re: The Auditors » Blog Archive » Liberté, Egalité, Fraternité: Big Lehman Brothers Troubles For Ernst & Young.

Francine McKenna’s take on Lehman and E & Y

A must read.

Richard Murphy Auditing, Banking, Ernst & Young

There’s much discussion today about whether the alleged professional negligence by Ernst & Young with regard to the audit of Lehman Brothers – where it appears they turned a blind eye to the rigging of the balance sheet – might be their Enron and lead to the demise of the firm.

I’m on record as saying I think the end of at least one of the Big 4 is nigh – and with it the whole audit market.

But let’s be clear – Ernst & Youngs’ defence – that their audit complied with US GAAP (Generally Accepted Accounting Principles - pronounced ’gap’) may be true. But that’s not the point. The point is US GAAP is crap and the Big 4 engineered that their audits do not need to report either truth  or fairness.

As the rules of the IAASB (International Auditing and Assurance Standards Board), which sets auditing standards  says, an audit is:

The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. In the case of most general purpose frameworks, that opinion is on whether the financial statements are presented fairly, in all material respects, or give a true and fair view in accordance with the framework. An audit conducted in accordance with ISAs and relevant ethical requirements enables the auditor to form that opinion.

The wording is not a chance: the emphasis is on compliance with the financial reporting framework first; the consequence of being true and fair is assumed to follow, but is consequential, not the goal.

So, E & Y influence the International Accounting Standards Board that sets the framework.

And they influence the IAASB which limits the scope of the audit to the point it’s useless.

And although financial statements are meant to be produced for the benefit of the providers of capital to a business (in itself far too narrow a requirement) the auditors in the UK (by reason of the Caparo decision) and in the US under Delaware law basically can’t be sued by those providers of capital.

In other words the auditors charge a lot for doing a job badly for which they know they have almost no liability. It’s not surprising they don’t really care.

It’s not E & Y who have erred here – it’s all those who let this situation develop that have erred. The accounting structures we use are rotten to the core and so is auditing. Unless both are reformed we are heading for collapse after collapse after collapse as the prevailing mood of society to promote expedient short term greed will destroy entity after entity without any check or balance in place to stop it happening.

This can be tackled.

It needs to be tackled.

Without the political will to tackle it just watch society collapse like a pack of dominos as big business begins to fail all round us.

And I think I’m underselling the melodrama in saying that.

Richard Murphy Accounting, Auditing, Big 4, Ernst & Young, Ethics, IASB

re: The Auditors » Blog Archive » EY Settles SEC Charges Re: Bally’s Fraud-Lives To Audit Another Day .

Ernst & Young picks up yet more penalties and Francine McKenna asks an apposite question: how many strikes does a firm get before it’s out?

Quite a lot, she suggests, if you’re on the regulatory body.

Richard Murphy Accounting, Auditing, Ernst & Young, Ethics

PWC and EY heavily implicated in unlawful privatization | AccMan .

PWC and E&Y have both been heavily criticised for unethical conduct in Sri Lanka that brings the reputations of both firms and the profession into disrepute but mysteriously the local Institute of Chartered Accountants has not acted.

Three things. As Dennis says:

The Sri Lankan Sunday Times/Financial Times has a detailed account of the role of the auditors in the Sri Lanka Insurance Corporation (SLIC) privatization. For the first time, we see the extent to which PWC and EY partners were implicated in what has turned into something of a scandal in Sri Lanka. The accusations levied are extremely serious and damaging including acting on both sides of the transaction, charging exorbitant fees, unexplained and retrospective reclassification of accounts and accounts manipulation.

This is no minor issue: this is blatant abuse.

Second, as ever, self regulation does not work. When the elite is corrupt it can never regulate itself.

Third, again quoting Denis:

Should I be surprised that partners are conflicted and the extent to which that taints their work? Of course not. This is the way people operate when their moral and ethical compass is out of whack. If anything we should not be surprised at all. Instead, we should realize that despite the Big Four’s usual tactic of stone walling and feigning innocence, no amount of PR can hide these ugly findings. Message to the Big Four: stop pretending you are in control of the global networks. Either do the job properly or acknowledge that in reality it’s all a PR stunt.

I agree. get control of these firms or get rid of them.

Richard Murphy Corruption, Ernst & Young, Ethics, PWC

From the Observer today, commenting on the failure of Dutch / Belgian bank Fortis:

Fortis’s accounts were jointly audited by KPMG and PricewaterhouseCoopers - two of the big four practices. They have received audit fees running into tens of millions. But they seemingly failed to give investors an indication that Fortis was heading for severe problems.

‘The basis of an audit is the assessment of risk,’ said forensic accountant Richard Murphy. ‘These people, I believe, fundamentally failed to assess risk. They were responsible. That’s what their job was. They didn’t do it. We have to look at different audit systems for the future [and in the UK] the National Audit Office should now be protecting the taxpayers’ investments in banks. We can’t rely on the big four.’

Auditors at Bradford & Bingley, Northern Rock and a host of other institutions [also] failed to sound the alarm over the significant risks in these businesses.

KPMG and PricewaterhouseCoopers prefer not to discuss Fortis’s case, though representatives say it is unfair to pin the blame for destruction of global firms solely on them. They argue that credit rating agencies who gave ‘Triple A’ assessments of sub-prime bonds, and regulators who failed to bear down on over-leveraged institutions, must also share responsibility.

Two things follows:

1) KPMG et al say they audited within the rules, i.e. they confirmed ‘market value’, but what they do not say is they set the rules, and they were also responsible for suspending the previous rule that required a ‘true and fair over-ride’ meaning that the auditor had to do more than follow the rules.

2) There is no future for those who set the rules wrong. the Big 4 did that. Amongst the money things we’ll have to get right are new rules for auditing, as well as accounting. But in the meantime I cannot see who but the National Audit Office (with all its faults) that can protect HMG’s investments in banks.

Richard Murphy Accounting, Deloittes, Ernst & Young, KPMG, PWC

I was interviewed for this story in Accountancy Age:

Offshore tax probe hits the buffers

I’m not mentioned in the resulting piece. And I really don’t care: that’s what happens with 50% of all interviews, and it’s part of life.

I do care that the story is so very obviously wrong. I don’t for one minute believe that HMRC’s:

crackdown on offshore accounts is facing mounting problems this week, as the timetable drags on attempts to hit tax evaders hard.

Indeed, far from it. I believe it is going well. At least as well as can be expected given the enormous scale of abuse that has been discovered. And the fact that no prosecution has yet been announced is entirely appropriate. I’d expect it to take at least two years for investigations to get to that stage, and I’ve done my fair share of tax investigations in my time.

So what’s the real story here? Bluntly it’s this: that the Big 4 want to undermine this enquiry. Last weekend we had PWC blatantly calling for offshore investigations to be halted. Put it another way and that’s asking for a licence to tax evade. There’s no other reasonable interpretation.

Now we have E & Y saying:

On a score of one to ten I would probably give the investigation six to six and a half,’ said Bob Brown, global leader for tax and investigations for Ernst & Young.

‘The quality of information [on offshore accounts] is not as good as they thought and they lack enough experienced investigators to run with this,’ he said.

Of course, if E & Y cooperated the Revenue might have rather more of the information they need. I think it very unlikely that they are. What they will actually be doing is going as slowly as possible and delaying supplying information for as long as possible. The reason is obvious. As HMRC say:

We have opened enquiries into nearly 12,000 offshore accounts and will proceed with a further 79,000 over the next two years. We always knew the scale of the offshore disclosure project would be significant and we are fully resourced to carry it through.

I’m sure that’s true. But PWC and E & Y are doing their damnedest to make sure as many cases are not being opened as possible, I’m sure. Delay on already open cases will help that objective by tying up HMRC resources. And creating bad publicity for HMRC is designed, I have no doubt, to bring the process to a premature end when what HMRC are actually doing is a vital job protecting society from those who perpetrate fraud.

Frankly these firms disgust me. It’s in all our interests that offshore abuse stops. But these firms sell it and they protect it.

I’ve said it before, and I’ll say it again. If taxation is the foundation of democratic government then the four biggest threats to democracy in the world are not North Korea, Afghanistan, Iraq and Iran. They’re PricewaterhouseCoopers, Ernst & Young, Deloittes and KPMG.

These firms work deliberately and ruthlessly to undermine the taxation revenues due to democratic governments. I can think of very little that can do more to destroy society as we know it and have enjoyed it. As such they are a cancer destroying our democratic way of life. And like all cancer they need to be cut out and destroyed as soon as possible if the patient is to have any chance of recovery.

Richard Murphy Accounting, Deloittes, Ernst & Young, KPMG, PWC

It strikes me that there are four key firms behind the credit crunch who have suffered nothing like the exposure they deserve. They are:

• PricewaterhouseCoopers
• KPMG
• Deloittes
• Ernst & Young.

They audited all the serious players. They have signed off the accounts of all the banks on a going concern basis that have either now gone bust or needed emergency funding.

The provided the offshore mechanisms for many of the off balance sheet deals that allowed sub-prime refinancing to happen.

They audited those offshore structures.

They ensured they fell out of the tax net.

You can be pretty sure they’re auditing most of the hedge funds.

They have been some of the fiercest advocates of the neo-liberal model that has brought the world to its knees.

Why aren’t we holding them liable?

Why aren’t we creating a new model of auditing?

Why aren’t we saying if you want to audit in the UK you can’t have an offshore office?

Why are we still allowing people to audit the structures they create?

Why, oh why haven’t we learned the lessons of previous debacles when they were so obviously there to see. After all, Prem Sikka has recounted them for years.

Auditing and accounting has to be subject to the regulatory reform that must change the world of finance forever if we survive the current mess.

Richard Murphy Accounting, Deloittes, Ernst & Young, KPMG, PWC

The FT has reported that:

Banks have been given a one-year reprieve by US accounting standard-setters from having to take up to $5,000bn (£2,520bn) of debt assets on to their balance sheets, easing fears that they would be forced to raise large amounts of new capital quickly.

Robert Herz, FASB chairman, said that the move was made reluctantly after a staff recommendation for a delay because there might not be enough time for all companies to adjust to the up-heaval.

As the FT notes:

Since the credit crunch, many banks have been forced to bring some such vehicles back on to their books, angering investors who did not know about the holdings.

In May, analysts at Citigroup forecast that banks could be forced to bring up to $5,000bn of assets back on to their balance sheets when the new rules came into force.

Lawmakers and banking industry groups have issued calls for a delay in recent weeks because of the potentially huge detrimental effect the changes could have on banks’ capital bases and their ability to raise new capital.

As justification:

The FASB said it had decided to change the date as a result of “comments and feedback that we received”. The original proposed date was an “ambitious” one that had been reconsidered, it said.

Mr Herz said during the meeting he was “chagrined” by what had been uncovered as the rule changes were prepared.

He added that there had been a mixture of poor reporting and a lack of proper enforcement.

Now let’s be clear what this means. Banks who have been responsible for poor reporting, which has been tolerated due to their auditor’s failing to properly enforce existing rules have submitted comment to FASB that they cannot possibly comply with new accounting rules as yet because they need to raise new capital in the meantime, and can only succeed in doing so if they can continue to misrepresent the true extent of their assets of limited worth and actual liabilities.

In a litigious world wouldn’t you think that FASB might be putting themselves at risk of class actions from future aggrieved shareholders by knowingly putting those people’s wellbeing at risk by allowing continuing misrepresentation of the true and fair view in the accounts of US banks? That seems to me to be exactly what they are doing.

I am staggered at FASB’s complicity with this abuse, and lack of willing to impose appropriate rules. I do not agree that the banks could not comply: their inability is self motivated lack of willing, which is something quite different.

And whilst this continues expect the credit crunch to get much worse as the spiral of losses goes on.

And who do I blame? There are just four audit firms who can carry the blame for failure of proper enforcement. They are of course PWC, KPMG, Ernst & Young and Deloittes. They carry an enormous burden of responsibility for the failure of accounts to show a true and fair view, a failure that allowed the credit crunch to develop.

Richard Murphy Accounting, Deloittes, Ernst & Young, KPMG, PWC, Regulation

Accountancy Age reported last week that:

The push for auditor liability limitation in the US received a boost today when an influential audit group threw its weight behind the movement.

The Centre for Audit Quality, an autonomous organization which is aimed at serving investors, auditors and the capital markets by improving audit quality, has urged the US Treasury to consider setting a cap or introduce proportionate liability to reduce the risk of the collapse of another firm through litigation

But, let’s be candid: Accountancy Age’s claim that the Center for Audit Quality is an autonomous organisation looks a little hard to sustain. Its website is hosted by the AICPA, and that is the US auditing profession by any other name. I smell self-interest in this announcement.

More important though is the comment by Francine McKenna entitled “When” another one bites the dust. She is emphatic: another failure is just a matter of time. I strongly suspect she’s right.

But as she notes, the real question is so what? She puts it at slightly more length, saying:

What do you need in the way of financial reporting assurances, audits, due diligence, attestations? Does an audit and its useless, boring boiler plate make a hill of beans difference in your investment decisions, or do you all, analysts, sophisticated investors and other stakeholders, make your own decisions based all publicly available information assuming it’s timely and accurate? Can we find a way to uncover fraud, punish fraud and warranty the financial information that is distributed to the public so that financial statements are a tool rather than a throwaway?

Right now they are a throwaway. Worse than that in fact. And the audit report has been totally debased. It’s easy to explain why. When I was auditing we sought to establish if the accounts showed a true and fair view. Now auditors don’t do that. An audit is now defined as:

The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.

Remember, the change was not imposed on auditors. They chose to do it. And they chose the conceptual framework too. Fair value accounting is the result. But let’s be clear, inherent in this is a simple ‘mark to market’ concept that has meant (ludicrously) that it is assumed that all assets are up for sale at all times in every corporate’s accounts, and must be valued at current market worth. This was great when markets in financial markets could be rigged to produce the data auditors needed to show ever rising profits on behalf of their clients. But that did not prove sustainable, and now there is no market there is no price, and so we have massive right downs.

Both positions were ludicrous, but both arise because the framework is flawed: it assumes people only hold assets to sell, not to use. This is the ultimate evidence of the concept of financialisation that only accountants could really believe in. Second, the whole concept of auditing is destroyed by the convention: true and fair counts for nothing anymore because real value is not reported, only current market value. They are not the same thing, but only accountants don’t know that.

So, so what if another Big 4 form goes bust? It might just hasten the demise of the ludicrous accounting and auditing environment they created for their own benefit which is imposing massive cost on the world (like so much that the partners in PWC, KPMG, E& Y and Deloittes do). I hate to say this of my own profession, but I think that would be a good thing.

Richard Murphy Accounting, Deloittes, Economics, Ernst & Young, KPMG, PWC

On Thursday (when I was at a conference and out of blogging action) the FT reported that:

The US Internal Revenue Service is to solicit the help of the world’s top accounting firms in its widening effort to clamp down on offshore tax evasion.

The IRS is planning to speak on Tuesday to six accounting firms about how they could help find foreign banks that fail appropriately to identify US customers holding investments or income in offshore accounts, according to people briefed on the plan. A conference call has been scheduled between the agency and Deloitte, Ernst & Young, KPMG, PwC, Grant Thornton, and BDO Seidman, they say.

This is absurd. The firms in question are some of the principle architects of tax haven structures. They are the almost universal consistent element to be found in every offshore financial centre. The know they have created a world in which tax evasion is not only possible, but happens. They helped created it to make money. They’re not going to kill the golden hen that brings them so much profit.

It’s precisely why PWC and Deloittes joined with Citi and HSBC to offer bland and inane comments on tax havens to the Treasury Select Committee last week.

It’s why in Tax Havens: Creating Turmoil I argue that it is the accountants as well as the lawyers and bankers who need to be regulated now. It is precisely because regulators continue to make this sort of elementary mistake in the approach they are taking by somehow thinking the accountants are on their side that I am convinced the change we propose is essential.

Richard Murphy Accounting, Corruption, Deloittes, Ernst & Young, Ethics, KPMG, PWC, Tax Havens