (Science, vol. 185, 1974), and was surveyed comprehensively in his encyclopedic work, “Thinking, Fast and Slow” (Farrar, Straus and Giroux 2011).

Standing on the broad shoulders of Kahneman and Tversky, and the two generations of scholars and practitioners who have refined and applied their insights, we look over a landscape of now-familiar concepts -- representativeness, familiarity and anchoring; sunk costs and loss aversion; misaligned incentives and the dangers of not knowing what you don’t know.

Studies of judgment errors have focused over a half-century on bias, with multitudes of strategies for its identification and reduction. “Noise” now offers an awareness of something distinctly different –- the all-too-frequent, under-recognized and undesirable variability of human judgments, in decisions and outcomes that are sub-optimal and costly at best and deeply unfair or unjust at worst.

A selection among the many colorful examples:

• The wide and perplexing range of prison sentences imposed for the same crimes by different judges, or even by the same judge.
• The amount of disagreement among diagnostic physicians, assessing the same case.
• The high-low spread of insurance premiums quoted by different underwriters for identical risks.
• The divergence of “expert” predictions on future events, from movie sales to interest rates to election outcomes.

The authors bring several surprises – one, that although decision-makers have been frustrated by the degree of noisy variability, they have not (until now) treated it as a subject for identification, analysis and pursuit of responses.

Another, the commonality of noise-inducing conditions across multiple environments:

• Single decisions are as much infected by noise as those that are repetitive or frequent.
• Individuals and groups or teams are similarly susceptible.
• Noise is no less present in predictive decisions whose future outcomes are unknowable, as in choices where simple research or fact-checking would have been relevant and valuable.

The authors readily recognize that variability in judgments is often desirable. Diversity of creative approaches and contrarian opinions are important across fields from film making to market making. But while diversity of views may benefit entrepreneurship and risk taking, it is detrimental elsewhere. If two doctors disagree on a diagnosis, at least one of them is wrong; errors in underwriting do not cancel or average out, but are cumulative; it does not inspire confidence that a job offer or a performance evaluation can be skewed by the time of day it is decided.

Space allows only a sampling of the authors’ analytic taxonomy:

• System noise is broken down between level noise – the variability of judgments due to process ambiguities – and pattern noise – differences in results based on the personal predilections of the decision-makers.
• A noise audit is proposed as the starting point for an organization’s systemic commitment to a noise-reduction effort.
• Decision hygiene encompasses noise reduction by analogy to hand washing in a hospital, reducing the presence of errors, even –- like germs -- without their precise identification.

“Noise” commends tailored and specific strategies to address and reduce unwanted variability, recognizing that the balance between the predictability of strict application and enforcement of rigid rules, and the elasticity of general standards at the discretion of an enforcement authority, is fraught with complexity. It is also at pains to recognize the necessity for trade-offs -- two in particular:

First, costs and benefits require evaluation. As an example, difficult as it is to predict the eventual success of newly hired employees, HR decisions can be improved, at least up to a point. Results improve with inputs from multiple interviewers, provided independence is preserved and the process is not subverted by committee influence or the urgings of a vocal advocate, or where sequential evaluations are passed along, so that an early rating takes on undue influence.

Similarly, noise in the grading of student work owes to the vagueness of evaluation criteria and the fatigue factor or even work hours of the grader. Research shows improvement where essays are ranked best-to-weakest –- a technique more dependable than the assignment of individual numeric scores. Having more than one grader reduces variability, although the time and cost are more easily justified for university admissions or graduate theses than for fifth graders.

Second, reduction in unwanted variability can implicate fairness and equity. Criminal sentencing, long and widely criticized as so unpredictable as to be a “lottery,” depends not only on the judge assigned, but also on such seemingly irrational factors as the time of day or day of the week of a sentencing hearing.

Which said, judges themselves and other critics have reacted negatively to rigid sentencing guidelines, with “three strikes” thresholds and mandatory prison terms, as removing discretion to consider extenuating circumstances or the prospects for rehabilitation.  

That challenge was on display at my boarding school, a very long time ago. The slender Students Handbook was simplicity itself. Strict prohibitions were few: curfews were explicit, attendance and punctuality were expected and enforced, alcohol and drugs were banned. Beyond that, judgment was expected. Alumni of those years recall and recite the central but unwritten principle, “There are no rules here – until you break them” – at which point, official wrath was swift, unambiguous, and unappealable.

Modern examples are available. Readers who share my long-running concern for the model by which assurance is provided on the financial statements of the world’s large public companies will know first-hand the impossibility of divining predictability, comparability or certainty from the pronouncements of purported authorities in such areas as accounting and reporting standards and auditor performance quality.

With its attention to the necessity for balancing and trade-offs, “Noise” has a somewhat provisional feel, especially compared with the notorious rigor that characterized the scholarship of team Kahneman/Tversky, who were unwilling to publish until they had tested themselves and their ideas in protracted scrutiny and debate. Instead, freely admitting the uncertainties and acknowledging the difficulty of generalizing across different domains, the authors both warn readers to proceed with caution and skepticism, and make explicit calls for further scholarship.

A message for my graduate students in Risk Management and Decision-Making who are staying in post-classroom contact: add “Noise” to your reading list, along with my other extra-curricular recommendations.

It’s not a summer beach book. But it will be rewarding, as you extend your studies and as your careers take shape.

(To other readers, if interested in the scope and themes of this course –- for questions, or a syllabus or reading list, drop me an email.)

The affectionate dual biography of Kahneman and Tversky by Michael Lewis, “The Undoing Project” (W.W.Norton 2016), includes the former’s simple test and measure of intelligence: the smarter you were, the faster you realized that Tversky was smarter than you. Modified here, for the sympathetic who have already over-come the natural resistance that inhibits best quality decision-making:

The concepts laid out in “Noise” are complex and provocative. The sooner those responsible for consequential decision-making become engaged, the sooner may come valuable changes in areas previously deemed intractable.

 

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Vax Resistance? Gimme A Break

This is the effort a white-haired Chicago veteran went to, to get his Covid-19 shot this morning, at the VA hospital’s vax site where I volunteer:

In addition to the indebtedness that we all owe him for his service, he now enjoys the protection delivered by the best of science, medical research and good leadership.

And we share in common the attitude that Tucker Carlson is both scum beneath contempt, and an active and dangerous menace to the health and safety of our society.

 

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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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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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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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A Valedictory for My Students: Keep the Bar High

My law school teaching in Paris -- “Risk Management and Decision-Making” -- is wrapping up for the spring semester. Classes at ZOOM distance are finished – final papers and grade submission await. To my regret, on-going lock-down means I will miss the students’ graduation, unable to deliver my appreciation in person.

Here is a message of congratulations and encouragement I would have offered:

“Our course sought to be a testing ground – a gathering of professionals with a performance bar as it would be in the real world. It’s now your opportunity to stand tall out there and deliver, with the same focus, energy and confidence you showed to me.”

I assume and expect excellence from students – as would a supervisor, a manager or a client. In the worlds of business and the professions, there is neither time nor tolerance for less. Just as it is not acceptable for an employee to turn in a report or a project with the preface, “I’m not sure if this is what you wanted….” – I want students to ask, if a discussion topic has been obscure or they see an ambiguity in an assignment or a test.

Clarifying questions show both curiosity and interest, and a shared commitment to the efficient use of time and energy. In both contexts: understand what’s expected – do the necessary research – draft and edit until the result is your best work.

And bring best efforts – the classroom should be preparation for the workplace. So it was, back when I was among the eighty law students who filled the old-style amphitheater of my largest first-year class. There we were obliged to recite on our feet, knees knocking, in response to the professor’s intimidating summons and pointed finger: “You – stand up and make a noise like a lawyer.”  

For a professional to do any less is to detract from stature, credibility and effectiveness. Examples abound:

Take the attempted ploy, “I’m just a small-town lawyer” and its distasteful equivalent in other fields. No perceptive adversary needs to be told. If truly the case, a real yokel will be revealed immediately. If not, the rule not to under-estimate an opponent means that while competence will be apparent, an attempt to be disarming but obviously disingenuous will be seen as insincere and untrustworthy.  

Related was my experience with a newly arrived corporate general counsel – by his admission from a transactional background and unfamiliar with disputes and litigation. His self-effacing introduction was along the lines, “I’m new here, and you know this is not my background.” He did himself no favors. Instead he invited the assessment of his peers that he had not done his work, was indeed not qualified, and never had his views given the weight and credibility he thought he deserved.

Not to suggest that there is anything wrong with an appropriate degree of restraint and humility. Boastfulness will be revealed all too soon as well, when results have spoken; as baseball legend Dizzy Dean said, “it ain’t bragging, if you can do it.” Or as the story goes of ancient Greece, you never asked a man if he was from Sparta – if he was, you’d have known it, and if not, you’d hurt his feelings by asking.

In these days of physical isolation and distance communication there’s a new form of avoidable self-inflicted wound: the footer on the message or the e-mail – “please excuse my typos” or “kindly forgive the orthography and erroneous auto-corrects.”

Don’t do it. True there are no virtue points for an error-free message – because that’s what’s expected from a professional anyway. But neither is there a license for sub-standard work. An advance disclaimer only draws attention and closer scrutiny. Put attention instead into extra editing – fix the weaknesses in logic and presentation, over-ride the errant auto-corrects, and catch the typos rather than apologize for them.    

To my smart and appealing students, then, with regret we have not been on campus together:

“Godspeed – keep it up -- all success to you, out there where a world of opportunity awaits.”

 

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Clorox, UV and Coronavirus – Trump’s Ignorance Stirs A Toxic Cocktail

“So, supposing we hit the body with a tremendous — whether it’s ultraviolet or just very powerful light…. supposing you brought the light inside the body, which you can do either through the skin or in some other way….

 “I see the disinfectant that knocks it out in a minute, one minute. And is there a way we can do something like that by injection inside, or almost a cleaning? Because you see it gets inside the lungs, and it does a tremendous number on the lungs, so it would be interesting to check that.”

 - Remarks by President Trump, Vice President Pence, and Members of the Coronavirus Task Force in Press Briefing, April 23, 2020

 This dangerous display of the boundless ignorance of POTUS 45 was also the day of my last class for the spring semester -- “Risk Management and Decision Making,” by ZOOM with a group of smart and curious law school students at CY Cergy Université in Paris.

That coincidence lets me appreciate and say thank you to my students – the experience was as rich for me as I hope it was useful and fulfilling for them. With brief context setting, it also tees up the punch line lesson offered here.

Our course examines how humans with all our foibles and limitations make decisions under complex and uncertain conditions. The contexts are broad – personal and social, but especially professional, business and political; the processes are often sub-optimal, and the outcomes frequently somewhere between poor and disastrous.

Topping a multi-disciplinary reading list is the pioneering work of Daniel Kahneman and Amos Tversky, whose landmark 1974 paper essentially invented the field of behavioral economics – recently brought down for public accessibility by Kahneman’s own encyclopedic “Thinking, Fast and Slow” (2011) and Richard Thaler’s “Misbehaving” (2015).

Together we explore the many sources of recurrent but avoidable decision-making bias, flaws and error -- among them are herding, over-confidence, proximity bias, anchoring and frame blindness, hindsight, rationalizations, and leadership over-ride and disregard for non-confirming evidence.

Toward the end of the semester, the students take up with enthusiasm the Dunning-Kruger effect – that the less you know about a complex topic, the more likely you are to display your ignorance in flawed but over-confident actions and decisions that reveal – often with tragic and highly destructive consequences -- how little you actually know.

That trait is conspicuously displayed by POTUS 45. His egregious invitation to ingest or inject toxic household cleansers or internalize UV radiation is only the latest. Recall his allusions to nuclear weapons against hurricanes and wind turbines as cancer agents, a weather map re-drawn by sharpie, his challenges with the basics of aircraft catapults and domestic and international geography. The list seems endless of his stunning disregard and disrespect for technical, scientific and professional knowledge and expertise.    

In an affectionate joint biography of Kahneman and Tversky, “The Undoing Project” (2016), author Michael Lewis includes a version of Kahneman’s single sly metric for intelligence: “the smarter you are, the faster you realize that Amos Tversky is smarter than you are.”

To their credit, my agile students will recognize that this maxim honoring the brilliance of Kahneman’s friend and collaborator can be inverted:

“The extent of someone’s stupidity can be measured -- how long does it takes to realize how stupid Donald Trump truly is?”

 

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