Re:Balance -- Jim Peterson

Refuge from the Storm – Seeking Shelter in Troubling Times

 

“… but we must cultivate our garden”

                          - Voltaire’s Candide, 1759

This space has been quieter than usual for a while. As the season approaches for year-end meditation and review, there are two reasons.

First, with the cyclical state of the capital markets somewhere between benign and robust, the critics’ cries of “where were the auditors?” are muted, and the regulators are largely quiescent. Second, in a highly charged political environment that shows no sign of relief, “commentary overload” is real – for both providers and consumers.

So it’s not that I’m withdrawing – far from it. Real issues continue to be worthy of attention. But it’s well to re-calibrate the quantity and quality of information that can be absorbed and processed. 

Taking these in order:

Serious concerns persist, for sure, around Big Audit – the model that provides assurance by global accounting networks on the financial statements of the world’s large companies. That structure only exists and survives because auditors’ opinions are required by the major securities regulators; the uneasy “public/private” relationship traces to the passage in 1933 and 1934 of the foundational American securities laws, although it is threatened at least by these:  

• A litigation impact on the scale of Enron’s collapse in 2001, causing the immediate collapse of Arthur Andersen and reducing the population of firms with the geographic scope and expertise required for global-scale audits down to the critical minimum of the surviving Big Four.

• The accounting profession’s propulsive rush to the forefront with the rapid evolution in corporate recording and reporting on the topics under the expansive rubric of Sustainability, lurching toward the provision of expert independent assurance. That’s despite the unconverged and unready array of “standards” to be applied, and the yawning chasm between the investing public’s unrealistic demand for “zero defects” and the over-estimated performance capability of the aspirant assurance providers. Barring an unlikely outbreak of reflection and prudence, this new “expectations gap” will erupt into an entire new and potentially catastrophic outburst of professional liability exposure and litigation.

• The still-to-be-measured flood of private equity and other third-party capital directed at and eagerly embraced by firms in the tier below the Big Four – where uncertainty clouds the impacts:
  • On the personnel side, freshly-funded departures of senior leadership, career and advancement prospects for the next generation, and the questionable appeal of this new model to potential entrants to the profession from the universities.
  • On the service delivery model, the constraining effects of the independence rules that will inhibit the firms’ services to clients of their new third-party investors, and the potential constriction, discontinuance or disposal of their audit practices.
  • On the governance and structural side, the very viability of a multi-disciplinary firm having the breadth of skills and expertise to handle either complex audit engagements or the evolving scope of Sustainability assurance, as the pressures of new investors will incentivize the re-structuring and separation of practice lines deemed insufficiently profitable.

These all being noted, the environment is quiet for the moment. The wave of large litigations extending from the collapse of Carillion in 2018 appears receded, so far without the deadly consequences that their scale initially threatened – although as has been the case for the last half-century, a fresh threat of existential size is as imminent and predictable as the next and inevitable large-scale global scandal.

Meanwhile the regulators in the most significant jurisdictions lie becalmed. The post-Carillion sound and fury in the UK has gone silent, and the impending change of administration in the US augurs a return to the somnolence of its first term.

           (With one supportive observation and one exception: The PCAOB just announced the shelving of its deservedly-criticized proposal to re-write the rules on auditor disclosure of client violations of laws and regulations. And its November 21 release, looking to impose a suite of information disclosure requirements on the large firms, is certain never to see final implementation. SEC approval is required, but unlikely to survive chairman Gensler’s resignation announcement the same day and effective in January; at the same time the vigorously dissenting member, Denise Ho, is tipped to become head of the agency in the new administration, which can in any event be expected to return to its first-term state of paralysis and inaction.

And there is Australia, too distant to be audible or influential above a whisper, where PwC has managed to extend attention to its tax practice’s misuse of confidential government information into the maladroit handling of the political aftermath, providing fuel to a retaliatory slate of proposed “reforms” appearing to be cribbed from those proposed without significant adoption or effect in the UK.)

Last in this area, much ink is spilled over an asserted “pipeline problem” – that is, concern over the volume and quality of potential new entrants – with the youth either declining accounting majors at school, passing on the credential of the CPA or its equivalent, or opting out of practice altogether in favor of careers in consulting or finance.

As for the second of these themes – attention is urgent to the personal challenges of conserving and preserving mental health and emotional well-being. That’s because – with particular focus on the last American election cycle - the approaching new year threatens an extension and expansion of the soul-trying inflictions of the last.

That is, on the losing side, the bubbles inhabited by the politicians and their media enablers continue to look as opaque and resistant as ever to the necessary evolution in vision and messaging that outside influence might bring about.

As the election outcome so resoundingly demonstrated, those most visible and audible up through November 5 comprehensively failed to understand, appreciate or act effectively on the state of the American electorate. Falling so short, to use their own unappealing chiché, in “grasping the Zeitgeist,” they continue to serve up volumes of recriminations, tinfoil-hat conspiracies and outlandish “analysis” from the same tiresome and manifestly unsatisfactory perspectives.

Those are conversations I decline to join. Rather, while reserving the desirability of accessing legitimately reported news, my healthier choice is to forego the sterility of both the op-ed equivalents of toxic junk food and the social and conversational re-hashing by the unqualified of last night’s broadcast sound bites.  

Meanwhile on the other side of the trenches, the near-term future looks to be populated by knee-bending sycophants whose shortcomings in experience and competence are overlain by slavish devotion and ideological fervor. Confidence is not inspired – disruptions and break-downs in major areas of the nation’s political and bureaucratic institutions will quickly emerge under the mismanagement of those too ignorant or too blinkered to appreciate the extent of their “not knowing what they don’t know.”

In this dispiriting environment, under the two-fold influences here outlined, adjustment is indicated. As I have sought over two decades to respect both the patience of my readers and the credibility of my content, I have neither need nor desire to publish for the sake of a timetable or to keep up visibility for its own sake.

Ample opportunities will emerge soon enough, to dial up the energy and re-focus on matters deserving attention. For that, I look for perspective to Candide’s observation, after all the mayhem and violence in Voltaire’s satire - not the counsel of despair, but a call instead for the importance of optimism tempered by experience.

However you may celebrate this turning of the year, then – hug your loved ones, be grateful for your blessings, and keep the faith. 

Thanks for joining this dialog. Please share with friends and colleagues. Comments and reactions are invited and welcome, and subscription sign-up is easy and free – both on the Main page.

“Fall and Slip” -- The Uncertain Timetable of EY’s Separation

“Sell while you can – You are not for all markets”

             Rosalind to Phebe, “As You Like It” (III,v,60)

Summer holidays are ended, schools are re-opened, the seasons turn. And the waiting continues, with no end in sight, since the news in May of EY CEO Carmine Di Sibio’s plan to separate the global network’s consulting and audit practices into NewCo and AssureCo.

Project Everest’s mountain-top remains shrouded, and Di Sibio has not descended. The timetable is reported to slip through the autumn, and the list becomes longer of issues that could de-rail the project.  

“Waiting” is a culturally familiar device. Interests are focused, and tensions build. In movie Westerns the anxious town-folk wait for John Wayne and the cavalry. Theatre-goers wait for Samuel Beckett’s eponymous Godot. Investors salivate for monthly government statistics. Cult devotees await saviors or, perhaps, an apocalypse.

In mid-August I drew contrasts between the structure and organization of EY and history’s benchmark, the 2001 IPO of Accenture, newly liberated after its divorce from Arthur Andersen’s audit practice –- views that, still hostage to fortune at this writing, will eventually be tested.

This supplement looks further at some of the questions beneath the masses of numbers generated by the hordes of banker/advisors feeding at the trough of the EY project. Reactions to the relevant uncertainties will have multiple impacts: on the entire sector including EY’s competitors around the globe, and –- centrally –- for the EY partners’ career-defining decisions as they assess their professional goals and options.   

For EY partners considering a future with a NewCo consulting firm:

Without the anchor of a legacy audit practice, what are the real prospects for NewCo and the mélange of country-scale consulting practices that last year gathered in some $ 25 billion in revenue? To compete for both work and personnel, NewCo would confront not only the other Big Three and their commitment to continued full-service practices, but also the broad-service consultancies with long and well-established global brands and market presence –- Accenture itself at 2021 revenue of $ 44.5 billion, and the deep pockets of Bain, BCG, and McKinsey -– reportedly offering compensation packages for new MBAs in the US approaching $ 250,000.

For consulting partners on the fence and able to choose between the two:

Considering the fluid and evolving state of the global regulators’ views on the provision of ancillary services to audit clients, is there a preferred choice between jumping to NewCo with its uncertain future, or opting for AssureCo, where client development and service expansion may be constrained in a practice focused on that legacy firm’s book of audit clients?

To illustrate the depth of this question -- the SEC’s March 2022 proposed rule-making on greenhouse gas reporting and assurance, mired as it is in critical comments and political wrangling, still makes clear the agency’s view that the intended assurance would fall within the permissible scope of the statutory auditors. Well and good, except a sourcing question for EY: would it be an appealing career path, for a GHG expert, to accept a practice confined to the portion of the annual audits of AssureCo’s US registered clients, against the opportunities to work across the entire sector?

For audit partners who might choose a future home in AssureCo:

• How would the audit-oriented practice of AssureCo either employ or engage the diverse scope of expertise necessary to carry out the complex audits of global-scale clients?

• • These skills extend to valuation, financial instruments, sustainability of all kinds –- where practitioners may for the sake of their own career ambitions be unwilling to confine themselves within the limits of independent statutory audit.

• • Would an independent GHG expert consider it an appealing engagement to support an AssureCo audit, if obliged to demonstrate SEC-level independence and therefore be forced to foreswear sustainability consulting for that company, whether GHG or otherwise?

• How would AssureCo’s limitations in practice scope respond to the market’s evolving needs for broadened and more complex forms of assurance?

• How would it compete not only with the other Big Three firms, which remain committed to multi-disciplinary practice models, but with the new providers eager to expand especially into the world of Sustainability reporting and assurance?

In addition to the already-mooted issues of liability exposure, pension funding, and retention of experienced staff, these questions are of sleepless-night importance for the EY partners, wherever their current location in the EY global structure. 

For them, the wait must seem endless.   

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are invited and welcome, and subscription sign-up is easy and free – both on the Main page.      

UK Audit Reform: The Boris Johnson Government Flies A White Flag

Fifteen long months after launching its consultative White Paper, “Restoring Trust in Audit and Corporate Governance, the UK government of Boris Johnson has surrendered on the “audit “ portion.

That’s on reading the Response of May 31, 2022, from Kwasi Kwarteng, Secretary of State for Business, Energy and Industrial Strategy.

His Ministerial Foreward promises “ambitious plans to further strengthen the UK’s audit and corporate governance framework” (p.3). But a slog through its 197 pages reveals a mélange of delay, retreat, and withdrawal.

Four years and counting after the January 2018 collapse of Carillion that triggered this latest spasm of public dissatisfaction with the functioning of Big Audit, the Response devotes massive verbiage to corporate governance, but a mere nine pages to the only two topics with direct bearing on the performance of large-company audits.

Even for the former, the Response natters on, its proposals reflecting a “built-in scope for fine tuning” (p.4) that is euphemistic for “who knows what may work, or what the unintended consequences may be.”

Readers are largely left to speculate –- generously assuming that Johnson can stay in office in the face of a dramatic loss of confidence in his leadership -- on the particulars that may be expected in possible legislation to be put to an unspecified future session of Parliament, by way of possible legislation to replace the discredited Financial Reporting Council as the profession’s regulator with a new Audit, Reporting and Governance Authority.

Among the multiple examples of what the ICAEW generously called on May 31 a “half-hearted” Response:

• The absence of Sarbanes/Oxley-style corporate reporting and assurance on internal controls (§2.1.27).
• The absence in the new proposal for a corporate Resilience Statement of a similar statement by statutory auditors (§3).
• Leaving for the market the consideration of widened financial information assurance (§6.1.48).
• The absence of commitment to the new qualification of “corporate auditor,” as proposed in Sir Donald Brydon’s December 2019 report (§6.1.48-49).
• Leaving with the accountancy bodies the consideration of auditor training, qualification and skills (§6.1.54).
• Explicitly taking a “wait and see” view on the intractable problems with fraud detection and prevention (§6.2.16).
• Passing entirely on the existential threat posed under the existing regime for auditor liability (§6.1.70).

On the lesser topic bearing on the audit firms –- “operational separation” of Big Four audit and consulting (§8.2) -– the air has long since gone out of any energy for further change; authorizing ARGA to legislate on what is already in process would be inconsequential.  

On the second -- competition, market share and auditor choice -- the Response would inject the challenger firms into FTSE 350 audits by legislating ARGA’s power to set the terms: the percentage of a FTSE 350 audit to be performed by a challenger firm (§8.1.16), definitional metrics (§8.1.17), international reach (§8.1.18), and exceptions for the unavailability of a challenger (§8.1.19).

Importantly, such steps would phase in only over the ten years of the audit tender cycle under §C.3.7 of the FRC’s Corporate Governance Code (§8.1.2). Big Four dominance of FTSE 350 audits not having budged in the nine years since imposition of that requirement, however, suggests the passage of another decade over which evidence might emerge of market share changes perhaps supporting an enforced market share cap (§8.1.15 and §8.1.20).

The necessary conclusion -- implicit in the Government’s comprehensive passivity, and in the Secretary’s explicit readiness to “(set) market participants the challenge of shaping their own future” (p.4) -- is that developments over the next generation will be shaped by already evident market dynamics:

First, KPMG’s announcement of an intent to carry out a cull of its client list, if taken seriously, could open challenger opportunities, if only:

• To the extent its Big Four colleagues were to stand aside voluntarily in the tender process.
• Subject to the challengers’ resource development, risk appetite, and survival in the face of litigation and regulatory exposures.

Second, the roaring enthusiasm for extended corporate reporting and assurance on “Sustainability,” the catch-all adopted by the newly-launched International Sustainability Standards Board, has potential. Whether the advocates are rushing headlong toward a promised land of opportunity or a cliff-edge of disaster remains to be seen, however; there are such overhanging and unresolved issues as the extent of convergence of “standards,” the permissible scope and structure of the audit firms’ ESG resources and practices, and the impact of the litigation and regulatory exposures for which the SEC’s recent enforcement actions in America for ESG reporting deficiencies by both Vale and BNY Mellon are canaries in the mine.

Last, potentially most significant and least appreciated is the very viability of the large-firm assurance franchise itself –- now brought to the fore with the news of EY’s consideration of a global separation of its audit and consulting practices.   

Not for now to ponder pro’s and con’s -- the challenges facing CEO Carmine Di Sibio and his global team are dire. The prospects should not be minimized that the outcome –- rather than a clean global split with all pieces intact and a handsomely-financed windfall for at least some groups of EY partners –- may instead be the exposure of an organization riven with anxieties and antagonisms, ill-equipped for the stresses of publicly-visible divorce proceedings.

Arthur Andersen’s unhappy history is this movie’s prequel. Briefly put, EY’s leaders have put the entire enterprise into play, with the potential that critical numbers of partners in country firms and practices may opt to serve their local and personal interests.

Should that happen, the Government Response to the question of large-firm viability -- that “to provide ARGA with the ability to operate a market share cap in the event of the failure of a major audit firm” would be “intended to give the regulator the ability to react quickly and to limit further concentration in the FTSE 350 audit market in the event of firm failure” (§8.3.23) –- would be exposed as an empty and meaningless charade.

The environment of another large-network disintegration should instead recall the late William McDonough, preparing to step down as chairman of the American PCAOB in the fall of 2005, with his warning -- never since modified or disavowed by any of the profession’s regulators -- that “none of us has a clue what to do if one of the Big Four failed.”

In which case, the irrelevance of the Government’s Response will be well and truly evident. For readers with the fortitude to follow this dreary story, there will be reason for another installment, for this look:

At the level of energy, vision and intelligence brought by the Government to this highly relevant set of issues for the capital markets, its flaccid Response is probably the best it has the capability to deliver.   

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are invited and welcome, and subscription sign-up is easy and free – both at the Main page.