Time for adult supervision of auditors

Posted on

The FT has reported:

Top accounting firms were hoodwinked by Bernard Madoff's alleged $50bn fraud as well as several leading banks and some of the world's biggest hedge fund investors, according to lists of service providers to Madoff-linked funds.

PwC, KPMG and Ernst & Young, three of the "big four" accountants, and an arm of BDO International, the fifth largest, were all auditors of the feeder funds which channelled money into accounts at Mr Madoff's New York brokerage.

Mr Madoff, who has been charged with fraud and electronically tagged, told investigators his business was "one big lie", according to prosecutors. The head of the US brokerage industry's compensation scheme said records at Bernard L Madoff Investment Securities were "certainly falsified".

Do not expect them to have any liability though

Do not expect them to have any liability though. Remember, because the auditing firms changed the rules of auditing there is no requirement that they report that the accounts of an entity now show a true and fair view. They have only to report that the financial statements give a true and fair view in accordance with the applicable financial reporting framework . This is something very different. If, as was the case when I was trained as an auditor, you had to ensure that the accounts gave a true and fair view then you had to look to beyond the evidence that the client is presented to you and assess whether it was credible. Now, however, the relevant and applicable financial reporting framework is fair value, mark to market, reporting. In that circumstance all the auditor has to prove is that there is a market for the security that is traded, and no doubt there was the those that Madoff was supplying. There is no obligation on the alter to look behind act to check whether the security has real worth.

This will, no doubt, be a matter of some considerable relief to the partners of the firms in question.

Of course, it's fundamentally undermines the whole meaning of audit. And it undermines the whole credibility of the audit profession. But right now they will not care about that.

That is an issue that does, however, have to be addressed. Auditing has been degraded to the point where it is utterly meaningless. Financial reporting standards allow the preparation of accounts that are meaningless. The profession's credibility is in tatters and real people are losing money. Yes, I know this was a fraud, but some apparently saw it coming. As the Guardian has reported:

A Boston fraud investigator, Harry Markopolos, has revealed he waged an unsuccessful eight-year campaign to alert the SEC, sending documents and peppering officials with phone calls arguing that the financier's purported 10% to 12% annual returns were illusory.

Markopolos, who used to work for a rival fund management firm, became suspicious in 2000 when he analysed Madoff's investment method to see whether he could emulate it. He calculated that there were insufficient options in existence to support the amount of hedging Madoff claimed he was doing.

I believe him. I know that feeling of crying out about a system that is obviously corrupt and no one wants to listen.

There's no doubt that auditors are amongst those who will now need to be subject to 'adult supervision' of the sort Barack Obama described yesterday. It's well overdue.

The days of the 'chaps looking over the shoulder of the chaps' has to end.