Auditing » Tax Research UK

The three lessons from the Olympus debacle

Accounting, Auditing, Corruption, Secrecy jurisdictions, Tax Havens, Uncategorized 5 Responses »

Nov 092011

The unfolding story at Olympus is quite extraordinary.

What seems to have happened, based on reports that I’ve read, is that fraudulent fees paid at the time of acquisition of new investments were filtered through tax havens to support the valuation of investments previously made on which losses had been incurred. The precise details of the shenanigans are, of course, not yet known but it seems likely that this process has been going on for at least 20 years. Three observations seem pertinent at this moment.

The first is to note that a situation where an overly strong board of directors with weak or non-existent nonexecutive directors, none of them accountable to effective shareholder scrutiny gives rise to a situation where corruption and abuse is far too easy. We should not be complacent and think that this applies to Japan alone. This is also an accurate description of the UK quoted company environment where boards are almost entirely unaccountable, whether to non-executive directors (almost all of whom are recruited from the same small coterie of people) or to shareholders, where institutions dominate. Since, however, those institutions show no willingness to act on behalf of those whom they are supposed to represent, but do instead align their self-interest with the City of London and in turn with the companies they are supposed to be monitoring, we have no effective governance of these arrangements in the UK either, so we have no reason to take comfort from this situation by pretending it is peculiar to Japan alone.

Second, and inevitably, questions will be asked about the role of Ernst & Young as auditors, and rightly so. How can such a situation have persisted for so long in the accounts of a major company? Surely the time has come when the competence of these firms has been proven to be non-existent and massive reform of the audit environment is put on the international agenda to ensure that a suitable financial architecture but the 21st-century is created?

Thirdly, and very obviously, it’s obvious that the use of disguised ownership facilitated by tax haven entities made this whole arrangement possible. How many times do we have to say that these structures exist to facilitate corruption, abuse, fraud, and tax evasion before the world’s major states take action to close them because of the costs they impose upon the ordinary people that democratic governments are meant to represent? The cost of the Olympus failure will inevitably fall upon its shareholders, many of whom will in turn be pension funds. The argument that tax havens impose cost upon these people is surely proven now, and yet the counter-argument is persistently put forward by those who argue that these places facilitate international trade and the free movement of capital. There’s no doubt they might facilitate the free movement of capital, but only in the pursuit of abuse, fraud and the debasement of shareholder worth.

In that case the time to demand that every country require that the beneficial ownership of every single corporation that it allows to be created be put on public record, and be proven beyond doubt, has surely arisen. This fraud proves yet again that the company registries of the world are a simple mechanism for the facilitation of such fraud because of the lax standards of regulation that they impose. We cannot any longer tolerate this abuse and sustain effective capital markets. The choice is either that capital markets fail, or that transparency and accountability is required, not just in the major centres, but within every single jurisdiction in which limited liability entities are allowed to trade, or companies must automatically be banned from engaging with companies located in those places. That is the only option that is tenable. And now is the time for reform.

Will the Big 4 fight back?

Auditing, Big 4 1 Response »

Oct 042011

I liked an article by Ian Fraser in the Sunday Herald this week. In it he said:

The “Big Four” accountancy firms, whose complacency and dereliction of duty were major contributors to the banking crisis that tipped the UK into recession, could be getting their comeuppance at the hands of the European Union.

The story of Deloitte, Ernst & Young, KPMG and PWC and their obliviousness to malfeasance and fraud in the banking sector in the bubble years has not been sufficiently told. They didn’t raise any red flags about the massive risks that were building up in the financial system. And they gave a clean bill of health to numerous diseased brands including HBOS and Royal Bank of Scotland weeks before the undertakers arrived.

And as he notes:

Proposals from the EU’s internal market commissioner Michel Barnier would [seek to] put a stop to all this. He wants to force accountancy firms to choose between being consultants or auditors. As already happens in France, audit firms would have to work jointly with other audit firms and face time limits on how long they could act as auditors to the same company.

I’ve already commented on this idea, warmly welcoming it. Unsurprisingly Ian Fraser thinks the Big 4 might not share that view:

The Big Four are aghast at these proposals. Their lobbying machine is already getting into gear and they’re warning of “unintended consequences”.

He thinks they might win support for their view too:

In the UK, the Big Four may gain some traction. The firms enjoy an entrenched position thanks to the revolving door between the Big Four and the civil service via secondments and government contracts.

And as he concludes:

The outcome of Barnier’s plan remains uncertain. However policymakers need to set aside their cronyism and ask themselves a simple question. Can the UK really afford to maintain an accountancy profession which, by its own actions, has proved itself to be a danger to capitalism itself? Barnier’s proposals would not fully address the problem, but they are a sensible start.

I wholeheartedly agree.

The reform of finance does not begin and end with the banks.

PWC – not up to scratch, yet again – with no hint of reform in sight

Accountancy, Auditing, PWC 7 Responses »

Aug 162011

It’s depressing to note the ongoing incompetence of my own profession. As the Guardian reports:

Auditor PricewaterhouseCoopers admitted to years of mistakes relating to the failure of investment bank JP Morgan to ensure that billions of pounds of its clients’ assets had been properly ring-fenced.

PwC is now expected to face a heavy fine over its role in the client asset scandal which could have wrought unnecessary mayhem had the bank collapsed at the height of the financial crisis in October 2008. At that point, JP Morgan’s futures and options desk held $23bn (£14bn) of client money, largely belonging to hedge funds, which was not segregated from the bank’s own funds.

This is basic stuff. It’s not, as PWC implies, a small slip. It’s an absolutely fundamental failure to audit. It’s incompetence on a gross scale. And incredibly easy to spot.

But PWC did not do it.

So threee questions:

1) Why not?

2) Why are they allowed to continue in operation in that cae?

3) When will auditing be totally reformed?

The answer is, in all cases ‘conflicts of interest’ do in differing ways explain a) why it happened b) why it will continue to happen c) why reform is blocked.

And if ministers won’t tackle this then you can be sure they won’t tackle other deep problems in society either.

Time to look at the systemic issues: Hackgate is not just about one company; it’s about the need for enhanced corporate accountability

Accounting, Auditing, Big 4, IASB 5 Responses »

Jul 182011

Hackgate (as it now seems to be called on Twitter at least) is not, I venture to suggest just about hacking, Rupert Murdoch and his acolytes, one rotten newspaper or even the media as a whole. It is about a systemic failure of responsibility and accountability, assisted by massive opacity.

That opacity has in turn led to three things. The first is massive wealth imbalances which are only dimly but none the less accurately perceived. The second is a real threat to democracy that has been almost completely hidden from view. Those two in turn have led to alienation that is now leading to a breakdown in trust. That, of course, then threaten society itself.

There is enormous opacity about business activity in the UK, and throughout the world. Company accounts have become longer but less meaningful. New accounting rules introduced by the International Accounting Standards Board have reduced the status of those accounts to being data solely designed to assist those speculating on financial markets. All responsibility of the directors for the stewardship of corporate assets under their control or any hint of responsibility on their part to long-term investors has been eliminated from financial reporting by this body. The result is that, as was witnessed in much of the discussion headed by Luke Johnson, chair of the Royal Society of Arts on BBC 24 last night, the capacity of the business community to assess the impact of this issue is reduced to discussion of its consequence for the share price. Nothing else, apparently matters.

And yet, we know it does. We know that what corporations do is fundamentally important. We know that they can hide the truth of what they do. They can do this within their own accounts, and most especially they can do it in the accounts of their subsidiaries, and particularly those that are located in tax havens. They can hide the existence of those tax haven subsidiaries from view.

An addition, the way in which company accounts are presented to members, on a purely consolidated basis so that internal transactions are not seen means that those payments made within organisations to hide the location from which corruption is managed can never be identified. But then, not can most of their use of tax havens for any reason be identified, any more than their use of such locations to ensure they minimise their contribution to society in a way designed to undermine the democratic mandate of elected governments be assessed.

This is of course suits the cheat, the crook, the monopolist and the person simply seeking to hide from regulatory purview; they’re all assisted by this opacity, deliberately created over many years, and advanced considerably over the last few by the complicity of the Big 4 firms of accountants who have set out to create an accounting framework that lets multinational corporations undertake their trades behind a veil that outs them almost beyond scrutiny.

The consequences are clear. We have companies like News Corporation that have, it is now clear, committed illegal acts (because some people have already been found guilty of them) where directors can apparently claim that they knew nothing of what was going on. Well of course that is, theoretically, possible in the situation I describe. Because such multinational corporations can heap subsidiary company on subsidiary company within the organisation and push responsibility for payments down into lower entities within the group which the higher directors can then claim to only have interest in as shareholders those high-level directors can then use this structure to seek to avoid responsibility for the activities of the companies which they control. I have little doubt that at some point in time this defence will be rolled out in the case of News International.

This, however, is not good enough. Business is an amazing thing: it has delivered, and can still deliver, enormous prosperity within the UK and around the world. Let’s not forget that for a minute. But it also has the capacity to abuse. It can abuse employees; it can abuse shareholders and it can abuse the public at large. Despite this the only account that we have of what it does is provided by the financial statements that each multinational corporation is obliged to supply to its members each year, The content of those accounts is regulated almost entirely by the International Accounting Standards Board which has very recently sought to narrow its remit and the scope of its responsibility. As I noted on Forbes recently, the existing constitution that governs the International Accounting Standards Board says its purpose is:

(a) to develop, in the public interest, a single set of high quality,understandable, enforceable and globally accepted financial reporting standards based upon clearly articulated principles.These standards should require high quality, transparent and comparable information in financial statements and other financial reporting to help investors, other participants in the world’s capital markets and other users of financial information make economic decisions.

(b) to promote the use and rigorous application of those standards.

(c) in fulfilling the objectives associated with (a) and (b), to take account of, as appropriate, the needs of a range of sizes and types of entities in diverse economic settings.

Note that right at the outset the public interest comes first ( at least on paper, if not in practice). And note too that whilst participants in the world capital markets are important (and they are) it is recognised that the interests of other users of financial information are just as important, even if again practice has not followed principle. Finally, amongst the many points that could be noted, it is clear that this body thought it had obligation to all types of economic entity, in all types of market, and economies.

However, at this moment the International Financial Reporting Standard Foundation that governs the International Accounting Standards Board is revising its constitution. I have no doubt at all that one reason it is doing so is because of the pressure brought to bear on it by the in civil society campaigning for country-by-country reporting which would expose the tx haven activity of multinational corporations, which is being massively resisted by the accounting profession. This is what it says in its proposed revised constitution:

In carrying out the IFRS Foundation’s mission as the standard-setting body, the IASB should develop financial reporting standards that provide a faithful presentation of an entity’s financial position and performance. Those standards should serve investors and other market participants in their economic and resource allocation decisions. The confidence of all users of financial statements in the transparency and integrity of financial reporting is critically important to the effective functioning of capital markets, efficient capital allocation, global financial stability and sound economic growth.

All mention of the public interest has gone. Now the sole purpose of financial reporting is to serve the needs of financial markets. There is nothing else.

This is extraordinary: at a time when the need for greater transparency and accountability with in multinational corporations has never been higher to restore public confidence, to support democracy, and to ensure that people are not abused the accounting profession is closing ranks to make sure that the information available on the trading and other activities of the world’s largest companies is more hidden from view than ever before.

Hackgate must have consequences. One of them is that questions must be asked about the right of the self appointed, private sector, tax haven-based organisation called the International Accounting Standards Board to create rules for accounting for the world’s largest companies when there is a complete conflict-of-interest within it because the Big 4 firms of accountants sponsor it, their clients help promote it, and the needs of society at large and the democratic principle that companies are accountable to the states in which they are incorporated, and to the people of the world at large are ignored by it.

We cannot hold the world’s corporations to account when they control the rules of accounting. The time to reclaim those rules for parliaments has come, and the process of oversight of that rulemaking has now to be transparent and accountable itself, with the rights of large corporations being respected, but by no means being dominant within the process.

Will our legislators have the confidence to do this? Will they grab this opportunity? If they don’t, they will leave us for ever guessing about what large corporations are doing, and will give those multinational corporations the opportunity to hide for good their activities, licit or otherwise, from public view. We cannot afford that. Democracies cannot survive that. Our society is threatened by the current opacity we suffer. The time for reform is now.

Do Ernst & Young have a case to answer on News International?

Auditing, Ernst & Young 4 Responses »

Jul 152011

As the FT notes this morning:

Allegations of police bribery at the News of the World have raised fresh questions about the role of auditors and their responsibility for preventing corporate wrongdoing.

But as preparations are made for a judge-led inquiry into the disgraced tabloid, the firm that vetted its accounts seems unlikely to face investigation by audit regulators, at least not in the coming weeks.

As the they note, Ernst & Young has audited News Group Newspapers for more than a decade and never qualified its accounts. But they then note:

But the details that have so far emerged raise questions about whether Ernst & Young fully discharged its duties, according to Richard Murphy, a former auditor who runs the Tax Research UK consultancy.

“What Ernst & Young did or did not do is an issue of concern,” said Mr Murphy, who campaigns against corporate tax dodging.

Media coverage of questionable practices at the News of the World over several years ought to have caused Ernst & Young to suspect its internal controls, he said: “The auditors must surely have done the most basic of Google searches on their client.”

Ernst & Young is saying nothing, citing client confidentiality. Which is fair enough, but I note the FT found little problem finding people to defend them.

However, members of the financial establishment say it would be unfair to expect auditors to challenge small payments amid the flow of hundreds of millions of pounds in and out of the business – assuming any bribes were of the order of thousands of pounds, as reports suggest.

Mike Power, an accounting professor at the London School of Economics, said: “I don’t think they [the auditors] are on the hook.”

That’s an odd idea given the regulatory framework for auditing I noted here, which gave rise to this story. But as the FT notes, the profession is very reluctant to investigate anything until it has to, about which might as the FT says:

In the meantime, the News of the World saga could feed into a broader debate about whether audits have become irrelevant and need to be rethought.

It is a debate Ernst & Young knows well, given the adverse comment that its auditing of Lehman Brothers has already attracted.

I personally think this one will run, and run.

It’s time to hire KPMG to tell you how to…hire KPMG

Accounting, Auditing, KPMG Comments Off

Jul 142011

Accountancy Age reports:

Almost half of local authorities admitted they are unprepared to appoint auditors, just as the government is preparing to hand over this responsibility following the planned closure of the Audit Commission.

A survey by KMPG showed that, for 44% of chief executives, directors of finance and chairs of audit committees, the issue is “not yet on the radar”, and no one on their team had any experience of audit procurement.

So, KPMG undertakes a survey to show that local authorities need to hire their services to help them buy audit services from….well, KPMG.

Gravy train, anyone?

Just as George ordered, of course.

The government’s accounts are blatantly wrong and must be qualified

Accounting, Auditing, Economics, Uncategorized 40 Responses »

Jul 132011

The UK government has for the first time ever issued a set of consolidated accounts covering its activities today. They are, admittedly in draft, but they are also blatantly wrong, and so seriously misstated that any auditor must be duty-bound to qualify them as being a completely unfair view of the state of the government’s finances.

The reason for saying this is simple: it is an absolute rule of accounting that revenue must be recognised as it falls due and any sum not collected must be treated as a bad debt. However, the revenue included in these accounts is the net sum of cash collected relating to the year 2010/11. As such the accounts are stated net of losses to tax evasion, which the Revenue themselves admit might be £35 billion a year, and may be as high as £70 billion a year in my estimate, and they are also stated net of tax avoidance. The Revenue have admitted they have £25 billion worth of tax avoidance subject to dispute at present, and I believe that this is the sum lost annually for this reason.

As a result I contend that the top line of these accounts is understated by at least £95 billion, meaning they are grossly and materially misstated in accounting terms or, in layperson’s terms, they are just a straightforward lie about the true financial state of the government.

Unless and until the UK government can accept the fact that it fails to collect a very large part of the tax owing to it then we have no hope of economic competence being restored at heart of government. Basic recognition of this truth is the first step towards achieving that goal, and these accounts suggest that the government remains in denial on this fundamental issue that could transform the well-being of the UK government, help slash the deficit to a point where it would be of no great consequence, restore social justice in this country by giving preference to honest people over cheats, and at the same time uphold the rule of law and the democratic will of Parliament.

Right now, the government chooses to do none of those things. It prefers to leave money in the pockets of cheats instead of using it to pay for pensions, provide education and ensure the health service is secure for the future. Worse still, by stating its accounts in this way it denies that there is even a problem to address.

The government should be ashamed of these accounts and ashamed of their cowardice with regard to tax collection and I sincerely hope that the auditor of these accounts has the courage to say that they do not represent a true fair view of the government’s activities, because that is very obviously true. If they do they will be doing us all a great service: this government may demand greater transparency and accountability but unless it adopts that maxim for itself then there is no hope of it being achieved elsewhere. So far they are a long way from coming up to scratch.

Why any inquiry into News International should demand Ernst & Young’s working papers

Auditing, Corruption, Uncategorized 1 Response »

Jul 112011

I mentioned on Saturday that Ernst & Young had a role in the News International corruption debacle because of their role as auditors of the company. This has been challenged by a couple of commentators, so let me expand my case.

Auditing standards recognise that an auditor has a duty to check that a company is compliant with the legal framework in which a company operates. The relevant standard is here.

Now, it’s clear that an auditor has to check the accounting and legal environment and compliance with obvious regulation relevant to a company when auditing its accounts. But it’s not responsible for everything else.

But, it’s also got a responsibility to review risk and that is company specific. So if a company suffers an allegation of phone hacking, for example, the auditor would be on notice to look for risk in that area. It’s inconceivable, in my opinion, given all the attention given to hacking and payments to police given to News International over the last few years that the auditors did not look at this issue, and tat is they did not they were negligent.

So I believe any inquiry must call for Ernst & Young’s working papers from their audit files. And examine what they did, or did not find and report on it.

Where were the auditors at News International?

Auditing, Corruption, Ernst & Young 9 Responses »

Jul 092011

It looks like the Business model of a major News International subsidiary in the UK was corrupt.

Where were the auditors, Ernst & Young?

What did they have to say?

Or was it all ‘immaterial’? It doesn’t look that way now. And an auditor does have a duty to review the legal environment in which a company operates and its compliance with it.

Just a thought…..