Bob Jensen's Threads on Accounting Professionalism and Independence
Bob Jensen at Trinity University
 


25 Accounting Certifications in the USA --- http://maaw.info/AccountingCertifications.htm

The Saga of Auditor Professionalism and Independence 

Lawsuit Databases

Audit Committee Professionalism

Monetary Caps on Damages Due to the Liability of Auditors for Audit Failures in Publicly Listed Companies

The Controversial Proposals to Rotate Auditing Firms

The Controversial Proposals to Expose the Names of In-Charge Partners on Audits

Auditing Flaws 

Ethics Flaws

Compliance Testing

Forensic Accounting

Moral Hazard:  Auditing of Hedge Fund Shorts

How to Improve Audit Reports

Risk-Based Auditing Under Attack   

Accounting Fraud and CPA Firm Lawsuits ---
http://www.trinity.edu/rjensen/Fraud001.htm

Accounting Scandals --- http://en.wikipedia.org/wiki/Accounting_scandals

Bob Jensen's threads on accounting scandals are in various documents:

Accounting Firms --- http://www.trinity.edu/rjensen/Fraud001.htm

Fraud Conclusion --- http://www.trinity.edu/rjensen/FraudConclusion.htm

Enron --- http://www.trinity.edu/rjensen/FraudEnron.htm

Rotten to the Core --- http://www.trinity.edu/rjensen/FraudRotten.htm

Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm

American History of Fraud --- http://www.trinity.edu/rjensen/FraudAmericanHistory.htm

Fraud in General --- http://www.trinity.edu/rjensen/Fraud.htm

Future of Auditing --- http://www.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing

Fraud Detection and Reporting --- http://www.trinity.edu/rjensen/FraudReporting.htm

American History of Fraud ---  http://www.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm

Daily News Sites for Accountancy, Tax, Fraud, IFRS, XBRL, Accounting History, and More ---
http://www.trinity.edu/rjensen/AccountingNews.htm

Bob Jensen's threads on ethics and accounting education are at 
http://www.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation

Bob Jensen's threads on great minds in management are at http://www.trinity.edu/rjensen/theory/00overview/GreatMinds.htm

Incompetent and Corrupt Audits are Routine ---
http://www.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits

Computer Fraud Casebook: The Bytes that Bite ---
http://www.journalofaccountancy.com/Issues/2009/Sep/BookshelfReview3.htm

Richard Campbell notes a nice white collar crime blog edited by some law professors ---
http://lawprofessors.typepad.com/whitecollarcrime_blog/ 

Lexis Nexis Fraud Prevention Site ---  http://risk.lexisnexis.com/prevent-fraud

From the AICPA
Overview of Certified in Financial Forensics (CFF) Credential --- Click Here
http://www.aicpa.org/InterestAreas/ForensicAndValuation/Membership/Pages/Overview Certified in Financial Forensics Credential.aspx 

Accounting Professor Blogs
http://www.trinity.edu/rjensen/ListServRoles.htm 
Example
 FraudBytes (Mark Zimbelman) --- http://fraudbytes.blogspot.com/

 2011 PCAOB Standards and Related Rules
Published by the AICPA
http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/AuditAttest/Standards/PCAOBStandards/PRDOVR~PC-057207/PC-057207.jsp

AICPA Fraud Resource Center --- Click Here
http://www.aicpa.org/INTERESTAREAS/FORENSICANDVALUATION/RESOURCES/FRAUDPREVENTIONDETECTIONRESPONSE/Pages/fraud-prevention-detection-response.aspx

Accounting Humor

 

Although somewhat dated, Corporate Scandal provides a nice summary of many of the recent scandals --- 
http://www.econstats.com/scandal.htm
 

Investor Protection Trust --- http://www.investorprotection.org/
This site provides teaching materials.

The Investor Protection Trust provides independent, objective information to help consumers make informed investment decisions. Founded in 1993 as part of a multi-state settlement to resolve charges of misconduct, IPT serves as an independent source of non-commercial investor education materials. IPT operates programs under its own auspices and uses grants to underwrite important initiatives carried out by other organizations.

Bob Jensen's threads on fraud prevention and fraud reporting ---
http://www.trinity.edu/rjensen/FraudReporting.htm

Bob Jensen's personal finance helpers ---
http://www.trinity.edu/rjensen/Bookbob1.htm#InvestmentHelpers


"An Analysis Of The 2012 Financial Performance Of The World’s Largest Accounting Firms," Big Four Blog, January 2013 ---
http://www.big4.com/wp-content/uploads/2013/01/The-2012-Big-Four-Firms-Performance-Analysis.pdf

EXECUTIVE SUMMARY

Deloitte, Ernst & Young, KPMG and PwC: 2012 Revenues Increase to Historic Levels 2012 was a banner year for the Big Four accounting firms: Deloitte & Touche, Ernst & Young (E&Y), KPMG and PricewaterhouseCoopers (PwC) following strong growth in 2011, and erasing the impacts of subdued performance of 2009 and 2010. 2009 combined revenue for the four firms of $94 billion fell 7% from 2008’s record of $101 billion, but stabilized in 2010 as revenue increased 1.4% to $95 billion. 2011 revenue rose a further 9% to historic high levels of $103 billion, setting a new record.

Another new record was set in 2012, with strong growth momentum in all service lines and geographies continuing from 2011, helped by emerging countries, improvements in global economic profiles and increased business deal activity. Combined 2012 revenue for the four firms rose to a record historic high level of $110 billion, up 6% from 2011. With all global economies, except those in Europe, showing continued growth in 2012, the Big Four firms had outstanding performance in 2012, with revenues rising in all geographies, service lines and industries. KPMG revenues grew the slowest at 1.4%, Ernst & Young at 6.7%, PwC increased 7.8% and

Deloitte posted the highest rate at 8.6%. PwC grew slower than Deloitte yet reported 2012 revenues of $31.5 billion, just $200 million more than Deloitte, thus maintaining its leadership position as the largest accounting firm on the planet. KPMG’s modest growth is well out of line with peers. Our analysis shows three factors: Europe is 50% of global revenues and was negatively impacted by US dollar appreciation versus the Euro,

Advisory service line had modest growth and Audit presumably lost some relative market share. In terms of geography, Americas have 40% and falling share of global combined revenues. From 2011 to 2012 however, Americas had a strong performance growth of 9.2%. Europe has 43% of combined firm revenues and increased 3.3% from 2011 to 2012, growing the slowest due to regional uncertainty. Asian revenues have more than doubled from $7 billion in 2004 to $18.5 billion in 2012, 17% of the total, and grew a strong 8.0% from 2011 to 2012.

By service line, Audit accounts for 45% of total revenues and grew 2.9% from 2011 to 2012. Tax services are 23% of total revenues and also rose 5.6% from 2011 to 2012. Advisory services have been the fastest growing service line for several years increasing share from 22% of total revenues in 2004 to 33% in 2012. Advisory revenues grew a strong 12.2% from 2011 to 2012.

The Big Four firms cumulatively employ more than 690,000 staff globally, with a total of 37,000 partners overseeing a steep pyramid of about 530,000 professionals. Net employment increased by 39,000 from 2011 to 2012.

The outlook for 2013 and beyond is quite optimistic, revenue is expected to grow at a good pace, with help from strong emerging markets, Advisory services, Dodd-Frank and other regulations, conversions to IFRS and favorable economic conditions. 2013 will also prove whether PwC can continue to be the leader and whether KPMG can attempt to narrow its gap with E&Y.

A detailed analysis can be downloaded at http://www.Big4.com/analysis .

Bob Jensen's threads on the largest accounting and auditing firms ---
http://www.trinity.edu/rjensen/Fraud001.htm


Five Auditor Independence Issues PCAOB SAG Not Yet Addressing," by Francine McKenna, re:TheAuditors, November 11, 2013 ---
http://retheauditors.com/2013/11/11/five-auditor-independence-issues-pcaob-sag-not-yet-addressing/

My headline story yesterday was about the regulatory black hole that exists for the consulting practices of the Big Four audit firms. (The abyss exists for all of the audit firms but, as usual, we will focus here in the business of the Big Four given their influence on issuers, aka publicly listed companies.)

There are five big issues that space prevented a full discussion of yesterday and that are not on the agenda of the PCAOB Standing Advisory Group meeting this week. My hope is that regulators, policy makers and other interested parties will start talking about these issues, too, while I am in DC this week.

1)    US regulators are not enforcing existing rules —the pre- and post- Sarbanes-Oxley rules — regarding auditor independence for the US firms of the Big Four auditors who also provide consulting services for those clients.

I’ve written numerous times about independence violations only to see no visible action by the SEC or PCAOB. This is what I’ve written just since the beginning of 2012 about auditor independence issues. Many posts reference earlier warnings about the activities, especially the broker-dealer independence issues.

January 26, 2012, KPMG Nixes GE Loaned Tax Staff Engagement

February 22, 2012, Are Auditors Reporting Fraud And Illegal Acts? The SEC Knows But Isn’t Telling

December 1, 2012, Deloitte, HP And Autonomy: You Lose Some But You Win Some More, Much More Big, big story at the end of 2012 that involves all four of the Big Four audit firms and is a prime example of the growing influence  – and the threat to auditor independence – of the reestablished consulting practices in the firms. It also highlights the media confusion about the all roles audit firms are playing these days. Often they are not audit-related and yet the media often does not know for sure how to refer to the firms or their specific responsibilities and potential legal liabilities.

December 26, 2012, PwC and Thomson Reuters: Too Close For Comfort

February 1, 2013, A Summary of Writing on the “Independent” Foreclosure Reviews and the AG Mortgage Settlement

February 18, 2013, Tax Pays: HP Pays Ernst & Young Two Million To Testify

April 22, 2013, Scott London Subverted Sarbanes-Oxley: Big Four Mock Audit Partner Rotation

June 30, 2013, More Conflicts For The “Independent” Foreclosure Reviews

September 3, 2013, Broker-Dealer Audits Still Badly Broken

September 29, 2013, Pershing Square’s Bill Ackman Tells PwC, “Herbalife Is Your Problem Now”

Continued in article

Bob Jensen's threads on audit firm professionalism and independence ---
http://www.trinity.edu/rjensen/Fraud001c.htm


Big Accounting Firms Walking a Tightrope Between Consulting and Auditing
"Strategic moves Big consulting and accounting firms are making a risky move into strategy work," The Economist, November 9, 2013 --- Click Here
http://www.economist.com/news/business/21589435-big-consulting-and-accounting-firms-are-making-risky-move-strategy-work-strategic-moves?fsrc=scn/tw_ec/strategic_moves

OPERATIONS consultants sit at the front of the classroom,” says a partner at a strategy consultancy. “Strategy consultants stay in the back, not paying attention, throwing paper airplanes. But they still get the girls and get rich.” Like so many caricatures, this one is cruel but contains a grain of truth. Operations consultants—the fine-detail guys who tinker with businesses’ internal processes to make them run better—generally do not enjoy the same glamour or financial rewards as strategy specialists, whose job is to advise firms on make-or-break deals, adopting new business models and other big stuff.

Although in practice their work overlaps, the two have until now remained distinct businesses. Strategy firms like McKinsey, Bain and the Boston Consulting Group hire from the top universities, are packed with highly paid partners and whisper their counsel in CEOs’ ears. In contrast, operations specialists such as IBM, Accenture and the Big Four accounting firms (Deloitte, EY, KPMG and PwC) employ armies of lower-paid grunts; and tend to answer to the client firm’s finance or tech chiefs.

This year, however, that line has begun to blur. In January Deloitte became the largest of the Big Four by scooping up the assets of Monitor, a strategy firm that had gone bust. And on October 30th its closest rival, PwC, said it would buy another strategy firm, Booz & Company, for a reported $1 billion. If Booz’s partners approve the deal, it will vault PwC back into first place.

The accountancies’ push into strategy has been a decade in the making. During the late-1990s technology bubble they beefed up their IT-consulting arms. But in 2001 Enron, an energy-trading firm, went bust and took its auditor, Arthur Andersen, down with it. In response, America’s Congress passed the Sarbanes-Oxley corporate-governance reform, which banned firms from doing systems consulting for companies they audited. As a consolation prize, the Big Four made a fortune helping clients comply with the new law. Their advisory businesses, full of potential for conflicts of interest with their auditing side, by now seemed dispensable. All but Deloitte had sold off those divisions by 2003.

Just as the workload from Sarbanes-Oxley began to dwindle, the 2008-09 financial crisis hit, causing consulting revenues to dip (see chart). But once the economy recovered, the climate for the Big Four started to resemble the 1990s. They began to rush back into consultancy, encouraged by its high margins and double-digit annual growth rates at a time when revenue growth from auditing and tax work had slowed. In particular, Deloitte and PwC began gobbling up operations consultancies as they sparred for the top spot.

For years the strategy firms remained beyond the Big Four’s grasp. During the 2000s they had mostly prospered on their own, and their partners shuddered at the thought of being subsumed into giant bureaucracies. After the financial crisis, however, midsized strategy consultants hit hard times. Cost-conscious companies with globalising businesses wanted either to hire boutiques with deep knowledge of their industries, or to benefit from the scale of generalist firms with offices everywhere. Too big for some clients and too small for others, Monitor went under, and Booz—a spin-off from Booz Allen Hamilton, which now focuses on operations work for governments—went on the block.

Both Booz and PwC say that the two sides of consulting are converging, and that more clients want a one-stop shop that can both devise a strategy and execute it. Deloitte and Monitor claim their integration is already bearing fruit. “There’s been a very healthy two-way cross-selling opportunity,” says Mike Canning of Deloitte.

Nonetheless, Booz’s leadership still faces a hard sell to get the deal passed. In 2010 the company’s partners voted down a proposed merger with AT Kearney, another midsized strategy firm. This marriage involves far more risks. A significant number of Booz’s clients would immediately be in doubt because PwC audits them—strategy consulting for audit clients is banned in many countries, and even where it is legal it is frowned upon (not least in America). Since the Big Four are structured as associations of national partnerships, Booz’s staff would probably end up being divided by country, hindering the global co-operation that many big clients seek.

Most important, each of Booz’s 300 partners would have to trade meaningful sway over the direction of a highly profitable firm for a minuscule stake in a diversified, lower-margin empire. If the sale is approved, the test of its success will come in a few years, after Booz’s partners receive their full payout and can head off. An exodus would leave PwC empty-handed.

Continued in article

PwC's Biggest Rebranding Yet:  What Goes Around Comes Around
From the CFO Journal's Morning Ledger on October 31, 2013

PwC is banking on more growth in consulting with its acquisition of Booz
Terms weren’t disclosed, but the transaction appears to be among the biggest deals involving an accounting firm in at least the past decade
, the WSJ’s Michael Rapoport, Julie Steinberg and Joann S. Lublin report. The deal is expected to beef up PwC’s fast-growing advisory business and should also help it tap  Booz’s experience developing strategies for clients. “PwC has made it really clear they’re bulking up their management-consulting business,” said Tom Rodenhauser, managing director at Kennedy Consulting Research & Advisory. The move gives PwC “a real leg up in credibility in terms of business consulting.” The FT’s Sam Fleming says the hope is that Booz will allow PwC to offer a stronger challenge to the prime end of the management-consulting sector, where McKinsey, Boston Consulting Group and Bain dominate.

But it isn’t all smooth sailing. Sarbanes-Oxley bars audit firms from many types of consulting for their U.S. audit clients, so conflicts of interest are almost sure to arise in cases where Booz’s existing consulting clients have their yearly audit done by PwC, the Journal says. Meanwhile, former SEC Chairman Arthur Levitt, who pushed for rules to curb accounting firms from providing both auditing and consulting services to a client, tells Bloomberg that the deal puts the issue of independence front and center. “As the accounting profession becomes more committed to consulting, their audit activities have got to be questioned,” said Mr. Levitt. Some accounting firms “see their future in consulting rather than auditing, and that’s unfortunate for America’s markets.”

And Lynn Turner, the former chief accountant at the SEC, tells Bloomberg that mergers like this raise a serious question: “Are the auditors going to serve management, or are they going to serve the best interests of the investing public?” If the combined firm agrees not to do consulting for companies it audits, “then you eliminate the conflict,” Mr. Turner said, but he doubts that will happen. “Do you honestly think Booz partners would turn around and vote for this deal if they gave up all of their clients that PwC audits?”

Bob Jensen's threads on the failing professionalism and independence of large multinational auditing firms ---
http://www.trinity.edu/rjensen/Fraud001c.htm


Rebranding at KPMG
"Can’t KPMG Just Do Better Audits?" by Jonathan Weil, Bloomberg Businessweek, November 11, 2013 ---
http://www.bloomberg.com/news/2013-11-11/can-t-kpmg-just-do-better-audits-.html

KPMG is getting into venture-capital investing, according to an article today in the Times of London. It’s one more sign that the Big Four audit firms are moving beyond traditional accounting services and getting themselves into other more far-flung endeavors.

The newspaper said the fund, called KPMG Capital, will be based in London and “will invest predominantly in small British and American data and analytics businesses.” We can presume that KPMG would be smart enough to avoid auditing the books at places where it invests, although you never know.

Even if KPMG doesn’t audit the companies it owns, an obvious problem is that KPMG inevitably will be in the position of funding companies that compete against its own audit clients. That may not be a violation of any rules, but it can create conflicting interests nonetheless. (Then again, so can audit fees themselves, because the client is paying the auditor.)

Adversarial relationships can be as damaging to the notion of auditor independence as overly cozy ones. Plus, you have to wonder if this even makes good business sense. If I were on the board at a KPMG audit client and saw a KPMG-owned startup trying to take away my company’s market share, I would want to drop KPMG and hire a different firm.

This line from the Times article, quoting a senior KPMG partner named Simon Collins, caught my attention in particular: “Mr. Collins said that it would be `very difficult’ to provide audit services to the companies it invested in -- `but we can incubate them, we can advise them.’”

Let’s get this much straight: “Very difficult” is the wrong answer here. The correct response is that it should be impossible. Any first-year accounting student can tell you that auditors aren’t supposed to audit companies in which they have ownership stakes.

But maybe we shouldn’t be surprised. In February 2011 the Securities and Exchange Commission censured KPMG’s Australia affiliate over independence violations at two audit clients with U.S.-registered securities. The SEC found the firm sent staff members to work at an audit client under the client’s supervision and direction. In another situation the firm was paid commissions for promoting an audit client’s products and was retained by the client to provide legal services.

In another case, the SEC in 2005 settled with KPMG’s Canadian affiliate and two of its partners over audit-independence violations at a Colorado company, Southwestern Water Exploration Co. The firm prepared some of the company’s basic accounting records and financial statements and then audited its own work, the SEC said.

In 2002, the SEC censured KPMG because it purported to serve as the independent auditor for a mutual fund at the same time it had invested $25 million in the same fund. At one point KPMG accounted for 15 percent of the fund’s assets, the SEC said. That was a black-and-white violation of the auditor-independence rules.

Continued in article

Bob Jensen's threads on KPMG ---
http://www.trinity.edu/rjensen/Fraud001.htm




Professionalism and Independence

The Saga of Auditor Professionalism and Independence

The day Arthur Andersen loses the public's trust is the day we are out of business.  
Steve Samek, Country Managing Partner, United States, on Andersen's Independence and Ethical Standards CD-Rom, 1999

If a man's poor and not a bad fellow, he's considered worthless; if he is rich and a very bad fellow, he's considered a good client.
Titus Maccius Plautus, 255 BC to 185 BC

"My Top Twenty Favorites From 2012," by Francine McKenna, re:TheAuditors, January 1, 2013 ---
http://retheauditors.com/2013/01/01/my-top-twenty-favorites-from-2012/

"Business Ethics" (Judge) Richard Posner, Becker-Posner Blog, March 3, 2013 ---
http://www.becker-posner-blog.com/2013/03/business-ethicsposner.html

A Tear Jerker from the Center for Audit Quality
"Year in Review for 2013"---
http://www.thecaq.org/docs/reports-and-publications/caq_year_in_review_2013.pdf?sfvrsn=4


"Does Big 4 Consulting Revenue Impair Audit Quality?" by Ling Lei Lisic, Robert J. Pawlewicz, and Timothy A. Seidel, SSRN, June 1, 2014 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2460102

Abstract:
Over the past decade, the Big 4 public accounting firms have steadily increased the proportion of their revenue generated from consulting services (consulting revenue hereafter), primarily from nonaudit clients. Regulators and investors have expressed concerns about the potential implications of accounting firms’ expansion of consulting services on audit quality. We examine the associations between Big 4 audit firm consulting revenue and various measures of audit quality, including auditor going concern reporting errors, client misstatements, and client probability of meeting or just beating analyst earnings forecasts. Overall, our results suggest that a higher proportion of firm-level consulting revenue is not associated with impaired audit quality for the Big 4 firms. However, results of earnings response coefficient tests suggest that investors perceive a deterioration of audit quality when a higher proportion of the firms’ revenue is generated by consulting services.

Jensen Comment
Given the repeated deficiencies in Big Four audits as reported in PCAOB inspection reports year after year perhaps cost cutting is more of a problem in Big 4 audit professionalism than independence. In some cases the Big Four firms are flagged for poor audit supervision of inexperienced staff auditors. In most instances, however, the problem is one of failure to do enough detail testing.

Bob Jensen's threads on audit firm independence and professionalism ---
http://www.trinity.edu/rjensen/Fraud001c.htm


From the CPA Newsletter on April 24, 2014

IAASB proposes requirements for auditors
The International Auditing and Assurance Standards Board has a proposal for an enhanced International Standard on Auditing. It clarifies what information should be included in corporate annual reports as well as introduces new auditor reporting responsibilities. Under the proposed standard, auditors would have to evaluate other information with the audited financial statements to ensure there are no material inconsistencies between the information and the auditor's knowledge of the company gathered during the audit. In general, an auditor has to be watchful for signs that the other information is materially misstated. Accounting Today (4/23)


Question
When can an auditor having sex with the Chief Accounting Officer (CAO) be an appropriate application of "detail testing?"

Possibility
It may beat statistical sampling and analytical review combined. Maybe it should not ipso facto get a bad rap. But it does become more difficult to remain independent.

Yeah it probably should get a bad rap for the same reason teachers should not assign grades to students with whom they are "sleeping."

"Ventas Fires EY as Auditor Over Independence Violation," by Adrienne Gonzalez, Going Concern, July 10, 2014 ---
http://goingconcern.com/post/ventas-fires-ey-auditor-over-independence-violation

And sent out a press release, no less:

Ventas, Inc. (NYSE: VTR) (“Ventas” or the “Company”) today announced that the Company has dismissed Ernst & Young (“E&Y”) as its public accounting firm, effective July 5, 2014, due to E&Y’s determination that it was not independent solely as a result of an inappropriate personal relationship between an E&Y partner and Ventas’s former Chief Accounting Officer and Controller. Ventas also announced that, following such dismissal, its Audit Committee has engaged KPMG LLP (“KPMG”) as the Company's independent public accounting firm.

E&Y has advised the Company that, solely due to the inappropriate personal relationship, it determined that it was not independent of the Company during the periods in question. As a result of such determination, E&Y stated that it was obligated under applicable law and professional standards to withdraw (and it has withdrawn) its audit reports on the Company’s financial statements for the years ended December 31, 2012 and 2013, and its review of the Company’s results for the quarter ended March 31, 2014. E&Y’s decision to withdraw such audit reports and review was made exclusively due to the personal relationship in question, and not for any reason related to Ventas’s financial statements, its accounting practices, the integrity of Ventas’s controls or for any other reason.

The crony in question, one Robert J. Brehl, has "separated himself" from his duties as Chief Accounting Officer and Controller.

Continued in article

Added Jensen comment?
Are the working papers on this audit X-rated?

Bob Jensen's threads on EY are at
http://www.trinity.edu/rjensen/FraudUpdates.htm

 


From the CPA Newsletter on May 22, 2014

Audits of internal controls improving
The Public Company Accounting Oversight Board will soon start publishing its 2013 inspection reports, and they will reveal that while audit firms have improved internal-controls audits, there is still progress to be made, says PCAOB member Jay Hanson. Compliance Week/Accounting & Auditing blog (5/20)


From the CFO Journal's Morning Ledger on April 11, 2014

Mark-to-market (fair value) accounting and testing of corporate internal controls challenge auditors
A review of audit inspections by 30 regulators around the world found key trouble spots for auditors,
CFOJ’s Emily Chasan reports. Auditors of public firms were most likely to be cited for improperly auditing fair-value measurement, troubles in testing internal controls and evaluating the adequacy of financial statements and disclosures, according to the International Forum of Independent Audit Regulators. Audit deficiencies also rose last year to 1,260, an 18% increase from 2012.

Bob Jensen's threads on fair value accounting ---
http://www.trinity.edu/rjensen/theory02.htm#FairValue


And they all studied auditing at Lake Woebegone --- http://en.wikipedia.org/wiki/Lake_Wobegon
Illusory Superiority --- http://en.wikipedia.org/wiki/Lake_woebegone_effect

"All The Auditors Are Above Average: Jay Hanson Allergic To 'Audit Failure'," by Francine McKenna, re:TheAuditors, March 26, 2014 ---
http://retheauditors.com/2014/03/26/all-the-auditors-are-above-average-jay-hanson-allergic-to-audit-failure/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+ReTheAuditors+%28re%3A+The+Auditors%29

What does it take for an auditor to admit failure? Public Company Accounting Oversight Board (PCAOB) member Jay Hanson, a former audit partner from next-tier firm McGladrey LLP, is suddenly acting like the agency’s go-to accounting industry apologist. In a recent speech, Hanson said he was “troubled” by the PCAOB’s use of the term “audit failure” in its inspection reports. He thinks the term confuses users of the auditor’s opinion. As if there are any…

“…calling every such deficiency an “audit failure” appears to have caused confusion among investors, audit committees and others, some of whom have interpreted our findings as meaning that the financial statements are misstated or that there is a problem in the company’s accounting or internal controls. In fact, however, only very few of our inspection findings ultimately can be linked to a problem in the company’s financial statements, and restatements arising out of our inspection process are rare, although they do occur.”

Should audit and auditor failure be solely defined by identified material misstatements that result in restatements, and internal control failures? The PCAOB considers auditors’ failure to audit internal controls over financial reporting a big enough problem in October 2013 it issued Staff Audit Practice Alert No. 11, Considerations for Audits of Internal Control Over Financial Reporting. The PCAOB inspectors have been citing significant deficiencies in audits of internal controls over financial reporting during the last three years.

The deficiencies include the failure to:

  • Identify and sufficiently test controls that are intended to address the risks of material misstatement
  • Sufficiently test the design and operating effectiveness of management review controls that are used to monitor the results of operations
  • Obtain sufficient evidence to update the results of testing of controls from an interim date to the company’s year end (i.e., the roll-forward period)
  • Sufficiently test controls over the system-generated data and reports that support important controls
  • Sufficiently perform procedures regarding the use of the work of others
  • Sufficiently evaluate identified control deficiencies.

We know that formal restatements are way down, after hitting highs right after the passage of the Sarbanes-Oxley Act in 2002. Research firm Audit Analytics keeps telling us so. But are restatements down because there is less corporate accounting and disclosure fraud? Many thinkle peep so but I definitely don’t. The SEC agrees with me and reinstated its Accounting Fraud and Disclosure Task Force last year. That’s the team dismantled by former SEC Enforcement Director Robert Khuzami who used the deceptively low formal restatement numbers as his excuse. Not so fast, I wrote in Forbes in October 2012 right before Khuzami resigned.

A study by two University of Connecticut accounting professors found auditors have waved the weakness flag in advance of a small and declining share of earnings restatements–just 25% in 2008 and 14% in 2009, the last year studied. There was no auditor warning before Lehman Brothers’ 2008 collapse, even though a bankruptcy examiner later concluded it used improper accounting gimmicks to dress up its balance sheet. And no warning before Citigroup lowballed its subprime mortgage exposure in 2007. (It paid a $75 million SEC fine.)

Instead, companies and auditors flag material weaknesses as they’re restating earnings–that’s what JPMorgan did in August when it revised first-quarter earnings to show $459 million more in losses from “the London Whale’s” trading bets than it first reported.

Yet another Sarbox provision, absent vigorous SEC enforcement, may even be leading, perversely, to less disclosure of accounting problems. It provides that a year of performance-based pay can be “clawed back” from a CEO or CFO who signed off on earnings that have to be restated. Thus executives have a financial incentive to handle problems they discover quietly–either internally or with an “earnings revision” instead of a restatement. Last year revisions (as opposed to formal restatements) accounted for 57% of 727 earnings fixes, up from 33% of 1,384 fixes in 2005, Audit Analytics reports.

Never heard of a “revision”? Companies and auditors like it that way. With a formal restatement, a company must file a special form, 8-K, calling attention to its corrections. With a revision it can fix flawed accounting without filing an 8-K or formally restating old earnings, since the change supposedly isn’t “material.” With a revision executives’ prior pay isn’t at risk, auditors don’t have to retract their approval of earlier statements, and there’s usually little impact on the stock and so no investor lawsuits.

The SEC has also established another initiative, Operation Broken Gate, targeting auditors, lawyers and directors who enable corporate accounting and disclosure fraud. In addition, in fiscal 2013 accounting and disclosure fraud was the largest percentage of the SEC’s Dodd-Frank whistleblower tips, the second year in a row. So, maybe the SEC and PCAOB need to question the increase in characterization of misstatements as non-material and fixes made only on a go-forward basis.

Why are restatements declining?

  • Auditors make the final call on the necessity of a restatement under pressure from executives and their lawyers. It’s in all parties’ best interest to minimize restatements.
  • Making fewer restatements reduces the likelihood auditors will be named as a defendant in a shareholder lawsuit.
  • Compromising on the requirement for a restatement by downgrading the materiality of errors or misstatements reduces the likelihood auditors will irk executives by setting them up for SOx or Dodd-Frank clawbacks claims. A restatement is required to force reimbursement under both laws.
  • Fewer restatements means auditors can argue with PCAOB that a significant inspection deficiency didn’t result in “restatement” and therefore can be left out of its public inspection report. Likelihood of additional follow-up by the SEC resulting in sanctions or fines is also minimized.

Continued in article

Bob Jensen's threads on audit firm professionalism ---
http://www.trinity.edu/rjensen/Fraud001c.htm

 


"Exclusive From Monadnock Research: Big Four Fiscal 2013 Advisory Practice Rankings and Conflict Risk Metrics," by Francine McKenna, re:TheAuditors, March 18, 2014 ---
http://retheauditors.com/2014/03/18/exclusive-from-monadnock-research-big-four-fiscal-2013-advisory-practice-rankings-and-conflict-risk-metrics/

Regular readers of re: The Auditors will be familiar with Mark O’Connor and Monadnock Research. Mark has written some very insightful guest posts for me and was interviewed for the special accounting industry issue of Crain’s Chicago Business a last fall.
Crain’s Chicago Business Focuses On Big Four Auditors And Consulting

EY Bets The Farm On Advisory With Vision 2020: A Guest Post From Mark O’Connor

An Honest Services Crisis: Professional Poison and a Chicago Connection

2013 marked the transition of Monadnock Research to all-inclusive Research Portal based on a subscription model. Here’s a special report of interest to our readers:

Monadnock Research 2013 Big Four Fiscal 2013 Advisory Practice Rankings and Conflict Risk Metrics

re: The Auditors and Francine McKenna are not being compensated for this post. This is not a sponsored post.

**********************************************************************************************************
 

Global non-audit advisory services of Big Four firms, including tax services, increased to $64.73 billion in fiscal 2013 (in USD here and throughout), a 5.47% increase over fiscal 2012 levels.

Total non-tax consulting and advisory services of Deloitte, KPMG, PricewaterhouseCoopers and Ernst & Young were $38.54 billion, an increase of 6.8% over fiscal 2012. Overall, Big Four fiscal 2013 growth was only about half that of last year in most categories. That growth in advisory, however, contrasts sharply with an overall increase of 3.15% for the Big Four across all service areas, and just 0.25% growth in audit services. KPMG’s audit revenues actually declined for a second year by approximately 1%, joined by PwC, whose audit revenues decreased by 0.7 percent.

This is the fourth year that Monadnock Research has published analysis of the consulting and advisory services operations of the Big Four. We note that the Big Four continue to seek organic growth and strategic M&A in non-audit services. This Research Note offers an in-depth analysis of that, highlighting the growing risks associated with an increasing proportion of advisory relative to audit services at Big Four firms – and the conflict risk that this unique mix of services presents.

Our analysis shows that the aggregated fiscal 2012-2013 ratios for audit to non-tax advisory revenues for the Big Four continued its shift toward increased conflict risk, albeit at a slower pace. The exhibits below detail increases in Audit Conflict Risk Exposure Metrics from fiscal 2012 to 2013. Relevance of the metrics themselves is discussed in more detail in the “Conflict Risk Exposure Metrics” and “The Audit Underwriter Paradox” sections below.

Continued in article


Teaching Case on Auditor Independence and Professionalism
From The Wall Street Journal Accounting Weekly Review on March 7, 2014

Auditors Draw Clients Closer
by: Emily Chasan
Mar 04, 2014
Click here to view the full article on WSJ.com
 

TOPICS: Audit Firms, Auditing, Auditing Services, Auditor Independence, Consulting, PCAOB, Public Accounting, Public Accounting Firms

SUMMARY: The PCAOB "...says it has started quizzing accounting firms on whether their fast-growing consulting practices could hurt the quality of their audits...[T]he European Parliament is expected to vote in April on legislation that would cap nonaudit services provided by a company's auditor at 70% of the audit fee. At least 300 companies in the U.S. and Europe paid their auditors as much for add-on services as they did for audit work...Auditing firms say they work to avoid conflicts of interest and that providing extra services can improve audits by enhancing their knowledge of an audit client's business."

CLASSROOM APPLICATION: The article may be used in an auditing class.

QUESTIONS: 
1. (Introductory) How much are public accounting firms earning for consulting revenues as compared to performing financial statement audits? What are the concerns with this relative level of accounting services?

2. (Advanced) From where does data analysis firm Audit Analytics and stock-research firm Exane BNP Paribas SA find this information about fees paid to audit firms for various services?

3. (Introductory) What do the accounting firms say is the benefit of providing these nonaudit services to their clients?

4. (Advanced) Consider the case of KPMG LLC, its settlement with the SEC, and its client HSBC Holdings. What is the apparent choice KPMG has made about the type of services it wants to provide to this firm?
 

Reviewed By: Judy Beckman, University of Rhode Island

"Auditors Draw Clients Closer," by Emily Chasan. The Wall Street Journal, March 7, 2014 ---
http://online.wsj.com/news/articles/SB10001424052702303630904579415831029918244?mod=djem_jiewr_AC_domainid&mg=reno64-wsj

Some companies and their auditors might be getting a little too close for comfort.

Since the collapse of Enron and its auditor, Arthur Andersen, more than a decade ago, regulators on both sides of the Atlantic have been cautious about auditors receiving big fees for consulting and other services that could potentially cloud their judgment when reviewing a company's books. Now, they are taking a fresh look at the issue.

The U.S. government's audit watchdog says it has started quizzing accounting firms on whether their fast-growing consulting practices could hurt the quality of their audits. Overseas, the European Parliament is expected to vote in April on legislation that would cap nonaudit services provided by a company's auditor at 70% of the audit fee.

At least 300 companies in the U.S. and Europe paid their auditors as much for add-on services as they did for audit work, according to public filings from the past two years reviewed separately by data provider Audit Analytics and stock-research firm Exane BNP Paribas SA BNP.FR -0.03% .

"You are talking about a huge amount of fees" at some companies, says Yohann Terry, an analyst who has studied the matter for Exane BNP. Auditors "are all pushing to develop consulting fees because the margins are higher," he says.

Auditing firms say they work to avoid conflicts of interest and that providing extra services can improve audits by enhancing their knowledge of an audit client's business.

HSBC Holdings HSBA.LN -0.37% PLC paid its auditor, KPMG LLP, $208 million for "other services" between 2010 and 2012. That's more than five times as much as the U.K. bank paid the firm for checking its books. The added work included "ad hoc accounting advice," consulting on information-technology security, and subsidiary audits, according to a regulatory filing.

The filing added that HSBC only uses KPMG for extra services when it can benefit from the firm's historical knowledge of the bank and when its independence won't be compromised.

HSBC declined to comment on the nonaudit fees, but the bank is set to change its auditor next year to PricewaterhouseCoopers LLP after 23 years with KPMG. "We thought it was the right thing to do," said HSBC spokeswoman Heidi Ashley.

"KPMG is fully committed to ensuring our independence with respect to all of our audit clients," said KPMG spokeswoman Deborah Primiano.

After Enron imploded, the U.S. barred auditors from performing many consulting services for audit clients, such as providing appraisals. The pending legislation and fee cap in Europe would mean even stricter regulations for businesses there. It isn't clear how new European rules would define, audit, nonaudit, and audit-related fees; companies vary widely in their own definitions.

The main concerns for regulators are "scope creep" and conflicts of interest that could distract auditors from their core responsibilities, says Paul Beswick, the SEC's chief accountant. "There are permissible services that are allowed, but over time if the nature of those services change, they can actually evolve into independence violations," he says.

In January, KPMG paid $8.2 million to settle allegations by the Securities and Exchange Commission that it violated independence rules with some clients where it provided additional services. The firm didn't admit or deny wrongdoing, and the SEC didn't identify the clients.

Companies going through mergers, initial public offerings or spinoffs frequently pay their auditors far more for additional services, such as meetings with deal underwriters and due diligence, company filings show.

From 2011 through 2012, German auto maker Porsche PAH3.XE -0.20% SE paid auditor Ernst & Young more than 20 times as much as its audit fee for work related to taxes and its integration with Volkswagen AG VOW.XE +0.14% . Over the past two years, Manchester United MANU -0.46% PLC paid auditor PwC nearly eight times as much as its audit fees, largely for work on the British soccer club's IPO. U.S. grocer Harris Teeter Supermarkets Inc., which Kroger Co. KR -0.71% acquired in January, paid KPMG more than 1.5 times its audit fee for extra services in the two years ahead of the deal.

Manchester United and Kroger declined to comment. Porsche didn't reply to requests for comment.

"There are some cost efficiencies associated with it, but it's also easy to use your auditor—they're just one phone call away," says Ed Nusbaum, chief executive of auditor Grant Thornton International Ltd.

Last year, retailer Target Corp. TGT +0.23% paid Ernst & Young $3.7 million for an audit and the same sum for other work, including a "tax inventory accounting" project. Target declined to comment.

Some nonaudit services, such as providing quarterly reviews of internal controls or "comfort letters" to lenders, aren't considered controversial, but some companies may have to monitor such work more closely to ensure they don't exceed the potential fee caps in Europe, he said.

Continued in article


Auditor Independence and Professionalism

From the CFO Journal's Morning Ledger on March 3, 2014

Regulators (read that the PCAOB) are taking a closer look at the consulting services that some auditors provide for clients—and the big fees they generate.

The U.S. government’s audit watchdog says it has started quizzing accounting firms on whether their fast-growing consulting practices could hurt the quality of their audits, writes CFOJ’s Emily Chasan in today’s Marketplace section. Overseas, the European Parliament is expected to vote in April on legislation that would cap nonaudit services provided by a company’s auditor at 70% of the audit fee.

At least 300 companies in the U.S. and Europe paid their auditors as much for add-on services as they did for audit work, according to public filings from the past two years. HSBC paid its auditor, KPMG, $208 million for “other services” between 2010 and 2012. That’s more than five times as much as the U.K. bank paid the firm for checking its books. The added work included “ad hoc accounting advice,” consulting on information-technology security, and subsidiary audits, according to a regulatory filing. “You are talking about a huge amount of fees” at some companies, says Yohann Terry, an analyst who has studied the matter for Exane BNP. Auditors “are all pushing to develop consulting fees because the margins are higher,” he says.

The main concerns for regulators are “scope creep” and conflicts of interest that could distract auditors from their core responsibilities, says Paul Beswick, the SEC’s chief accountant. “There are permissible services that are allowed, but over time if the nature of those services change, they can actually evolve into independence violations,” he says.

Jensen Comment
Recall that the Houston Office of the Andersen Audit firm was receiving $50 million per year from Enron, half of with was for auditing services and half of which was for consulting services. Enron was repeatedly threatening to change consulting firms if Andersen's auditors did not march to Enron's orders ---
http://www.trinity.edu/rjensen/FraudEnron.htm

Bob Jensen's threads on audit firm independence and professionalism ---
http://www.trinity.edu/rjensen/Fraud001c.htm

 



  • "Next Up On The “Operation Broken Gate” Agenda? Could Be PwC and Thomson Reuters," by Francine McKenna, reTheAuditors, February 3, 2014 ---
    http://retheauditors.com/2014/02/03/next-up-on-the-operation-broken-gate-agenda-could-be-pwc-and-thomson-reuters/

    Now that the Securities and Exchange Commission and its “Operation Broken Gate” initiative has crossed KPMG’s independence violations off its to-do list, the agency can move on to the rest of the ones I’ve already identified for them.

    One set of facts that should be very easy to wrap up in shiny paper with a big bow would be the potentially illegal business relationships between PwC and its audit client Thomson Reuters. I wrote about them way back in December of 2012 at Forbes and then in more detail here.

    It goes like this:

    [There’s] a new business alliance between PwC China and Thomson Reutersa PwC audit client. The three-year agreement is a license to use Thomson Reuters tax software exclusively – in an ironic twist of fate the software was originally developed by Deloittefor client service in China. PwC UK already uses the software for its clients.

    PwC US is also a “Certified Implementer” (CIP) of Thomson Reuters One Source software. The deal was signed just this past August. That means PwC consulting professionals implement Thomson Reuters for third-parties, perhaps at times in joint engagements with Thomson Reuters. Are there incentives paid? There must be a joint marketing and training arrangement at least. Oh, there is…

    Through the CIP, Thomson Reuters will provide PwC US with training and technical support that PwC will use to work with clients who use Thomson Reuters software solutions in their corporate tax and accounting departments.

    There is a certainly a shared benefit to teaming up to sell software and consulting services. You can agree or disagree whether such arrangements should be prohibited, but under existing rules in the UK and for US listed audit clients of the global firms, they are prohibited.

    I checked and PwC is still listed is a “Certified Implementer” (CIP) of Thomson Reuters One Source tax software. In fact, the contact name for the PwC/Thomson Reuters business alliance is a partner right here in my hometown of Chicago.

    (PwC and Thomson Reuters never responded to my original requests for comment via Forbes on the Decemeber 2012  report. I didn’t, therefore, check again this time but if something’s changed they can give me a holler.)

    Thomson Reuters sells its software products all over the world and they are used by PwC member firms for their clients in at least the US, UK and now in China. Thomson Reuters is dual listed on the New York Stock Exchange and the Toronto Stock Exchange. Thomson Reuters recently changed auditors effective with the 2012 fiscal year—from the PwC Canada firm to the PwC US firm. That may not seem like a big deal but it is. The fees, $41 million in 2012, crossed the border with no disguises or fake passports necessary.

    As a result of the SEC’s recent investigation of KPMG’s independence violations, the staff is, I hope, now intimately and thoroughly reacquainted with its Final Rule: Revision of the Commission’s Auditor Independence Requirements effective February 5, 2001. The SEC put everyone on notice as a result of the recent enforcement action that the perception of auditor independence is as important, or maybe even more important, than the fact of auditor independence. That’s especially when it comes to putting your tax professionals on the job and in the audit client’s cafeteria every day.

    The SEC staff has also hopefully memorized Rule 2-01(b) of Regulation S-X (17 CFR 210.2-01.), amended under the Sarbanes-Oxley Act of 2002 to enhance auditor independence after the Enron and Arthur Andersen failures.

    Continued in article

    Bob Jensen's threads on PwC ---
    http://www.trinity.edu/rjensen/Fraud001.htm 


    From the CFO Journal's Morning Ledger on January 27. 2014

    KPMG settles SEC charges
    KPMG has agreed to pay $8.2 million to settle SEC allegations that the Big Four accounting firm violated rules intended to keep outside auditors from getting too close to their clients,
    the WSJ reports. KPMG provided nonaudit services such as bookkeeping and payroll to affiliates of two of its audit clients, the SEC said, and the firm also hired a recently retired senior-level tax counsel of a third audit client’s affiliate only to lend him back to the affiliate to do the same work. KPMG didn’t admit or deny wrongdoing in agreeing to the settlement.

     

    "SEC Charges KPMG With Violating Auditor Independence Rules," SEC Press Release, January 24, 2014 ---
    http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540667080#.UuKm27ROlQx

    FOR IMMEDIATE RELEASE
    2014-12
    Washington D.C., Jan. 24, 2014

    The Securities and Exchange Commission today charged public accounting firm KPMG with violating rules that require auditors to remain independent from the public companies they’re auditing to ensure they maintain their objectivity and impartiality. 

     

    The SEC issued a separate report about the scope of the independence rules, cautioning audit firms that they’re not permitted to loan their staff to audit clients in a manner that results in the staff acting as employees of those companies.

    An SEC investigation found that KPMG broke auditor independence rules by providing prohibited non-audit services such as bookkeeping and expert services to affiliates of companies whose books they were auditing.  Some KPMG personnel also owned stock in companies or affiliates of companies that were KPMG audit clients, further violating auditor independence rules.

    KPMG agreed to pay $8.2 million to settle the SEC’s charges.

    “Auditors are vital to the integrity of financial reporting, and the mere appearance that they may be conflicted in exercising independent judgment can undermine public confidence in our markets,” said John T. Dugan, associate director for enforcement in the SEC’s Boston Regional Office.  “KPMG compromised its role as an independent audit firm by providing prohibited non-audit services to companies that it was supposed to be auditing without any potential conflicts.”

    According to the SEC’s order instituting settled administrative proceedings, KPMG repeatedly represented in audit reports that it was “independent” despite providing services to three audit clients that impaired KPMG’s independence.  The violations occurred at various times from 2007 to 2011.

    According to the SEC’s order, KPMG provided various non-audit services – including restructuring, corporate finance, and expert services – to an affiliate of one company that was an audit client.  KPMG provided such prohibited non-audit services as bookkeeping and payroll to affiliates of another audit client.  In a separate instance, KPMG hired an individual who had recently retired from a senior position at an affiliate of an audit client.  KPMG then loaned him back to that affiliate to do the same work he had done as an employee of that affiliate, which resulted in the professional acting as a manager, employee, and advocate for the audit client.  These services were prohibited by Rule 2-01 of Regulation S-X of the Securities Exchange Act of 1934. 

    The SEC’s order finds that KPMG’s actions violated Rule 2-02(b) of Regulation S-X and Rule 10A-2 of the Exchange Act, and caused violations of Section 13(a) of the Exchange Act and Rule 13a-1.  The order further finds that KPMG engaged in improper professional conduct as defined by Section 4C of the Exchange Act and Rule 102(e) of the Commission’s Rules of Practice.  Without admitting or denying the findings, KPMG agreed to pay $5,266,347 in disgorgement of fees received from the three clients plus prejudgment interest of $1,185,002.  KPMG additionally agreed to pay a penalty of $1,775,000 and implement internal changes to educate firm personnel and monitor the firm’s compliance with auditor independence requirements for non-audit services.  KPMG will engage an independent consultant to evaluate such changes.

    The SEC’s investigation separately considered whether KPMG’s independence was impaired by the firm’s practice of loaning non-manager tax professionals to assist audit clients on-site with tax compliance work performed under the direction and supervision of the clients’ management.  While the SEC did not bring an enforcement action against KPMG on this basis, it has issued a report of investigation noting that by their very nature, so-called “loaned staff arrangements” between auditors and audit clients appear inconsistent with Rule 2-01 of Regulation S-X, which prohibits auditors from acting as employees of their audit clients.

    The report also emphasized:

    • An auditor may not provide otherwise permissible non-audit services (such as permissible tax services) to an audit client in a manner that is inconsistent with other provisions of the independence rules.
    • An arrangement that results in an auditor acting as an employee of the audit client implicates Rule 2-01 regardless of whether the accountant also acts as an officer or director, or performs any decision-making, supervisory, or ongoing monitoring functions, for the audit client. 
    • Audit firms and audit committees must carefully consider whether any proposed service may cause the auditors to resemble employees of the audit client in function or appearance even on a temporary basis.

    The SEC’s Office of the Chief Accountant has a Professional Practice Group that is devoted to addressing questions about auditor independence among other matters.  Auditors and audit committees are encouraged to consult the SEC staff with questions about the application of the auditor independence rules, including the permissibility of a contemplated service.

    “The accounting profession must carefully consider whether engagements are consistent with the requirements to be independent of audit clients,” said Paul A. Beswick, the SEC’s chief accountant.  “Resolving questions about permissibility of non-audit services is always best done before commencing the services.”

    The SEC’s investigation was conducted by Britt K. Collins, Dawn A. Edick, Michael Foster, Heidi M. Mitza, and Kathleen Shields.  The SEC appreciates the assistance of the Public Company Accounting Oversight Board.

    Teaching Case
    From The Wall Street Journal Accounting Weekly Review on January 31, 2014

    KPMG to Pay $8.2 Million to Settle SEC Charges
    by: Michael Rapoport
    Jan 25, 2014
    Click here to view the full article on WSJ.com
     

    TOPICS: Auditor Independence, Consulting

    SUMMARY: "The Big Four firms have drawn attention for their push to provide more consulting and nonaudit services in recent years. They've been deriving much of their growth recently from consulting, rather than from their core auditing businesses." Regarding the $8.2 million in charge specifically, "KPMG provided nonaudit services such as bookkeeping and payroll to affiliates of two of its audit clients, the SEC said, and the firm also hired a recently retired senior-level tax counsel of a third audit client's affiliate only to loan him back to the affiliate to do the same work. Those moves by KPMG between 2007 and 2011... , the commission said, violated "auditor independence" rules...."

    CLASSROOM APPLICATION: The article may be used in an auditing or other professional accounting class to discuss concerns about current trends in the public accounting profession and the specific need for independence as a cornerstone of the practice of accounting.

    QUESTIONS: 
    1. (Introductory) List all actions in the article the SEC alleges were committed by KPMG. Describe how each action might lead to loss of independence from audit clients

    2. (Advanced) Why do Securities and Exchange Commission rules require auditors to maintain independence from audit clients?

    3. (Advanced) Do any other rules besides the SEC require independence of public accountants? Explain your answer and again comment on the reason for this needed independence by accountants.
     

    Reviewed By: Judy Beckman, University of Rhode Island

    "KPMG to Pay $8.2 Million to Settle SEC Charges," by Michael Rapoport, The Wall Street Journal, January 25, 2014 ---
    http://online.wsj.com/news/articles/SB10001424052702303448204579340820706911040?mod=djem_jiewr_AC_domainid

    KPMG LLP agreed Friday to pay $8.2 million to settle Securities and Exchange Commission allegations that the Big Four accounting firm violated rules intended to keep outside auditors from getting too close to their clients.

    KPMG provided nonaudit services such as bookkeeping and payroll to affiliates of two of its audit clients, the SEC said, and the firm also hired a recently retired senior-level tax counsel of a third audit client's affiliate only to loan him back to the affiliate to do the same work.

    Those moves by KPMG between 2007 and 2011, the commission said, violated "auditor independence" rules that require auditors to avoid conflicts of interest that could compromise their ability to audit a company's financial statements impartially and rigorously.

    In addition, certain KPMG employees owned stock in one of the clients and in affiliates of another, the SEC said. The clients weren't identified.

    KPMG didn't admit or deny wrongdoing in agreeing to the settlement.

    In a statement, KPMG said it is "fully committed to ensuring our independence with respect to all of our audit clients" and has implemented internal changes to help make sure it complies with the independence rules.

    The settlement spotlights concerns that have lingered since the Enron Corp. scandal of more than a decade ago, in which the now-defunct audit firm Arthur Andersen earned lucrative fees from both auditing Enron and providing it with consulting and other nonaudit services.

    Many observers believed that affected Andersen's impartiality as a watchdog of Enron's financial statements during the scandal, and the Sarbanes-Oxley Act subsequently barred audit firms from providing many types of consulting and nonaudit services to their audit clients.

    The SEC previously reached a separate but similar settlement with KPMG's Australian affiliate in 2011, in which the SEC alleged the affiliate had provided nonaudit services to audit clients from 2001 to 2004. The Australian firm didn't admit or deny any wrongdoing.

    In addition to the KPMG settlement, the SEC also issued a separate report warning audit firms that they aren't permitted to loan staff to their audit clients if it results in the staff acting as employees of the clients. The report was prompted by an SEC investigation of KPMG's practices in that area—the commission ultimately decided not to bring an enforcement action from its probe, but said it was "appropriate and in the public interest" to clarify the rules regarding loans of staff and how they might affect an auditor's independence.

    The Big Four firms have drawn attention for their push to provide more consulting and nonaudit services in recent years. They've been deriving much of their growth recently from consulting, rather than from their core auditing businesses.

    Revenues from KPMG's advisory business, for instance, rose 4.8% in U.S. dollar terms in fiscal 2013, and tax revenues rose 2.3%, compared with a 1% decline in audit revenues.

    Even though the consulting-revenue growth comes from companies that aren't audit clients, the trend has led to concern among some critics.

    "I think that this is an indication they're more focused on the bottom line than they are on their audits," said Lynn Turner, a former SEC chief accountant.

    Though the Sarbanes-Oxley rules are supposed to prevent any conflicts of interest from arising, the critics contend the firms' increased concentration on consulting still could be problematic, by leading them to lose focus on their responsibilities as auditors.

    Continued in article

    And One Year Earlier
    "SEC Charges KPMG Auditors in TierOne Failure
    ," Tammy Whitehouse, Compliance Week, January 9, 2013 ---
    http://www.complianceweek.com/sec-charges-kpmg-auditors-in-tierone-failure/article/275490/

    Jensen Comment
    Why does the SEC even bother until it seriously takes on the criminals and not the firms.?

    Bob Jensen's threads on KPMG ---
    http://www.trinity.edu/rjensen/Fraud001.htm

    Jensen Comment
    Why does the SEC even bother?

    Bob Jensen's threads on audit firm professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    From the CFO Journal's Morning Ledger on December 5, 2013

    The PCAOB is moving forward with a proposal to name the partners who sign off on a company’s books
    The plan to make auditors name their lead engagement partners on annual reports will be open for public comment for 60 days and a final rule could be issued in the spring,
    CFOJ’s Emily Chasan reports. The proposal sparked a heated debate, but proponents say the change will help investors assess audit quality and performance—for instance, investors who know a partner’s name could check out other audits that partner has headed, to get a sense of his or her track record, the Journal’s Michael Rapoport writes. “It holds the promise of improving audit quality by sharpening the mind and reminding auditors of their responsibility to the public,” PCAOB Chairman James Doty said.

    The issue of naming the lead audit partner drew attention earlier this year after Scott London, a former KPMG senior partner, was implicated in an insider-trading scheme, Rapoport notes. KPMG had to resign as auditor of two companies whose audits Mr. London had headed, but since his name initially wasn’t released and there was no requirement to name the audit partner, investors had no immediate way to identify who he was. Accounting companies would also be required to disclose the names of outside firms that helped on an audit—a provision brought about by accounting problems at China-based companies listed on U.S. markets, Reuters says. Many of the audits of those companies were conducted by the Chinese arms of major U.S. audit firms, but U.S. regulators have had limited success in gaining oversight over the work of the China-based auditors.

    The PCAOB vote on the proposal was unanimous, but some board members said they felt it had serious shortcomings, Chasan writes. Board member Jeanette Franzel said there is little knowledge about whether disclosure of auditor names would improve audit quality. Auditors may run into operational issues if a subcontractor doesn’t consent to having their name revealed. And Jay Hanson, another board member and a former auditor, said the information would be more useful if it were disclosed in annual PCAOB filings, rather than the auditor’s report.


    Teaching Case
    From The Wall Street Journal Accounting Weekly Review on January 31, 2014

    Judge Suspends Chinese Units of Auditors
    by: Michael Rapoport
    Jan 23, 2014
    Click here to view the full article on WSJ.com
     

    TOPICS: Auditing

    SUMMARY: SEC administrative law judge Cameron Elliot has ruled that "the Chinese units of the Big Four accounting firms [plus a fifth China-based accounting firm, Dahua CPA, formerly associated with the accounting firm BDO] should be suspended from auditing US-traded companies for six months....[The] ruling...doesn't take effect immediately, and the firms might appeal the ruling, first to the [SEC] itself, then to the federal courts....The SEC had sought audit work papers from the firms to assist its investigations of some of the 130-plus Chinese companies trading on U.S. markets....But the Chinese firms refused...They said their hands were tied, as Chinese law treats the information in such audit documents as akin to 'state secrets'..." and thus could not cooperate with the SEC "without the Chinese government's blessing." The ruling could significantly affect audits of U.S. multinational companies because the Big Four use Chinese affiliates to assist in those engagements.

    CLASSROOM APPLICATION: The article may be used in an auditing, international accounting, or international business course. The related article was covered in this review; that review includes links to other articles as well.

    QUESTIONS: 
    1. (Advanced) Why is it important for the U.S. and China to have audit oversight and cross-border enforcement cooperation? What problems have arisen in this area?

    2. (Introductory) Why does the U.S./Chinese agreement described in the related article not resolve ongoing issues in audit oversight and cross-border enforcement cooperation?

    3. (Advanced) What is the impact on an audit report when the auditor relies on the work of an affiliate or another auditor? What do you think will happen to U.S. audit firms' work and their reports if Judge Elliot's ruling stands?
     

    Reviewed By: Judy Beckman, University of Rhode Island
     

    RELATED ARTICLES: 
    U.S., China Set Pact on Auditor Access
    by Michael Rapoport
    May 24, 2013
    Page: C3

    "Judge Suspends Chinese Units of Auditors," by Michael Rapoport, The Wall Street Journal, January 23, 2014 ---
    http://online.wsj.com/news/articles/SB10001424052702303448204579337183810731744?mod=djem_jiewr_AC_domainid

    The Chinese units of the Big Four accounting firms should be suspended from auditing U.S.-traded companies for six months, a judge ruled, a move that could complicate the audits of dozens of Chinese companies and some U.S.-based multinationals.

    he audit firms, plus a fifth China-based accounting firm, broke U.S. law when they refused to turn over documents about some of their clients to the Securities and Exchange Commission to aid the commission in investigating those U.S.-traded Chinese companies for possible fraud, ruled Cameron Elliot, an SEC administrative law judge.

    Judge Elliot's ruling Wednesday doesn't take effect immediately, and the firms can appeal the ruling, first to the commission itself, then to the federal courts. But if the ruling stands, it could temporarily leave more than 100 Chinese companies that trade on U.S. markets without an auditor. It also could throw a monkey wrench into the audits of U.S. multinational companies that have significant operations in China, because the Chinese affiliates of the Big Four—PricewaterhouseCoopers, Deloitte Touche Tohmatsu, KPMG and Ernst & Young—often help their U.S. sister firms complete those audits.

    Without audited financial statements, a company can't sell securities in the U.S. or stay listed on U.S. exchanges.

    "This is a body blow to the Big Four," said Paul Gillis, a Beijing-based professor at Peking University's Guanghua School of Management. "It's really quite a harsh ruling."

    The ruling will be inconvenient for the companies those Chinese firms audit, said Jacob S. Frenkel, a former SEC enforcement attorney now in private practice. It is a middle ground, he said. The judge could have gone further and permanently barred the Chinese firms from issuing audit reports on U.S.-traded companies, as the SEC had requested and as the accounting industry had feared.

    In a joint statement, the Big Four firms in China called the judge's decision "regrettable" and said they would appeal. "In the meantime the firms can and will continue to serve all their clients without interruption."

    The SEC said it was gratified by the ruling and that it upholds the commission's authority to obtain records that are "critical to our ability to investigate potential securities law violations and protect investors."

    Officials at China's Ministry of Finance and the China Securities Regulatory Commission said they didn't have an immediate comment.

    The fifth firm, Dahua CPA, was censured by Judge Elliot but not suspended. Dahua was an affiliate of another large accounting firm, BDO, until last April, but the two are no longer affiliated.

    The SEC had sought audit work papers from the firms to assist its investigations of some of the 130-plus Chinese companies trading on U.S. markets that have encountered accounting and disclosure questions in the past few years. Many of those companies have their independent audits performed by the Chinese affiliates of the Big Four, and the SEC had wanted to know more about what the auditors had found about the companies. (All the major accounting firms are international networks made up of individual, free-standing firms in each country in which they do business.)

    But the Chinese firms refused to turn over the documents. They said their hands were tied, as Chinese law treats the information in such audit documents as akin to "state secrets." The firms said their auditors could be thrown in jail if they cooperated with the SEC without the Chinese government's blessing.

    That led the SEC to file an administrative proceeding against the five firms in December 2012, arguing that U.S. law compels the firms to cooperate with such requests.

    The judge agreed, saying the firms "have failed to recognize the wrongful nature of their conduct" and showed "gall" in complaining that complying with the SEC's demands would hurt them. The firms knew when they registered with U.S. regulators and built their businesses in China that they might ultimately be put between a rock and a hard place in providing documents, the judge said.

    The judge wasn't deterred by an agreement last year between the U.S. and Chinese governments that somewhat alleviated the stalemate over documents, by allowing some documents from the audit firms to come to the U.S. after they were funneled through Chinese regulators. Since July, documents the SEC had sought relating to at least six companies have either been provided to U.S. regulators or were "in the pipeline" to be provided, the audit firms said in filings in November and December.

    The five Chinese firms involved in the case have a total of 103 U.S.-traded companies that they audit or in which they played a substantial role in the audit, according to their 2013 annual reports filed with U.S. regulators. The companies might have to make other arrangements for audits if their firm is suspended during the period when their yearly audit is being performed.

    Continued in article

     


    "One Way Or Another: The SEC Versus The Chinese Big Four Firms," by Francine McKenna, re:TheAuditors, December 30, 2013 --- 
    http://retheauditors.com/2014/01/25/one-way-or-another-the-sec-versus-the-chinese-big-four-firms/

    . . .

    We’ve already seen the Big Four plus one have lawyers and a key law firm opinion in common. The judge’s opinion also contains many mentions, via the firms’ testimony, of joint meetings between the firms and the regulators in China to discuss the regulatory impasse and their approach to US regulators requests. Here are a few examples:

    Another meeting took place the next day, October 10, 2011, at CSRC headquarters. A request went out in the morning for a meeting in the afternoon. Attendees included at least one official from the CSRC and MOF, and representatives of Dahua, E&Y, DTTC, PwC, Grant Thornton, and KPMG, with KPMG represented by Yan [[Len Jui (Jui), who heads KPMG's regulatory and public affairs unit] and Tian [Belinda, another KPMG partner]. The accounting firms briefed the CSRC and MOF regarding the requests they had received and their responses, which included whether each accounting firm had produced any work papers to overseas regulators.

    According to PwC, in December 2012, after issuance of the OIP, PwC and the other Respondents (except Dahua) attended a meeting with the CSRC and MOF.

    On June 4, 2013, representatives of all Respondents, including Yan for KPMG, met with the CSRC and MOF to discuss the present proceeding, in particular, to discuss it in light of the announced hearing date and to find out if the recent MOUEC changed anything. The CSRC and MOF told the accounting firms that they “just have to wait for instruction” from the CSRC and MOF.

    When the judge’s decision was announced, the China Big Four even issued a joint statement to media:

    It is regrettable that the SEC’s administrative law judge has recommended sanctions against the big four firms in China for failing to produce work papers to the SEC in circumstances where such production would have violated Chinese law and regulations. However, the firms note that the decision is neither final nor legally effective unless and until reviewed and approved by the full US SEC Commission. The firms intend to appeal and thereby initiate that review without delay. In the meantime the firms can and will continue to serve all their clients without interruption.

    The firms are heartened by the significant progress on information sharing between the Chinese and US regulators over the past year, which the firms have worked hard to support. The firms continue to support this co-operative working relationship and believe it is in the best interests of all parties.

    (My copy of the statement came for a spokesman at DTTC.)

    If the US and UK Government is looking for another reason to investigate the China Big Four auditors and their international leadership they might want to try collusion and anti-trust.

    Nota Bene: I just got a note from Professor Don Clark who provided expert witness testimony on behalf of the SEC in this case.  He pointed me to his post on the case from earlier in January that has useful citations for background on the relevant law.

     

     


    Punishing Audit Firms for Negligence:  Take that feather duster swat!
    "Paper Tiger Becomes "Tony the Tiger:" They're Grrrreat!" by Anthony H. Catanach, Jr., Grumpy Old Accountants Blog, November 26, 2013 ---
    http://grumpyoldaccountants.com/blog/2013/11/26/paper-tiger-becomes-tony-the-tiger-theyre-grrrreat

    That accountants can shirk their audit responsibilities to the public with little or no lasting harm to themselves...surely, not as much harm as they caused the investing public. The public should be outraged that not one of these accountants lost their license permanently, and that they continue to prey on the trust of the unsuspecting investor.”
    But my how times have changed…the “Paper Tiger” has become Tony the Tiger,” and that is just grrrrreat!

    What am I talking about?  Well, it has been a really bad month for the global accounting firms (GAFS).  First, Deloitte gained notoriety by receiving one of the largest civil penalties ever imposed by the Public Company Accounting Oversight Board (PCAOB).  In addition to a $2 million civil penalty, the PCAOB also censured the firm for allowing former partner Christopher Anderson to continue to “practice” while he was suspended by the PCAOB.  According to the PCAOB: 

     

    “The Board found that, in anticipation of the PCAOB suspension, the partner was made a salaried Director and transferred to an audit group in the firm’s National Office. After his transfer, Deloitte permitted the suspended auditor to become or remain an “associated person” by engaging in activities in connection with the preparation or issuance of public company audit reports.”
    Remember, this is the guy who “violated PCAOB standards in auditing Navistar Financial Corporation’s FY 2003 financial statements” and authorized an unqualified opinion (page 3, PCAOB Release No. 105-2008-003).

    And what makes this particularly interesting is that Mr. Anderson had his CPA license suspended  by the Illinois Department of Financial & Professional Regulation (see https://www.idfpr.com/LicenseLookUp/disc.asp)  beginning on June 30, 2009.  The Wisconsin Department of Regulation & Licensing also suspended his license for one year until November 1, 2009 (license expired December 14, 2011).  Michigan’s Department of Licensing and Regulatory Affairs was much kinder to Anderson, only fining him $500 (license expired December 31, 2011).  Isn’t it amazing that none of these state regulatory agencies saw fit to actually revoke his CPA license outright?  And despite all of this adverse regulatory action, Deloitte kept Mr. Anderson on the payroll doing “audit related work”…I wonder if they got $2 million worth of value?

    Next, on November 6, 2013, the PCAOB took a bold and much needed step by creating a Center for Economic Analysis “to study the role and relevance of the audit in capital formation and investor protection.”  This move suggests a failure by the Center for Audit Quality (CAQ) to provide meaningful or relevant research into improving audit quality.  I am shocked…you mean the GAFS’ blatant attempt to use the CAQ to direct academic research away from real audit quality problems has failed?  Do you really believe that CAQ- (i.e., GAFS) funded research performed by accounting academics can be unbiased?  Not if you want to get more CAQ research funding in the future!  

    Think I am being too critical?  Well, just take a look at the quality of the “unbiased research” coming out the CAQ, specifically the descriptive study titled An Analysis of Alleged Auditor Deficiencies in SEC Fraud Investigations: 1998-2010.  If one really wanted to analyze audit deficiencies with the goal of improving audit quality, why would one restrict the sample to 87 “old” cases of alleged fraudulent reporting reported by the Securities and Exchange Commission (SEC), and ignore more recent PCAOB disciplinary orders since 2005?  And what significant insights does this “research” yield?  According to a recent article by Tammy Whitehouse, the study suggests “that auditors faced SEC disciplinary actions primarily related to audits of smaller companies.”  As for the study’s contribution, according to one of the authors:

     

    “It’s hard to know exactly what it means, other than it’s not the large multinationals where we see problems.”
    The implications?  If the multinationals aren’t the problem, then neither are the GAFS, right?  So, was this real research or a CAQ promotion?  Now you can see why the PCAOB’s new Center for Economic Analysis is a terrific development. And it just has to irritate the GAFS and CAQ.  By the way, the CAQ’s Newsroom seems to have missed the PCAOB’s terrific news…I wonder why?

    Then, on November 13th, PCAOB Chairman James Doty took another giant step toward GAFS’ transparency and audit quality when he announced at the PCAOB’s recent Standing Advisory Group meeting that it will propose a rule on December 4th requiring public companies to reveal the name of their lead engagement audit partner as part of the annual reporting process. Francine McKenna provides a compelling argument as to why “we deserve to know audit partner names.”  As Francine seems to suggest, would things have been different had the GAFS’ partners been required to sign their audit opinions?  Maybe we should ask Linda McGowan (PwC, MF Global), Chris Anderson (Deloitte, Navistar Financial Corporation), Scott London (KPMG, Sketchers), or Jeffrey S. Anderson (E&Y, Medicis)…

    Finally, on Friday November 22nd, the PCAOB again publicly reprimanded Deloitte for its failure to adequately address quality control problems related to its audit practice by releasing the previously nonpublic portions of the PCAOB’s April 16, 2009 inspection report.  And as usual, we see that this audit “emperor has no clothes.”  Is an audit being done in name only?  The PCAOB raised the following serious audit quality concerns in its report (PCAOB Release No. 104-2009-051A):

    • Did Deloitte perform appropriate procedures to audit significant estimates, including evaluating the reasonableness of management's assumptions and testing the data supporting the estimates (page 10).
    • How appropriate was Deloitte's approach in using the work of specialists and data provided by service organizations when auditing significant management estimates (page 11). Specifically, the PCAOB raised questions about Deloitte’s testing of controls and data, audit documentation, etc.
    • Did Deloitte fail to obtain sufficient competent evidential matter, at the time it issued its audit report, to support its audit opinions, specifically as it related to the exercise of due care, professional skepticism, supervision and review (page 12).

    What’s really depressing about the these audit quality problems, is that they were almost exactly the same as those noted in the PCAOB’s May 19, 2008 report (pages 12 through 16).  Also, problematic is the waning interest of the popular press in these PCAOB report releases, suggesting that GAFS’ strategy to downplay and even ignore the PCAOB just may be working.

    Continued in article

    Bob Jensen's threads on Deloitte ---
    http://www.trinity.edu/rjensen/Fraud001.htm


    "The “Chilling Effect”: No One Important Wants The Auditor’s Opinion," by Francine McKenna, re:TheAuditors, November 13, 2013 ---
    http://retheauditors.com/2013/11/13/the-chilling-effect-no-one-important-wants-the-auditors-opinion/

    Jensen Comment
    Francine misses the point about what investors and donors to charities want most from their CPA auditors.

    First and foremost, they want auditors they think (even at absurdly high prices)  are going to do the best job preventing fraud, errors, and other abuses that are more likely, in my opinion, to protect them than if an organization faces no external auditors. We really have no data on how many frauds, errors, and other abuses are prevented by having external auditors, but in my opinion the preventative role of auditing trumps all other roles of auditing in general.

    Maybe the auditor's opinion is of little consequence until the tort lawyer pit bulls are called in to commence growling in court..

    Second, most astute investors and donors to charities want auditors having the deepest possible pockets when the tort lawyers grab onto the throat of an audit firm. The investors in the Madoff Ponzi scheme were perhaps the most naive investors in the world. Most of those investors were wealthy Jewish investors who could not imagine that one of their own with impeccable Wall Street credentials would steal billions from the the Jewish community. Their faith is in each other is to be expected, but one of the Big Six auditing firms with very deep pockets would have been value added in this case. Sometimes auditors don't even have to be from the Big Six as the City of Dixon, Illinois happily found out.


    "A New Audit Report? No...Auditor Accountability!" by Anthony H. Catanach Jr., Grumpy Old Accountants Blog August 3, 2013 ---
     http://grumpyoldaccountants.com/blog/2013/8/3/a-new-audit-report-noauditor-accountability

    "PCAOB to consider proposing new auditor’s reporting model," by Ken Tysiac, Journal of Accountancy, August 8, 2013 ---
    http://journalofaccountancy.com/News/20138496.htm

    August 14, 2013 message from Denny Beresford

    If you are interested in the new PCAOB proposal on the auditor’s report, and most accounting educators should be, you can get a good summary of what’s in the proposal and what are some of the contentious issues by reading the statements of the Board members at the public meeting when the release was unanimously approved. You can see from those statements that most of the Board members were less than thrilled with at least certain aspects of the proposal so it is far from a done deal. See:
    http://pcaobus.org/Rules/Rulemaking/Pages/Docket034.aspx

    Teaching Case from The Wall Street Journal Accounting Weekly Review on August 16, 2013

    Audit Reports Add Beef
    by: Michael Rapoport
    Aug 14, 2013
    Click here to view the full article on WSJ.com
     

    TOPICS: Audit Report, Auditing

    SUMMARY: The article reports on proposed changes to the standard form of audit report to discuss "Critical Audit Matters" [CAMS] and other disclosures. "The moves are aimed at making the audit report more useful for investors, as opposed to the current boilerplate letter that critics say tells investors little of substance about a company's true condition." The Public Company Accounting Oversight Board (PCAOB) issued the proposal and is accepting public comments until December 11, may hold a public roundtable early in 2014, and plans for required implementation by early 2017.

    CLASSROOM APPLICATION: The article may be used in an auditing class when discussing forms of the audit report and the scope of responsibility for reviewing items related to audited financial statements.

    QUESTIONS: 
    1. (Advanced) What are the components of the standard, unqualified form of an audit report on an entity's financial statements?

    2. (Advanced) Under current audit practice, what departures from the standard, unqualified report may be required? Under what circumstances are these report changes required?

    3. (Introductory) What are the proposed changes to the standard form auditor's report as described in the article?

    4. (Introductory) What entity is proposing these report changes? Why are the changes being proposed?

    5. (Advanced) According to the article, what expanded responsibilities are being proposed for auditors? Compare the proposed expansion to an auditor's responsibility under current standards to review items related to audited financial statements.
     

    Reviewed By: Judy Beckman, University of Rhode Island

     

    "Audit Reports Add Beef," by Michael Rapoport, The Wall Street Journal, August 14, 2013 ---
    http://online.wsj.com/article/SB10001424127887324769704579010561839513086.html?mod=djem_jiewr_AC_domainid

    Auditors would have to tell investors more about the tough decisions they had to make in evaluating a company's finances under a new proposal from the government's audit-industry regulator.

    The proposal, issued Tuesday by the Public Company Accounting Oversight Board, also would require auditors to evaluate whether the assertions a company makes in its annual report are accurate—a move which would take the auditors beyond their traditional rule of verifying a company's numbers.

    Both changes are part of a plan by the PCAOB to overhaul and expand the audit report— the letter in every annual report in which an auditor avers that the company's financial statements are "fairly presented." The moves are aimed at making the audit report more useful for investors, as opposed to the current boilerplate letter that critics say tells investors little of substance about a company's true condition.

    The PCAOB's proposal also would add some disclosures to the audit report, notably information about how long the auditor has worked for the company. Many companies have used the same audit firms for decades, and some critics think that can lead to coziness that can jeopardize an auditor's professional skepticism and ability to conduct a tough audit.

    "I think we've got a better mousetrap," said PCAOB Chairman James Doty. He called the proposal "a watershed moment for auditing."

    Change won't come soon, though.

    If the PCAOB's proposal is enacted in its current form, the first audit reports with the new information wouldn't be required until early 2017. The board is accepting public comments through Dec. 11 and may hold a public roundtable early next year to discuss the proposal.

    nvestor advocates and accounting-industry leaders were both guardedly positive about the proposal. The Council of Institutional Investors, which represents pension funds and other large investors, called it "a positive step forward to considering improvements to the usefulness of the standard form auditor's report."

    PricewaterhouseCoopers LLP, one of the Big Four accounting firms, "strongly supports any enhancements to the auditor's report that will address the needs of today's users," said Vin Colman, PwC's U.S. assurance leader.

    Cindy Fornelli, executive director of the industry's Center for Audit Quality, said her group is "committed to embracing calls for responsible change to the auditor's report."

    The proposed new report would retain the current pass-fail judgment by the auditor on a company's numbers.

    In addition, however, auditors would have to discuss any "critical audit matters," or "CAMs," as PCAOB members and staff are already calling them—parts of the audit in which the auditor had to make its toughest or most complex decisions, or which gave it the most difficulty in forming its audit opinion.

    For instance, the PCAOB said, an auditor might have a "critical audit matter" when it tries to determine whether a company has assigned a reasonable valuation to a large portfolio of thinly traded, hard-to-value securities.

    "It's telling investors what kept the auditors awake at night," said PCAOB member Jay Hanson.

    Auditors also would have to evaluate other information in a company's annual report beyond the financial statements—the company's assertions in its Management's Discussion and Analysis section, for example—to see if they have any errors or misstatements and to make sure they don't conflict with the numbers the company is reporting.

    Not everyone was on board with the PCAOB's proposal. PCAOB member Steven Harris said he voted to issue the proposal to start a discussion, but that he still thought it was "not strong enough to meet the concerns of investors."

    Continued in article

    August 19, 2013 reply from Steve Kachelmeier

    Thanks Bob. This makes for excellent case-discussion material -- I used it last spring in my intro-audit class based on the IAASB's proposal. Two major themes of discussion emerged. First, to the extent that an auditor reveals specifics related to audit strategy, this can make (future?) audits more predicable, potentially leaving the auditor vulnerable. Second, will users really understand what it means when an auditor identifies a certain area as high risk? Presumably, the auditor would have undertaken additional tests commensurate with the risks identified, but there is a possibility that users could interpret "high risk" accounts as simply being less reliable.

    Overall -- I strongly support using this proposal as a case exercise. It does not need to follow the specific format outlined in the post -- just get students to think about and evaluate the second-order, potentially unintended consequences of such an initiative.

    Steve

    August 19, 2013 reply from Denny Beresford

    The three examples of critical audit matters (CAMs) that would be included in the new auditor's report that the PCAOB gives in the proposal are particularly interesting. First, each of these could be read, in my opinion, by a reasonable person as a "condition" or qualification as to the overall fair presentation of the report - a sort of quasi "subject to." See if you agree when you read them. Second, for most companies, there would almost certainly be several (4-7?) of these CAMs that would have to be included and judging from the examples given they would expand the typical report to perhaps five pages or more. Thus, the retained "pass-fail" objective, which the PCAOB states is still quite important, would be buried in a sea of words and would require bold face type or some other form of highlighting to bring to investors' attention.

    Is this real progress?

    Your basic example is pretty much the same as Hypothetical Auditing Scenario #3 - Fair Value of Fixed Maturity Securities Held as Investments That are Not Actively Traded, starting on page A5-74 of the PCAOB exposure draft. What makes the situation even more problematic than what you describe is that, after explaining all of the reasons why this was determined to be a critical audit matter, the PCAOB illustration does not say anything about the auditor having reached reasonable assurance about this matter. The reader is simply left to reach his own conclusion about the implication of all of the special audit work. Presumably, the PCAOB believes that by a later overall clean opinion the reader will understand that the individual critical audit matters were just there to help him understand the financial reporting better - but is that so?

    A few other observations.

    The draft says that the disclosures only need to describe the critical audit matters and not necessarily describe what procedures the auditor has applied to address them. But all three illustrations given in the draft include the latter. In practice, I'm not sure which direction auditors would go if they had a choice. Adding the description of the procedures makes them much more problematic, in my view. Otherwise, they might be nothing more than a roadmap to the company's financial statements.

    With respect to my observation about no position being taken on the reasonable assurance about the specific CAMs, while this seems to be an obvious omission, on the other hand auditor's reports are on the financial statements taken as a whole and I can see where they may have major reservations about adding comments about particular aspects of the financial statements.

    The exposure draft notes that in the normal situation the Board expects that there would be at least a few CAMs included in all but the simplest company reporting situations. Throughout the draft there is language that would seem to drive auditors to err on the side of more rather than fewer of these being reported, else bad consequences through the inspection process. This will not be well received by company management and counsel.

    To be continued.

    Denny

    Bob Jensen's threads on professionalism and independence in auditing and financial reporting ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    Five Auditor Independence Issues PCAOB SAG Not Yet Addressing," by Francine McKenna, re:TheAuditors, November 11, 2013 ---
    http://retheauditors.com/2013/11/11/five-auditor-independence-issues-pcaob-sag-not-yet-addressing/

    My headline story yesterday was about the regulatory black hole that exists for the consulting practices of the Big Four audit firms. (The abyss exists for all of the audit firms but, as usual, we will focus here in the business of the Big Four given their influence on issuers, aka publicly listed companies.)

    There are five big issues that space prevented a full discussion of yesterday and that are not on the agenda of the PCAOB Standing Advisory Group meeting this week. My hope is that regulators, policy makers and other interested parties will start talking about these issues, too, while I am in DC this week.

    1)    US regulators are not enforcing existing rules —the pre- and post- Sarbanes-Oxley rules — regarding auditor independence for the US firms of the Big Four auditors who also provide consulting services for those clients.

    I’ve written numerous times about independence violations only to see no visible action by the SEC or PCAOB. This is what I’ve written just since the beginning of 2012 about auditor independence issues. Many posts reference earlier warnings about the activities, especially the broker-dealer independence issues.

    January 26, 2012, KPMG Nixes GE Loaned Tax Staff Engagement

    February 22, 2012, Are Auditors Reporting Fraud And Illegal Acts? The SEC Knows But Isn’t Telling

    December 1, 2012, Deloitte, HP And Autonomy: You Lose Some But You Win Some More, Much More Big, big story at the end of 2012 that involves all four of the Big Four audit firms and is a prime example of the growing influence  – and the threat to auditor independence – of the reestablished consulting practices in the firms. It also highlights the media confusion about the all roles audit firms are playing these days. Often they are not audit-related and yet the media often does not know for sure how to refer to the firms or their specific responsibilities and potential legal liabilities.

    December 26, 2012, PwC and Thomson Reuters: Too Close For Comfort

    February 1, 2013, A Summary of Writing on the “Independent” Foreclosure Reviews and the AG Mortgage Settlement

    February 18, 2013, Tax Pays: HP Pays Ernst & Young Two Million To Testify

    April 22, 2013, Scott London Subverted Sarbanes-Oxley: Big Four Mock Audit Partner Rotation

    June 30, 2013, More Conflicts For The “Independent” Foreclosure Reviews

    September 3, 2013, Broker-Dealer Audits Still Badly Broken

    September 29, 2013, Pershing Square’s Bill Ackman Tells PwC, “Herbalife Is Your Problem Now”

    Continued in article

    Bob Jensen's threads on audit firm professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    Big Accounting Firms Walking a Tightrope Between Consulting and Auditing
    "Strategic moves Big consulting and accounting firms are making a risky move into strategy work," The Economist, November 9, 2013 --- Click Here
    http://www.economist.com/news/business/21589435-big-consulting-and-accounting-firms-are-making-risky-move-strategy-work-strategic-moves?fsrc=scn/tw_ec/strategic_moves

    OPERATIONS consultants sit at the front of the classroom,” says a partner at a strategy consultancy. “Strategy consultants stay in the back, not paying attention, throwing paper airplanes. But they still get the girls and get rich.” Like so many caricatures, this one is cruel but contains a grain of truth. Operations consultants—the fine-detail guys who tinker with businesses’ internal processes to make them run better—generally do not enjoy the same glamour or financial rewards as strategy specialists, whose job is to advise firms on make-or-break deals, adopting new business models and other big stuff.

    Although in practice their work overlaps, the two have until now remained distinct businesses. Strategy firms like McKinsey, Bain and the Boston Consulting Group hire from the top universities, are packed with highly paid partners and whisper their counsel in CEOs’ ears. In contrast, operations specialists such as IBM, Accenture and the Big Four accounting firms (Deloitte, EY, KPMG and PwC) employ armies of lower-paid grunts; and tend to answer to the client firm’s finance or tech chiefs.

    This year, however, that line has begun to blur. In January Deloitte became the largest of the Big Four by scooping up the assets of Monitor, a strategy firm that had gone bust. And on October 30th its closest rival, PwC, said it would buy another strategy firm, Booz & Company, for a reported $1 billion. If Booz’s partners approve the deal, it will vault PwC back into first place.

    The accountancies’ push into strategy has been a decade in the making. During the late-1990s technology bubble they beefed up their IT-consulting arms. But in 2001 Enron, an energy-trading firm, went bust and took its auditor, Arthur Andersen, down with it. In response, America’s Congress passed the Sarbanes-Oxley corporate-governance reform, which banned firms from doing systems consulting for companies they audited. As a consolation prize, the Big Four made a fortune helping clients comply with the new law. Their advisory businesses, full of potential for conflicts of interest with their auditing side, by now seemed dispensable. All but Deloitte had sold off those divisions by 2003.

    Just as the workload from Sarbanes-Oxley began to dwindle, the 2008-09 financial crisis hit, causing consulting revenues to dip (see chart). But once the economy recovered, the climate for the Big Four started to resemble the 1990s. They began to rush back into consultancy, encouraged by its high margins and double-digit annual growth rates at a time when revenue growth from auditing and tax work had slowed. In particular, Deloitte and PwC began gobbling up operations consultancies as they sparred for the top spot.

    For years the strategy firms remained beyond the Big Four’s grasp. During the 2000s they had mostly prospered on their own, and their partners shuddered at the thought of being subsumed into giant bureaucracies. After the financial crisis, however, midsized strategy consultants hit hard times. Cost-conscious companies with globalising businesses wanted either to hire boutiques with deep knowledge of their industries, or to benefit from the scale of generalist firms with offices everywhere. Too big for some clients and too small for others, Monitor went under, and Booz—a spin-off from Booz Allen Hamilton, which now focuses on operations work for governments—went on the block.

    Both Booz and PwC say that the two sides of consulting are converging, and that more clients want a one-stop shop that can both devise a strategy and execute it. Deloitte and Monitor claim their integration is already bearing fruit. “There’s been a very healthy two-way cross-selling opportunity,” says Mike Canning of Deloitte.

    Nonetheless, Booz’s leadership still faces a hard sell to get the deal passed. In 2010 the company’s partners voted down a proposed merger with AT Kearney, another midsized strategy firm. This marriage involves far more risks. A significant number of Booz’s clients would immediately be in doubt because PwC audits them—strategy consulting for audit clients is banned in many countries, and even where it is legal it is frowned upon (not least in America). Since the Big Four are structured as associations of national partnerships, Booz’s staff would probably end up being divided by country, hindering the global co-operation that many big clients seek.

    Most important, each of Booz’s 300 partners would have to trade meaningful sway over the direction of a highly profitable firm for a minuscule stake in a diversified, lower-margin empire. If the sale is approved, the test of its success will come in a few years, after Booz’s partners receive their full payout and can head off. An exodus would leave PwC empty-handed.

    Continued in article

    PwC's Biggest Rebranding Yet:  What Goes Around Comes Around
    From the CFO Journal's Morning Ledger on October 31, 2013

    PwC is banking on more growth in consulting with its acquisition of Booz
    Terms weren’t disclosed, but the transaction appears to be among the biggest deals involving an accounting firm in at least the past decade
    , the WSJ’s Michael Rapoport, Julie Steinberg and Joann S. Lublin report. The deal is expected to beef up PwC’s fast-growing advisory business and should also help it tap  Booz’s experience developing strategies for clients. “PwC has made it really clear they’re bulking up their management-consulting business,” said Tom Rodenhauser, managing director at Kennedy Consulting Research & Advisory. The move gives PwC “a real leg up in credibility in terms of business consulting.” The FT’s Sam Fleming says the hope is that Booz will allow PwC to offer a stronger challenge to the prime end of the management-consulting sector, where McKinsey, Boston Consulting Group and Bain dominate.

    But it isn’t all smooth sailing. Sarbanes-Oxley bars audit firms from many types of consulting for their U.S. audit clients, so conflicts of interest are almost sure to arise in cases where Booz’s existing consulting clients have their yearly audit done by PwC, the Journal says. Meanwhile, former SEC Chairman Arthur Levitt, who pushed for rules to curb accounting firms from providing both auditing and consulting services to a client, tells Bloomberg that the deal puts the issue of independence front and center. “As the accounting profession becomes more committed to consulting, their audit activities have got to be questioned,” said Mr. Levitt. Some accounting firms “see their future in consulting rather than auditing, and that’s unfortunate for America’s markets.”

    And Lynn Turner, the former chief accountant at the SEC, tells Bloomberg that mergers like this raise a serious question: “Are the auditors going to serve management, or are they going to serve the best interests of the investing public?” If the combined firm agrees not to do consulting for companies it audits, “then you eliminate the conflict,” Mr. Turner said, but he doubts that will happen. “Do you honestly think Booz partners would turn around and vote for this deal if they gave up all of their clients that PwC audits?”

    Bob Jensen's threads on the failing professionalism and independence of large multinational auditing firms ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    Rebranding at KPMG
    "Can’t KPMG Just Do Better Audits?" by Jonathan Weil, Bloomberg Businessweek, November 11, 2013 ---
    http://www.bloomberg.com/news/2013-11-11/can-t-kpmg-just-do-better-audits-.html

    KPMG is getting into venture-capital investing, according to an article today in the Times of London. It’s one more sign that the Big Four audit firms are moving beyond traditional accounting services and getting themselves into other more far-flung endeavors.

    The newspaper said the fund, called KPMG Capital, will be based in London and “will invest predominantly in small British and American data and analytics businesses.” We can presume that KPMG would be smart enough to avoid auditing the books at places where it invests, although you never know.

    Even if KPMG doesn’t audit the companies it owns, an obvious problem is that KPMG inevitably will be in the position of funding companies that compete against its own audit clients. That may not be a violation of any rules, but it can create conflicting interests nonetheless. (Then again, so can audit fees themselves, because the client is paying the auditor.)

    Adversarial relationships can be as damaging to the notion of auditor independence as overly cozy ones. Plus, you have to wonder if this even makes good business sense. If I were on the board at a KPMG audit client and saw a KPMG-owned startup trying to take away my company’s market share, I would want to drop KPMG and hire a different firm.

    This line from the Times article, quoting a senior KPMG partner named Simon Collins, caught my attention in particular: “Mr. Collins said that it would be `very difficult’ to provide audit services to the companies it invested in -- `but we can incubate them, we can advise them.’”

    Let’s get this much straight: “Very difficult” is the wrong answer here. The correct response is that it should be impossible. Any first-year accounting student can tell you that auditors aren’t supposed to audit companies in which they have ownership stakes.

    But maybe we shouldn’t be surprised. In February 2011 the Securities and Exchange Commission censured KPMG’s Australia affiliate over independence violations at two audit clients with U.S.-registered securities. The SEC found the firm sent staff members to work at an audit client under the client’s supervision and direction. In another situation the firm was paid commissions for promoting an audit client’s products and was retained by the client to provide legal services.

    In another case, the SEC in 2005 settled with KPMG’s Canadian affiliate and two of its partners over audit-independence violations at a Colorado company, Southwestern Water Exploration Co. The firm prepared some of the company’s basic accounting records and financial statements and then audited its own work, the SEC said.

    In 2002, the SEC censured KPMG because it purported to serve as the independent auditor for a mutual fund at the same time it had invested $25 million in the same fund. At one point KPMG accounted for 15 percent of the fund’s assets, the SEC said. That was a black-and-white violation of the auditor-independence rules.

    Continued in article

    Bob Jensen's threads on KPMG ---
    http://www.trinity.edu/rjensen/Fraud001.htm


    Teaching Case
    From The Wall Street Journal's Accounting Weekly Review on September 20, 2013

    Deloitte Fined for Conflicts of Interest With Auto Maker
    by: Margot Patrick
    Sep 10, 2013
    Click here to view the full article on WSJ.com
     

    TOPICS: Ethics

    SUMMARY: In London, Big Four accounting and auditing firm Deloitte was fined 14 million pounds ($22 million) for "failing to manage conflicts of interest in advice it gave to MG Rover Group...." London's Financial Reporting Council alleged that Deloitte "failed to consider the public interest in a series of transactions."

    CLASSROOM APPLICATION: The article may be discussed in an ethics or auditing class to discuss conflicts of interests in services provided by public accounting firms.

    QUESTIONS: 
    1. (Introductory) From the article and/or other outside sources, describe the work for which Deloitte is accused of "failing to manage conflicts of interest" and therefore violating the public interest in its work.

    2. (Introductory) What is the public interest? What are conflicts of interest?

    3. (Advanced) Why do accounting firms have a duty to consider the public interest in the work they do?

    4. (Advanced) What self-regulatory mechanisms are used by the public accounting profession to ensure this obligation is upheld?
     

    Reviewed By: Judy Beckman, University of Rhode Island

     

    "Deloitte Fined for Conflicts of Interest With Auto Maker," by Margot Patrick, The Wall Street Journal, September 10, 2013 ---
    http://online.wsj.com/article/SB10001424127887324549004579064873397832060.html?mod=djem_jiewr_AC_domainid

    Accountancy firm Deloitte was fined £14 million ($22 million) on Monday for failing to manage conflicts of interest in advice it gave to MG Rover Group and its owners before the British auto maker entered administration in 2005.

    A tribunal handed down the fine after upholding 13 allegations made by regulatory body the Financial Reporting Council against Deloitte and one of its former partners, Maghsoud Einollahi The FRC's allegations centered around Deloitte's failure to consider the public interest in a series of transactions between the auto maker, its owners and associated companies, and to address the potential conflicts of interest between the parties.

    A Deloitte spokeswoman said the firm is disappointed with the outcome and disagrees with the tribunal's main conclusions. It has 28 days to appeal the decision but the spokeswoman declined to comment on whether it would take action.

    The tribunal also issued "a severe reprimand" to Deloitte, and presented Mr. Einollahi with a £250,000 fine and three-year ban from working in the profession. A spokesman at Freshfields, the law firm representing Deloitte and Mr. Einollahi, declined to comment.

    The FRC said the tribunal's decision should "send a strong and clear message to all members of the accountancy profession about their responsibility to act in the public interest and comply with their code of ethics."

    MG Rover collapsed in 2005, five years after a group of four businessmen bought the loss-making auto maker for £10. Deloitte was auditor for MG Rover while also acting as corporate finance adviser to companies controlled by or affiliated with the businessmen.

    The fine came as Deloitte and other auditing firms face pressure from regulators to sharpen their standards and act with greater independence in questioning clients' activities.

    Continued in article

    Bob Jensen's threads on Deloitte's legal woes ---
    http://www.trinity.edu/rjensen/Fraud001.htm

     


    ""Ten Commandments" for Today's CFO," by Anthony H. Catanach Jr., Grumpy Old Accountants, September 17, 2013 ---
    http://grumpyoldaccountants.com/blog/2013/9/14/ten-commandments-for-todays-cfos


    In a speech, incoming Chairman Russ Golden stated the following on September 12, 2013 ---
    http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176163302661

    . . .

    When people talk about independence in connection with the FASB, they usually mean

    one of several things:

    • Independence from the influence of powerful stakeholders who have a vested interest in the outcome of a particular standard-setting decision;
       
    • Independence from political interference; or in some cases,  (emphasis added)
       
    • Independence from meddling – perceived or real –by our governing body, the Financial Accounting Foundation.

    Each of these is a valid concern that, I believe, the Board must take seriously. Independence is critical to the establishment of high-quality accounting standards that promote decision-useful financial reporting. But in my view, the independence of the FASB is not a right to be exercised. It‘s a privilege to be earned – every day – through all that we undertake.

     

    Here's an example of how pressure is or might be placed upon accounting standards setters, thereby threatening their "independence"

    From the CFO Journal on September 16, 2013

    Banks in Spain and Italy look for relief in accounting
    Italian and Spanish banks are trying to improve the appearance of their financial health by persuading their governments to change accounting-related rules, the WSJ reports. In Spain, bank executives are lobbying to transform potentially worthless tax assets into government-guaranteed tax credits that would bolster the banks’ capital positions. And in Italy, top banking executives are pushing for a revaluation of the Bank of Italy that would translate into an accounting windfall for the banks and thereby inflate their capital levels. But critics say the requested changes are sleight-of-hand maneuvers that don’t improve the banks’ abilities to weather future losses. “If capital-adequacy measures can be manipulated to make banks appear better without really improving their financial health, the purpose of the [capital] regulation is undermined,” said Anat Admati, a finance professor at Stanford University’s business school. She described the Spanish effort in particular as “disturbing.”

    "New accounting rule would ease Greek pain: IASB," By Silke Koltrowitz and Huw Jones,  Reuters, July 5, 2011 ---
    http://www.reuters.com/article/2011/07/05/us-accounting-idUSTRE7643WU20110705

    European Union banks would have more breathing space from losses on Greek bonds if the bloc adopted a new international accounting rule, a top standard setter said on Tuesday.

    The International Accounting Standards Board (IASB) agreed under intense pressure during the financial crisis to soften a rule that requires banks to price traded assets at fair value or the going market rate.

    This led to huge writedowns, sparking fire sales to plug holes in regulatory capital.

    The new IFRS 9 rule would allow banks to price assets at cost if they are being held over time.

    The European Commission has yet to sign off on the new rule for it to be effective in the 27-nation bloc, saying it wants to see remaining parts of the rule finalized first.

    Continued in article

     

     


    One of the moral hazards of being a relatively low paid government regulator is the opportunity to turn your acquired knowledge and internal contacts into comparative advantages that make the companies you regulate flock to you like bees to sweet nectar.

    It is almost rare when top regulators do not leave for high compensation from companies they used to regulate --- FAA regulators leave to work for airlines, FPC regulators leave leave to work for airlines, FDA regulators leave to work for drug companies and agribusiness, DOJ regulators and judges leave to work for law firms, IRS regulators leave to work for law and accounting firms, etc.

    When I lived in Bexar County, Texas I had a real estate appraisal firm on retainer to fight to lower my property taxes. The firm I hired was very popular since it mostly hired away former appraisers in the Bexar County Appraisal District's office.

    Teaching Case on Moral Hazards of Regulation and Audit Firm Independence
    From The Wall Street Journal Accounting Weekly Review on August 23, 2013

    Delaware Job Hop Stirs Flap
    by: Vipal Monga
    Aug 20, 2013
    Click here to view the full article on WSJ.com
     

    TOPICS: Auditing, Auditor Independence, Ethics, Governmental Accounting

    SUMMARY: "A top Delaware finance official sent out 125 audit notices this year to companies incorporated in the First State. Three weeks ago, he retired and joined the auditing firm expected to do the lion's share of those audits in exchange for millions of dollars in fees...the second holder of that office in a row to leave it for a job at Kelmar Associates, which typically does between 70% and 80% of the auditors ordered by the...office."

    CLASSROOM APPLICATION: The article may be used in an auditing, general ethics, or governmental accounting course.

    QUESTIONS: 
    1. (Introductory) What is the office of the state escheator in Delaware?

    2. (Advanced) For what purpose did the Delaware state escheator send out audit notices? Describe your understanding of the audits that must be conducted. The related article can help in answering this question.

    3. (Advanced) Ignoring specific rules described in the article, define the conflict of interest which is evident when an individual leaves the role of state escheator for the firm conducting the audits demanded by that officer.

    4. (Advanced) Does the fact that the state of Delaware has no rule against Mr. Udinski's actions mean that a conflict of interest does not exist? Explain your answer.

    5. (Advanced) Does following the rule precluding Mr. Udinski from working on audits ordered by him during his former state role for two years eliminate the conflict of interest? Explain your answer.
     

    Reviewed By: Judy Beckman, University of Rhode Island
     

    RELATED ARTICLES: 
    Unclaimed? Delaware Gets It
    by Vipal Monga
    Jan 29, 2013
    Page: B7

    "Delaware Job Hop Stirs Flap," by Vipal Monga, The Wall Street Journal, August 20, 2013 ---
    http://blogs.wsj.com/cfo/2013/08/20/delaware-job-hop-stirs-flap/?mod=djem_jiewr_AC_domainid

    A top Delaware finance official sent out 125 audit notices this year to companies incorporated in the First State. Three weeks ago, he retired and joined the auditing firm expected to do the lion’s share of those audits in exchange for millions of dollars in fees.

    As state escheator, Mark Udinski’s job was to collect unclaimed property, such as dormant bank accounts, uncashed checks and gift certificates and life-insurance benefits, and then try to locate and reimburse the rightful owner. This month he became the second holder of that office in a row to leave it for a job at Kelmar Associates, which typically does between 70% and 80% of the audits ordered by the escheator’s office.

    Mr. Udinski’s move to the privately held auditing firm doesn’t violate any state rules. The state requires only that he refrain from working on Delaware-related cases for two years. But some critics say the job switch creates the appearance of a conflict of interest.

    Among them is Doug Lindholm, president of the Council on State Taxation, which lobbies state governments on tax issues and whose nearly 600 member companies include Coca-Cola Co., AT&T Inc. and Pfizer Inc., which are incorporated in Delaware. Mr. Udinski’s new job “looks like a reward for years of directing business to Kelmar,” he said.

    Attempts to contact Mr. Udinski were unsuccessful.

    Mark McQuillen, a principal at Wakefield, Mass.-based Kelmar, said that Mr. Udinski was the right person for the job. “He’s a smart, competent guy,” Mr. McQuillen said of the former state official. “There aren’t enough people out there who do that sort of work.”

    Mr. McQuillen added that he didn’t sense any conflict in Mr. Udinski’s new role. But, he said, “The state would determine what’s a conflict.”

    Mr. Udinski’s predecessor, Patrick Hurley, who also left for Kelmar and works in the firm’s legal department, couldn’t be reached for comment.

    Tom Cook, Delaware’s secretary of finance and Mr. Udinski’s former boss, dismissed any suggestion of conflict. “No one has made any allegation at all that Mark has done something improperly,” Mr. Cook said. “If there are people that are criticizing the integrity of the department of finance, Mark Udinski or myself, I suggest they come to me, and they better have proof.”

    Some critics aren’t convinced. “It shows the cozy relationship between Kelmar and Delaware, and calls into question the decisions [Mr. Udinski] has made,” said Jennifer Borden, general counsel for Unclaimed Property Recovery & Reporting, which advises companies being audited by the state.

    Over half of the nation’s publicly traded companies are incorporated in Delaware. That obliges them to turn over unclaimed property to the state if they can’t locate the owner. If the state sees an inconsistent pattern in the company’s unclaimed-property reports, it will order an audit.

    Once in state hands, the money sits in the general fund, unless or until the owner is traced, accounting for a sizable chunk of state revenue—14% in the most recent fiscal year ended June 30, according to state data.

    Under Mr. Udinski, a former pro football player who became escheator in 2009, Delaware developed a reputation for aggressively pursuing companies for unclaimed property. During his tenure, the state collected $2.2 billion of such property.

    Mr. Udinski “was a big reason for Delaware’s success in the area,” said Chris Hopkins, a partner at accounting firm Crowe Horwath LLP, which has advised several companies involved in unclaimed-property audits.

    The state confirmed that the bulk of the 125 audits it ordered this year will be done by Kelmar, which has earned more than $90 million in fees from Delaware over the past three years.

    Kelmar’s Mr. McQuillen said it was only natural that Kelmar, one of the largest audit firms specializing in unclaimed property, would get the bulk of the state’s business in that area. “We got those jobs because of our capacity and the quality of the work we do, nothing more. If not us, who?” he said in an email.

    Over the years, companies including CA Technologies Inc. and Staples Inc. have paid millions to the state to settle unclaimed-property audits. This year, Select Medical Corp. filed a lawsuit alleging Delaware officials were improperly claiming $300,000 in unclaimed-property fees and called their tactics “unconstitutional and illegal,” according to the complaint.

    Continued in article


    From the CFO Journal's Morning Ledger on August 20, 2013

    PCAOB finds problems with broker-dealer audits
     Auditors of broker-dealers need to improve their performance
    when it comes to compliance with independence requirements and other accounting rules, the PCAOB said. A new report released by the board found deficiencies in an expanded review of audit firms performing work for securities brokers and dealers. The results are “very similar” to the PCAOB’s report released a year ago, showing auditors have a “long way to go” to ensure compliance with audit requirements, said Jay Hanson, a member of the group’s board. Auditors, he said, should “up their game.”


    Huber, W.D., (2013) Audit Fees, PCAOB Sanctions, Sanction Risk, Sanction Risk Premiums, and Public Policy: Theoretical Framework and a Call for Research. Journal of Accounting, Ethics & Public Policy, 14(3), 647-663.

    Abstract: The Sarbanes-Oxley Act of 2002 (SOX) was enacted to “protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws…” The Public Company Accounting Oversight Board (PCAOB) was created as part of SOX and given a duty to impose monetary sanctions on PCAOB registered accounting firms for intentional, knowing, or reckless conduct that results in violation of the statutory, regulatory, or professional standards of auditing, or for repeated instances of negligent conduct. This creates a new risk for both individual auditors and auditing firms separate and distinct from business, audit, and litigation risk—sanction risk. This paper establishes the legal and economic bases of sanction risk and proposes that research be conducted to determine whether sanction-risk premiums are being incorporated into audit fees and passed on to clients by registered accounting firms thereby subverting the intended purpose of the sanctions.


    Free to download (Paper #5) at http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=371197

    "PCAOB to consider proposing new auditor’s reporting model," by Ken Tysiac, Journal of Accountancy, August 8, 2013 ---
    http://journalofaccountancy.com/News/20138496.htm

     


    KPMG is at it again. In the most recent allegation of violating independence standards of the accounting profession

    "Threats to Independence Raise Ethical Questions for the Big-Four CPA Firms," by Steven Mintz, Ethics Sage, May 7, 2013 ---
    http://www.ethicssage.com/2013/05/threats-to-independence-raise-ethical-questions-for-the-big-four-cpa-firms.html

    KPMG is at it again. In the most recent allegation of violating independence standards of the accounting profession, KPMG’s Columbus, Ohio office was auditing JobsOhio’s books while, at the same time, an out-of-state office of the firm was seeking $1 million in taxpayer money from JobsOhio for an unnamed client. As the state’s lead economic-development agency, JobsOhio is charged with recommending financial incentives for companies seeking to relocate in the state. On November 5, 2012, about the time that the audit was being conducted, KPMG was also listed on a sheet of eight pending grant commitments from the state for fiscal year 2013, one of which was for the unnamed client.

    I will return to this case later on, but first a review of the recent insider trading charges against the firm. I have previously written about about insider trading at KPMG. In that case, KPMG resigned two audit accounts and withdrew its blessing on the financial statements of Herbalife for the past three years and of Skechers for the past two. KPMG withdrew its audit opinions, a serious step for any auditor, after concluding it was not independent because of alleged insider trading.

    The KPMG insider trading case is a particularly egregious one because it involves an auditor tipping off a friend about stock of audit clients. Scott London, the KPMG auditor, did not trade in the stock himself but he did gain personal wealth (“unjust enrichment”) when his friend, Brian Shaw, used the inside information to trade in stock of Herbalife Ltd. and Skechers USA Inc. Shaw benefitted by $1.27 million on the trades. Shaw paid London $50,000 cash and gave him a Rolex watch.

    Looking at the JobsOhio case, as KPMG was auditing JobsOhio's books in the fall of 2012 the firm also was seeking $1 million in taxpayer money from JobsOhio for an unnamed client. JobsOhio, the state's privatized development agency, said that the grant request was handled separately from and without the knowledge of the firm's auditing division.

    The ethical problem for KPMG in the JobsOhio case is independence in appearance. This is an important requirement of an independent audit because factual independence is sometimes difficult to determine. Factual independence goes to the mindset of the auditor in approaching an audit with objectivity and professional skepticism. It is difficult to assess so appearances serve as a proxy in that regard.

    JobsOhio denies any conflict of interest. Laura Jones, a spokeswoman for JobsOhio, said KPMG LLP's Columbus office conducted the audit, but the grant was sought by an out-of-state office. "The fact that KPMG serves JobsOhio and countless other businesses ... from the same office here in Columbus is not a conflict in our minds," she said, adding that “the state also monitors and ultimately approves taxpayer-funded incentives to companies.”

    Most observers would probably conclude that the two offices of KPMG would never collude on their own to achieve some benefit for the firm. However, the more troubling issue is whether JobsOhio might perceive some pressure on them to provide financial incentives to the KPMG audit client perhaps to make it less likely that KPMG would point out problems with the JobsOhio audit, assuming any occur.

    The accounting profession has strict independence standards to protect the public interest. Shareholders, creditors, and the beneficiaries of public funds rely on the honesty, trustworthiness, and responsibility of auditors to go the extra mile to ensure that the financial statements of entities that operate in the public interest are based on an independent audit – both in fact and in appearance.

    KPMG is not alone in violating the most basic and cherished independence standards. As I have previously blogged, in 2010 Deloitte and Touche was investigated by the SEC for repeated insider trading by Thomas P. Flanagan, a former management advisory partner and a Vice Chairman at Deloitte. Flanagan traded in the securities of multiple Deloitte clients on the basis of inside information that he learned through his duties at the firm. The inside information concerned market moving events such as earnings results, revisions to earnings guidance, sales figures and cost cutting, and an acquisition. Flanagan’s illegal trading resulted in profits of more than $430,000. In the SEC action, Flanagan was sentenced to 21 months in prison after he pleaded guilty to securities fraud.

    On January 7, 2013, the SEC announced it is investigating whether Ernst & Young violated independence rules by letting its lobbying unit perform work for several major audit clients. The SEC inquiry began shortly after Reuters reported in March 2012 that Washington Council Ernst & Young, the E&Y unit, was registered as a lobbyist for several corporate audit clients including Amgen, CVS Caremark, and Verizon Communications.

    The problem for EY is that U.S. independence rules bar auditors from serving in an "advocacy role" for audit clients. The goal is to allow auditors to maintain some degree of objectivity regarding the companies they audit, based on the idea that auditors are watchdogs for investors and should not be promoting management's interests.

    Finally, in December 2012, Thomson Reuters announced it signed a three-year contract with PwC, the company’s auditor, to provide use of the Thomson Reuters ONESOURCE Corporate Tax solution for China. PwC U.K. also uses this Thomson Reuters software for its tax clients. Business alliances between a company and its auditor are prohibited under U.S. and U.K. auditor regulations. Once again an independence violation exists because such arrangements create a “mutuality of interests” as a result of the business relationship between the auditor and audit client.

    Continued in article

    Bob Jensen's threads on KPMG ---
    http://www.trinity.edu/rjensen/Fraud001.htm

     


    Ethical Video Dilemmas for use in the classroom from KPMG --- Click Here

    http://emailcc.com/collect/click.aspx?u=yBkk0yFkQBUYhLtB0iEBFmUseoUsqrE3Dvx/pWbQzRFv6VS1ngkmZHUQgfaiTiOzbtC9dsBLaDuNzSN3elnG7KqpqZ4gUCv1aVtnb7PdTsGsnf7V+NKo0sTNSGcmspf9&rh=ff000e36e0e62e7a3efaa54b8d4999362097bc09


    From the AICPA Newsletter on March 11, 2013

    New audit reports available from the Ethics Team
    The AICPA Professional Ethics Team serves the AICPA membership by performing investigations of engagements and prescribing corrective action when violations of AICPA Professional Standards are discovered. The AICPA has compiled reports of deficiencies frequently found in its investigations of employee benefit plan and governmental and not-for-profit engagement audits during the last two years. Most often, the reporting, disclosure, and auditing errors have occurred as a result of a lack of experience and lack of specific continuing professional education in these areas. Typically, the deficiencies could have been detected by a quality control review of the financial statements and risk areas.

    Jensen Comment
    Since the AICPA sells continuing education courses and materials, I a bit dubious of the causality attributions. I', more inclined to blame poor supervision due to cost saving efforts of the auditing firms.


    How could KPMG believe such fantasies?
    "The SEC, Like Everyone Else, Didn’t Believe Citi’s Financial Statements ," Dealbreaker, February 25, 2013 ---
    http://dealbreaker.com/2013/02/the-sec-like-everyone-else-didnt-believe-citis-financial-statements/

    Every once in a while I almost write “I don’t envy big bank CEOs,” and then I consider my own finances and the mood passes. But it does seem hard, no? The job is basically that you run around all day looking at horrible messes – even in good times, there are some horrible messes somewhere, and what is a CEO for if not to look at them and make decisive noises? – and then you get on earnings calls, or go on CNBC, or sign 10Ks under penalty of perjury, and say “everything is great.” I mean: you can say that some things aren’t great, if it’s really obvious that they’re not. If you lost money, GAAPwise, go ahead and say that; everyone already knows. But for the most part, you are in the business of inspiring enough confidence in people that they continue to fund you, and if you don’t persuade them that, on a forward-looking basis, things will be pretty good, then they won’t be.

    Also, when you’re not in the business of convincing people to fund you, you’re in the business of convincing people to buy what you’re selling and sell what you’re buying, which further constrains you from saying “what we’re selling is dogshit.”1

    Anyway I found a certain poignancy in Citi’s correspondence with the SEC over Morgan Stanley Smith Barney, which was released on Friday. Citi and Morgan Stanley had a joint venture in MSSB, and MS valued it at around $9bn, and Citi valued it at around $22bn, and at most one of them was right and, while the answer turned out to be “neither,” it was much closer to MS than C. Citi was quite wrong, and since this was eventually resolved by a willing seller (Citi) selling to a willing buyer (MS) at a valuation of $13.5bn, Citi had to admit its wrongness in the form of a $4.7 billion write-down, and the stock did this:

    Which is the market’s way of saying: no biggie Vikram, we already knew you’d be taking the writedown, honestly we thought it’d be worse than that, we just didn’t say anything because we didn’t want you to feel bad, but we’re glad that’s cleared up now.

    But the SEC doesn’t get to do that, because – and this is sort of endearing – the SEC has to pretend that a company’s financial statements convey meaningful information about the actual world, and so last year they sent Citi a bunch of letters to the effect of “um, really, with that MSSB valuation?” To be fair even Citi was admitting, back in its 10-K a year ago, that MSSB wasn’t worth what its balance sheet said it was worth – but it said that this was a temporary impairment and so didn’t need to be reflected on Citi’s financials since MSSB would recover soon and anyway it’s not as if Citi was looking to sell at a depressed price. Here is how the SEC responded in April:

    We note your disclosure related to the temporary impairment of your equity method investment in the Morgan Stanley Smith Barney (MSSB) joint venture. Please address the following:

    • You assert that, as of December 31, 2011, you do not plan to sell your investment in this joint venture prior to recovery of the value. Please tell us how you were able to reach this conclusion given the fact that you are currently in negotiations with Morgan Stanley to sell at least part of your equity interest in this joint venture pursuant to options held by Morgan Stanley.
    • We note that you have based the fair value of this equity investment on “the midpoint of the current range of estimated values.” However, you do not disclose this range, nor do you disclose how the range was estimated.

    Citi’s response is absolutely gorgeous; it says:

    • We are not in fact negotiating with Morgan Stanley about selling the rest of MSSB, and
    • We can’t disclose our internal estimate of MSSB’s value, because that would hurt us in our negotiations with Morgan Stanley about selling the rest of MSSB.

    See what they did there?2 The SEC did, a few months later anyway, when the negotiations got so advanced that the SEC pushed Citi for more information about its internal valuation of the MSSB joint venture. Citi obligingly provided that valuation to the SEC, confidentially, ten days after it disclosed the write-down.

    Also during these negotiations Citi’s investment banking division provided a valuation of MSSB “that slightly exceeded Citi’s carrying value of approximately $11 billion for that 49% interest as of June 30, 2012.” So:

    • Citi provided a valuation of an asset to its counterparty as a negotiation tool,3
    • which was higher than the valuation it reflected in its publicly filed financial statements,
    • which was higher than its internal estimate of the correct valuation,
    • which was closest to the market’s estimate of the correct valuation, and the ultimate valuation at which Citi sold the asset.

    So Citi “knew” that its financials, and the valuation it gave in negotiations with MS, were “wrong.”

    Continued in article

    "When Will the SEC Finally Go After the Auditors?" by Jonathan Weil, Bloomberg, September 27, 2012 ---
    http://www.bloomberg.com/news/2012-09-27/when-will-the-sec-finally-go-after-the-auditors-.html

    Something very unusual happened at the Securities and Exchange Commission this week: The SEC accused three former bank executives of committing fraud by deliberately understating their company's loan losses during the financial crisis. Such accusations have not been made often in recent years.

    Unless you happen to live in Nebraska, you probably haven't heard of Lincoln-based TierOne Corp., which had about $3 billion assets when it failed in 2010. Yet it's an important story because of what it shows about the state of securities-law enforcement in the U.S.

    On Tuesday the SEC said it had reached settlements with the company's former chief executive officer and chairman, Gilbert Lundstrom, and another former senior executive, who will both pay fines. (Per the usual custom, neither admitted or denied any wrongdoing.) A third former executive is contesting the agency's claims, which include allegations of egregious accounting violations.

    Several times in recent years the SEC's enforcement division has seemed to bend over backwards to avoid accusing anyone at a failed financial institution of committing accounting fraud. To name a few: When the SEC filed fraud claims against former executives of Countrywide Financial Corp., IndyMac Bancorp, Freddie Mac and Fannie Mae, it accused them of making false disclosures. But it made sure not to allege that any of the companies' books were wrong; none of them ever admitted to any accounting errors.

    At Countrywide, for instance, the SEC accused former CEO Angelo Mozilo of failing to disclose known loan losses. If the SEC's allegations against him were true, then the company's financial reports by definition must have contained misstatements -- except the SEC never alleged so in its complaint against him. He committed disclosure fraud, the SEC said, not accounting fraud.

    The main beneficiary of the SEC's approach in such cases has been the Big Four auditing firms, as I wrote in a column last year. They can claim their audits were fine, because there was never any official finding that the numbers were incorrect. That has helped the firms enormously in class-action litigation brought by investors.

    TierOne's auditor was KPMG LLP, which also was the auditor for Countrywide. (The other Big Four firms are Ernst & Young LLP, PricewaterhouseCoopers LLP and Deloitte & Touche LLP.) Neither KPMG nor any of its personnel were named as defendants in the SEC's complaint this week. One of the allegations against the former TierOne executives was that they lied to KPMG auditors. Under the Sarbanes-Oxley Act, passed in 2002, lying to an auditor is a punishable offense.

    Does this mean KPMG got a pass from the SEC? My guess is yes. An SEC spokesman, John Nester, declined to say. A spokesman for KPMG, Manuel Goncalves, declined to comment.

    There is somebody out there, however, who believes KPMG should be held liable for failing to catch TierOne's accounting chicanery. TierOne's Chapter 7 bankruptcy trustee earlier this year sued the accounting firm, accusing it of negligence and breaches of fiduciary duty. KPMG has denied the allegations and asked that the matter be resolved in arbitration proceedings rather than in court. It was TierOne's regulator, the U.S. Office of Thrift Supervision, that caught the bank's accounting manipulations -- not KPMG, which continually blessed TierOne's financial statements and resigned as auditor in 2010 only weeks before the bank failed.

    The financial crisis was in large part about financial institutions' cooked books. A big reason that companies such as Lehman Brothers, Fannie Mae and Freddie Mac failed was that investors could tell from the outside looking in that their balance sheets were bogus. Even Hank Paulson, the former Treasury secretary, said as much in his memoir. (The SEC never brought a single enforcement action against a former Lehman executive.)

    Continued in article

    Bob Jensen's threads on the two faces of KPMG are at
    http://www.trinity.edu/rjensen/Fraud001.htm

     

     

    "Small Auditors Pose Misstatement Risks: PCAOB:  Deficiencies found in audits by smaller firms have dropped in recent years. But the oversight board warns that they’re still too high," by Kathleen Hoffelder, CFO.com, February 25, 2013 ---
    http://www3.cfo.com/article/2013/2/auditing_audit-inspections-pcaob-jay-hanson-jeanette-franzel

    While the number of significant audit deficiencies for small domestic auditors has shrunk since the Public Company Accounting Oversight Board issued its last report on this group in 2007, the auditing overseer still believes the number of deficiencies is unacceptable.

    “Audit deficiencies are still high,” said PCAOB board member Jeanette M. Franzel during a press call today describing the results of a study the board completed on small audit firms in the United States that were inspected between 2007 and 2010. “We continue to be concerned about the level and types of significant deficiencies in the triennial firm inspections.”

    The PCAOB report showed that 44% of the audit firms, each of which audits 100 or fewer public companies, had at least one “significant audit performance deficiency,” meaning the deficiency resulted in the audit firm lacking enough evidence to support its opinion. That number compares with 61% that had audit deficiencies in the PCAOB’s last report on this group in 2007, which covered inspections from 2004 to 2006.

    While the number of deficiencies is trending lower, the PCAOB considers the amount to be a wake-up call for CFOs and other corporate executives to scrutinize their auditors carefully. As Franzel noted, these deficiencies are “significant.”

    The report should be “useful for the firms themselves so they may take note of the more troubling findings from the triennial inspection. Audit committees may wish to discuss this report with their auditors to better understand whether any of the deficiencies may be something they should consider in connection with their own company audit.” If its audit firm’s audit has a faulty basis in fact and the resulting audit goes awry, a company could face regulatory action or a shareholder lawsuit.

    Most of the audit deficiencies in the study were found in auditing revenue recognition and other areas pertinent to smaller clients, such as share-based payments (like stock options or rights) and equity financing instruments. Because smaller audit clients often face difficulties in raising capital or accessing credit markets, share-based payments and equity financing instruments are more common, noted PCAOB board member Jay D. Hanson during the call. Such financing, he noted, may contain terms and conditions that increase the risk of material misstatements.

    The PCAOB audits smaller audit firms once every three years, though some are audited a bit more frequently if warranted. (Audit firms with more than 100 issuers have an annual inspection.) The size of the firms in today’s study ranged from those that audited just 1 firm to others that audited more than 80 firms. The report included 748 inspections of 578 audit firms.

    Other deficiencies outlined in the report included auditing convertible debt, fair-value measurements, impairment of intangible assets, accounting estimates, the use of analytical procedures, and the ways a firm responds to the risk of misstatements due to fraud.

    Why the long list of deficiencies? The report cited a lack of technical competence in an audit area, a paucity of professional skepticism, ineffective supervision, client acceptance and inability to consider technical knowledge called for in particular audits, and ineffective auditor engagement quality reviews.

    “These are just the nuts and bolts of high-quality auditing that need to be attended to. We hope that firms really focus on these areas,” said Franzel, who is also hopeful the PCAOB will be able to perform more frequent reports than once every three years for this group of audit firms.

    To be fair, those firms that did have deficiencies seemed to take appropriate steps within 12 months to address those deficiencies, she said. At the same time, some ended up even worse the second time around. Of the 455 firms that had their second inspection during 2007 through 2010, 36%, or 164 firms, had at least one significant audit-performance deficiency in their second inspections, which compares with 55%, or 249 firms, in their first inspections.

    Continued in article

    Guide to PCAOB Inspections," Center for Audit Quality, 2012 ---
    http://www.thecaq.org/resources/pdfs/GuidetoPCAOBInspections.pdf
    Note this has a good explanation of how the inspection process works.

    PCAOB Inspection Report Database ---
    http://pcaobus.org/inspections/reports/pages/default.aspx

    Bob Jensen's threads on audit firm professionalism ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    Follow the Herd:  "All the Firms are Doing It"
    "EY Bets The Farm On Advisory With Vision 2020," by Mark O’Connor as Guest Post on Frnacine's blog re:TheAuditors, June 30, 2013 ---
    http://retheauditors.com/2013/06/30/ey-bets-the-farm-on-advisory-with-vision-2020-a-guest-post-from-mark-oconnor/

    Francine sked Mark O’Connor, CEO and Co-founder of Monadnock Research, to comment on the Going Concern post about Ernst & Young’s “Vision 2020″ announcement.

    Caleb Newquist at GoingConcern.com thinks Ernst & Young’s goals are a bit ambitious.

    One of our sources at EY thought so [too] and told us there are a few key things that would have to happen for the firm to come even remotely close to achieving it:
    1) A rapidly expanding advisory business
    2) More acquisitions and
    3) A lot more Partners, Principals, and Executive Directors.

    Caleb also mentions the “I” word.

    As the advisory business expands, the more potential there will be for conflicts with the firm’s audit clients. Since EY and the rest of the Big 4 want to be known as trusted business advisors rather than simply auditors or tax preparers, the advisory business gravy train will continue to be a priority and circumventing independence will become an ongoing exercise. We’ve already seen EY cross the line in this area with the revelation that it was lobbying on behalf of audit clients, so it stands to reason they can make make arguments in other cases for the sake of expanding business lines that expand their influence can command larger fees while the audit business gets pushed into the background.
    Really, the timing of all this is perfect for EY because all the firms are doing it and they don’t give a damn if people think they’re less independent. The advisory businesses have momentum and since independence is in the eye of the beholder, it’s easy for any firm to say, “That’s just, like, your opinion, man.”

    The reality is the consulting practices of the Big Four audit firms – and of their lesser competitors – exist in a regulatory no-man’s land. The PCAOB legally can only address audit quality and SEC won’t touch it unless there’s an independence issue with consulting to audit clients. The SEC’s enforcement actions for independence violations have, since Sarbanes-Oxley initiated the additional nine prohibitions against consulting to audit clients, been few and far between. That’s in spite of numerous examples that independence violations are still occurring and occurring in a big way.

    It’s up to renegade regulators like Ben Lawsky and private plaintiffs to keep the consulting side of the audit firms honest.

    Here are Mark O’Connor’s comments on Ernst & Young’s Vision 2020 strategy.

    One important aspect of Ernst & Young’s “Vision 2020” is a global strategic initiative to reach $50 billion in revenues by 2020. That’s a very aggressive goal, and there are a few important reasons why that might be both out of reach and bad for global business.

    Lofty goals like EY’s Vision 2020 serve a promotional purpose to attract top talent, and create the rationalization for promises of vast internal opportunities to keep top performers engaged. Beyond that, it allows current “EY” partners to move from the global advisory leadership sidelines to join principals at other Big Four firms reaping the rewards of higher-margin consulting work. But it is on this point that unintended consequences would likely foreclose any real possibility that the $50 billion aspect of EY’s 2020 strategic plan could be executed as currently conceived.

    Big Four firms tend move in lock-step without huge percentage year-over-year gains relative to one another in any line of business without large M&A transactions – buying or selling. Unless the firm’s strategy was to lower its quality or margin expectations in an attempt to go after the audit business of other Big Four firms and large auditors around the world, almost all of EY’s proposed growth will need to come from advisory. Otherwise, such dramatic growth in assurance would come at the expense of lower margins across a sector that already has very low margins. Anything far beyond the current Big Four average audit growth rate of 3.4% is unlikely, so any EY scenario with $50 billion in revenues by 2020 based primarily on assurance practice growth has a probability close to zero.”

    Given this, virtually all of EY’s extraordinary growth would need to come from advisory. EY had around $13.5 billion in non-assurance revenues in fiscal 2012, so it would need to grow that by around 266% to reach that goal. That would require an 11. 5% compound annual growth rate (CAGR) coming out of our “great global recession”, assuming that the assurance revenues independently grow at a 3.5% annual rate. EY’s 2012 advisory non-assurance non-tax growth was close to 13%, so in isolation an 11.5% sustained advisory CAGR might seem aggressive, but reasonable.

    Continued in article

    Bob Jensen's threads on Ernst & Young ---
    http://www.trinity.edu/rjensen/Fraud001.htm

    Bob Jensen's threads on audit firm professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

     

     

     


    "UK's "Big Four" accountants under fire from watchdog," by Huw Jones, Reuters, February 22, 2013 ---
    http://www.reuters.com/article/2013/02/22/us-britain-accounting-idUSBRE91L0C920130222

    Companies in Britain could be forced to switch accountants to break up the cozy relationships between the "Big Four" and their clients, blamed for masking weaknesses exposed by the financial crisis.
     


     

    The "Big Four" - KPMGKPMG.UL, PwC PWC.UL, Ernst & Young ERNY.UL and Deloitte DLTE.UL - check the books of nearly all listed companies in Britain and around the world, and have often served the same clients for decades.
     


     

    The UK's Competition Commission proposed that companies put out their audit work to tender every five to seven years, and change accounting firms every seven to 14 years - roughly in line with changes being discussed at the European Union level.
     


     

    Investors would also play a role in selecting an auditor, according to plans put forward by the commission, which published preliminary findings from a probe it began in 2011.
     


     

    The industry was put under scrutiny after auditor "complacency" was blamed by UK lawmakers for deepening the financial crisis.
     


     

    The Competition Commission found that 31 percent of the top 100 companies in the UK and a fifth of the next 250 firms had had the same auditor for over 20 years.
     


     

    Competition in the UK is restricted by factors that make it hard for companies to switch accountants, the Competition Commission found, and there is a tendency for auditors to focus on satisfying management rather than shareholder needs, it said.
     


     

    The findings add weight to a draft European Union law which contains plans for boosting competition in the 27-country bloc's audit market which would override UK changes.
     


     

    The United States is also mulling auditor rotation as the sector faces questions for giving banks a clean bill of health just before governments had to step in and rescue them in the 2007-09 financial crisis.


     

    Critics have said the Big Four should separate out their audit and advisory units, a step the draft EU law looks at.
     


     

    "The real issue we have identified is stickiness in the market," Laura Carstensen, who chaired the probe, told Reuters. "The question of break-up was not on our list."
     


     

    There was "significant dissatisfaction" among big investors, the commission said, but changing the "long standing and entrenched" system would take time.
     


     

    Its proposals go further than a recent change introduced by Britain's Financial Reporting Council (FRC), which requires companies to consider changing accountants every decade. The FRC said it was pleased the Commission was looking at taking more steps to enhance competitiveness and switching.
     


     

    PIRC, which represents pension funds and fund managers, said mandatory rotation was the best way to ensure auditor independence and large shareholders increasingly favored this.
     


     

    The commission also proposes banning "Big Four only" clauses, meaning banks could not insist on a borrower using one of the four top audit firms.
     


     

    "GROSSLY UNDERESTIMATED"
     


     

    The Big Four insist there is strong competition and point to downward pressure on fees and some recent switchings of auditors among big companies.
     


     

    PwC said the Competition Commission had "grossly underestimated" the critical role the audit committees at client firms play in protecting shareholder interests.
     


     

    Ernst & Young said it was pleased the watchdog found no collusion, abuses or excess profits but rejected accusations that the audit market was not serving shareholders, as did Deloitte and KPMG.
     


     

    "In addition, we believe that competition between audit firms is healthy and robust and that the evidence supports this," E&Y said.
     


     

    But second tier audit firms, such as Mazars, BDO and Grant Thornton, welcomed the findings after having argued it would not be worthwhile expanding unless there was some intervention to help prise open the market.

    Continued in article


     

    "Big four accountants 'insufficiently independent and sceptical' of City:  Competition Commission criticises Ernst & Young, Deloitte, KPMG and PwC for 'higher prices, lower quality and less innovation'," by Josephine Moulds and David Feeney, The Guardian, February 22, 2013 ---
    http://www.guardian.co.uk/business/2013/feb/22/big-four-accountancy-competition-commission-audits


     

    Jensen Comment
    I doubt that the U.K. has the jurisdiction to trust-bust these large international auditing firms. However, the U.K. may be the first to force audit firm rotation in auditing. The U.K. has more problems than just audit firms. Among all the giant banks in the world, the U.K. has some of the most criminally-inclined banks that money launder for Iran and the large drug cartels. And then there's the massive LIBOR scandal that will cost U.K. banks billions in fines. If we start putting bankers in prison, the place to start is the U.K.


     

    The U.K. could force its big companies to give more audit work to smaller firms. But this may have negative repercussions on the cost of capital for those firms to say nothing of the formidable startup costs for any small firm to take on giant companies like giant banks and insurance companies headquartered in the U.K.


     

    A simpler solution would be for the U.K. to become more litigious and make the large auditing firms more vulnerable to billion-dollar audit negligence tort cases. The costs will, of course, be passed on the U.K. clients, but if this is what the U.K. wants in order to have more professional and independent audits then this is the route that I would recommend.
     


     

    As a parting question, do the Brits spell skeptical as sceptical?
    I do know that they spell judgment as judgement.

     


    "IESBA Proposes Changes to The Code of Ethics for Professional Accountants to Address Conflicts of Interest," IFAC, December 20, 2011 ---
    http://www.ifac.org/news-events/2011-12/iesba-proposes-changes-code-ethics-professional-accountants-address-conflicts--0

    Bob Jensen's threads on professionalism in accounting and auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    "Exclusive: SEC probes Ernst & Young over audit client lobbying," by Sarah N. Lynch and Dena Aubin, Chicago Tribune, January 7, 2013 ---
    http://www.chicagotribune.com/business/sns-rt-us-usa-accounting-ernst-secbre9060vx-20130107,0,5471559.story

    The Securities and Exchange Commission is investigating whether auditing company Ernst & Young violated auditor rules by letting its lobbying unit perform work for several major audit clients, people familiar with the matter told Reuters.

    The SEC inquiry began shortly after Reuters reported in March 2012 that Washington Council Ernst & Young, the E&Y unit, was registered as a lobbyist for several corporate audit clients including Amgen Inc, CVS Caremark Corp and Verizon Communications Inc [ID:nL2E8DL649], according to one of the sources.

    The SEC's enforcement division and its Office of the Chief Accountant are looking in to the issue, according to the two sources, who spoke in recent days and who could not be named because the investigation is not public.

    It is unclear how far along the probe is, or whether it could result in the SEC filing civil charges against Ernst & Young, one of the world's largest audit and accounting firms.

    An SEC spokesman declined to comment.

    Ernst & Young spokeswoman Amy Call Well declined to comment on whether the company was being investigated. "All of our services for audit clients undergo considerable scrutiny to confirm they are consistent with applicable rules," she said.

    U.S. independence rules bar auditors from serving in an "advocacy role" for audit clients. The goal is to allow auditors to maintain some degree of objectivity regarding the companies they audit, based on the idea that auditors are watchdogs for investors and should not be promoting management's interests.

    The SEC's rule does not definitively say whether lobbying could compromise an auditor's independence. It is more focused on barring legal advocacy, such as expert witness testimony.

    In interviews last year, former SEC Chief Accountant Jim Kroeker told Reuters that certain lobbying activities could potentially be covered under the general prohibition on advocacy. Kroeker is now an executive at Deloitte, a rival of Ernst & Young.

    'ABUNDANTLY CLEAR' LINE

    Harvard Business School Professor Max Bazerman said on Monday that it was "abundantly clear" that a firm that is lobbying for a company is no longer capable of independently auditing that company.

    Ernst & Young has previously said it complied with independence rules. It also said that it did not act in an advocacy role and that the work performed by its lobbying unit was limited to tax issues.

    Tax consulting is a permissible activity under auditor independence rules if it does not involve public advocacy.

    About two months after publication of the Reuters story, federal records showed Washington Council Ernst & Young was no longer registered as a lobbyist for Amgen, CVS Caremark or Verizon Communications.

    A spokesman for Amgen did not immediately respond to calls seeking comment. Verizon and CVS spokesmen declined to comment.

    Ernst & Young also terminated a lobbying relationship with a fourth company, Nomura Holdings Inc, which also used an E&Y affiliate for auditing services.

    Obtaining an independent view on the books is the main reason companies are required to hire outside auditors, said Richard Kaplan, law professor at the University of Illinois.

    Continued in article

    "Ernst & Young 'covered up judge bribe case’," by Jonathan Russell, London Telegraph, June 30, 2012 ---
    http://www.telegraph.co.uk/finance/financial-crime/9367075/Ernst-and-Young-covered-up-judge-bribe-case.html

    A senior partner closed an investigation into a £100,000 “bribe” despite colleagues suspecting the money had been paid to a judge overseeing a multi-million-pound tax case the company was fighting.

    The allegations were disclosed by former E&Y partner and whistle-blower Cathal Lyons, who is suing the accountant for $6m for breach of contract.

    He claims medical insurance he was relying on to treat injuries sustained in a car accident was withdrawn after he raised the issue of the alleged bribe with the accountant’s global head office in London.

    Mr Lyons was a partner with E&Y’s Russian practice when the alleged wrongdoing came to light. It was originally investigated by James Mandel, E&Y’s general counsel in Moscow. In a witness statement supplied in support of Mr Lyons’s case, Mr Mandel said he suspected the payment may have been corrupt and wrote a report to that effect.

    “I had the suspicion that this payment was not a proper payment for legal fees, but was an illegal payment possibly made to facilitate a positive outcome of a tax case,” he claimed in his witness statement.

    He suspected that the €120,000 payment via a Russian law firm was made to influence a 390m rouble (£8.4m) court case brought by Russian tax authorities investigating a tax avoidance scheme E&Y was using to pay its Russian partners. E&Y was later cleared of liability in the case.

    The accountant has admitted there was an investigation into allegations of bribery, but said the case was closed by Herve Labaude, a senior partner, in January 2010.

    Mr Lyons claims that after he reported his concerns about the case to E&Y’s global head office, his medical insurance was withdrawn and he was dismissed.

    In his writ he says the dismissal flowed from “personal animosity against him rising from a discussion in late 2010 between the claimant and Maz Krupski [E&Y’s director of global tax and statutory] regarding alleged corruption by the practice.”

    Mr Lyons relied on his medical insurance to cover the cost of treatment flowing from a serious car accident he suffered in 2006. The accident left him with permanent disabilities and partial amputation. It is estimated medical cover in his current condition would cost $300,000 per year. He is suing for 20 years’ cover, or $6m.

    Continued in article


    "Does an 'A' in Ethics Have Any Value? B-Schools Step Up Efforts to Tie Moral Principles to Their Business Programs, but Quantifying Those Virtues Is Tough," by Melissa Korn, The Wall Street Journal, February 6, 2013 ---
    http://professional.wsj.com/article/SB10001424127887324761004578286102004694378.html?mg=reno64-wsj

    Business-school professors are making a morality play.

    Four years after the scandals of the financial crisis prompted deans and faculty to re-examine how they teach ethics, some academics say they still haven't gotten it right.

    Hoping to prevent another Bernard L. Madoff-like scandal or insider-trading debacle, a group of schools, led by University of Colorado's Leeds School of Business in Boulder, is trying to generate support for more ethics teaching in business programs. [image] Richard Mia

    "Business schools have been giving students some education in ethics for at least the past 25 or 30 years, and we still have these problems," such as irresponsibly risky bets or manipulation of the London interbank offered rate, says John Delaney, dean of University of Pittsburgh's College of Business Administration and Katz Graduate School of Business. Related

    Can Globalization Be Taught in B-School? B-Schools Give Extra Help for Foreign M.B.A.s

    He joined faculty and administrators from Massachusetts' Babson College, Michigan State University and other schools in Colorado last summer in what he says is an effort to move schools from talk to action. The Colorado consortium is holding conference calls and is exploring another meeting later this year as it exchanges ideas on program design, course content and how to build support among other faculty members.

    But some efforts are at risk of stalling at the discussion stage, since teaching business ethics faces roadblocks from faculty and recruiters alike. Some professors see ethics as separate from their own subjects, such as accounting or marketing, and companies have their own training programs for new hires.

    A strong ethics education can help counteract a narrowing worldview that often accompanies a student's progression through business school, supporters in academia say. Surveys conducted by the Aspen Institute, a think tank, show that about 60% of new M.B.A. students view maximizing shareholder value as the primary responsibility of a company; that number rises to 69% by the time they reach the program's midpoint.

    Though maximizing shareholder returns isn't a bad goal in itself, focusing on that at the expense of customer satisfaction, employee well-being or environmental considerations can be dangerous.

    Without tying ethics to a business curriculum, "we are graduating students who are very myopic in their decision-making," says Diane Swanson, founding chair of the Business Ethics Education Initiative at Kansas State University.

    Stand-alone ethics courses are a start, but they "compartmentalize" the issue for students, as if ethical questions aren't applicable to all business disciplines, says David Ikenberry, dean of University of Colorado's Leeds School.

    Some schools are experimenting with a more integrated approach. This fall, Boston University's School of Management is introducing a required ethics course for freshman business students, and is also tasking instructors in other business classes to incorporate ethics into their lessons. It may also overhaul a senior seminar to reinforce ethics topics.

    "We need to hit the students hard when they first get here, remind them of these principles throughout their core classes, and hit them once again before they leave," says Kabrina Chang, an assistant professor at Boston University's business school, who is coordinating the new freshman class.

    Students likely know right from wrong, so rather than, say, discussing whether a student would turn in a roommate caught stealing, Ms. Chang says she'll lead a debate on how or if a student might maintain a relationship with the thief.

    Students may find the roommate-thief scenario more relevant than a re-examination of recent Ponzi schemes, but many remain skeptical of how such discussions apply to real life.

    As one M.B.A. wrote last year on College Confidential, an online message board, "It's not like Johnny is going to be at the cusp of committing fraud and then think back to his b-school days and think, "gee, Professor Goody Two Shoes wouldn't approve."

    What's more, schools can't calculate the moral well-being of their graduates the same way they can quantify financial success or technical acumen. One of the few rankings available—the Aspen Institute's "Beyond Grey Pinstripes" report—was suspended last year, in part because researchers could not determine the net benefit of ethics courses. Without demonstrable returns, there's little incentive for deans to add classes and instructors.

    Employers, who have in the past pushed schools to add more hands-on training and global coursework, could successfully agitate for more ethics instruction. But many companies say completing an ethics course won't make or break a hiring decision—especially since firms tend to offer their own training for new hires.

    Continued in article

    This article also has a video.

     


    "Does Everyone Lie? Are we a Culture of Liars?" by accounting professor Steven Mintz, Ethics Sage, February 1, 2013 ---
    http://www.ethicssage.com/2013/02/does-everyone-lie.html

    "The Lying Culture," by J. Edward Ketz & Anthony H. Catanach Jr.,  SmartPros, February 2011 ---
    http://accounting.smartpros.com/x71398.xml

    From time to time, it is good to stop and assess one's progress in life. Such an evaluation helps people to figure out how they are doing and to make strategic decisions to take advantage of upcoming opportunities and to meet future challenges. When we do this for the accounting profession, we shake our heads because accounting shenanigans remain abundant and the seeds for further scandals are sown, watered, and fertilized.

    The kernel of this problem is simple: company managers and their advisers are liars. Ok, not all of them, but so many are liars that the business community is in danger of falling on its own petard. Maybe this is because American society has a problem with the truth, as exemplified by our political, military, bureaucratic, sports, and entertainment leaders. We often hear the mantra, “the truth shall make you free,” but our leaders apparently desire to enslave others through their destructively self-serving, lying behaviors.

    One obvious current example is the toxic assets still held by banks in the wake of the financial crisis of 2008. These investments have real values lower than their carrying values, but banks refuse to write them down, citing mush about earnings volatility and the adverse effects of mark-to-market accounting. They reject fair value accounting because it would reveal the precarious position of the banking industry. In short, banks are lying about asset values and really are not well capitalized.

    Continued in article

     
    "Who is Telling the Truth?  The Fact Wars:  ," as written on the Cover of Time Magazine
     "Blue Truth-Red Truth: Both candidates say White House hopefuls should talk straight with voters. Here's why neither man is ready to take his own advice ,"
     by Michael Scherer (and Alex Altma), Time Magazine Cover Story, October 15, 2012, pp. 24-30 ---
     http://www.cs.trinity.edu/~rjensen/temp/PresidentialCampaignLies2012.htm

     

    Bob Jensen's threads on professionalism and ethics in auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

     


    Audit committees might find it helpful to review the PCAOB's report on deficiencies in audits of internal control over financial reporting that it identified in 2010 inspections and discuss it with their audit firm.

    "The PCAOB’s views on internal control audit deficiencies," Ernst & Young, January 10, 2013 --- Click Here
    http://www.ey.com/Publication/vwLUAssetsAL/TothePoint_EE0916_ICFR_10January2013/$FILE/TothePoint_EE0916_ICFR_10January2013.pdf

    What you need to know

    • The PCAOB has issued a report on its 2010 inspections that provides its views about the number and significance of deficiencies in audits of internal control over financial reporting (ICFR) for the eight domestic registered firms that it inspects annually.

    • The PCAOB found that 15% of integrated audits failed to obtain sufficient appropriate audit evidence to support the audit opinion on the effectiveness of ICFR. The rate is expected to increase to 22% for 2011 inspections.

    • report helpful in discussions with auditors about their audit procedures over ICFR.

    Overview

    The Public Company Accounting Oversight Board (PCAOB or Board) identified concerns about audits of ICFR in its report, Observations from 2010 inspections of domestic annually inspected firms regarding deficiencies in audits of internal control over financial reporting.

    The deficiencies identified during the inspections, which generally involved 2009 audits, have raised questions about whether auditors have completed sufficient procedures to support their audit opinions on the effectiveness of ICFR and, as a result, their audit opinions on the financial statements. The PCAOB also described what it believes are the root causes contributing to the findings in this area.

    No. 2013-02

    10 January 2013

    To the Point

    PCAOB report

    The PCAOB’s views on internal control audit deficiencies

    The PCAOB says a sharper focus is needed by audit firms across the profession to improve the quality of auditing internal control over financial reporting. Ernst & Young AccountingLink www.ey.com/us/accountinglink

    2 10 January 2013 To the Point The PCAOB’s views on internal control audit deficiencies

    Background

    PCAOB auditing standards lay out a risk-based approach to auditing ICFR. The PCAOB’s inspections have challenged whether auditors are appropriately applying the requirements of the standards in their audits of ICFR, and identifies specific areas where the PCAOB believes auditors are not meeting the requirements in all cases.

    In its 2010 inspections, the PCAOB inspected 309 integrated audits performed by the eight firms. It noted that in 46 (15%) of those audits, the firm failed to obtain sufficient appropriate evidence to support its audit opinion on the effectiveness of ICFR. The PCAOB has said this percentage will likely increase to 22% for its 2011 inspections, though that number isn’t yet final.

    The PCAOB noted that deficiencies in testing internal controls can result in the failure to perform sufficient substantive audit procedures because conclusions on the effectiveness of ICFR usually support the extent of substantive testing performed as part of the financial statement audit. Therefore, for a number of the audits with deficiencies in testing ICFR, the inspections staff concluded that such work also resulted in a failure to obtain sufficient appropriate audit evidence to support the opinions on the financial statements. However, the PCAOB said that in many cases, the inspections staff did not identify significant issues in the audits of ICFR, which they said is encouraging and reflects well on the firms’ ability to implement the auditing standards appropriately when audit teams approach the issues properly.

    How we see it

    Sharper focus is needed by audit firms across the profession to improve the quality of auditing ICFR. Ernst & Young has put significant focus in the areas highlighted in the report and has taken significant steps to help our audit teams focus on the matters necessary to improve the execution of our audits of ICFR.

    Key considerations

    The report highlights six areas where PCAOB inspectors identified deficiencies in the audits of ICFR, including the failure to:

    Identify and sufficiently test controls that are intended to address the risk of material misstatements — This often results from an auditor’s insufficient understanding of how a process works and what the likely sources of misstatement are in that process, and consequently, an inability to appropriately evaluate whether management has designed effective internal controls to address the risks of material misstatement.

    Sufficiently test the design and operating effectiveness of management review controls used to monitor the results of operations (e.g., quarterly balance sheet reviews) — The PCAOB challenged whether auditors performed sufficient testing to evaluate whether management review controls were sensitive or precise enough to prevent or detect errors or fraud that could result in a material misstatement to the financial statements.

    Obtain sufficient evidence to update the results of testing of controls from an interim date to year-end — Inspection results indicate an overreliance on inquiry to update the results on interim internal control testing through year-end, rather than an appropriate mix of inquiry, observation, inspection and reperformance procedures.

    Ernst & Young AccountingLink www.ey.com/us/accountinglink

    3 10 January 2013 To the Point The PCAOB’s views on internal control audit deficiencies

     

    Sufficiently test the system-generated data and reports that support important controls — When management uses system-generated data in its controls (for example, a review of an accounts receivable aging report), auditors are not always testing whether the underlying data used in the control are accurate and complete.

    Sufficiently perform procedures for using the work of others (e.g., internal auditors) — Inspectors believe that auditors are, in certain cases, relying too heavily on the work of internal auditors in areas with higher risk of material misstatement or higher subjectivity (e.g., judgments and estimates) or relying on such work without performing the necessary procedures to evaluate the design of the internal auditor’s testing procedures.

    Sufficiently evaluate identified control deficiencies and consider their effect on both the financial statement audit and the audit of ICFR — Inspections indicated that auditors did not always adequately document their consideration of whether control deficiencies were a material weakness or significant deficiency (individually or in the aggregate). Some auditors failed to consider and document the effect that control deficiencies had on their strategy to substantively test account balances to support their opinion on the financial statements.

    How we see it

    Management and audit committees have likely noticed more attention by their auditors in these areas. This focus will continue as auditors continue their efforts to improve audits of ICFR.

    As companies evaluate their own ICFR assessment process, they should consider the areas highlighted by the PCAOB. Management may find room for improvement in the design of the company’s controls, or in the documentation and testing of controls.

    The PCAOB identified the following root causes that it believes may have contributed to the findings:

    • Improper application of the top-down approach detailed in the auditing standards, including overreliance on entity-level controls (e.g., management review controls), not testing controls over all significant accounts and disclosures, and not understanding the likely sources of potential misstatements in an entity’s significant classes of transactions to identify the appropriate controls to test

    • Decreases in audit firm staffing through attrition or other reductions, and related workload pressures

    • Insufficient firm training and guidance, including more focus on the areas highlighted in the report

    • Ineffective communication with firms’ information systems specialists on the engagement team

    The report notes that firms should also perform their own root cause analyses of the deficiencies identified, take appropriate corrective actions and monitor whether such actions were successful in remediating deficiencies.

    PCAOB inspections have identified several specific areas with deficiencies in the auditing of internal controls over financial reporting.

    Next steps

    • We expect the PCAOB inspections staff to continue its focus on the quality of audit procedures over ICFR.

    • Audit committees and management are encouraged to read and evaluate the report and discuss with their auditor how the auditor is addressing issues identified by the PCAOB.

    • Audit committees should consider engaging in conversations with management about the issues identified by the PCAOB, and consider whether improvements may be needed in the company’s ICFR assessment process.

    Continued in article

    "Guide to PCAOB Inspections," Center for Audit Quality, 2012 ---
    http://www.thecaq.org/resources/pdfs/GuidetoPCAOBInspections.pdf
    Note this has a good explanation of how the inspection process works.

    PCAOB Inspection Report Database ---
    http://pcaobus.org/inspections/reports/pages/default.aspx

    Bob Jensen's threads on audit firm professionalism ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

     


    "Ernst & Young dismissed from IndyMac shareholder case," by Amanda Bronstad, Law.com, June 8, 2012 ---
    http://www.law.com/jsp/nlj/PubArticleNLJ.jsp?id=1202558691320&Ernst__Young_dismissed_from_IndyMac_shareholder_case&slreturn=1

    Jensen Comments
    The courts have been very kind to large auditing firms that allowed clients to grossly underestimate bad debt reserves and failed to detect (or at least report) insider frauds and going concern questions for nearly 2,000 clients that went bankrupt after 2007. This particular IndyMac case judge was also not a bit sympathetic with the SEC's case in general.


    "An (Almost) Unnoticed $497 Million Accounting Error," by Jonathon Weil, Bloomberg, May 2, 2012 ---
    http://www.bloomberg.com/news/2012-05-02/an-almost-unnoticed-497-million-accounting-error.html

    One telltale sign of a bull market is that investors don't care as much about dodgy corporate accounting practices. A case in point: the public reaction -- or lack thereof -- to a financial restatement disclosed late yesterday afternoon by Williams Cos., the natural-gas producer.

    Williams didn't issue a press release about the restatement. As far as I can tell, there have been no news reports about the company's accounting errors, which Williams divulged in a filing with the Securities and Exchange Commission. They aren't a small matter, though.

    As a result of the restatement, Williams said its shareholder equity fell $497 million, or 28 percent, to $1.3 billion as of Dec. 31. Additionally, the company said it had "identified a material weakness in internal control over financial reporting," which is never a good sign. Net income wasn't affected.

    Shares of Williams were trading for $33.65 this afternoon, down 73 cents, after setting a 52-week high yesterday. The stock is up 88 percent since Oct. 4.

    Williams, which is audited by Ernst & Young, said the restatement was necessary to correct errors in deferred tax liabilities related to its investment in Williams Partners LP, a publicly traded master limited partnership in which it owns a 68 percent stake. A Williams spokesman, Jeff Pounds, declined to comment when asked why the company didn't issue a press release flagging the restatement.

    The answer seems obvious, though: The company didn't want anyone to write about it. Oh well.

     

    Bob Jensen's threads on Ernst & Young are at
    http://www.trinity.edu/rjensen/Fraud001.htm

    Bob Jensen's threads on audit firm professionalism and independence are at
    http://www.trinity.edu/rjensen/Fraud001c.htm


    "Clients Flounder And Fail But Auditor PwC Prevails," by Francine McKenna, Forbes, February 4, 2013 ---
    http://www.forbes.com/sites/francinemckenna/2013/02/04/clients-flounder-and-fail-but-auditor-pwc-prevails/

    PricewaterhouseCoopers LLP audits several companies in the news recently but the global professional services firm seems to have escaped scrutiny for those clients’ serious missteps. Watchdog PwC never warned investors of faulty management and fraud that’s tanked shares, forced out top executives and resulted in expensive, ongoing private, civil, and potential criminal litigation.

    PricewaterhouseCoopers LLP is, for 2012, again the largest accounting firm in the world, according to Big4.com, after losing the crown temporarily to Deloitte in 2010. PwC is also the largest audit firm, a distinction that must be made given the reemergence of the consulting practices at PwC, KPMG, and Ernst & Young ever since the expiration of non-compete agreements signed when their consulting arms were sold post-Sarbanes-Oxley. (Deloitte never sold its consulting arm and has, therefore, enjoyed a distinct advantage to the other firms, not losing any growth momentum between 2002 and 2007.)

    All four – Deloitte, PwC, KPMG, and Ernst & Young – audit and consult, advise on taxes and manage bankruptcies, provide due diligence and accounting advice for acquisitions and investigate frauds when deals go wrong. You can’t throw a rock at a fraud or scandal nowadays without hitting three, sometimes all four, of the largest firms performing one role or another. The Big Four global accounting firms make money whether clients survive and thrive or flail and fail.

    Chesapeake Energy, a PwC audit client since its IPO in 1993, made news last week for firing its beleaguered CEO, Aubrey McClendon. Ryan Chittum at the Columbia Journalism Review says Reuters gets the credit for this “scalp”.

    Continued in article

     

    Question
    Why is Francine fuming?

    "Accountants Skirt Shareholder Lawsuits," by Jonathan D. Glater, The New York Times, December 27, 2012 ---
    http://dealbook.nytimes.com/2012/12/27/accountants-skirt-shareholder-lawsuits/

    The accountants who service publicly traded companies are likely to have something to be thankful for this year: shareholders are not filing federal securities fraud lawsuits against them.

    Just 10 years ago, public company accountants were in the cross hairs of shareholders, regulators and prosecutors. A criminal indictment destroyed Enron’s auditor, Arthur Andersen. Congress created a new regulator, the Public Company Accounting Oversight Board, to oversee the profession. And in dozens of lawsuits in the years afterward, shareholders named accountants as co-defendants when alleging accounting fraud.

    But things have changed. According to NERA Economic Consulting, which tracks shareholder litigation and reported on the decline in accounting firm defendants in its midyear report in July, not one accounting firm has been named a defendant so far this year. One of the study’s co-authors, Ron I. Miller, confirmed that the trend has continued at least through November.

    That prompts the question, why don’t shareholders sue accountants anymore?

    “To the extent that firms have been burned for a lot of money, they have some pretty strong incentives to try to behave,” Mr. Miller said. “That’s the hopeful side of the legal system: You hope that if you put in penalties, that those penalties change people’s actions.”

    The less positive alternative, he added, is that public companies “have gotten better at hiding it.”

    From 2005 to 2009, according to the NERA report, 12 percent of securities class action cases included accounting firm co-defendants. The range of federal securities fraud class action cases filed per year in that period was 132 to 244.

    The absence of accounting firm defendants this year can probably be explained at least in part by court decisions; the Supreme Court has issued rulings, as in Stoneridge Investment Partners LLC v. Scientific-Atlanta Inc. in 2008, making it more difficult to recover damages from third parties in fraud cases.

    So perhaps more shareholder suits would take aim at accountants, if the plaintiffs believed that their claims would survive a defendant’s motion to dismiss. And it is possible that plaintiffs will add accounting firm as defendants to existing cases in the future, if claimants get information to support such claims.

    Over all, fewer shareholder class action lawsuits are based on allegations of accounting fraud, as opposed to other types of fraud. The NERA midyear report found that in the first six months of 2012, about 25 percent of complaints in securities class action cases included allegations of accounting fraud, down from nearly 40 percent in all of 2011.

    Perhaps the Sarbanes-Oxley Act, the legislative response to the accounting scandals of the early 2000s, actually worked, Mr. Miller said.

    “There’s been a lot of complaining about SOX, and certainly the compliance costs are high for smaller publicly traded companies,” he said, but accounting fraud “is to a large extent what SOX was intended to stop.”

    Public company accountants still have potential civil liability to worry about, said Joseph A. Grundfest, a former commissioner of the Securities and Exchange Commission who teaches at Stanford Law School. Regulators, he said, are investigating potential misconduct involving accounting firms.

    Continued in article

    Bob Jensen's threads on lawsuits where CPA firms have not been so lucky ---
    http://www.trinity.edu/rjensen/Fraud001.htm



    "PCAOB Delivers Bad Inspection News to 3 More Firms, by Tammy Whitehouse, Compliance Week, December 26, 2012 ---
    http://www.complianceweek.com/pcaob-delivers-bad-inspection-news-to-3-more-firms/article/273958/

    Three major audit firms received less than glowing inspection reports from the Public Company Accounting Oversight Board, continuing a theme of high failure rates that the audit regulator is hammering firms to fix.

    The latest reports for Deloitte & Touche, Ernst & Young, and Grant Thornton say that in four cases concerns raised by inspectors ultimately led to restatements, two for Deloitte and one each for E&Y and Grant Thornton. Deloitte showed a slight improvement in its failure rate from 2010 to 2011, but the failure rates rose for both E&Y and Grant Thornton, according to the reports.

    Inspectors dug into 56 audit reports at E&Y and found problems with 20 of them for a failure rate of 36 percent. That's a big increase over the 21 percent rate of problem audits in the firm's 2010 inspection report. Grant Thornton, likewise, saw a jump in the rate of problem audits from 37 percent in 2010 to 43 percent in 2011. Deloitte, however, showed some improvement from a problem rate of 45 percent in 2010 to 42 percent in 2011.

    None of the three firms challenged the PCAOB findings in their letters to the PCAOB that are attached to their inspection reports. Each firm simply acknowledged the PCAOB's findings, indicated they complied with auditing and documentation standards in making adjustments called for by inspectors, and said they are working internally to improve audit quality.

    The PCAOB earlier published its latest inspection findings for PwC and KPMG. While KPMG's failure rate held fairly steady around 22 percent, the rate jumped for PwC, from 37 percent in 2010 to 41 percent in 2011. The board also offered no improvement in its findings at McGladrey.

    The most commonly cited audit problems for all the major firms center on many of the same areas that have been problematic for several years -- issues around allowance for loan losses, impairments, fail value, revenue recognition, and problems with internal control over financial reporting. In its letter to the board, PwC challenged the PCAOB to step up progress on some auditing standards that would give auditors more concrete guidance on how to handle some of the toughest areas of auditing that are most often cited by inspectors.

    PCAOB Member Jeanette Franzel recently warned the board is not seeing the improvement in its 2011 inspection cycle that it hoped for after 2010 inspections were complete. The board recently published a summary report of the problems it sees most frequently among the major firms in the audit of internal control over financial reporting, and it is developing another report that will summarize its greatest concerns with respect to financial statement audits. The board also is working on an additional report to summarize the themes it has identified in audits performed by smaller firms, or those that audit fewer than 100 issuers.

    Jensen Comment
    The big auditing firms seem to not much care anymore about their bad PCAOB inspection reports. This could possibly be due to the client market not caring about that the PCAOB says about large audit firms. Or it could be that all the big auditing firms have such bad inspection reports that the none of the firms rise to the top due to great PCAOB inspection reports.

    PCAOB Inspection Report Database ---
    http://pcaobus.org/inspections/reports/pages/default.aspx

    The PCAOB That Stole Christmas: Lumps of Coal Stocking Stuffers
    "The PCAOB Has Conveniently Released 2011 Inspection Reports For Deloitte, Grant Thornton and Ernst & Young the Friday Before Christmas," by Adrenne Gonzalez, December 21, 2012 ---
    http://goingconcern.com/post/pcaob-has-conveniently-released-2011-inspection-reports-deloitte-grant-thornton-and-ernst-young

    Bob Jensen's threads on audit firm professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

    After PwC's Miserable 2012 PCAOB Inspection Reports
    "PwC to Require More Robust Review and Supervision of Auditors, Although “Minimum Supervision" Still Has Its Place (in Court)," by Caleb Newquist, Going Concern, December 7, 2012 ---
    http://goingconcern.com/post/pwc-require-more-robust-review-and-supervision-auditors-although-minimum-supervision-still-has

    Bob Jensen's threads on PwC ---
    http://www.trinity.edu/rjensen/Fraud001.htm


     

    "PwC and Thomson Reuters: Too Close For Comfort," by Francine McKenna, re:TheAuditors, December 26, 2012 ---
    http://retheauditors.com/2012/12/26/pwc-and-thomson-reuters-too-close-for-comfort/

    A few days ago I reported at Forbes.com on a new business alliance between PwC China and Thompson Reutersa PwC audit client. The three-year agreement is a license to use Thomson Reuters tax software exclusively – in an ironic twist of fate the software was originally developed by Deloittefor client service in China. PwC UK already uses the software for its clients.

    PwC US is also a “Certified Implementer” of Thomson Reuters One Source software. That means PwC consulting professionals implement Thomson Reuters for third-parties, perhaps at times in joint engagements with Thomson Reuters. Are there incentives paid? There must be a joint marketing and training arrangement at least. There is a certainly a shared benefit to teaming up to sell software and consulting services. You can agree or disagree whether such arrangements should be prohibited, but under existing rules in the UK and for US listed audit clients of the global firms, they are prohibited.

    Why isn’t the SEC and PCAOB enforcing auditor independence rules prohibiting business alliances between auditors and their audit clients?

    PwC and Thomson Reuters would not comment for Forbes.com.

    Professor Paul Gillis, a PCAOB SAG member and author of the China Accounting Blog, thinks I “jumped the shark” with this one.

    Here’s the thing… According to the SEC’Final Rule: Revision of the Commission’s Auditor Independence Requirements effective February 5, 2001, the perception of auditor of independence is as important, or maybe even more important, than the fact of auditor independence.

    This is not new.

    The independence requirement serves two related, but distinct, public policy goals. One goal is to foster high quality audits by minimizing the possibility that any external factors will influence an auditor’s judgments. The auditor must approach each audit with professional skepticism and must have the capacity and the willingness to decide issues in an unbiased and objective manner, even when the auditor’s decisions may be against the interests of management of the audit client or against the interests of the auditor’s own accounting firm.

    The other related goal is to promote investor confidence in the financial statements of public companies. Investor confidence in the integrity of publicly available financial information is the cornerstone of our securities markets. Capital formation depends on the willingness of investors to invest in the securities of public companies. Investors are more likely to invest, and pricing is more likely to be efficient, the greater the assurance that the financial information disclosed by issuers is reliable. The federal securities laws contemplate that that assurance will flow from knowledge that the financial information has been subjected to rigorous examination by competent and objective auditors.

    The two goals — objective audits and investor confidence that the audits are objective — overlap substantially but are not identical. Because objectivity rarely can be observed directly, investor confidence in auditor independence rests in large measure on investor perception. For this reason, the professional literature, such as the AICPA’s Statement on Auditing Standards (SAS) No. 1, has long emphasized that auditors “should not only be independent in fact; they should also avoid situations that may lead outsiders to doubt their independence.” The Supreme Court has emphasized the importance of the connection between investor confidence and the appearance of independence:

    The SEC requires the filing of audited financial statements in order to obviate the fear of loss from reliance on inaccurate information, thereby encouraging public investment in the Nation’s industries. It is therefore not enough that financial statements be accurate; the public must also perceivethem as being accurate. Public faith in the reliability of a corporation’s financial statements depends upon the public perception of the outside auditor as an independent professional. . . . If investors were to view the auditor as an advocate for the corporate client, the value of the audit function itself might well be lost.

    Here’s my column aForbes.com.

    Apparently, PwC ad Thomson Reuters believe what happens in China stays in China.

    Thomson Reuters announced it signed a three-year contract with PwC, the company’s auditor, to provide use of the Thomson Reuters ONESOURCE Corporate Tax solution for China. PwC U.K. also uses this Thomson Reuters software for its tax clients. Business alliances between a company and its auditor are prohibited under U.S. law and U.K. auditor regulations. Thomson Reuters, headquartered in New York, has its shares listed on the Toronto and New York Stock Exchanges.

    Rule 2-01(b) of Regulation S-X (17 CFR 210.2-01.), amended under the Sarbanes-Oxley Act of 2002 to enhance auditor independence after the Enron and Arthur Andersen failures, provides the standard used to judge a business relationship between a company and its auditor or services provided  to an audit client:

    • Does the relationship create a mutual or conflicting interest between the accountant and the audit client?
    • Does the relationship place the accountant in the position of auditing his or her own work?
    • Does the relationship result in the accountant acting as management or an employee of the audit client?
    • Does the relationship place the accountant in a position of being an advocate for the audit client?

    For business relationships specifically, the law allows contracts between a auditor and its client only if the auditor is a consumer in the normal course of business and receives no incentives, special pricing or other advantage that other customers would not receive.

    Continued in article

    Bob Jensen's threads on PwC ---
    http://www.trinity.edu/rjensen/Fraud001.htm

     


    PCAOB faults auditor staffing, training for deficiencies
    "'Control' Problems Cited," by Michael Rapoport, The Wall Street Journal, December 10, 2012 ---
    http://professional.wsj.com/article/SB10001424127887324478304578171280865613110.html?mod=djemCFO_h

    A U.S. regulator reported an increase in the percentage of audits of "internal controls" at companies that were flawed because of inadequate work by major accounting firms.

    The Public Company Accounting Oversight Board said the eight biggest accounting firms failed in 22% of the audits it reviewed last year to gather enough evidence to support opinions issued by the firms that claimed a company's internal controls were effective.

    The percentage was up from 15% of the audits the PCAOB reviewed in 2010. PCAOB officials said the increase shows auditors are at greater risk of letting serious financial errors or even fraud slip through undetected.

    "When audit firms do not approach their work appropriately, they are increasing their own risk of not detecting problems," PCAOB member Jeanette Franzel said after the findings were released Monday. The PCAOB regulates and inspects firms that audit public companies, while setting and enforcing standards that govern audits.

    The Center for Audit Quality, which represents major accounting firms, said in a statement that the industry "recognizes the need to improve performance in this important area" and has already poured "significant" resources into doing so.

    "Internal controls" are safeguards meant to insure that a company's financial statements are accurate. At all but the smallest public companies, auditors are required by U.S. law to evaluate those controls annually for effectiveness.

    The PCAOB's conclusion that an accounting firm's review of internal controls was deficient doesn't necessarily mean the controls were inadequate or a company's finances are shaky. The findings are a sign that auditors haven't done the job needed to tell. To fix the problem, accounting firms should consider providing more training and guidance to auditors, the PCAOB said Monday.

    PCAOB members said the percentage of audits where they found problems is too high. And when an audit of internal controls isn't done properly, it usually means the corresponding audit of a company's financial statements also is deficient, the PCAOB said.

    The results released Monday are based on annual inspections by the PCOAB of big accounting firms to evaluate their audit work and compliance with professional standards.

    No firms were singled out for criticism in the report, but the findings were based on inspections of BDO Seidman LLP, Crowe Horwath LLP, Deloitte & Touche LLP, Ernst & Young LLP, Grant Thornton LLP, KPMG LLP, McGladrey LLP and Pricewaterhouse Coopers LLP. The regulator's board said it has found similar problems at other auditing firms.

    Continued in article


    "Consulting By Auditors: NYU Stern Ross Roundtable Explores Post-Enron Reemergence," by Francine McKenna, Forbes, November 27, 2012 ---
    http://www.forbes.com/sites/francinemckenna/2012/11/27/consulting-by-auditors-nyu-stern-ross-roundtable-explores-post-enron-reemergence/

    Experts from the finance sector, industry, regulatory agencies, government, legal and accounting professions, and academia got together last night at NYU Stern School of Business for a Ross Roundtable to discuss the reemergence of consulting practices in the major audit firms. I’m honored to have been asked to join the panel with Bob Herz (a former FASB Chairman and current audit committee and PCAOB SAG member), former Fed Chairman Paul Volcker, professors from Stern, and Christopher Davies of Wilmer Hale who pinch hit for PwC’s Brendan Dougher who canceled at the last minute. Davies represents PwC and Ernst & Young in auditor liability matters.

    Yes, the firms sent the lawyer instead!

    Here’s the text of my remarks with links. Bob Herz interrupted me in the first few seconds of my remarks to object to my characterization of the independent foreclosure reviews by PwC as a problem. I convinced him to allow me to continue. I suggest he, and Christopher Davies who also said he didn’t get it, read some of my American Banker columns on the subject – consumer advocates, the GAO and congressional members have – or this compilation of all the writing I’ve done on the subject.

    If they don’t get it then, they never will.

    The remarks also include some new information about HP’s allegations against Autonomy. All four of the largest global audit firms are involved in the scandal one way or the other by virtue of their roles as auditors or consultants or both.

    If they don’t get your money going in, they’ll surely get it going out.

    I’ve worked on the consulting side of two Big Four firms during my career: at KPMG, at KPMG’s spinoff BearingPoint (as a Managing Director and practice leader in Latin America) and at PwC in internal audit of the firm itself.

    The last time the audit business was flat, a commodity, and under pricing pressure from clients was when I started working for KPMG Consulting in 1993 after ten years in industry. This was before KPMG Consulting split from KPMG the audit firm and became BearingPoint and just as auditors as consultants became an issue, well before Enron brought it to a head.

    I am now watching the second coming of consulting for the Big Four auditors.

    Consulting never left Deloitte, only grew bigger while the other three large firms went back to being semi-pure audit firms because they were worried about trouble with regulators. Their concerns were misplaced.

    Lane Green writes in a piece called Shape shifters” in the Economist in September:

     “In fiscal 2012 Deloitte increased its revenues from consulting by 13.5% and from financial advisory by 15%—compared with just 6.1% for audit and 3.9% for tax and legal services Barry Salzberg, Deloitte’s boss, says he expects consulting to continue to grow by double digits, whereas the audit market is mature.

    If the two businesses continue to grow at the 2012 rate, the firm would do more consulting than auditing by 2017.”

    I could make points about auditors and how consulting compromises their independence, professional skepticism and eventually their professionalism using any of the Big Four firms. There are enough cases for each. But Brendan is sitting here on this panel (Doughan did not show up), so, to be polite, I will try to make my points today without picking on PwC too much.

    These comments focus on the business model of the Big Four firms and the auditors’ primary public duty to shareholders, via the franchise granted by the public via SEC and exchange regulations that require “certified” audits for all public listings.

    Continued in article

    Bob Jensen threads on audit firm professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    Sarbanes-Oxley Legislation --- http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act

    SOX Down Rather Than Sox Up
    "Eyebrows Go Up as Auditors Branch Out," by Michael Rapoport, The Wall Street Journal, December 6, 2012 ---
    http://professional.wsj.com/article/SB10001424127887324705104578149222319470606.html?mod=WSJ_hp_LEFTWhatsNewsCollection&mg=reno64-wsj

    Auditing wasn't all Deloitte LLP did for Autonomy Corp., the software firm recently accused of accounting improprieties by its parent company. To many observers, that sort of multitasking is potentially an industry problem.

    As auditor, the U.K. unit of Deloitte Touche Tohmatsu was in charge of signing off on Autonomy's financial statements before Hewlett-Packard Co. HPQ +0.07% bought the company in 2011. But Deloitte also was paid significant fees for other work it did for Autonomy, like due-diligence work on a potential acquisition. In 2010, Deloitte received $1.2 million from Autonomy for nonaudit work, close to the $1.5 million the firm was paid for the audit itself.

    Nonaudit businesses form a steadily increasing portion of Deloitte's business, with 39.6% of revenue now coming from consulting or financial advisory, up nearly a third since 2006.

    The rise in Deloitte's nonaudit revenue spotlights a recent resurgence in consulting and other nonaudit work by the Big Four accounting firms, a decade after conflict-of-interest concerns and corporate scandal sharply limited such work.

    The firms—Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers—say that their nonaudit businesses operate within legal boundaries, and that their growth isn't cause for concern. They focus their nonaudit work on U.S. companies they don't audit, and on foreign companies that aren't U.S.-listed and thus aren't subject to the U.S. restrictions on nonaudit work.

    Even so, the move has revived fears that an increased focus on nonaudit work compromises companies' capacity to sniff out fraud.

    "If firms become too preoccupied with consulting, I think it hurts the authenticity of the audit," said former Federal Reserve Chairman Paul Volcker in an interview. Mr. Volcker spoke last week at a New York University roundtable on the comeback of consulting by accounting firms.

    Plunging too far into nonaudit services can "distract" firms' attention from auditing and "weakens the public trust" in audits, Paul Beswick, the Securities and Exchange Commission's acting chief accountant, said at an accounting conference Monday. Even if it's only a matter of perception, "negative perceptions can undermine confidence in audits," he said.

    The growing focus on consulting and other nonaudit services "threatens to weaken the strength of the audit practice in the firm overall," James Doty, chairman of the Public Company Accounting Oversight Board, the U.S. government's auditing regulator, said at the conference.

    H-P alleged last week that Autonomy is riddled with accounting improprieties, though it hasn't alleged any wrongdoing by Deloitte and hasn't cited the firm's dual role as a problem.

    Deloitte said much of its nonaudit fees for Autonomy were for "audit-related services" typically carried out by the auditor and actually classified by Deloitte as audit revenues. The firm says it didn't do any consulting work for Autonomy, and that Autonomy had procedures to ensure that any nonaudit services provided by Deloitte didn't compromise its independence.

    A decade ago, there was widespread concern that the Big Four would get too cozy with their audit clients because the same companies also were paying them lucrative consulting fees. Those fears peaked when Arthur Andersen imploded after shredding company documents related to Enron Corp.; the auditor made more consulting for Enron than it did for auditing.

    The Sarbanes-Oxley Act subsequently barred most consulting for audit clients, and all of the Big Four except Deloitte divested themselves of their consulting businesses.

    The firms have since rebuilt those businesses by providing nonaudit services to other companies, within the new prescribed limits. Demand for Sarbanes-Oxley compliance, forensic investigations and merger-and-acquisition work have helped the growth in nonaudit services.

    Consulting and other nonaudit lines of business are growing at rates far outpacing auditing. At PwC, for instance, advisory revenue rose 16.9% in fiscal 2012, versus 3.4% for auditing.

    "The auditing market is pretty much saturated," said Martin G.H. Wu, an associate professor of accounting at the University of Illinois at Urbana-Champaign. "Consulting, on the other hand, is pretty unlimited."

    If consulting growth continues to boom, the Big Four effectively could become consulting firms that "dabble" in auditing, said Joseph Carcello, a University of Tennessee accounting professor. "I think if we get to that point, we'd have a major, major problem."

    The firms disagree. "We wouldn't jeopardize audit quality for anything," said Greg Garrison, clients and markets leader at PwC. "I don't think there's any chance we'd take our eye off the ball, and I don't think our competition would either."

    At PwC, 90% of advisory work is for nonaudit clients, said Dana Mcilwain, PwC's U.S. advisory leader. The Big Four also argue that consulting provides synergies even if they don't consult for and audit the same companies. Offering consulting gives them expertise they can draw upon when related issues arise at their audit clients, they say.

    "We believe the services we're in actually help us on the front of audit quality," said John Ferraro, Ernst & Young's global chief operating officer.
    Jensen Question:  Did Andersen say the same thing about Enron when Andersen's billings were $25 million for auditing and #25 million for consulting?

    Continued in article

     

    Jensen Comment
    Asking audit firms to resist consulting is like kids and senior citizens in the Littleton, NH downtown store that has the "world's longest candy counter." Even though parents, teachers, dentists, and physicians have warned them over and over again about the evils of candy, it's virtually impossible to leave that store without bags of candy both arms. Even though the SEC, the AICPA, the Courts, the laws like Sarbanes Oxley, and the professors all warn auditors over and over again, it's hard to leave an audit without bags of money in both arms from additional consulting. The buzz word is "rebranding" amongst auditing firms.

    Video of the World's Longest Candy Counter ---
    http://www.youtube.com/watch?v=hSxpebM6SUA

    Bob Jensen's threads on auditing independence and professionalism ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

    Lastly, I mention the post-Andersen speech of a former Andersen executive research partner:

    Art Wyatt admitted:
    "ACCOUNTING PROFESSIONALISM: THEY JUST DON'T GET IT" ---

    http://aaahq.org/AM2003/WyattSpeech.pdf

    And they Still Don't Get It!

     

     


    "Guide to PCAOB Inspections," Center for Audit Quality, 2012 ---
    http://www.thecaq.org/resources/pdfs/GuidetoPCAOBInspections.pdf
    Note this has a good explanation of how the inspection process works.

    PCAOB Inspection Report Database ---
    http://pcaobus.org/inspections/reports/pages/default.aspx


    "New tool aids in evaluation of external auditors," by Ken Tisiac, Journal of Accountancy, October 15, 2012 ---
    http://journalofaccountancy.com/News/20126656.htm

    With interactions between audit committees and external auditors a focus of a steady stream of news recently, a new tool has been developed to assist audit committees in annual evaluations of external auditors.

    The Center for Audit Quality (CAQ), which is affiliated with the AICPA, is one of seven organizations that helped develop the tool. It is designed to help audit committees make an informed recommendation to boards of directors on whether to retain their auditor.

    Public company audit committees are responsible for hiring and monitoring auditors, and the tool provides guidance on how to perform those duties. The guidance also could be used by audit committees at private companies, not-for-profits, and government as well as others who monitor external audit services, including company boards, oversight bodies, and even management.

    “In assessing information obtained from management,” the tool says, “the audit committee should be sensitive to the need for the auditor to be objective and skeptical while still maintaining an effective and open relationship.”

    The tool will operate in a space that has received significant scrutiny over the past few years. The European Union is debating mandatory audit firm rotation requirements proposed by the European Commission. The PCAOB is exploring the idea of mandatory audit firm rotation for public companies in its project aimed at enhancing auditors’ independence, objectivity, and professional skepticism.

    In addition, a PCAOB standard regulating audit committees’ communications with external auditors has been forwarded to the SEC for ratification.

    The new evaluation tool states that public focus on how audit committees perform, including how they oversee external auditors, has increased significantly. During a PCAOB hearing in March devoted to enhancing auditors’ independence and objectivity, audit committee chair Cathy Lego said audit committee members are devoted to that oversight.

    “The audit committee is there on behalf of the board to oversee the integrity of the financials,” said Lego, who chairs the audit committees of California-based tech companies SanDisk and Lam Research. “We are there to appoint, to compensate, to look over the qualifications, review the independence, and perform an evaluation of the firms. We do that periodically. We may need to add a little more rigor around the timing of that, but we do it.”

    The new tool says audit committees should evaluate auditors annually to make an informed recommendation to the company board on whether to retain his or her services. The tool says the evaluation should assess:

    • The auditor’s qualifications and performance.
    • The quality and candor of the auditor’s communications with the audit committee and the company.
    • The auditor’s independence, objectivity, and professional skepticism.


    Sample questions in the tool highlight important areas for consideration. The guide also encourages audit committee members to evaluate the auditor’s performance throughout the audit process.

    “These contemporaneous assessments provide important input into the annual assessment,” the tool states. “Audit committees may wish to consider those contemporaneous observations during a more formal assessment process, perhaps by using a questionnaire or guide that considers all relevant factors year-over-year.”

    Last week, the CAQ also issued a practice aid on how external auditors and audit committees should proactively communicate in a timely and forthright way about PCAOB inspections and audit firms’ quality-control matters.

    A recent accountics science study suggests that audit firm scandal with respect to someone else's audit may be a reason for changing auditors.
    "Audit Quality and Auditor Reputation: Evidence from Japan," by Douglas J. Skinner and Suraj Srinivasan, The Accounting Review, September 2012, Vol. 87, No. 5, pp. 1737-1765.

    We study events surrounding ChuoAoyama's failed audit of Kanebo, a large Japanese cosmetics company whose management engaged in a massive accounting fraud. ChuoAoyama was PwC's Japanese affiliate and one of Japan's largest audit firms. In May 2006, the Japanese Financial Services Agency (FSA) suspended ChuoAoyama for two months for its role in the Kanebo fraud. This unprecedented action followed a series of events that seriously damaged ChuoAoyama's reputation. We use these events to provide evidence on the importance of auditors' reputation for quality in a setting where litigation plays essentially no role. Around one quarter of ChuoAoyama's clients defected from the firm after its suspension, consistent with the importance of reputation. Larger firms and those with greater growth options were more likely to leave, also consistent with the reputation argument.

     


    "The Big Four accounting firms:  Shape shifters (With the audit market maturing, accounting firms become consultancies)"
    The Economist Magazine
    September 29-October 5, pp. 76-77
    http://www.economist.com/node/21563726

    IT IS hardly news that the “Big Four” accounting firms get bigger nearly every year. But where they are growing says a lot about how they will look like in a decade, and the prospects worry some regulators and lawmakers. On September 19th Deloitte Touche Tohmatsu was the first to report revenues for its 2012 fiscal year, crowing of 8.6% growth, to $31.3 billion. Ernst & Young, PwC and KPMG will soon report their revenues (as private firms the Big Four choose not to report profits).

    For all four, Asia is a bright region. Deloitte’s revenue in Asia grew by 16.3% in dollar terms, faster than anywhere else. This was despite long-running worries about dodgy audits of Chinese companies by Western firms. American and Chinese regulators have been rowing over whether America’s accounting watchdog may inspect Deloitte Shanghai’s work. The two sides recently announced that American regulators could visit and observe, but not perform their own inspections.

    Yet more important, at all four firms consulting has been growing much faster than the audit business in recent years. In fiscal 2012 Deloitte increased its revenues from consulting by 13.5% and from financial advisory by 15%—compared with just 6.1% for audit and 3.9% for tax and legal services (see chart). Barry Salzberg, Deloitte’s boss, says he expects consulting to continue to grow by double digits, whereas the audit market is mature. Deloitte is adding consulting staff at twice the rate as employees for audits (at the end of May the firm had 193,000 people on its payroll).

    If the two businesses continue to grow at the 2012 rate, the firm would do more consulting than auditing by 2017. Some lawmakers already fret that consulting and tax advisory (when the Big Four are explicitly helping companies make money) can be in conflict with auditing (where the firms should take a wary, outside view of the books, in the service of investors not management). Lynn Turner, a former chief accountant at America’s Securities and Exchange Commission, calls the audit firms a “public utility”, but worries that they do not see themselves that way.

    In 2002 the Sarbanes-Oxley act limited what kind of non-audit services an American accounting firm can offer to an audit client. But contrary to what many people believe, it did not forbid all of them. In its last full proxy statement before being bought by JPMorgan, Bear Stearns reported paying Deloitte in 2006 not only $20.8m for audit, but $6.3m for other services. The perception that auditors and clients are hand-in-glove, fair or not, is a reason why shareholders of Bear Stearns sued Deloitte along with the defunct bank. (JPMorgan and Deloitte settled in June. Deloitte paid out $20m, denying any wrongdoing.)

    The European Commission in Brussels recently proposed taking a meat-axe to the problem. A draft directive provides for the creation of audit-only firms in the European Union. But the legal-affairs committee of the European Parliament does not like the idea. With the EU’s legislative machinery slow and complex, it is impossible to predict the final outcome.

    Asked what would happen if people perceived Deloitte as a consulting firm with an audit business rather than the other way round, Mr Salzberg replies: “we’re not going to take our eye off our professional responsibility with respect to either.” The future of the Big Four’s business model may depend on whether lawmakers in Europe and America are convinced that this is possible.

    "Auditors and Consulting: Claims of No Conflict Strain Credibility," by Francine McKenna, re:TheAuditors, February 14, 2011 ---
    http://retheauditors.com/2011/02/14/auditors-and-consulting-claims-of-no-conflict-strain-credibility/

    Big 4 audit firms are focusing on growth in their global consulting businesses but the conflicts that drove three out of four of the firms to sell them after Enron are a bigger problem than ever before. Deloitte was the only firm that held on to its consulting arm after abuses of the privilege of doing everything for clients resulted in prohibitions in the Sarbanes-Oxley Act of 2002 on the scope of services auditors could provide.

    Between 2000 and 2002, in response to the new rules, the IT consulting practices of four of the Big five accounting firms were either sold to public companies or spun off and IPO’d.

    - In February 2000, Ernst & Young Consulting was sold to Cap Gemini.

    - In February 2001, KPMG Consulting (later BearingPoint, Inc.) was floated with an IPO. (This IPO was delayed and re-priced several times in order to wait until more favorable market conditions after the millennium change, but finally took place and then went nowhere.)

    - In July 2001, Accenture (known as Andersen Consulting before its split from Arthur Andersen) also went through an IPO.

    - In October 2002, PricewaterhouseCoopers Consulting was sold to IBM. (They failed on their first attempt to sell to HP.)

    Only Deloitte Consulting did not, in the end, separate from Deloitte & Touche.

    Since the end of 2006, however, the audit firms have been rebuilding their consulting arms. All the largest accounting firms, including Deloitte, are making acquisitions and hiring to expand consulting practices. Fee increases from advising companies on Sarbanes Oxley started slowing down significantly in 2006 and other regulatory changes such as IFRS and XBRL mandates have seen repeated delays. M&A went into a slump that only now looks to be recovering slightly and the financial crisis caused significant contraction in the population of large financial services audit clients.

     

    Global highlights via CPA Trendlines and International Accounting Bulletin

    The report found that fee pressure is still widespread, but easing, and this has hit the audit sector hardest. However, revenues from audits have actually increased for most networks, with PwC taking the lead and Deloitte following.

    Tax was the strongest performer, buoyed by a strong demand in transfer pricing work and international tax advice and PwC led the way in this sector too. The mid-tier are starting to make more noise in the sustainability services market, which continues to grow, but corporate finance, IPO services and transaction support remain flat

    • Only four networks failed to grow revenue, a complete turnaround in fortunes from last year
    • Deloitte takes the mantle as the world’s largest professional services network for the first time in history
    • Deloitte reports $9 million more global revenue than PwC, the slenderest margin
    • Consulting growth alone (12%), including major acquisitions in the US (Bearing Point) and UK (Driver’s Jonas) help propel Deloitte to top spot
    • PwC is still the largest global audit firm and has the largest tax business. The steady growth in these core businesses in comparison to Deloitte places the network in a good position for 2011

    Service lines

    • Fee pressure still widespread in the developed economies although it is easing
    • Audit the hardest hit by fee pressure although audit revenue from most networks increased. PwC is the top audit firm followed by Deloitte
    • Tax was the strongest performer, buoyed by a strong demand in transfer pricing work and international tax advice. PwC leads tax followed by E&Y
    • Advisory/consulting was a mixed bag with some networks growing particularly well and others losing out. There is healthy demand for risk management, internal audit and due diligence services
    • Sustainability services continues to grow and the mid-tier are starting to become more involved

    One of the selectively booming non-audit businesses has been workouts or bankruptcy advisoryPwC’s huge long-term engagement with the Lehman bankruptcy in the UK is a prime example. Some of PwC’s financial services audit clients JPMorgan Chase and Bank of America also grew because of acquisitions during the crisis. Combined with their audit of Goldman Sachs and involvement in Treasury TARP activitiesnon-audit revenues are growing for PwC. But revenues and profitability are distributed unevenly by geography and service line in all the firms. Although Deloitte overtook PwC as the largest global firm in revenue this past year, those rankings are not only based on the firms own un-audited, self-reported figures, but show a definite emphasis on consulting and advisory services as a growth engine versus audit.

    Continued in article

    "Auditors’ Independence: An Analysis of Montgomery’s Auditing Textbooks in the 20th Century"
    by Hossein Nouri and Danielle Lombardi
    Accounting Historians Journal
    June 2009
    http://umiss.lib.olemiss.edu:82/articles/1038280.7113/1.PDF 


    "Guide to PCAOB Inspections," Center for Audit Quality, 2012 ---
    http://www.thecaq.org/resources/pdfs/GuidetoPCAOBInspections.pdf
    Note this has a good explanation of how the inspection process works.

    PCAOB Inspection Report Database ---
    http://pcaobus.org/inspections/reports/pages/default.aspx

    Bob Jensen's threads on audit independence and professionalism ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    "ARROGANCE OR IGNORANCE: WHY THE BIG FOUR DON’T DO BETTER AUDITS," by Anthony H. Catanach and J. Edward Ketz, Grumpy Old Accountants Blog, October 22, 2012 ---
    http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/787

    This year we have been outspoken critics of the Big Four’s auditing “prowess.”  SeeThe Auditor’s Expectations GAP…Not Again!  Excuses, Excuses, Excuses!” and “Who Really Cares About Auditor Rotation?  Not Us!Each of these commentaries implicitly, if not explicitly, called on these firms to make substantive, meaningful changes to their audit models so that they might once again fulfill their oversight responsibilities to the investing public.  Instead, according to David Ingram and Dena Aubin at Reuters, the Big Four continue to channel resources into lobbying efforts presumably to maintain the status quo, rather than reengineering the defective service that they label an “audit,” which they continue to peddle with the tacit approval and blessing of the SEC.

    Public Company Accounting Oversight Board (PCAOB) board member Jay Hansen seems to agree that auditors face some significant hurdles.  In a recent speech (“The PCAOB’s Role in Investor Protection) at University of Nebraska, Mr. Hansen stated,

    Recent inspection findings tell us that auditors have struggled with auditing fair value measurements, impairment of goodwill, indefinite-lived intangible assets, and other long-lived assets, allowance for loan losses, off-balance-sheet structures, revenue recognition, inventory and income taxes. Our inspection results in 2010 and 2011 showed an increase in inspection findings, particularly in the area of fair value, but also in the auditors’ testing of internal controls.

    Basic business strategy demands attention to the customer value proposition, as well as product and/or service differentiation.  The fact that the Big Four continue to ignore the real customer (the investing public), and make no attempt to distinguish their audit product on any dimension (quality would be nice), dooms whatever “strategy” that they think they may have to complete to utter failure.

    So what’s prompted our recent rant?  Well, several weeks ago one of our Executive MBA students (i.e., a mature, experienced, and motivated individual) shared with us an interaction that he and his audit committee recently experienced with their Big Four auditor.  This particular student serves as both the corporate secretary and as a member of the board of directors and audit committee for a medium-size financial institution.  At a recent meeting with its independent auditor, the audit committee asked the external auditor what the firm was doing to address concerns expressed by the PCAOB about the quality of audits conducted by their firm.  Here is where it gets interesting.

    Instead of addressing the question posed by the audit committee or acknowledging that their firm needed to improve audit quality, the engagement partner chose to blame the CLIENT for the firm’s poor audit quality.  Moreover, the partner suggested that if the client would pay higher fees, then their firm could do more work and improve their audits!

     Does this Big Four audit partner’s argument have any merit?  Yes, but only a little…we have known for quite a while that declining audit fees were becoming a problem.  And of course, companies must also share in the blame to the extent that they play theauditor shoppinggame. But a bigger and more troubling question is “why is the audit firm accepting engagements if the fees are not sufficient to guarantee a quality audit?”  The answer of course is that the Big Four just “can’t say no!” What…walk away from a client over fees?

    Continued in article

    Jensen Comment
    The problem with the above article is that the evidence presented just does not support the authors' wide-sweeping inditement of the Big Four. Whereas journalists can get away with such poorly researched headlines, members of our academy should know better. Firstly, there's no definition of what constitutes a "better audit." Secondly, there's no consideration given to the variance of audit quality within a Big Four firm. And lastly, there's no consideration given to why investors prefer that companies have Big Four audits  --- namely investors want companies to choose audit firms with the deepest pockets.

    For example, suppose an enormous multinational client has an unbelievably complicated ERP system. It's doubtful whether any firm other than a Big Four or other very, very large audit firm has the IT experts necessary to even consider auditing that client. The issue of "better job" no longer is a consideration if other audit firms have not invested in the experts and auditing software needed to take on the job.

    The same applies to certain types of specialty clients. Very few audit firms have the technical expertise to bid audits of companies having very specialized accounting such as the audit of Fannie Mae and its millions of derivatives contracts and complicated hedge accounting that one time got KPMG fired from the unbelievably complicated Fannie Mae audit. Who other than another Big Four firm could even consider taking over for KPMG on that trillion-dollar Big Fannie?

    The PCAOB increasingly is leaving us with anecdotal evidence that the Big Four is not necessarily have quality audits in many instances that is consistent with their claims and hype. But the PCAOB evidence is far too sparse to support the above damnation conclusions of this article by the Grumps.

    "New tool aids in evaluation of external auditors," by Ken Tisiac, Journal of Accountancy, October 15, 2012 ---
    http://journalofaccountancy.com/News/20126656.htm

     


    "Forbes Magazine: Lying With Numbers," by Francine McKenna, re:TheAuditors, October 18, 2012 ---
    http://retheauditors.com/2012/10/18/forbes-magazine-lying-with-numbers/

    I have a new feature article for Forbes magazine, “Lying With Numbers”, on newsstands October 22.

    The article is also posted on my blog at Forbes.com today.

    The SEC is busy chasing Ponzi schemers and foreign bribers. But bogus accounting remains a bigger danger to the markets. Is another Enron brewing?
    http://www.forbes.com/sites/francinemckenna/2012/10/18/is-the-secs-ponzi-crusade-enabling-companies-to-cook-the-books-enron-style/

    Enron. Qwest. Adelphia.

    Sunbeam. WorldCom. HealthSouth. A decade ago investors knew what those companies had in common: top executives who cooked the books. After their phony accounting was exposed, most went to jail–and hundreds of billions of dollars of shareholder wealth evaporated.

    The Securities & Exchange Commission remains quite busy. In fiscal 2011 the agency brought a record 735 enforcement actions. But those looking to see the next Jeff Skilling or Richard Scrushy frog-marched in front of television cameras will be sorely disappointed. Only 89 of those actions targeted fraudulent or misleading accounting and disclosures by public companies, the fewest, by far, in a decade.

    So what happened? Call it the Bernie Madoff effect. Embarrassed that it missed the Ponzi King’s $65 billion scheme, the SEC reorganized its enforcement division, eliminating an accounting-fraud task force and adding new units to pursue crooked investment advisors and asset managers, market manipulations and violations of the Foreign Corrupt Practices Act. Since then Pfizer, Oracle, Aon, Johnson & Johnson and Tyson Foods have all paid fines to settle foreign-payoff charges.

    That’s all fine and good. But remember this: Foreign-payola charges (absent alleged accounting abuses) have minimal effect on a company’s stock. Accounting fraud risks massive market disruption. Groupon, Zynga and Green Mountain Coffee Roasters are all down at least 75% in the past year, amid doubts about their accounting and prospects. And those examples don’t even carry allegations of illegality.

    Is a stretched SEC neglecting accounting fraud? In a statement to FORBES, SEC Enforcement Director Robert Khuzami argued that the task force was no longer needed because accounting expertise exists throughout the agency, and the number and severity of earnings restatements (a flag for possible accounting fraud) has declined dramatically since the mid-2000s. He added: “In a world of limited resources, we must prioritize our efforts. … The reorganization helped to focus us on where the fraud is and not where the fraud isn’t, while allowing us to remain fully capable of addressing cases of accounting and disclosure fraud.”

    Accounting experts agree that the Sarbanes-Oxley Act of 2002, Congress’ response to Enron, has reduced abuses. But they worry the SEC is risking those gains. “The SEC enforcement of Sarbanes-Oxley has been minimal,” says Jack Ciesielski, a CPA who sells accounting alerts to stock analysts. “Sarbanes-Oxley may have bought us some peace for our time, but without vigilance through long-term enforcement, it can’t last.”

    Anyway, it’s not like all numbers games have ceased. Public company CFOs, responding to a survey last year by Duke and Emory business profs, estimated that 18% of companies manipulate their earnings, by an average of 10%, in any given year–to influence stock prices, hit earnings benchmarks and secure executive bonuses. Most of this finagling goes undetected.

    Sarbox aimed to limit accounting shenanigans by requiring companies to set up internal accounting controls and CEOs and CFOs to personally “certify” financial statements, risking civil and even criminal penalties if they knowingly signed off on bogus numbers.

    In addition, public auditors were required to flag any “material weaknesses” in a company’s internal controls, presumably providing an early warning to companies, investors and the SEC.

    How’s that working? A study by two University of Connecticut accounting professors found auditors have waved the weakness flag in advance of a small and declining share of earnings restatements–just 25% in 2008 and 14% in 2009, the last year studied. There was no auditor warning before Lehman Brothers’ 2008 collapse, even though a bankruptcy examiner later concluded it used improper accounting gimmicks to dress up its balance sheet. And no warning before Citigroup lowballed its subprime mortgage exposure in 2007. (It paid a $75 million SEC fine.)

    Continued in article

    Bob Jensen's threads on fraud ---
    http://www.trinity.edu/rjensen/Fraud.htm


    Teaching Case from The Wall Street Journal Weekly Accounting Review on October 19, 2012

    A 'Waste of a Board Seat'?
    by: Maxwell Murphy
    Oct 16, 2012
    Click here to view the full article on WSJ.com
     

    TOPICS: Audit Committee, Board of Directors, Sarbanes-Oxley Act

    SUMMARY: Due to the push for greater independence of boards of directors from company managements, "just 19 [chief financial officers] CFOs of fortune 500 companies sit on their own boards, down from 37 in 2005....Eleven of those CFOs joined their boards more than a decade ago, before the Sarbanes-Oxley Act of 2002 prompted U.S. stock exchanges to require that the majority of public-company directors be independent...." Further, 'governance advocates back the idea of fewer CFOs serving on their respective company's board...[because it] calls into question the relationship with the audit committee..."

    CLASSROOM APPLICATION: The article helps students to see the detailed impact of Sarbanes-Oxley on the structure of boards of directors, particularly with respect to participation by the top finance/accounting executive, the CFO.

    QUESTIONS: 
    1. (Advanced) What are the responsibilities of a company's chief financial officer (CFO)? Include in your list at least one item required by Sarbanes-Oxley Act of 2002.

    2. (Advanced) What are the responsibilities of a company's board of directors? Of the audit committee of a board of directors?

    3. (Advanced) What might be the benefit of having a CFO on a company's board of directors? Consider the benefits if that CEO is from the company itself and consider the benefits if that CEO is from another company.

    4. (Introductory) Based on the discussion in the article, what factors weigh against having CFOs on the board of directors?

    5. (Advanced) Given the difficulties of a CFO obtaining board experience within his or her own company, what are the implications for these executives to obtain positions on other boards? How can a CFO overcome these obstacles?
     

    Reviewed By: Judy Beckman, University of Rhode Island

     

    "A 'Waste of a Board Seat'?" by Maxwell Murphy, The Wall Street Journal, October 16, 2012 ---
    http://professional.wsj.com/article/SB10000872396390443624204578058642536086764.html?mod=djem_jiewr_AC_domainid&mg=reno64-wsj

    Chief financial officers serving as directors at their own companies are a dying breed, thanks to a push for greater board independence.

    Just 19 CFOs of Fortune 500 companies sit on their own boards as of earlier this year, down from 37 in 2005, according to new research by executive-recruiting firm SpencerStuart. And 11 of those CFOs joined their boards more than a decade ago, before the Sarbanes-Oxley Act of 2002 prompted U.S. stock exchanges to require that the majority of public-company directors be independent, with certain exceptions. The last appointment among the group came in late 2009, when Milton Johnson was named a director of hospital operator HCA Holdings Inc. HCA -2.37% Corporate-governance experts don't expect the CFO ranks to grow. Boards are more keen to appoint so-called independent directors—those who don't have a connection to current management.

    Independent boards are also seen as less likely to harbor an entrenched management team that, for example, wants to avoid even attractive mergers that would see them lose their jobs.

    "Boards are becoming much more independent each year," says Julie Daum, co-head of SpencerStuart's North American board and CEO search practice. Sarbanes-Oxley actually created a demand to recruit outside CFOs to corporate boards to improve board audit and finance committees, but that demand has subsided after an initial surge.

    Governance advocates, of course, back the idea of fewer CFOs serving on their respective company's board.

    Naming the sitting CFO to the board of directors is "a waste of a board seat," says Paul Hodgson, chief research analyst for governance firm GMI Ratings.

    Including a CFO on a corporate board calls into question the relationship with the audit committee that oversees company financials and the CFO's performance, Mr. Hodgson says. A better approach is to simply have the CFO available for questions on an as-needed basis, Mr. Hodgson adds.

    The CEOs of virtually all Fortune 500 companies are on the boards of their respective companies, according to SpencerStuart's Ms. Daum.

    Recent CFO moves provide further evidence that finance chiefs are less likely to serve on their own boards, at least until they retire.

    Last month, Goldman Sachs Group Inc. GS -1.22% said CFO David Viniar would retire at the end of the January and then become a director on the board.

    Goldman on Monday appointed Adebayo Ogunlesi to the board as the first of what it expects to be two additional independent director appointments to offset adding Mr. Viniar, who would be considered nonindependent. Goldman declined to comment.

    At AOL Inc., AOL -0.25% which isn't part of the Fortune 500, Karen Dykstra had to step down as a board director in September to assume the role of CFO after Artie Minson was promoted to chief operating officer.

    AOL Chief Executive Tim Armstrong says the company's board has had a policy of allowing only its CEO to serve as a director ever since its late-2009 spinoff from Time Warner Inc., TWX -2.11% so the matter of keeping Ms. Dykstra on the board was never up for discussion.

    But Mr. Armstrong says he feels AOL's board will benefit both from the continued counsel of Ms. Dykstra, and the new independent directors.

    "The CFO is an integral part of the board process," and sits in on the majority of director meetings, Mr. Armstrong says.

    Richard Galanti has held the top finance post of warehouse retailer Costco Wholesale Corp. COST -1.61% since 1984, and joined its board in 1995. Mr. Galanti says he brings perspective to the board, having been with the company as it grew from four warehouse clubs to more than 600 in the U.S. and overseas.

    But he says he understands the push for "good governance and good independence," and thought it would be unlikely that his successor would sit on the board.

    A majority of Costco's directors are independent, he adds, and the company believes its governance is both "pro-shareholders" and "pro-Costco."

    Among the 19 finance chiefs who sit on their company's board is News Corp NWSA -2.01% . CFO David DeVoe. He has been CFO and on the News Corp. board since 1990. A spokesman for News Corp., which owns Dow Jones and The Wall Street Journal, declined to comment.

    Representatives for the other 18 companies either declined to comment or didn't respond to inquiries.

    Adam Kovach, a member of SpencerStuart's financial officer practice, says CFO candidates continue to ask about the possibilities of a board seat at companies interested in hiring them, even though such a discussion is "not even an option."

    And while there is still a market for CFOs on corporate boards, Mr. Kovach says most companies want a director that has served on a public-company board before, experience that they now have little chance of obtaining at their employer.

    Continued in article

    Bob Jensen's threads on corporate governance are at
    http://www.trinity.edu/rjensen/Fraud001.htm#Governance 


    Can You Train Business School Students To Be Ethical?
    The way we’re doing it now doesn’t work. We need a new way

    Question
    What is the main temptation of white collar criminals?

    Answer from http://www.trinity.edu/rjensen/FraudEnronQuiz.htm#01
    Jane Bryant Quinn once said something to the effect that, when corporate executives and bankers see billions of loose dollars swirling above there heads, it's just too tempting to hold up both hands and pocket a few millions, especially when colleagues around them have their hands in the air.  I tell my students that it's possible to buy an "A" grade in my courses but none of them can possibly afford it.  The point is that, being human, most of us are vulnerable to some temptations in a weak moment.  Fortunately, none of you reading this have oak barrels of highly-aged whiskey in your cellars, the world's most beautiful women/men lined up outside your bedroom door, and billions of loose dollars swirling about like autumn leaves in a tornado.  Most corporate criminals that regret their actions later confess that the temptations went beyond what they could resist.  What amazes me in this era, however, is how they want to steal more and more after they already have $100 million stashed.  Why do they want more than they could possibly need?

    "Can You Train Business School Students To Be Ethical? The way we’re doing it now doesn’t work. We need a new way," by Ray Fisman and Adam Galinsky, Slate, September 4, 2012 ---
    http://www.slate.com/articles/business/the_dismal_science/2012/09/business_school_and_ethics_can_we_train_mbas_to_do_the_right_thing_.html

    A few years ago, Israeli game theorist Ariel Rubinstein got the idea of examining how the tools of economic science affected the judgment and empathy of his undergraduate students at Tel Aviv University. He made each student the CEO of a struggling hypothetical company, and tasked them with deciding how many employees to lay off. Some students were given an algebraic equation that expressed profits as a function of the number of employees on the payroll. Others were given a table listing the number of employees in one column and corresponding profits in the other. Simply presenting the layoff/profits data in a different format had a surprisingly strong effect on students’ choices—fewer than half of the “table” students chose to fire as many workers as was necessary to maximize profits, whereas three quarters of the “equation” students chose the profit-maximizing level of pink slips. Why? The “equation” group simply “solved” the company’s problem of profit maximization, without thinking about the consequences for the employees they were firing.

     

    Rubinstein’s classroom experiment serves as one lesson in the pitfalls of the scientific method: It often seems to distract us from considering the full implications of our calculations. The point isn’t that it’s necessarily immoral to fire an employee—Milton Friedman famously claimed that the sole purpose of a company is indeed to maximize profits—but rather that the students who were encouraged to think of the decision to fire someone as an algebra problem didn’t seem to think about the employees at all.

     

    The experiment is indicative of the challenge faced by business schools, which devote themselves to teaching management as a science, without always acknowledging that every business decision has societal repercussions. A new generation of psychologists is now thinking about how to create ethical leaders in business and in other professions, based on the notion that good people often do bad things unconsciously. It may transform not just education in the professions, but the way we think about encouraging people to do the right thing in general.

     

    At present, the ethics curriculum at business schools can best be described as an unsuccessful work-in-progress. It’s not that business schools are turning Mother Teresas into Jeffrey Skillings (Harvard Business School, class of ’79), despite some claims to that effect. It’s easy to come up with examples of rogue MBA graduates who have lied, cheated, and stolen their ways to fortunes (recently convicted Raj Rajaratnam is a graduate of the University of Pennsylvania’s Wharton School of Business; his partner in crime, Rajat Gupta, is a Harvard Business School alum). But a huge number of companies are run by business school grads, and for every Gupta and Rajaratnam there are scores of others who run their companies in perfectly legal anonymity. And of course, there are the many ethical missteps by non-MBA business leaders—Bernie Madoff was educated as a lawyer; Enron’s Ken Lay had a Ph.D. in economics.

     

    In actuality, the picture suggested by the data is that business schools have no impact whatsoever on the likelihood that someone will cook the books or otherwise commit fraud. MBA programs are thus damned by faint praise: “We do not turn our students into criminals,” would hardly make for an effective recruiting slogan.

     

    If it’s too much to expect MBA programs to turn out Mother Teresas, is there anything that business schools can do to make tomorrow’s business leaders more likely to do the right thing? If so, it’s probably not by trying to teach them right from wrong—moral epiphanies are a scarce commodity by age 25, when most students start enrolling in MBA programs. Yet this is how business schools have taught ethics for most of their histories. They’ve often quarantined ethics into the beginning or end of the MBA education. When Ray began his MBA classes at Harvard Business School in 1994, the ethics course took place before the instruction in the “science of management” in disciplines like statistics, accounting, and marketing. The idea was to provide an ethical foundation that would allow students to integrate the information and lessons from the practical courses with a broader societal perspective. Students in these classes read philosophical treatises, tackle moral dilemmas, and study moral exemplars such as Johnson & Johnson CEO James Burke, who took responsibility for and provided a quick response to the series of deaths from tampered Tylenol pills in the 1980s.
    It’s a mistake to assume that MBA students only seek to maximize profits—there may be eye-rolling at some of the content of ethics curricula, but not at the idea that ethics has a place in business. Yet once the pre-term ethics instruction is out of the way, it is forgotten, replaced by more tangible and easier to grasp matters like balance sheets and factory design.  Students get too distracted by the numbers to think very much about the social reverberations—and in some cases legal consequences—of employing accounting conventions to minimize tax burden or firing workers in the process of reorganizing the factory floor.

     

    Business schools are starting to recognize that ethics can’t be cordoned off from the rest of a business student’s education. The most promising approach, in our view, doesn’t even try to give students a deeper personal sense of mission or social purpose – it’s likely that no amount of indoctrination could have kept Jeff Skilling from blowing up Enron. Instead, it helps students to appreciate the unconscious ethical lapses that we commit every day without even realizing it and to think about how to minimize them.  If finance and marketing can be taught as a science, then perhaps so too can ethics.

     

    These ethical failures don’t occur at random – countless experiments in psychology and economics labs and out in the world have documented the circumstances that make us most likely to ignore moral concerns – what social psychologists Max Bazerman and Ann Tenbrusel call our moral blind spots.  These result from numerous biases that exacerbate the sort of distraction from ethical consequences illustrated by the Rubinstein experiment. A classic sequence of studies illustrate how readily these blind spots can occur in something as seemingly straightforward as flipping a fair coin to determine rewards. Imagine that you are in charge of splitting a pair of tasks between yourself and another person. One job is fun and with a potential payoff of $30; the other tedious and without financial reward. Presumably, you’d agree that flipping a coin is a fair way of deciding—most subjects do. However, when sent off to flip the coin in private, about 90 percent of subjects come back claiming that their coin flip came up assigning them to the fun task, rather than the 50 percent that one would expect with a fair coin. Some people end up ignoring the coin; more interestingly, others respond to an unfavorable first flip by seeing it as “just practice” or deciding to make it two out of three. That is, they find a way of temporarily adjusting their sense of fairness to obtain a favorable outcome.

     

    Jensen Comment
    I've always thought that the most important factors affecting ethics were early home life (past) and behavior others in the work place (current). I'm a believer in relative ethics where bad behavior is affected by need (such as being swamped in debt) and opportunity (weak internal controls at work).  I've never been a believer in the effectiveness of teaching ethics in college, although this is no reason not to teach ethics in college. It's just that the ethics mindset was deeply affected before coming to college (e.g. being street smart in high school) and after coming to college (where pressures and temptations to cheat become realities).

    An example of the follow-the-herd ethics mentality.
    If Coach C of the New Orleans Saints NFL football team offered Player X serious money to intentionally and permanently injure Quarterback Q of an opposing team, Player X might've refused until he witnessed Players W, Y, and Z being paid to do the same thing.  I think this is exactly what happened when several players on the defensive team of the New Orleans Saints intentionally injured quarterbacks for money.

    New Orleans Saints bounty scandal --- http://en.wikipedia.org/wiki/New_Orleans_Saints_bounty_scandal

     

    Question
    What is the main temptation of white collar criminals?

    Answer from http://www.trinity.edu/rjensen/FraudEnronQuiz.htm#01
    Jane Bryant Quinn once said something to the effect that, when corporate executives and bankers see billions of loose dollars swirling above there heads, it's just too tempting to hold up both hands and pocket a few millions, especially when colleagues around them have their hands in the air.  I tell my students that it's possible to buy an "A" grade in my courses but none of them can possibly afford it.  The point is that, being human, most of us are vulnerable to some temptations in a weak moment.  Fortunately, none of you reading this have oak barrels of highly-aged whiskey in your cellars, the world's most beautiful women/men lined up outside your bedroom door, and billions of loose dollars swirling about like autumn leaves in a tornado.  Most corporate criminals that regret their actions later confess that the temptations went beyond what they could resist.  What amazes me in this era, however, is how they want to steal more and more after they already have $100 million stashed.  Why do they want more than they could possibly need?

    See Bob Jensen's "Rotten to the Core" document at http://www.trinity.edu/rjensen/FraudRotten.htm
    The exact quotation from Jane Bryant Quinn at http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

    Why white collar crime pays big time even if you know you will eventually be caught ---
    http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

    Bob Jensen's Rotten to the Core threads ---
    http://www.trinity.edu/rjensen/FraudRotten.htm

    September 5, 2012 reply from Paul Williams

    Bob,

    This is the wrong question because business schools across all disciplines contained therein are trapped in the intellectual box of "methodological individualism." In every business discipline we take as a given that the "business" is not a construction of human law and, thus of human foible, but is a construction of nature that can be reduced to the actions of individual persons. Vivian Walsh (Rationality Allocation, and Reproduction) critiques the neoclassical economic premise that agent = person. Thus far we have failed in our reductionist enterprise to reduce the corporation to the actions of other entities -- persons (in spite of principal/agent theorists claims). Ontologically corporations don't exist -- the world is comprised only of individual human beings. But a classic study of the corporation (Diane Rothbard Margolis, The Managers: Corporate Life in America) shows the conflicted nature of people embedded in a corporate environment where the values they must subscribe to in their jobs are at variance with their values as independent persons. The corporate "being" has values of its own. Business school faculty, particularly accountics "scientists," commit the same error as the neoclassical economists, which Walsh describes thusly:

    "...if neo-classical theory is to invest its concept of rational agent with the penumbra of moral seriousness derivable from links to the Scottish moral philosophers and, beyond them, to the concept of rationality which forms part of the conceptual scheme underlying our ordinary language, then it must finally abandon its claim to be a 'value-free` science in the sense of logical empiricism (p. 15)." Business, as an intellectual enterprise conducted within business schools, neglects entirely "ethics" as a serious topic of study and as a problem of institutional design. It is only a problem of unethical persons (which, at sometime or another, includes every human being on earth). If one takes seriously the Kantian proposition that, to be rationally ethical beings, humans must conduct themselves so as to treat always other humans not merely as means, but also always as ends in themselves, then business organization is, by design, unethical. Thus, when the Israeli students had to confront employees "face-to-face" rather than as variables in a profit equation, it was much harder for them to treat those employees as simply disposable means to an end for a being that is merely a legal fiction. One thing we simply do not treat seriously enough as a worthy intellectual activity is the serious scrutiny of the values that lay conveniently hidden beneath the equations we produce. What thoughtful person could possibly subscribe to the notion that the purpose of life is to relentlessly increase shareholder wealth? Increasing shareholder value is a value judgment, pure and simple. And it may not be a particularly good one. Why would we be surprised that some individuals conclude that "stealing" from them (they, like the employees without names in the employment experiment, are ciphers) is not something that one need be wracked with guilt about. If the best we can do is prattle endlessly on about the "tone at the top" (do people who take ethics seriously get to the top?), then the intellectual seriousness which ethics is afforded within business schools is extremely low. Until we start to appreciate that the business narrative is essentially an ethical one, not a technical one, then we will continue to rue the bad apples and ignore how we might built a better barrel.

    Paul

    September 5, 2012 reply from Bob Jensen

    Hi Paul,


    Do you think the ethics in government is in better shape, especially given the much longer and more widespread history of global government corruption throughout time? I don't think ethics in government is better than ethics in business from a historical perspective or a current perspective where business manipulates government toward its own ends with bribes, campaign contributions, and promises of windfall enormous job benefits for government officials who retire and join industry?


    Government corruption is the name of the game in nearly all nations, beginning with Russia, China, Africa, South America, and down the list.


    Political corruption in the U.S. is relatively low from a global perspective.
    See the attached graph from
    http://en.wikipedia.org/wiki/Corruption_%28political%29

     

     

    Respectfully,
    Bob Jensen


    "Audit Firms' Work Deemed Deficient," by Michael Rapoport, The Wall Street Journal, September 16, 2012 ---
    http://professional.wsj.com/article/SB10000872396390443720204578000132856766230.html?mg=reno64-wsj

    Regulators still are finding a high level of serious deficiencies in the work of major audit firms, continuing a trend begun last year, a member of the U.S.'s audit-industry oversight panel said.

    Most of the Public Company Accounting Oversight Board's 2011 inspection reports of the biggest firms have yet to be issued, but they will show a continued "spike" in audits found to have serious problems, PCAOB member Jeanette Franzel said in a speech in Chicago on Thursday.

    In some cases, Ms. Franzel said, the board's inspectors found that auditors gave their clients a clean bill of health even though the audit work wasn't completely or properly conducted, or the company's financial statements were contradicted by other evidence.

    Last year, in reports issued on 2010 inspections, "we saw a high level of serious inspection findings, an increase over previous years," and that trend remains in the 2011 reports, Ms. Franzel said. In the reports issued last year, the board found deficiencies in nearly a third of the audits they examined at the Big Four accounting firms—PricewaterhouseCoopers LLP, Deloitte & Touche LLP, Ernst & Young LLP and KPMG LLP.

    The PCAOB conducts annual inspections of the biggest firms, scrutinizing a sample of their audits. The inspections focus on audits that the board believes are at highest risk for problems, so the PCAOB says the results may not reflect how frequently a firm's overall audit work is deficient. The inspections are intended only to evaluate a firm's performance and point out areas for improvement, so offending firms aren't subject to penalties.

    PCAOB findings of problems are "to be taken seriously and firms will continue to work on areas that need to be improved," said Cindy Fornelli, executive director of the accounting industry's Center for Audit Quality.

    The only Big Four firm with a 2011 report issued thus far is KPMG, in which the PCAOB found deficiencies in 12 out of the 52 audits they examined.

    Bob Jensen's threads on audit firm professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    Crowe Horwath May Have the Worst Audit Inspection Report in the History of the PCAOB
    It will frustrate Francine that Deloitte's record has been broken

    "Crowe Horwath Sees Spike in Audit Inspection Findings," by Tammy Whitehouse, Compliance Week, July 31, 2012---
    http://www.complianceweek.com/crowe-horwath-sees-spike-in-audit-inspection-findings/article/252603/

    Crowe Horwath, the last of the top eight accounting firms to have its 2010 audit inspection report published, took the same lashing as its counterparts with a significant increase in the number of audits criticized by inspectors.

    Two years after 2010 inspections were performed, the Public Company Accounting Oversight Board published its report on Crowe's audit work finding fault with eight of the 13 audits selected for inspection. By comparison, inspectors criticized only two of the 13 Crowe Horwath audits that they inspected in 2009, and only one audit in 2008. The PCAOB had no comment on why it took two years to publish the report.

    Crowe's 2010 report outlines the same audit-by-audit summary of inspectors' concerns found in other reports, focusing on many of the same issues that cropped up across all firms in 2010. Among the eight audits criticized, most comments revolve around allowances for loan losses, impairments, and over-reliance on third-party pricing services for establishing fair values.

    The PCAOB report says deficiencies included failures to identify or properly address financial statement misstatements, including failures to comply with disclosure requirements, as well as failures to perform certain audit procedures. Inspectors noted that in some cases, the failure stems from inadequate documentation. The report says Crowe issued a revised opinion on one audit report after inspectors unearthed problems with the audit of internal control over financial reporting.

    The firm says in its response to the inspection findings that it is committed to quality auditing and has designed its quality control and monitoring systems to drive improvement. Crowe says it took actions to address each matter raised in the inspection report, including providing more documentation in audit files to more completely describe procedures, evidence, and conclusions. “We remain committed to continual improvement in our audit practice and making responsive changes in areas identified by the PCAOB for improvement, and look forward to further dialogue towards the shared goal of audit quality,” the firm wrote.

    Among the top eight audit firms that are inspected annually by the PCAOB, inspection findings jumped dramatically from 2009 to 2010. The ratio of failed audits to the total number of audits inspected more than doubled at some firms, like Crowe. The eight major firms that are inspected annually include Ernst & Young, KPMG, PwC, Deloitte & Touche, Grant Thornton, BDO USA, McGladrey & Pullen, and Crowe.

    Continued in article

    Bob Jensen's threads on the woes of auditing firms ---
    http://www.trinity.edu/rjensen/Fraud001.htm


    Issues of Auditor Independence
    Never underestimate the government’s capacity for incompetence.

    "Saying ‘You’re Fired’ (to PwC) Is the Only Answer Here," by Jonathan Weil, Bloomberg News, July 26, 2012 ---
    http://www.bloomberg.com/news/2012-07-26/saying-you-re-fired-is-the-only-answer-here.html

    Never underestimate the government’s capacity for incompetence when it comes to overseeing large financial institutions. The latest example: an ill-advised consulting contract between Freddie Mac’s outside auditor and the federal agency in charge of running the company.

    Freddie Mac, the housing financier with a $2.1 trillion balance sheet that was seized by regulators in 2008, remains under the control of its conservator, the Federal Housing Finance Agency. Yet its shares and bonds are still publicly traded. And it continues to file reports with the Securities and Exchange Commission, which means it must follow the SEC’s rules.

    Some of those regulations seem to have been ignored when the FHFA hired Freddie Mac’s auditor, PricewaterhouseCoopers LLP, in May to provide advice on managing the company. The firm’s work includes consulting services that are barred under the SEC’s auditor-independence rules, as far as I can tell. The agency and the accounting firm say they are following the rules. Their explanations aren’t convincing.

    The contract came to light this week after the housing- finance agency released a copy to Vern McKinley, a consultant working with the Washington-based advocacy group Judicial Watch, in response to a Freedom of Information Act request. The agency hired Pricewaterhouse to create contingency plans that would be used if the government someday decides that Freddie Mac, Fannie Mae or any of the Federal Home Loan Banks should be taken into receivership and liquidated.

    (Pricewaterhouse audits the 12 Federal Home Loan Banks, none of which is in conservatorship. Fannie Mae’s auditor is Deloitte & Touche LLP.) Promoting Confidence

    The reason for having auditor-independence rules is to promote confidence in the integrity of companies’ financial statements. Auditors are supposed to be watchdogs for the public, not beholden to their clients. To be sure, the system is a bit of a charade. The client pays the firm for its audit, so there always are conflicts of interest.

    The independence problem in this instance arises from the FHFA’s connection to Freddie Mac. In substance, the agency is Freddie Mac. (FMCC) Here’s how the company explained the relationship in its latest annual report:

    “As our conservator, FHFA succeeded to all rights, titles, powers and privileges of Freddie Mac, and of any stockholder, officer or director thereof, with respect to the company and its assets,” the company said. “FHFA has delegated certain authority to our board of directors to oversee, and to management to conduct, day-to-day operations. The directors serve on behalf of, and exercise authority as directed by, the conservator.”

    With that in mind, the auditor-independence problems become obvious. There are three main principles underlying the SEC’s rules: An auditor can’t function in the role of management. It can’t audit its own work. And it can’t serve in any advocacy role for an audit client.

    The contract, under which Pricewaterhouse will receive about $757,000, calls for “providing general advice on receivership preparation, assisting the FHFA in developing pre- and post-receivership procedures, implementing those procedures,” and “assisting the FHFA in the operation and administration of a receivership.”

    That means Pricewaterhouse is giving advice on how to run Freddie Mac, and even could be called upon to help operate the company at some point. The contract says the firm’s work includes making recommendations regarding “valuation services” and “human resources.” The SEC’s rules list those as services that auditors are prohibited from providing to audit clients. PR Work

    Additionally, the contract calls for Pricewaterhouse to offer advice on “public relations,” which is an advocacy role. Other services include making recommendations on risk management, claims management, asset management, and securities management.

    A Pricewaterhouse spokesman, Chris Atkins, released this statement: “PwC takes its auditor independence requirements very seriously. Our acceptance of the FHFA engagement was in consideration of the SEC’s auditor independence rules. The scope of services being performed for FHFA is consistent with those rules.” Asked to explain how, he declined to comment.

    The housing-finance agency released a statement from its general counsel, Alfred Pollard. “This is not a contract for PwC to perform work for Freddie Mac or any other entity regulated by FHFA,” he said. Additionally, Pollard said “measures are in place to ensure against conflicts of interest and to maintain independence, including a process that prevents PwC employees working on this FHFA contract from working on contracts for a regulated entity.”

    Nothing in his statement addressed the point that the agency, as Freddie Mac’s conservator, is standing in the company’s shoes, or that Pricewaterhouse is providing advice on how to manage the company’s affairs. A Freddie Mac spokeswoman, Sharon McHale, declined to comment.

    The independence issues here were easily avoidable. There are plenty of firms the agency could have hired instead. Plus, Pricewaterhouse was the auditor for Freddie Mac when it was seized in 2008. The company has never acknowledged anything wrong with its books, even though its asset values obviously were overstated before it collapsed. There’s no good reason to hire Pricewaterhouse for this work.

    Continued in article

    Bob Jensen's threads on PwC's woes are at
    http://www.trinity.edu/rjensen/Fraud001.htm

    Bob Jensen's threads on auditor professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    What's not different from the pre-Enron days, though, is that public companies still appear to structure transactions for no other reason than to reach strained accounting results, and auditors are pressured to sign off on those accounts. Those pressures can destroy an auditor's objectivity.
    "The Importance of Oversight," by James R. Doty (Chairman of the Public Company Accounting Oversight Board), .The New York Times, July 24, 2012 ---
    http://www.nytimes.com/roomfordebate/2012/07/24/has-sarbanes-oxley-failed/sarbanes-oxley-and-the-importance-of-independent-audit-oversight

    I took my job at the Public Company Accounting Oversight Board because I wanted to serve an organization that is responding vigorously to the risks to the investing public that were exposed by the recent financial crisis.

    The board has replaced the auditing profession's self-regulation, which had been based on peer reviews of standards written by the firms themselves. In 25 years of operation, the profession's self-regulatory system never issued an adverse or qualified report on a major accounting firm. Yet board inspections have identified scores of problems in audits by firms in each of the large accounting firm networks and other firms that audit public company financial statements. The inspection process doesn't stop there; it focuses firms on the need to do something to correct deficient audits. The board does not oversee or interact with public companies themselves, but in numerous instances, the audit-firm response to these deficiencies has led to restatements or other corrections to financial statements. These are big differences from the pre-Enron days.

    What's not different from the pre-Enron days, though, is that public companies still appear to structure transactions for no other reason than to reach strained accounting results, and auditors are pressured to sign off on those accounts. Those pressures can destroy an auditor's objectivity.

    Through rigorous and skillful inspections and enforcement, the board aims to maintain auditing as the attest function it is intended to be. Many things went wrong in the recent financial crisis, but the investing public would have been worse off without independent audit oversight. We are again at a point where new reforms are needed to strengthen investor protection. In a nutshell, the global audit firm is not too big to fail, and it is too important to leave unregulated.

    Our federal securities laws were not premised on the government’s making business judgments for enterprise, but on a vision that investor protection would further our national interest in capital formation and build investor confidence in our markets. That has worked for us, and we need to hold fast to that vision.

    As the Sarbanes-Oxley Act of 2002 approaches its 10th anniversary, a U.S. House of Representatives subcommittee debates its merits -- and a bill that would decrease the scope of the corporate governance law.
    "SOX’s anniversary marked with congressional debate on benefits and costs," by Ken Tysiac, Journal of Accountancy, July 26, 2012 --- Click Here
    http://journalofaccountancy.com/News/20126125.htm?cm_mmc=smartbrief-_-27Jul12-_-CPALD-_-SOXHouse&utm_source=smartbrief&utm_medium=12Jul12&utm_term=CPALD&utm_content=SOXHouse&utm_campaign=smartbrief

    Jensen Comment
    The public accounting industry in the United States could have a lot riding on these Congressional debates. In some ways SOX saved the auditing services. In the 1990s auditing was becoming an unprofitable service that was becoming more and more of a loss leader for obtaining more profitable advisory services. For example, for $25 million per year Andersen probably would've lost millions if it had performed the Enron audit professionally. On the other hand, auditing led to another $25 million in advisory services that were highly profitable for for Andersen even though some of these advisory services led to conflicts of interest with auditing services (e.g., Andersen helped design those 3,000+ Enron SPEs and helped design those incorrect accounting procedures for derivative financial instruments) ---
    http://www.trinity.edu/rjensen/FraudEnron.htm

    SOX was passed primarily to make it less likely that auditors would compromise their independence due to lucrative advisory services. Three of the Big Four firms even sold or spun off their consulting divisions. But at the same time, SOX restored profitability and more oversight (e.g., the PCAOB) to auditing services. Of course most corporations are not pleased with the greatly increased cost of obtaining CPA firm audits. And so we now have yet another Congressional subcommittee looking into perhaps reducing audit fees and quality such as quality of detail testing that is one of the most costly part of an independent audit.

    SOX was also controversial in that it greatly increased the responsibility of top managers of clients to design and implement effective internal controls to prevent accounting error and fraud. This part of SOX is greatly despised by corporations even though I think that audit firms are happy about this part of SOX. I also think there is a lot of anecdotal evidence that internal controls became much more effective as a result of SOX requirements.

    Hence, I'm not a fan of pulling the teeth out of SOX. I'm also not a fan of once again forcing auditors to offer cut-rate services.


    "Why Companies Fail:  GM’s stock price has sunk by a third since its IPO. Why is corporate turnaround so difficult and rare? The answer is often culture—the hardest thing of all to change," by Megan McArdle, The Atlantic, March 2012 ---
    http://www.theatlantic.com/magazine/archive/2012/03/why-companies-fail/8887/

    Jensen Comment
    There are some enormous causes not given enough credit in this article. For example, GM failed largely because it signed off on commitments that doomed it to failure such as underfunding of pensions by billions of dollars and agreeing to union wages that could not be sustained due to labor competition both inside the United States (e.g., from southern right-to-work states preferred by foreign automakers building assembly plants in the U.S,) and outside the U.S. such as in Mexico. Then there were the causes focused on in this article such as failure to adapt to changed competition building higher quality vehicles with newer technology.

    While I was reading this article I kept wondering how much of it could be extrapolated to the auditing industry that has and still is resisting change. The number one ingredient of audit firm success is its integrity. That ingredient seems to be crumbling with weekly headlines about one audit failure after another. How long can this go on? Fortunately, the courts and the SEC have given the U.S. audit industry new life by failing to punish it harshly for shoddy audits in the subprime banking scandals. But such leniency may not continue into the future, especially outside the U.S. where we're hearing rumblings about anti-trust breakups of the large auditing firms.

    "THE AUDITOR’S EXPECTATIONS GAP…NOT AGAIN! EXCUSES, EXCUSES, EXCUSES!" Anthony H. Catanach Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, February 13, 2012 ---
    http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/498


    Francine wishing that the courts would bring Deloitte to its knees
    "Big Four Auditors and Jury Trials: Not In The U.S.," by Francine McKenna, re:TheAuditors, June 19, 2012 ---
    http://retheauditors.com/2012/06/19/big-four-auditors-and-jury-trials-not-in-the-u-s/

    Deloitte has settled a shareholder case against the firm stemming from their role as auditor of Bear Stearns, one of the early financial services firms to fail, be force sold or nationalized during the financial crisis of 2008-2009. Deloitte was dangerously close to having to answer for its actions – or rather inactions – at a trial. For the Big 4 audit firms in the United States, trials over auditor liability are unheard of.

    Rare birds in modern times.

    Deloitte’s audits “were so deficient that the audit amounted to no audit at all,” the [Bear Stearns investors] plaintiffs argued in court papers.

    That was Reuters describing the rationale behind the decision of US District Judge Robert Sweet back on January 23, 2011 to allow a case against executives of Bear Stearns and its outside auditor, Deloitte, to go forward. I wrote in Forbes:

    In Ernst & Ernst v. Hochfelder, the Supreme Court held that actions under Section 10(b) of the Exchange Act and Rule 10b-5 require an allegation of “`scienter’—intent to deceive, manipulate, or defraud.” The “scienter” requirement, necessary to sustain allegations against the auditors in a securities claim under Section 10(b), is notoriously difficult to meet in an auditor liability case.

    If there’s anything of substance in a claim against auditors the case usually settles before the facts are made public. New Century Trustee v. KPMG is an early crisis mortgage originator case, cited several times in the Bear Stearns decision. However, those facts will never be heard in open court. In spite of – or perhaps because of – very particular examples of reckless behavior by the auditor documented by the bankruptcy examiner, the case was settled...since Ernst, most courts have concluded that recklessness can satisfy the requirement of “scienter” in a securities fraud action against an accountant.

    That standard requires more than a misapplication of accounting principles. Plaintiffs must prove that the accounting practices were so deficient that the audit amounted to no audit at all, or “an egregious refusal to see the obvious, or to investigate the doubtful,” or that the accounting judgments which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts.

    The plaintiffs’ attorneys In Re: Bear Stearns Companies, Inc. Securities Litigation successfully pled recklessness equivalent to “scienter” and more. They knocked the requirements for recklessness to prove “scienter” out of the park. The Complaint identified as a red flag the fact that Deloitte knew or should have known, absent recklessness, the risk factors inherent in the industry, such as declining housing prices, relaxation of credit standards, excessive concentration of lending, and increasing default rates.

    The Securities Complaint has alleged that JPMorgan discovered in the course of one weekend the overvaluation of assets and underestimation of risk exposure in Bear Stearns’ financial statements. JC Flowers & Co., a leverage-buyout company, had also reviewed Bear Stearns’ books the same weekend and made an unsuccessful proposal to buy 90% of the Company at a similar price between $2 and $2.60 per share. These allegations support an inference of Deloitte’s scienter.

     

    They’re specific enough about who, what, why, and when to nail “particularity”. The misstatements with respect to valuation and risk were adequately alleged with sufficient specificity and established as material. They showed how Deloitte, like the Bear Stearns executives, caused losses.

    But there will be no trial. Investors led by the State of Michigan Retirement Systems settled with Bear Stearns executives for $275 million – which will be covered by insurance –  and auditor Deloitte will pay, in cash, an additional $19.9 million.

    To put Deloitte’s settlement in perspective, I looked at the firm’s audit fees for Bear Stearns from 2003-2006. (Fee information for 2007 is not available since the firm was bought, under duress, by JP Morgan in 2008 and the proxy focuses on that transaction, not the typical disclosures.) Deloitte earned $110 million dollars, more than 5X this settlement amount, in just the last four years at Bear.

    . . .

    Next chance for a trial for a Big Four firm in the US is again against Deloitte. Steven Thomas, the only lawyer who consistently tries and wins cases against the biggest auditors has a trial for the Taylor Bean & Whitaker mortgage originator fraud case starting in June 2013.

    Continued in article

    Jensen Question
    Should we hope with Francine that this time Steven Tomas finally succeeds in destroying the fraudulent auditing firm of Deloitte and Touche?

    Maybe another Enron is the only way of making the remaining Big Three firms get more serious about audit independence and professionalism.

    "Deloitte’s Troubles Bubble To Surface," by Francine McKenna, re:TheAuditors, January 31, 2011 ---
    http://retheauditors.com/2011/01/31/deloittes-troubles-bubble-to-surface/

    "No Audit At All: Deloitte and Bear Stearns," by Francine McKenna, Forbes, January 25, 2011 ---
    http://blogs.forbes.com/francinemckenna/2011/01/25/no-audit-at-all-deloitte-and-bear-stearns/

    "PCAOB Inspection of Deloitte Audit – 20% Error Rate?" The Big Four Blog, May 6, 2010 ---
    http://bigfouralumni.blogspot.com/2010/05/pcaob-inspection-of-deloitte-audit-20.html

    Bob Jensen's threads on Deloitte are at
    http://www.trinity.edu/rjensen/Fraud001.htm

    From the AICPA on June 28, 2012

    Three ethics resources for CPA, CGMAs
    With the importance of ethics and non-financial reporting rising on the global agenda, CGMAs are in a unique position to make an important contribution to creating a sustainable ethical operating environment. The AICPA and CIMA have developed a number of resources to assist CPA, CGMAs in guiding their organizations to long-term sustainability and success. The Ethical reflection checklist is designed to provide organizations and individuals with an overview of how well ethical practices are embedded in the business. The CGMA case study: Navigating ethical issues highlights issues related to non-disclosure at the corporate level that come to the attention of non-executive financial managers and controllers. Responding to ethical dilemmas: CGMA ethics resources provides links to resources to help CGMAs navigate ethical dilemmas and respond in a manner that upholds their professional

    Bob Jensen's threads on Tools and Tricks of the Trade ---
    http://www.trinity.edu/rjensen/000aaa/thetools.htm

     

     


    AAA PUBLISHES STUDY ON DISCLOSURE TONE AND SHAREHOLDER LAWSUITS ---
    http://www.accountingeducation.com/index.cfm?page=newsdetails&id=151874

    In the U.S. there are both state and federal jurisdictions. And there can be individual or class action lawsuits brought by plaintiffs. One of the better sources for federal securities class action lawsuits is the Stanford University Law School Federal Class Action Clearinghouse ---
    http://securities.stanford.edu/
    But this by no means covers most of the lawsuits against large auditing firms. In fact, the database has surprisingly few hits for Big Four firms. Many of the SEC lawsuits are not in this database
    .

    For lawsuits dealing with derivative financial instruments I also have a tidbit timeline at
    http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

    Of course the lawyers are going to use their very expensive legal research databases. A list of sources in the U.S. is provided in
    http://en.wikipedia.org/wiki/Legal_Research

    Bob Jensen's threads on shareholder lawsuits ---
    http://www.trinity.edu/rjensen/Fraud001.htm


    US CHAMBER OF COMMERCE ISSUES REPORT FOR IMPROVING SEC OPERATIONS ---
    http://www.accountingeducation.com/index.cfm?page=newsdetails&id=151862


    "THE AUDITOR’S EXPECTATIONS GAP…NOT AGAIN! EXCUSES, EXCUSES, EXCUSES!" Anthony H. Catanach Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, February 13, 2012 ---
    http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/498

    Darn you Caleb Newquist for depressing us with yet another example of how Big Four accounting firm leaders think, not to mention how little they regard the investing public!  In discussing ways to improve audit quality in the wake of his firm’s atrocious inspection report by the Public Company Accounting Oversight Board (PCAOB), Deloitte’s CEO, Joe Echevarria stated:

     

    There is an “expectations gap” between what auditors do and what the public expects, but auditors do have an obligation to detect and report material (emphasis added) fraud.

    These two Grumpy Old Accountants simply can’t believe that today’s global accounting firms continue to rely on an almost 40 year-old excuse to justify their shoddy audit work.  Yes, we know this because we were accounting undergraduates when this feeble defense was rolled out for the first time.  While the “expectations gap” reasoning may have been believable in our youth, today it is nothing but a meaningless excuse.  After all, independent audits now are dramatically improved over days gone by (or so we are told), and the Big Four have had four decades (two generations of investors) to re-educate the investing public on what an independent audit really represents.

    So what does this term “expectations gap” mean anyway?  Well it depends on whom you ask, and when you ask them?  According to Lee et al. (2009), the term appears to have been coined in 1974 by C.D. Liggio who defined it as the difference between the levels of expected performance “as envisioned by the independent accountant and by the user of financial statements.”  Interestingly enough, in 1978, the American Institute of CPA’s Cohen Commission, which was appointed to investigate the existence of the “expectation gap,” concluded that it did in fact exist, and that users of financial statements were NOT principally responsible for its existence.  Of course this finding preceded the AICPA becoming the lapdog of big accounting firms.

    However, once academia got involved, the definition became more Big Four friendly…there’s a surprise given who funds most auditing research.  Monroe and Woodliff (1993) defined the audit expectations gap as the difference in beliefs between auditors and the public about the duties and responsibilities assumed by auditors and the messages conveyed by audit reports.  And, ten years later, at a forum convened by the U.S. Government Accounting Office, participants agreed that “an ‘expectation gap’ of what an audit is and what users expect continues to exist, especially with the auditor’s responsibility for fraud detection.”  So, it took almost 20 years for the big accounting firms to move the “expectation gap” argument from “what performance is expected of an auditor,” to “what an auditor’s responsibilities are.”  A subtle, but important change, especially if you are trying to avoid billions in legal liabilities for bad audits.

    And this “expectation gap” is not solely a U.S. phenomenon.  Lee et al. (2009) in their literature review, report evidence of such a gap globally.  They note that the issue has been investigated in numerous countries including the United Kingdom, Australia, New Zealand, China, Singapore, Malaysia, and the Middle East. Whatever the country, the results are the same: the audit “expectation gap” still exists.

    So how can the “expectations gap” be narrowed or eliminated?  One proposed solution has been to establish an independent oversight authority for auditors to enhance independence, regulate audit fees, and clarify auditor responsibilities to detect fraud.  Yet, despite the creation of the PCAOB in the U.S. and the Professional Oversight Board in the U.K., the gap continues.

    Another suggestion is that the audit report be expanded to better convey what an audit does and implies.  In fact, the 1978 Cohen Commission report noted that “evidence abounds that communication between the auditor and users of his work –especially through the auditor’s standard report – is unsatisfactory.” Almost 35 years later, the profession has finally gotten around to this potential remedy with the PCAOB’s release in June 2011 of a concept release with suggestions on modifying the auditor’s report.  Not surprisingly, the big accounting firms through their lobbying mouthpiece, the Center for Audit Quality, have voiced their usual concerns to changing the audit status quo in a September 2011 statement.

    It also has been suggested that the “expectation gap” can be narrowed by auditors’ increasing their use of decision aids.  Such aids include standard checklists, forms, or computer programs that assist auditors in making audit decisions which ensure that they consider all relevant information, and also assist them in weighting and combining information to make a decision.  As one might expect, this proposal is not very popular as it changes the status quo, admits the possibility that the audit process might actually be flawed, and potentially increases audit costs.  More significantly, despite the past decade’s dramatic changes in audit technologies, the expectation gap remains.

    Last, but not least is the solution most favored by the Big Four: the educating the public approach.  Why?  Because these big accounting firms don’t have to substantively change the way they do business, and it makes the expectation gap the public’s problem, not theirs. As Lee et al. (2009) point out, however, education is not a practical approach because the majority of the public is not university educated, and of the few that have been, even fewer have taken auditing courses.  More importantly, there is simply no public interest in the work of auditors per se.

    So, after almost 40 years, Deloitte’s Joe Echevarria treats us to yet another dose of the “expectation gap.”  But a question remains…could the Big Four meet the public’s expectation if they really wanted to?  The answer seems to be yes.  In fact, participants at the December 2002 GAO forum (see page 19) on governance and accountability suggested that a “forensic-type” audit might improve the likelihood that auditors will detect fraudulent financial reporting.  A similar call was voiced over 10 years ago in August 2000 by the Public Oversight Board’s Panel on Audit Effectiveness (page x) to “create a ‘forensic-type’ fieldwork phase on all audits.”

    And the Big Four clearly have consulting practice lines to do forensic auditing: Deloitte (Forensic Audit Assistance), E&Y (Fraud Investigation & Dispute Services), KPMG (KPMG Forensic), and PricewaterhouseCoopers (Forensic Services).  So why can’t they (or won’t they) tap these skills to close the expectation gap by giving the investing public what they want?  We know the answer: money!  As long as regulators are willing to accept poor quality audits as adequate oversight, the Big Four have no incentive to increase their service delivery costs to improve audit quality.  Instead, the Big Four have clear incentives to continue reducing their audit efforts (and costs) just as far as the regulators will tolerate.  And don’t forget, the regulators also now protect them from substandard products via the too few to faildoctrine.

    Continued in article

    Bob Jensen's threads on audit firm professionalism ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

     

     


    Another CBS Sixty Minutes Blockbuster (December 4, 2011)
    "Prosecuting Wall Street"
    Free download for a short while
    http://www.cbsnews.com/8301-18560_162-57336042/prosecuting-wall-street/?tag=pop;stories
    Note that this episode features my hero Frank Partnoy

    Sarbanes–Oxley Act (Sarbox, SOX) ---
    http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act

     Key provisions of Sarbox with respect to the Sixty Minutes revelations:

    The act also covers issues such as auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure.

    Sarbanes–Oxley Section 404: Assessment of internal control ---
    http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act#Sarbanes.E2.80.93Oxley_Section_404:_Assessment_of_internal_control

    Both the corporate CEO and the external auditing firm are to explicitly sign off on the following and are subject (turns out to be a ha, ha joke)  to huge fines and jail time for egregious failure to do so:

    • Assess both the design and operating effectiveness of selected internal controls related to significant accounts and relevant assertions, in the context of material misstatement risks;
    • Understand the flow of transactions, including IT aspects, in sufficient detail to identify points at which a misstatement could arise;
    • Evaluate company-level (entity-level) controls, which correspond to the components of the COSO framework;
    • Perform a fraud risk assessment;
    • Evaluate controls designed to prevent or detect fraud, including management override of controls;
    • Evaluate controls over the period-end financial reporting process;
    • Scale the assessment based on the size and complexity of the company;
    • Rely on management's work based on factors such as competency, objectivity, and risk;
    • Conclude on the adequacy of internal control over financial reporting.

    Most importantly as far as the CPA auditing firms are concerned is that Sarbox gave those firms both a responsibility to verify that internal controls were effective and the authority to charge more (possibly twice as much) for each audit. Whereas in the 1990s auditing was becoming less and less profitable, Sarbox made the auditing industry quite prosperous after 2002.

    There's a great gap between the theory of Sarbox and its enforcement

    In theory, the U.S. Justice Department (including the FBI) is to enforce the provisions of Section 404 and subject top corporate executives and audit firm partners to huge fines (personal fines beyond corporate fines) and jail time for signing off on Section 404 provisions that they know to be false. But to date, there has not been one indictment in enormous frauds where the Justice Department knows that executives signed off on Section 404 with intentional lies.

    In theory the SEC is to also enforce Section 404, but the SEC in Frank Partnoy's words is toothless. The SEC cannot send anybody to jail. And the SEC has established what seems to be a policy of fining white collar criminals less than 20% of the haul, thereby making white collar crime profitable even if you get caught. Thus, white collar criminals willingly pay their SEC fines and ride off into the sunset with a life of luxury awaiting.

    And thus we come to the December 4 Sixty Minutes module that features two of the most egregious failures to enforce Section 404:
    The astonishing case of CitiBank
    The astonishing case of Countrywide (now part of Bank of America)

    The Astonishing Case of CitiBank
    What makes the Sixty Minutes show most interesting are the whistle blowing  revelations by a former Citi Vice President in Charge of Fraud Investigations

    • What has to make the CitiBank revelations the most embarrassing revelations on the Sixty Minutes blockbuster emphasis that top CItiBank executives were not only informed by a Vice President in Charge of Fraud Investigation of huge internal control inadequacies, the outside U.S. government top accountant, the U.S. Comptroller General, sent an official letter to CitiBank executives notifying them of their Section 404 internal control failures.
       
    • Eight days after receiving the official warning from the government, the CEO of CitiBank flipped his middle finger at the U.S. Comptroller General and signed off on Section 404 provisions that he'd also been informed by his Vice President of Fraud and his Internal Auditing Department were being violated.
      http://www.bloomberg.com/news/2011-02-24/what-vikram-pandit-knew-and-when-he-knew-it-commentary-by-jonathan-weil.html
       
    • What the Sixty Minutes show failed to mention is that the external auditing firm of KPMG also flipped a bird at the U.S. Comptroller General and signed off on the adequacy of its client's internal controls.
       
    • A few months thereafter CitiBank begged for and got hundreds of billions in bailout money from the U.S. Government to say afloat.
       
    • The implication is that CitiBank and the other Wall Street corporations are just to0 big to prosecute by the Justice Department. The Justice Department official interviewed on the Sixty Minutes show sounded like hollow brass wimpy taking hands off orders from higher authorities in the Justice Department.
       
    • The SEC worked out a settlement with CitiBank, but the fine is such a joke that the judge in the case has to date refused to accept the settlement. This is so typical of SEC hand slapping settlements --- and the hand slaps are with a feather.

    The astonishing case of Countrywide (now part of Bank of America)

    • Countrywide Financial before 2007 was the largest issuer of mortgages on Main Streets throughout the nation and by estimates of one of its own whistle blowing executives in charge of internal fraud investigations over 60% of those mortgages were fraudulent.
       
    • After Bank of America purchased the bankrupt Countrywide, BofA top executives tried to buy off the Countrywide executive in charge of fraud investigations to keep him from testifying. When he refused BofA fired him.
       
    • Whereas the Justice Department has not even attempted to indict Countrywide executives and the Countrywide auditing firm of Grant Thornton  (later replaced by KPMG) to bring indictments for Section 404 violations, the FTC did work out an absurdly low settlement of $108 million for 450,000 borrowers paying "excessive fees" and the attorneys for those borrowers ---
      http://www.nytimes.com/2011/07/21/business/countrywide-to-pay-borrowers-108-million-in-settlement.html
      This had nothing to do with the massive mortgage frauds committed by Countrywide.
       
    • Former Countrywide CEO Angelo Mozilo settled the SEC’s Largest-Ever Financial Penalty ($22.5 million) Against a Public Company's Senior Executive
      http://sec.gov/news/press/2010/2010-197.htm
      The CBS Sixty Minutes show estimated that this is less than 20% of what he stole and leaves us with the impression that Mozilo deserves jail time but will probably never be charged by the Justice Department.

    I was disappointed in the CBS Sixty Minutes show in that it completely ignored the complicity of the auditing firms to sign off on the Section 404 violations of the big Wall Street banks and other huge banks that failed. Washington Mutual was the largest bank in the world to ever go bankrupt. Its auditor, Deloitte, settled with the SEC for Washington Mutual for $18.5 million. This isn't even a hand slap relative to the billions lost by WaMu's investors and creditors.

     No jail time is expected for any partners of the negligent auditing firms. .KPMG settled for peanuts with Countrywide for $24 million of negligence and New Century for $45 million of negligence costing investors billions.

    Bob Jensen's Rotten to the Core threads ---
    http://www.trinity.edu/rjensen/FraudRotten.htm

    Bob Jensen's threads on how white collar crime pays even if you get caught ---
    http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays


    A Very Long Historical Commentary
    "Sarbanes-Oxley and Public Reporting on Internal Control: Hasty Reaction or Delayed Action?" by Parveen P. Gupta , Thomas R. Weirich , and Lynn E. Turner, Accounting Horizons, June 2013, pp. 371-408 ---
    http://aaajournals.org/doi/full/10.2308/acch-50425
    You must be a member of the AAA to access this commentary electronically

    Since its passage, the Sarbanes-Oxley Act of 2002 has been criticized, and praised, by many on numerous grounds and claims. However, no single provision of this law has come under more attack than Section 404, which mandates public reporting of internal control effectiveness by an issuer's management as well as its independent auditors. Even after 10 years, the opposition to the Section 404 internal control requirements has continued to the point where the U.S. Congress through two separate Acts—the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, and the 2012 Jump Start Our Business Startups (JOBS) Act—have permanently exempted the non-accelerated SEC filers and the “emerging growth” issuers with revenues of $1 billion or less from Section 404(b) of the Sarbanes-Oxley Act of 2002. Many of those who oppose the Section 404 requirements rest their claim on grounds that the U.S. Congress acted in haste in mandating the public reporting of internal controls by U.S.-listed companies and that the issue was not well thought out or debated. They also contend that the U.S. Congress acted under pressure because of the public outrage over the bankruptcy filings of Enron and WorldCom. To the contrary, this paper shows that the debate over public reporting of internal control by U.S. public companies is more than six decades old, dating back to the McKesson & Robbins fraud. This paper reviews relevant legislative proposals, bills introduced in both the House and the Senate, regulatory efforts by the SEC, and the recommendations of many commissions set up by the private sector to inform the reader how these efforts were the deliberative precursors to what was eventually codified in Section 404 of the Sarbanes-Oxley Act of 2002.

    . . .

    CONCLUSION

    From the above historical commentary, it is abundantly clear that public reporting on internal control both by an issuer's management and its independent accountants has been the subject of public debate ad nauseam for decades. Every time these issues were raised in one form or the other, both by the legislative branch and the regulatory agencies, they were dismissed due to pressure from groups that were genuinely concerned about the cost/benefit of these reforms and those that in the name of free markets were willing to maintain the status quo and opaqueness in the nation's capital markets. Thus, with the exception of the banking industry, the changes proposed time and time again failed to materialize, while investor losses in trillions of dollars from poor-quality financial reporting continued to pile on from scandal after scandal. In the end, the Enron and the WorldCom frauds pushed the limits of Congress and the Republican President, who saw no choice but to pass the Sarbanes-Oxley Act of 2002 to reestablish investor confidence and to reassert that quality financial reporting is the bedrock of our nation's capital markets. Yes, Section 404 of SOX has been costly to implement for a variety of reasons, yielding many benefits, but it is clearly inaccurate to describe the enactment of the internal control requirement as “hasty.” Rather, it has been debated for decades and in SOX it finally became the law.

     


    "Where There's Smoke, There's Fraud:  Sarbanes-Oxley has done little to curb corporate malfeasance. Therefore, CFOs should implement a range of fraud-prevention measures," by Laton McCartney, CFO.com, March 1, 2011 ---
    http://www3.cfo.com/article/2011/3/regulation_where-theres-smoke-theres-fraud

    As a convicted felon, Sam E. Antar, the former CFO for the now-defunct consumer-electronics chain Crazy Eddie, no doubt has regrets. Among them: he is no longer in the game at a time when corporate fraud is experiencing a resurgence. "If I were out of retirement today, I'd be bigger than Bernie Madoff," he boasts.

    In conjunction with CEO Eddie Antar (his cousin), Sam Antar helped mastermind one of the largest corporate frauds in the 1980s, bilking investors and creditors out of hundreds of millions of dollars. Today, he makes a living lecturing about corporate fraud (and shorting the stocks of companies he thinks may have inflated earnings).

    Antar says that despite the antifraud provisions of the Sarbanes-Oxley Act of 2002 and the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act, it remains as easy today for bad guys, both internal and external, to loot corporate coffers as it was during the Enron and WorldCom days. "Nothing's changed," he says. "Wall Street analysts are just as gullible, internal controls remain weak, and the SEC is underfunded and, at best, ineffective. Madoff only got caught because the economy tanked."

    Antar won't get much of an argument from organizations that monitor corporate fraud. In fact, the consensus today is that financial shenanigans are markedly on the increase. "There's a lot more employee fraud and embezzlement today then there was 10 years ago, and this past year there was much more than a year ago," says Steve Pedneault of Forensic Accounting Services. "People blame the economy, but much of the fraud and embezzlement that's coming to the surface now was in the works for 4 or 5 years before the recession hit."

    Last year, the Committee of Sponsoring Organizations of the Treadway Commission's report on corporate fraud concluded that fraud continues to increase in depth and breadth despite Sarbanes-Oxley; the methods of committing financial fraud have not materially changed; and traditional measures of corporate governance have limited impact on predicting fraud. Median loss due to fraud, based on presence of antifraud controls, 2010No. of fraud cases, based on perpetrator's dept. (2010)

    In other words, same old same old, only worse: in its 2010/2011 Global Fraud Report, risk consulting firm Kroll found that business losses due to fraud increased 20% in the last 12 months, from $1.4 million to $1.7 million per billion dollars of sales. The report, based on a survey of more than 800 senior executives from 760 companies around the world, also found that 88% of the respondents reported being victims of corporate fraud over the past 12 months. If fraud were the flu, this would qualify as a pandemic.

    The most likely targets by industry are financial services, media, technology, manufacturing, and health care. Small and midsize companies are also more vulnerable. "Many of these organizations typically rely on a small accounting department, especially in today's economy," says Pedneault. They simply don't have the resources to catch fraudsters.

    That challenge becomes all the more daunting when one considers the many varieties of fraud that exist. Aside from various forms of embezzlement and outright theft, and the growing risk of information theft (think hackers), two other kinds of corporate malfeasance have come to the fore in recent years: fraud in the business model and fraud in the business process.

    The former is defined by a company selling illegal or worthless wares. "If the pharmaceutical industry sells alleged off-label drugs that have not been approved by the FDA, or the financial-services industry is offering worthless subprime mortgages, that can constitute business-model fraud," says Toby J. F. Bishop, director of the Deloitte Forensic Center for Deloitte Financial Advisory Services.

    Fraud of the business-practice variety, Bishop explains, can range from corporations ignoring or turning a blind eye to environmental or safety laws to the ever-popular practice of engaging in "window dressing" at the end of the quarter.

    An Action Plan With fraud on the rise, and with all parties that could possibly be tempted feeling more pressure to cross the line, how should companies respond? First, the bad news: "Most fraud today is uncovered by whistle-blowers, or by accident — a tip, a rogue piece of mail, or by happenstance," says Tracy L. Coenen, a forensic accountant and fraud investigator who heads up Sequence, a forensic accounting firm.

    In a sense, companies (at least those that are publicly traded) were supposed to self-insure against fraud by implementing, at great expense, the controls framework included in Sarbanes-Oxley. But a framework still requires an enforcer, and at many companies there is none. "There's often no single entity for oversight," says Deloitte's Bishop. "Many companies have no compliance or risk management at all."

    Even when they do, there's the issue of how effective it can be. It's not a job that wins friends and influences fellow workers. "The compliance officer is the most hated person in the company," notes Thomas Quilty, CEO of BD Consulting and Investigations. "Companies often retaliate against them," adds Antar.

    "Compliance staff frequently end up pushing paper [just] so it looks like the company has tried to do the right thing in case there's an investigation," says Coenen. "They're not effective."

    As for what to do, while no one has yet come up with a silver bullet, experts point to seven useful steps that all companies can take:

    Continued in a long article

    "ACCOUNTANTS BEHAVING BADLY," by Anthony H. Catanach, Jr. and J. Edward Ketz, Grumpy Old Accountants, October 3, 2011 ---
    http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/332

    Bob Jensen's fraud updates ---
    http://www.trinity.edu/rjensen/FraudUpdates.htm

    Bob Jensen's threads on professionalism in auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    Ernst & Young --- http://en.wikipedia.org/wiki/Ernst_%26_Young

    From The Wall Street Journal Accounting Weekly Review on January 27, 2012 ---
    http://online.wsj.com/article/SB10001424052970204301404577171531838421366.html?mod=djemEditorialPage_t

    Ernst Chief Seeks Balance as Industry's Woes Add Up
    by: Leslie Kwoh
    Jan 24, 2012
    Click here to view the full article on WSJ.com
    Click here to view the video on WSJ.com WSJ Video
     

    TOPICS: Accounting, Audit Firms, Audit Quality, Auditing, Auditing Services, Fraudulent Financial Reporting, PCAOB, Sarbanes-Oxley Act

    SUMMARY: The article covers an interview with Ernst & Young CEO James Turley. He comments on the change in the accounting profession from being self-regulated to highly regulated, E&Y's performance in regulatory reviews, the performance of the accounting profession following the financial crisis stemming from the burst housing bubble, and the situation E&Y faces through its client Olympus which has admitted to presenting fraudulent financial statements.

    CLASSROOM APPLICATION: The article is useful in auditing classes or other classes covering ethics and prevention of fraudulent financial reporting.

    QUESTIONS: 
    1. (Introductory) What are the accounting "industry's woes" indicated in the title of this article? Base your answer on the article, the related article, and other knowledge you have.

    2. (Introductory) Who regulates the accounting profession? Describe the process of regulatory review of the accounting and auditing profession as you understand it. What have been the recent findings from those reviews at E&Y?

    3. (Advanced) The interviewer asks whether "...accounting firms are scapegoats when clients get into trouble for irresponsible financial practices." Why do you think accounting firms could be considered "scapegoats" in these situations?

    4. (Advanced) Consider Mr. Turley's response to the question above. Why do auditors have a responsibility to "lift confidence in financial reporting"?

    5. (Advanced) In the related video, Mr. Turley states that few companies had to restate financial statements following the financial crises in contrast to the time period around the Enron collapse and resulting crisis. When are companies required to restate financial statements? How does this fact indicate that the accounting profession has functioned well within the time frame of the financial crisis following the burst housing bubble?
     

    SMALL GROUP ASSIGNMENT: 
    E&Y CEO James Turley states that during the 35 years he has worked in accounting, the profession has gone from being self-regulated to being highly regulated. Prepare a timeline of that progress in the accounting profession. Properly cite your sources for this information. (Hint: begin at the web site of the Public Company Accounting Oversight Board (PCAOB) on the web at http://pcaobus.org/About/Pages/default.aspx)

    Reviewed By: Judy Beckman, University of Rhode Island
     

    RELATED ARTICLES: 
    Olympus Casts Spotlight on Accounting
    by Kana Inagaki
    Nov 08, 2011
    Online Exclusive

    "Ernst Chief Seeks Balance as Industry's Woes Add Up," by: Leslie Kwoh, The Wall Street Journal, January 24, 2012 ---
    http://online.wsj.com/article/SB10001424052970203750404577173373289374952.html?mod=djem_jiewr_AC_domainid

    Ernst & Young LLP and its fellow auditors have spent some uncomfortable time in the spotlight.

    The company has been under scrutiny since October for its role in the $1.7 billion accounting scandal at Olympus Corp. A panel appointed by Olympus cleared Ernst & Young and KPMG Azsa LLC of any wrongdoing last week, but Japanese regulators continue to investigate the matter.

    Meanwhile, a U.S. watchdog said in December it found deficiencies in one-fifth of the audits it inspected at Ernst & Young as part of a broader inspection that found flaws at all the Big Four audit firms. The privately held company is also still fighting a 2010 lawsuit filed by the New York attorney general's office alleging it helped Lehman Brothers Holdings Inc. hide its financial woes before the bank's 2008 collapse.

    Chairman and Chief Executive James Turley remains optimistic about Ernst & Young's global prospects. Last year, Mr. Turley steered the firm toward growth across its tax, assurance and advisory services, with strong results in Brazil, India, Africa and China. Global revenues for the privately owned partnership rose to $22.9 billion for the 2011 fiscal year ending last June, from $21.3 billion a year earlier.

    It is a bittersweet end to a decade-long run for Mr. Turley, who plans to retire in June 2013 after joining the company 35 years ago as a fresh graduate of Rice University. He will be succeeded by Mark Weinberger, who runs Ernst & Young's global tax practice.

    The 56-year-old CEO recently talked to The Wall Street Journal about the responsibility of accounting firms and what should be done to regulate the profession. Edited excerpts:

    WSJ: Has the nature of the accounting profession changed in the last few years?

    Mr. Turley: I've been in the profession some 35 years now, and it's changed a lot during those times, from capital market requirements, to the responsibility we have to investors, to how we work with independent audit committees. When I started, this was a self-regulated profession. Today, we're highly regulated.

    WSJ: In December, the government's auditing-oversight board said it found 13 deficiencies in 63 audits at Ernst & Young, and identified flaws at all Big Four firms. Was this a matter of oversight?

    Mr. Turley: This was a matter of execution. It's a matter of us now analyzing the root causes of [flawed audits] and figuring out how we continue to improve our performance in delivery of audits. It's a matter we take extraordinarily seriously and work closely with our regulator in this country, the PCAOB [Public Company Accounting Oversight Board], to continue to improve.

    WSJ: Ernst & Young's Japanese arm, Ernst & Young ShinNihon LLC, is still being investigated over its role as an auditor in the Olympus accounting scandal. What's the latest?

    Mr. Turley: I can't say much about a matter that's in the process of being analyzed. But you should understand that in this two-decades-long issue at Olympus, we arrived on the scene about a year ago. So we came in pretty late in the game.

    WSJ: Ernst & Young has been caught up in a string of litigation involving clients including HealthSouth and Lehman Brothers. How do you maintain stability?

    Mr. Turley: We're in a very litigious world, and inevitably, when a company of any type fails or has any problems, one of the Big Four accounting firms typically has been delivering that work. So we, like all our competitors, have matters of litigation. Our people understand that.

    WSJ: Do you think accounting firms are scapegoats when clients get into trouble for irresponsible financial practices?

    Mr. Turley: We have a responsibility to do everything we can to lift confidence in financial reporting. That doesn't mean we get it right every time. But in any kind of a crisis, like the world has gone through, they're trying to point fingers. We all wish—we in this profession, we in society—we could have seen around the corner and seen that housing prices were going to tumble, liquidity challenges were going to come. Unfortunately, no one saw that, and we couldn't see around the corner any better than anyone else.

    WSJ: What else can be done to improve the quality and transparency of accounting?

    Mr. Turley: More trend information, more qualitative information, more key performance indicators from companies. Right now, we're essentially asked to give an on-off switch on how we feel about a set of financial statements. Are there different ways to communicate with investors that would be more informative?

    WSJ: Ernst & Young is now in more than 140 countries. In which markets do you see the most promise and growth?

    Mr. Turley: Last year or so, our fastest-growing market was Brazil. We continue to see great growth in both China and Southeast Asia. India and Eastern Europe, especially Russia, continue to perform very well. We're seeing strong growth in actually all of our businesses now, and in most of our geographies. Europe is the most challenged, because of the aftermath of the ongoing crisis that you read about every day.

    WSJ: What do you plan to do after you retire?

    Mr. Turley: I haven't any idea at this point. Most people I talk with who are retired would say don't make any decisions too fast.

    Continued in article

    Bob Jensen's threads on Ernst & Young ---
    http://www.trinity.edu/rjensen/Fraud001.htm  

     

     


    "Big four auditors face breakup to restore trust," by Huw Jones, Reuters, November 30, 2011 ---
    http://in.reuters.com/article/2011/11/30/eu-auditors-idINDEE7AT0CQ20111130

    The world's top four audit firms will have to split up and rename themselves under a far-reaching draft European Union law to crack down on conflicts of interest and shortcomings highlighted by the financial crisis.

    "Investor confidence in audit has been shaken by the crisis and I believe changes in this sector are necessary," Internal Market Commissioner Michel Barnier said on Wednesday.

    Large auditors said the plans won't improve audit quality, while smaller rivals accused Barnier of a climbdown.

    Policymakers have questioned why auditors gave a clean bill of health to many banks which shortly afterwards needed rescuing by taxpayers as the financial crisis began unfolding.

    Barnier said recent apparent audit failures at AngloIrish and Lehman Brothers banks, BAE Systems and Olympus "would strongly suggest that audit is not working as it should".

    More robust supervision is needed and "more diversity in what is an overly concentrated market, especially at the top end", he said.

    Just four audit firms -- Ernst & Young ERNY.UL, Deloitte DLTE.UL, KPMG KPMG.UL, and PwC PWC.UL -- check the books of 85 percent of blue-chip companies in most EU states, a situation the Commission said was "in essence an oligopoly".

    UK data shows the Big Four profit margins are 50 percent higher than the next four audit firms, the commission said.

    Under Barnier's plan, the four top firms will have to separate audit activities from non-audit activities, such as tax and other advisory services -- "to avoid all risks of conflict of interest".

    REBRANDING

    There would have to be legal separation of audit and non-audit services if over a third of revenues from auditing is from large listed companies and the network's total annual audit revenues are more than 1.5 billion euros in the EU.

    Claire Bury, one of Barnier's top officials, said these conditions, if approved by EU states and the European Parliament, would alter all the Big Four's business models and even one or two of the next tier down in some member states.

    Continued in article

    "European Commission Proposal will Hurt Audit Quality, says PwC," by Michael Foster, Big Four Blog, December 1, 2011 --
    http://www.big4.com/pricewaterhousecoopers/big4-com-exclusive-european-commission-proposal-will-hurt-audit-quality-says-pwc -

    In an exclusive interview with Big4.com, PwC Director of Global Communications Mike Davies insisted that the recent European Commission proposal to tighten auditing restrictions would lower auditing quality throughout the European Union.

    While PwC supports some of the ideas in the legislation proposed by EU Financial Services Commissioner Michel Barnier, Davies suggested that the restrictions go too far. Calling some of Barnier’s proposals “radical measures”, Davies told me that PwC is happy with the status quo. “We believe the audit market is already pretty competitive,” Davies said, adding that there are already “checks and safeguards in place and provisions about what you can and can’t provide to auditing clients”.

    At the same time, Davies acknowledged that steps could be taken to allow smaller auditing firms to compete with the Big4 firms such as PwC. “There’s always more that can be done in terms of how the market operates and how to get smaller firms to increase their share,” he added.

    However, Barnier and supporters of the EC proposal disagree. The commissioner’s final green paper pursued new rules that would make it illegal for firms to offer consulting services to auditing clients. This would essentially force the Big4 firms to split into separate consulting and auditing companies, which some believe is Barnier’s ultimate goal.

    Additionally, the new European legislation would require accounting firms to have a “cooling-off” period of several years before they could offer auditing services to the same clients. This practice, known as “firm rotation”, would require companies to hire more than one auditing company over a long period of time.

    While the legislation hopes that firm rotation would help remove conflicts of interest, Mike Davies insists that it would lower the quality of audits performed by all firms. “It would actually be detrimental to audit quality,” Davies said, adding that “there are quite a number of people who support our point of view.”

    Continued in article

     

    December 1, 2011 reply from Robert Bruce Walker in New Zealand

    What is set out below is a simulated scenario which discusses audit in New Zealand. I prepared the question for one of my staff who was doing the NZICA foundation course for admission. It just so happens that one of the topical issues she was preparing for arose from the recent enactment of the Audit Regulation Act.

    Interestingly the last issue of the Chartered Accountants Journal discussed this law change. The head of assurance a NZ EY (Simon O’Connor) wrote a very thoughtful piece in which he said, not in so many words: The big four will not even notice the change as they are already dealing with similar pieces of legislation overseas. He then said that all other firms will struggle, leaving the field open to the Big 4 in all spheres of audit. Essentially the cartel is complete – no other practitioner will be able to offer audit. Simon then went on to discuss the ‘audit expectation gap’ – the idea that an audit is much more modest in its ambition than the market expects – and makes a plea for proportionate sharing of responsibility upon failure. But he would say that, wouldn’t he?

    I have based my model answer on Simon’s analysis. As you will see it is very pessimistic. I consider audit a core skill of the accountant. Whilst it may be immodest of me to say so, I consider I could audit any entity providing I could build a team big enough.

    As I keep saying the fracture lines in our discipline are readily apparent. It reminds me of the engineer, being questioned yesterday at a commission of inquiry into the Christchurch earthquake, who said he didn’t think that the cracks in the building were very significant when he examined the building between the first earthquake and the killer. It fell down and killed 18 people.

    Question

    You are the technical director for a small to medium sized firm of accountants. The firm has 20 partners. Most of the services its sells is business advisory services. However, there is one full time audit partner and two other part time auditors who have a mix of government, not for profit and issuer audit clients. The issuers are about four in number, none of which is a listed company. They are involved in the wine and forestry industries. The firm does not have an international relationship with a global firm.

    About 50% of your workload is directly associated with the provision of auditing and financial reporting advice to the audit practice.

    You have told the managing partner that there are significant changes in the practice of audit. Having told her she becomes concerned about the firm’s involvement in the provision of audit services. She asks you to prepare a memorandum for the firm’s partners explaining the nature of the changes with a recommendation of what should be the strategic focus of the firm in this regard.

    The memorandum must contain the following:

    § An outline of the changes taking place.

    § The impact on the firm of those changes.

    § A recommendation as to what the firm should do.

    Memorandum

    To the Partners of XYZ

    Audit regulation and the future of auditing in the firm

    Introduction

    The purposes of this memorandum are to:

    § Provide a briefing on legislative changes that have taken place in the respect to audit and related matters.

    § Outline the implications for the firm and what its strategic response should be.

    Background

    In the field of auditing there have been two developments that will fundamentally change the practice of audit.

    Firstly, it became clear in the aftermath of the finance company collapses that audit has not performed the role which is expected of it. This is not really attributable to the so called ‘expectation gap’. There was true failure. The finance companies had taken enormous and unsustainable risks, and with the rotten balance sheets that ensued, continued to raise money from the public. Unfortunately, most, but not all, finance companies were audited by mid-tier and small accounting practices.

    Secondly, there has been a trend, since the failure of Enron, for overseas jurisdictions to establish quasi- governmental bodies to regulate audit and, in doing so, the responsibility for this regulation has been wrested away from the professional accounting bodies. The most obvious example is the Public Company Accounting Oversight Board created under the Sarbanes Oxley Act in the US. Other countries have followed this model.

    A related development has been the foundation of the External Reporting Board (XRB) under the Financial Reporting Act 1993. With the introduction of IFRS the Government established this organisation to ensure that New Zealand’s voice is heard in global standard setting process. XRB’s remit is not restricted to financial reporting standards. It also has responsibility for developing and giving legal effect to auditing standards as well.

    Legislative change

    The Government has perceived the need to respond to the crisis in auditing caused by the finance company collapses by enacting the Audit Regulation Act 2011 (ARA). This piece of legislation also has the added advantage, from the Government’s perspective, of aligning New Zealand practice with that of Australia. Those who practice audit will be inter-changeable across the Tasman, an objective consistent with long term policy to ensure the Australian and New Zealand markets operate as one.

    The ARA will establish a system of licensing of auditors under the auspices of the newly established Financial Markets Authority (FMA). It is important to understand that licensing will only apply to the audit of issuers. However, as will be seen below, the mere fact of licensing will have implications beyond the audit of issuers.

    The ARA does not specify the details of the licensing regime to be implemented. This has been delegated to the FMA and consultation is about to take place. Currently, the proposal is that enforcement, in respect to New Zealand chartered accountants at least, will remain with NZICA’s practice review process. The FMA will retain oversight and check on NZICA’s process to ensure the necessary standard of quality.

    The ARA envisages three possible punitive measures in the event of audit failure. These are licence restriction, suspension or cancellation.

    For any firm wishing to be licensed it will need to overcome two hurdles:

    § The grant of licence in the first instance.

    § The maintenance of licence across time as tested by the practice review process.

    The exact criteria have not yet been established. However, it is a safe bet that the criteria will be based on the principles in the Code of Ethics. Our firm is not likely to have difficulty with most of these principles. We will generally be able to demonstrate independence and integrity. Where I believe we may encounter difficulty is in the area of competence, or at least the perception of competence.

    As you will all be aware the Institute’s practice review has cast a very critical eye over our audit practice in the last two visits. The Institute seems to believe that unless a member is fully engaged in audit, he or she cannot ensure they have the necessary technical knowledge to effectively conduct audit. Further, the Institute seems to believe that there is a need for a critical mass of auditors to ensure the requisite internal oversight.

    A second factor that we would need to consider is that we will be compared, if only by implication, to the representatives of large international audit firms. These organisations benefit by having audit systems developed in much larger jurisdictions where the firms have the critical mass to develop more and more sophisticated audit approaches to align with developments in audit standards. These systems are transferred into New Zealand at basically no cost to the local firms.

    A third factor is the continuing development of audit standards themselves. With the advent of the XRB a new set of audit standards is being introduced, based on international models. To illustrate the level of complexity that entails it is to be noted that the number of ‘black letter’ standards under the NZICA audit standards is about 200, yet the new audit standards have over 500.

    A fourth factor that needs to be considered is the fracture line that has opened up or will open up in the financial reporting framework. With the introduction of IFRS there has been a realisation that these standards are too complex for general application amongst the closely held companies that are the mainstay of our practice. It seems to be official policy that differential adjustment is not possible. In consequence it is proposed that there be an entirely new framework of standards for application to the closely held company. In other words, it may gradually be the case that the opportunities for ‘cross-fertilisation’ from knowledge of full IFRS to financial statements of the bulk of clientele will diminish to a significant degree.

    Implications for our firm

    Our firm will, in short order, be confronted by a stark choice: do we attempt to continue to provide audit services to issuers or do we make a strategic decision to abandon this service?

    It first needs to be noted that licensing applies only the audit of issuers. Our audit clientele extends beyond the audit of issuers to delegated audit from Government and to the audit of not-for-profit entities such as charities, incorporated societies and the like. It will still be possible to provide audit services to organisations of that ilk. However, to practice without the benefit of a license will eventually limit our ability to compete in all audit markets. For example, how long will it take for the Auditor-General to restrict sub-contract to those with a licence even if that does not become official policy?

    The more immediate problem becomes whether or not we attempt to secure licences for some or all of our partners engaged in the provision of audit. To secure a licence it is clear that we will need to take steps to demonstrate competence. This matter has two dimensions to it.

    First, it is likely that there may be more issuer clients that become available as firms similar to ours abandon audit. There must, therefore, be a strategic opportunity available. However, we will have to compete with large firms for this market and there is no doubt that they will price keenly or the reasons given above – that is, they already have the systems in place. It is my calculation that unless we expand the number of issuers we audit, we will not be able to satisfy the Institute that we have the necessary continuing experience to prove competence.

    Second, if we were to take that strategic decision we will need to acquire the necessary audit systems to enable competence to be demonstrated. We can acquire such systems in one of two ways:

    § By developing them ourselves.

    § By joining some sort of co-operative that enables us to acquire those systems relatively cheaply.

    Whilst I have not scoped it out, my instinct is that the investment necessary to develop and continually up-grade an appropriate audit system is beyond us. And if it is not beyond us, it is likely to be a poor investment choice given the competitive nature of the audit market.

    The only alternative, therefore, is to join some international organisation and get the benefit of overseas developments in audit method and in overseas work opportunities for our partners and staff. Again, even if such opportunities are available, I doubt that it would be a costless decision. More importantly, if we did take that strategic decision we would need to be very careful about the company we would keep. There would be potential for reputational risk and, more importantly, financial risk that it would be difficult for us to manage.

    The only other matter that I think relevant is that at some point in the future there will be a realisation that ‘one size does not fit all’ with respect to audit such as prevails now in respect to financial reporting. If we abandon audit now we may not be in a position to re-enter the market if and when a ‘cut down’ audit process is developed for the smaller organisations that our practice currently specialises in. However, as no such regime is even proposed we would have to wait too long for such an opportunity even if it arises.

    Conclusion

    On balance I do not think it is cost effective for our firm to continue to offer audit services. My reasons for arriving at this conclusion are:

    § Audit practice, as expressed through audit standards, has become extremely complicated.

    § As matters stand, our firm would have difficulty demonstrating the necessary competence to obtain and maintain a licence to audit issuers.

    § Without a licence our ability to persuade existing and future non-issuer audit entities that we have the necessary skill and reputation will diminish significantly.

    § To maintain a licence we would need, one way or the other, to invest heavily in audit systems.

    § The market is not likely to be sufficiently lucrative to justify this investment as we would be competing with much larger organisations which have a better ‘economies of scale’ than we are likely to have.

    § The benefits to ‘corporate knowledge’ of practice of audit, in terms of financial reporting, might cease to exist in the near future.

    § There may come a time when there will be a differential audit regime suitable to our firm but this has not been mooted and we may need to wait too long for it to happen.

    Recommendation

    It is recommended that:

    1. The firm make a decision to not apply for an issuer audit licence under the Audit Regulation Act.

    2. The firm gradually disengage from its audit practice across all types of entity.

    Robert B Walker
    National Technical Director

    Audit Firm Rotation Every 25 Years?
    Just about long enough to pay off the house mortgages and raise a couple kids before starting over in a new town.
    Should we do the same thing for tenured professors?

    "EU lawmaker proposes ditching core parts of auditing shake up," by Huw Jones, Reuters, September 6, 2012 ---
    http://www.reuters.com/article/2012/09/06/us-eu-auditors-idUSBRE88512J20120906

    Core elements of a proposed European Union shake up of rules governing company auditors should be ditched, an influential member of the bloc's parliament suggested, in a move that is likely to delight the "Big Four" auditors and Britain.

    The EU's executive, the European Commission, authored the draft law to inject more competition into a market where Deloitte, KPMG, PricewaterhouseCoopers and Ernst & Young check the books of most top companies in the world.

    It proposed requiring the EU's 8,000 listed companies to switch auditor every six years and introduce caps on market share that would force the Big Four to split up into separate "pure audit" and advisory companies in some EU states.

    Sajjad Karim, the British centre-right lawmaker who is steering the reform through the parliament, said in his report published on the assembly's website on Thursday that a company should be allowed to keep the same auditor for up to 25 years.

    Market share caps that would trigger splitting up the big auditors should be scrapped outright, he said.

    He proposes that auditors should be banned from offering a much narrower range of services to a client being audited so that, for example, tax consulting would be allowed.

    Karim wants to scrap the proposal for the European Securities and Markets Authority (ESMA) to develop a "Quality Certificate" for auditors so that companies have fewer worries about using less known auditors.

    He will present his report to parliament's legal affairs committee on September 18 and is likely to face stiff opposition from Liberals and socialists.

    The European Parliament and EU countries have the final say and changes are expected as the approval process continues.

    Some suspect Karim has taken an extreme stance to open the door to a final deal that would probably still be a dilution compared with the original text.

    The reform has pitched smaller audit firms like Grant Thornton, Mazars, RSM and BDO International against the Big Four, who have campaigned hard to water down the measure.

    The Big Four question why smaller firms should be given a regulatory leg-up to build up market share. Smaller auditors say it will not be worth investing in expanding networks unless there is a realistic prospect of more work for them.

    "The draft does not address investor concerns in non audit services, long auditor tenure and the market structure," said Nick Jeffrey, a director at Grant Thornton.

    Separately, the EU is also waiting to see what changes, if any, Britain's Competition Commission will make in its probe of the UK audit market where the Big Four dominate.

    The UK anti-trust watchdog will publish preliminary findings in November.

    Britain is skeptical about the EU measure, believing market structure should be left to anti-trust bodies and that mandatory rotation of auditors is not the answer to boosting competition. It is also leery of giving EU regulator ESMA oversight powers.

    Jensen Comment
    When the Social Security age is raised to 75, both an auditor and a tenured professor could have three tours of duty before retiring. Maybe they could even wear combat tour ribbons on their chests like they do on military uniforms.

    "PCAOB Chair takes aim at auditors' controls testing and says mandatory rotation could be difficult," Reuters, November 11, 2011 ---
    http://www.reuters.com/article/2011/11/11/us-auditor-watchdog-doty-idUSTRE7A95XQ20111111

    Auditors are not properly testing U.S. companies' internal accounting controls, the head of the main auditor watchdog said, while also reiterating urgent concerns about audit firm inspections in China.

    Internal controls on books and records -- a requirement imposed on corporations by 2002's post-Enron Sarbanes-Oxley laws to combat accounting fraud -- are not being properly tested by outside auditors, Public Company Accounting Oversight Board (PCAOB) Chairman James Doty said on Thursday.

    "This is a very major issue for us," Doty told Reuters on the sidelines of a securities regulation conference.

    Internal control rules for ensuring the adequacy of accounting record-keeping and checks were among the costliest changes mandated by Sarbanes-Oxley, often requiring sophisticated electronic systems and detailed audits.

    Auditors are supposed to gain an understanding of the controls put in place by companies and test them, but "some auditors are just taking the business process that the company has put in place as a control," Doty said.

    Touching on another key issue for his group and auditors, Doty said the PCAOB needs to gain entrance soon to China to inspect firms that audit U.S.-listed companies.

    "We are not talking about something that should happen three years from now. It needs to happen now," he said.

    PRESSING CHINESE REGULATORS

    A meeting planned for October between U.S. and Chinese regulators to talk about inspections was canceled by the Chinese, possibly because of leadership changes at their regulatory body, Doty said.

    Late last month, China announced the appointment of Guo Shuqing as the new head of the China Securities Regulatory Commission, in a reshuffle of key financial regulators.

    The PCAOB and the U.S. Securities and Exchange Commission have been encouraging the new CSRC chairman to resume talks over inspections, Doty said.

    The PCAOB negotiated agreements this year to inspect audit firms in the United Kingdom, Switzerland and Norway, but Chinese regulators have resisted U.S. inspections on the grounds that it would infringe on their authority.

    The PCAOB is struggling over whether audit firms in China should lose their U.S. registration if that country does not allow inspections of its auditors, Doty said.

    "It is not something we want to have happen," he said.

    SEES PROBLEMS WITH TERM LIMITS

    In a speech at a Practicing Law Institute conference, Doty indicated a controversial proposal to require term limits for audit firms to increase their independence could be difficult to put into practice.

    "I recognize now that audit firm rotation presents considerable operational challenges," he said.

    The PCAOB in August issued a "concept release," or initial report, on rotation, the first step in drafting changes in auditor standards. It is seeking comments on the proposal through December 14.

    Considered as early as the 1970s, audit firm rotation has been strongly opposed by audit firms, which would lose some of their most lucrative clients if it went into effect.

    Sarbanes-Oxley mandated that lead auditors be switched every five years, but put no term limits on audit firms.

    Continued in article

    Bob Jensen's threads on professionalism and independence in auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

    Proof is a dangerous word in most any academic discipline except mathematics
    "Proof That Auditor Rotation is a Good Idea"

    As a PhD from an outstanding university (Virginia Tech), David should know better than to use the word "proof" so inappropriately
    However, his Web searches did turn up a rather surprising endorsement of the PCAOB's audit firm rotation proposal
    That endorsement comes from the U.S. Chamber of Commerce.

    I find that surprising since audit firm rotation, unlike the downsizing of the Big Four into more global audit firms that are more competitive, this audit firm rotation among today's largest firms can only increase the costs of auditing of the clients represented by the U.S. Chamber of Commerce. Those clients have tended to despise SarBox for increasing the costs of auditing.

    "Proof That Auditor Rotation is a Good Idea," by David Albrecht, Summa, December 1, 2011 ---
    http://profalbrecht.wordpress.com/2011/12/01/proof-that-auditor-rotation-is-a-good-idea/

    "European Commission Proposal will Hurt Audit Quality, says PwC," by Michael Foster, December 1, 2011 --
    http://www.big4.com/pricewaterhousecoopers/big4-com-exclusive-european-commission-proposal-will-hurt-audit-quality-says-pwc -


    To the Point: PCAOB public meeting on auditor independence and audit firm rotation

    More than 40 panelists participated in the PCAOB public meeting to discuss ways to enhance auditor independence, objectivity and professional skepticism, including mandatory audit firm rotation. Many of the panelists opposed mandatory audit firm rotation and suggested alternatives. The Board also reopened the comment period on its August 2011 concept release until 22 April 2012.

    The attached To the Point provides highlights of the two-day meeting. It is also available online.

     

    What you need to know

    • Panelists expressed support for efforts to further improve audit quality and enhance auditor independence, objectivity and professional skepticism.

    • There was consistent recognition that audit quality has improved since the implementation of the Sarbanes-Oxley Act of 2002 (the Act) and that the PCAOB should consider strengthening the existing structure created by the Act.

    • Views were mixed on the costs and perceived benefits of mandatory audit firm rotation, but nearly all parties supported enhancing audit committees and improving transparency and communications between auditors, audit committees, the PCAOB and shareholders.

    • The PCAOB reopened the comment period on its concept release on enhancing auditor independence, objectivity and professional skepticism until 22 April 2012.

    Overview
    More than 40 panelists participated in a public meeting hosted by the Public Company Accounting Oversight Board (PCAOB or Board) to discuss ways to enhance auditor independence, objectivity and professional skepticism, including mandatory audit firm rotation. The meeting followed a concept release the PCAOB issued in August 2011 (the Concept Release).

    The panelists included institutional investors, former government officials, audit committee chairs of major corporations, senior executives of issuers, representatives from trade associations, academics and senior leaders of audit firms. Many of the panelists were among the more than 600 people who submitted comment letters on the Concept Release.

    More than 90% of the letters opposed mandatory audit firm rotation.

    For further information on related topics, see our AccountingLink site.

    Bob Jensen's threads on professionalism and independence in auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

    Jensen Comment
    In my opinion audit firm rotation will turn auditors into nomads and destroy the auditing profession as the best students turn to other professions that do not require family living in motor homes and tents.


    "Business groups ask PCAOB to drop mandatory audit-firm rotation proposal," CFO Journal, April 20, 2012 ---
    http://blogs.wsj.com/cfo/2012/04/20/business-groups-forget-mandatory-auditor-rotation/tab/print/


    David Albrecht finds humor in audit firm rotation "with a twist" --- "
    http://profalbrecht.wordpress.com/2012/04/01/pcaob-proposes-auditor-rotation-with-a-twist/


    "How to Put More Distance Between Banks and Their Auditors," by Francine McKenna, Forbes, March 26, 2012 ---
    http://www.americanbanker.com/bankthink/PCAOB-mandatory-auditor-rotation-1047814-1.html

    Mandatory rotation of a company's external auditors is not a popular idea among the audit firms or their clients.

    The Public Company Accounting Oversight Board, the audit industry regulator, sought input last week from investors, auditors, academics and former regulators on a controversial "concept release" on the idea. More than 45 speakers gave their opinions of various ways to put rotation into practice. All of the suggestions made were intended to improve auditor independence, professional skepticism and, hopefully, audit quality.

    PCAOB Chairman Jim Doty opened the meetings this week with the admission that fixed term limits for auditor relationships "would significantly alter the status quo." That is an understatement. The PCAOB received more than 600 comment letters, almost all in opposition to mandatory rotation.

    Audit committee members object to such mandates because of the perceived cost. They also accuse the PCAOB of trying to usurp the enhanced role and responsibilities delegated to audit committees by the Sarbanes-Oxley Act. Audit firm CEOs say mandatory rotation would distract them from audit quality assurance and force the partners to focus on responding to constant requests for proposals and marketing activities. The auditor firms would rather collect oligopolistic fees from a government-mandated franchise without having to compete or justify those fees.

    Some company representatives claim they would have to spend too much time and money getting new auditors up to speed on company culture and complex customized systems. Academics and former regulators, politically sensitive when in doubt, are divided on the advantages and disadvantages of mandatory auditor swaps.

    Data firm Audit Analytics says that about 175 companies in the S&P 500 have used the same auditor for 25 years or more. The average tenure for audit firms at the top 100 U.S. companies by market cap is 28 years and 20 of those companies used the same auditor for 50 years or more.

    Inertia is in evidence among the largest banks. In 2010, Citigroup (or rather the U.S. Treasury, which still owned 27% of the bank’s stock at the time), reappointed KPMG to its 41st consecutive year as auditor. JP Morgan Chase and Bank of America have both been using PricewaterhouseCoopers for a while, since 1965 and 1958 respectively. KPMG has been working with Wells Fargo since 1931.

    And cozy ties between auditor and audited have an inglorious history. Consider that Ernst & Young had audited Lehman Brothers since before it was spun off from American Express in 1994, right up until the investment bank failed in 2008. Three of four chief financial officers at Lehman Brothers since 2000 were Ernst & Young alumni, including David Goldfarb, a former senior partner of the audit firm, who as Lehman’s CFO concoted the infamous Repo 105 balance sheet window-dressing technique.

    But I'm not in favor of mandatory auditor rotation, in particular for the big banks. That's not because it costs too much or disrupts the company. Good corporate governance costs money and that’s a cost of doing good business.

    Upsetting the relationships between banks and their auditors is, unfortunately, very disruptive to audit firms because of independence requirements. Rotation may force an audit firm to move all accounts, lines of credit, and other funding facilities to another bank. SEC rules prevent auditors from doing business with the bank that holds partner and firm money.

    Moreover, I oppose mandatory auditor rotation because it's too much like term limits for elected officials. Both allow abdication of the responsibility for booting bad actors. And it’s an exercise in futility. Companies would be forced to move their audit from one potentially corruptible audit firm to another.

    One of the speakers at the PCAOB forum last week, James Alexander, the head of equity Research at M&G Investment Management (a division of the U.K. life and pensions company Prudential PLC), said the implied guarantee by sovereigns for the too-big-to-fail banks means investors already depend more on regulators than audits to reassure them banks are safe and sound. In essence, for some banks, "audits don’t matter."

    Large banks went down the drain during the crisis with no warning or "going concern" qualification from the auditors prior to the failure, bailout, or nationalization. In the U.K., the CEOs of the four largest audit firms told the House of Lords that they held back on "going concern" qualifications for failing banks because the auditors were told the government would bail out the banks.

    Continued in article

     

    "Auditor Rotation and Banks: If It Makes You Happy…," by Francine McKenna, re:TheAuditors, March 26, 2012 ---
    http://retheauditors.com/2012/03/26/auditor-rotation-and-banks-if-it-makes-you-happy/


    Question
    What will be the major drawback of the Congressional proposal to ban audit firm rotation mandates?

    Answer
    Many jobs will be lost because tens of tens of thousands of auditors will not have to buy new motor homes for their families to live in.

     

    From The Wall Street Journal Accounting Weekly Review on March 30, 2012

    Auditor 'Rotation' Debate Heats Up
    by: Michael Rapoport
    Mar 28, 2012
    Click here to view the full article on WSJ.com
     

    TOPICS: Auditing, Auditing Services, Auditor Changes, Public Accounting

    SUMMARY: "Congress is poised to wade into the debate over 'term limits' for audit firms, in a move that has some proponents worried that the business community may be throwing its weight around to block a significant overhaul." The draft of a bill will be discussed in a House subcommittee on Wednesday, March 28, 2012.

    CLASSROOM APPLICATION: The article is useful to discuss ethics and public accounting business management as well as the Public Company Accounting Oversight Board (PCAOB), most likely in an auditing class.

    QUESTIONS: 
    1. (Advanced) What is the Public Company Accounting Oversight Board (PCAOB)? What is its responsibility with respect to the auditing profession?

    2. (Advanced) What has the PCAOB proposed in regards to auditor rotation?

    3. (Introductory) As described in the article, what are the arguments in favor of the PCAOB's proposal?

    4. (Introductory) What are the arguments against this proposal?

    5. (Introductory) What course of action are some members of Congress considering in relation to audit partner rotation?
     

    Reviewed By: Judy Beckman, University of Rhode Island

     

    "Auditor 'Rotation' Debate Heats Up," by: Michael Rapoport, The Wall Street Journal, March 28, 2012 ---
    https://mail.google.com/mail/?shva=1#inbox/13662348b23d75bf

    Congress is poised to wade into the debate over "term limits" for audit firms, in a move that has some proponents worried that the business community may be throwing its weight around to block a significant overhaul.

    A draft bill expected to be discussed at a House subcommittee hearing Wednesday would block regulators from requiring that companies change their outside auditors regularly. The move would be a pre-emptive strike against the Public Company Accounting Oversight Board, the government's audit-industry regulator, which is considering so-called rotation as a way of ensuring auditors don't get too cozy with their clients.

    Some supporters of rotation believe prominent opponents, like the accounting industry and the U.S. Chamber of Commerce, have enlisted Congress to come to their aid. Some big accounting firms and the chamber have lobbied Congress on the issue or are major campaign contributors to the congressmen involved with the draft bill, according to trackers of campaign finance and lobbying reports.

    "The business community has enormous resonance with this Congress," said former Securities and Exchange Commission Chairman Arthur Levitt, who supports rotation and spoken out in favor of it. Along with legislation easing corporate-governance rules for new public firms, blocking auditor rotation "would be a further erosion of investor protection," he said.

    PricewaterhouseCoopers LLP, one of the Big Four accounting firms, says it hasn't asked Congress to weigh in even though the firm opposes rotation. But "we recognize that others may have different opinions about how best to engage the PCAOB," said Laura Cox Kaplan, the firm's leader for U.S. government and regulatory affairs.

    The chamber, the board and the other Big Four firms—Ernst & Young LLP, KPMG LLP and Deloitte LLP—declined to comment or didn't provide comment.

    In testimony prepared for Wednesday's hearing, however, chamber official Tom Quaadman supports a congressional ban, contending that rotation is "a matter of corporate governance outside of the PCAOB's realm."

    A PCAOB spokeswoman said the Sarbanes-Oxley corporate-overhaul law gives the board authority over auditor-independence issues, subject to SEC approval.

    The board is exploring whether companies should have to change audit firms every several years and doesn't expect to make a decision on the issue until next year. Last week it held a two-day meeting to hear views on the issue.

    If enacted, rotation would break up auditor-client relationships that in some cases have lasted decades. Supporters say rotation would improve auditor independence and lead to more healthy skepticism among auditors in evaluating a company's books. Critics say it would raise audit costs and deprive a company of a long-tenured auditor's institutional knowledge.

    The draft bill to be discussed Wednesday would prohibit the board from requiring the use of "different auditors on a rotating basis." The bill, sponsored by Rep. Michael Fitzpatrick (R., Pa.), hasn't yet been introduced. But a draft of the measure is featured on the web page announcing Wednesday's hearing by the House Financial Services Committee's capital-markets subcommittee, and the panel has invited witnesses at the hearing to comment on it.

    According to data from the Center for Responsive Politics, which tracks campaign finance, Rep. Fitzpatrick has gotten major contributions from PricewaterhouseCoopers and Deloitte during the 2012 election cycle. PwC is his 10th-biggest contributor throughout his career in Congress, and the accounting industry has given him a total of $108,779 over his entire career.

    Continued in article


    "Big four auditors face breakup to restore trust," by Huw Jones, Reuters, November 30, 2011 ---
    http://in.reuters.com/article/2011/11/30/eu-auditors-idINDEE7AT0CQ20111130

    Bob Jensen's threads on professionalism and independence within auditing firms ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

    "Audit Reform in the European Union -- Michel Barnier Delivers A Holiday Turkey," by Jim Peterson, re:TheBlance, December 5, 2011 ---
    Click Here
    http://www.jamesrpeterson.com/home/2011/12/audit-reform-in-the-european-union-michel-barnier-delivers-a-holiday-turkey.html

    . . .

    What explains Barnier’s inability to grasp the complexities of the matrix of relationships among financial statement users, auditors and users? Perhaps it’s a simple matter of provincial bias, and lack of vision flowing down to reach its own level.

    Else it’s the basic principle taught in nursery schools:

    Give a toddler a hammer to play with, and expect breakage in the toy room

    Bob Jensen's threads on professionalism and independence within auditing firms ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    The PCAOB Going Nuclear
    PCAOB Just Won't Give Up on the Idea of Audit Firm Rotation

    In the first round of responses to the idea of rotating audit firms, over 94% of the 600 respondents wrote to the PCAOB that they did not think the idea of required audit firm rotation was a good answer to increasing audit firm independence. In fact a majority of the respondents declared that they thought it was an atrocious idea
    Click Here
    http://www.ey.com/Publication/vwLUAssets/TechnicalLine_BB2256_AuditFirmRotation_5January2012/$FILE/TechnicalLine_BB2256_AuditFirmRotation_5January2012.pdf

    Now the PCAOB has decided that maybe these respondents were lying through their teeth. So now before the PCAOB drives an unpopular idea down our throats the PCAOB is going to run a coaching hearing with panelists trying persuade these respondents that audit firm rotation is a good idea coupled with another round where respondents have a chance to declare that they really lied through their teeth the first time around ---
    http://pcaobus.org/News/Releases/Pages/03072012_PublicMeeting.aspx

    It's a little like having a municipal development project that voters overwhelmingly turned down on the first round of voting. You can count on City Hall and developers to keep calling vote after vote until they wear down the voters and get their way in the end.

    The PCAOB will just not listen on this one!

    "When Agencies Go Nuclear: A Game Theoretic Approach to the Biggest Sticks in an Agency’s Arsenal," by Brigham Daniels, George Washington University, February 2012 ---
    http://groups.law.gwu.edu/lr/ArticlePDF/80-2-Daniels.pdf

    March 8, 2012 reply from Dennis Beresford

    While I have my own view on this subject and wrote same in a comment letter to the PCAOB, I would like to add something to Bob’s comment on the hearings. This issue has been studied for many years and the Concept Release generated about 600 letters, as Bob noted. Thus, one might question what more the Board will learn at the hearings that hasn’t already been gleaned from years of research that was well summarized in the Concept Release as well as the 600 letters submitted.

    One significant difference between the PCAOB process and that of the FASB is that for the latter, public hearings (and later roundtables) generally were/are open to all who submitted comment letters and wished to have the opportunity to expand on their views in face to face meetings with Board and staff members or respond to their questions. These discussions were often quite useful as the Board members and staff could analyze the letters in advance and be prepared to ask very specific questions and contrast positions with other commentators, etc.

    For the PCAOB hearings, as I understand the situation, the Board hand-picked those who were asked to testify in order to get a “balance” of views even though at least some of those who will comment have not submitted a comment letter. I don’t know if those individuals will be asked to submit position outlines in advance, but I doubt it based on experience at other PCAOB meetings. Thus, the meeting will likely be a recitation of the Concept Release, in effect letting various parties say why they continue to support the position they do as has been well documented through the Release and through the comment letters. Of course, this will also allow the Board to demonstrate that there is “strong” support for mandatory audit firm rotation as there will be user, academic, and analyst panels that will offset the ones from accounting firms, corporate executives, audit committees, and others who were among the 94% that Bob mentioned.

    I guess that when this many smart people get together in one room there’s always the possibility of new information or a different way of looking at the issue. But that looks fairly doubtful.

    Denny Beresford


    Ernst & Young
    To the Point: Surprises lurk in the proposed revenue recognition model

    In conjunction with its November 2011 re-exposure of the joint revenue recognition proposal, the FASB issued a draft of the proposed consequential amendments to the Accounting Standards Codification. The proposed amendments include not only the proposed changes to Topic 605, Revenue Recognition, but also the changes to the guidance that resides outside of Topic 605. Our To the Point publication highlights some proposed changes to current guidance that companies may not have expected.
      Technical Line: Respondents to PCAOB overwhelmingly oppose mandatory audit firm rotation
    http://www.ey.com/Publication/vwLUAssets/TothePoint_BB2245_RevRecAmendments_5January2012/%24FILE/TothePoint_BB2245_RevRecAmendments_5January2012.pdf



    About 94% of the roughly 600 letters the PCAOB received on its concept release on possible ways to enhance auditor independence oppose mandatory audit firm rotation. It was the second-largest number of responses the Board has received on a rule-making project since it was created by the Sarbanes-Oxley Act of 2002. The PCAOB plans to hold a roundtable to gather more feedback in March 2012. Our Technical Line publication summarizes the responses.
    http://www.ey.com/Publication/vwLUAssets/TechnicalLine_BB2256_AuditFirmRotation_5January2012/%24FILE/TechnicalLine_BB2256_AuditFirmRotation_5January2012.pdf

    In Letters to PCAOB, EU, Australian and Japanese Accounting Groups Oppose Mandatory Audit Firm Rotation ---
    January 9, 2011 ---
    http://jimhamiltonblog.blogspot.com/2012/01/in-letters-to-pcaob-eu-australian-and.html

    One of the better (albeit older) articles I've seen on the issue of whether or not standard setters should require mandatory audit firm rotation is by the following interesting set of authors (including the very respected long-time research professor Kurt Pany).

    Barbara Arel, CPA, is a doctoral student at the W.P. Carey School of Business, Arizona State University, Tempe, Ariz.
    Richard G. Brody, PhD, CPA, is an associate professor at the College of Business, University of South Florida, St. Petersburg.
    Kurt Pany, PhD, CPA
    , is a professor at the W.P. Carey School of Business.

    "Audit Firm Rotation and Audit Quality," by Barbara Arel, Richard G. Brody, and Kurt Pany, The CPA Journal, January 2005 ---
    http://www.nysscpa.org/cpajournal/2005/105/essentials/p36.htm

    . . .

    Unanswered Questions

    The net effect of audit firm rotation is uncertain. On the one hand, it is bothersome that auditors placed in a situation where no rotation is expected are more likely to agree with a client on a difficult accounting issue. Logically, an expected long-term stream of audit fees could also result in different decisions, due to either conscious or subconscious reasons. Despite these considerations, the research indicating high first-year audit failure rates suggests that rotations might result in auditors with higher perceived independence performing lower-quality audits. Many other potential effects of mandatory audit firm rotation remain unmeasured. For example, how will a much larger annual supply of possible new audit clients affect auditors? Will marketing ability trump technical competence in winning new engagements? Would CPAs staff their audits differently toward the end of the rotation period? In addition, there is no information on likely changes in the costs of audits due to rotation.

    Even the high audit failure rates in the early years of an engagement are uncertain. Under mandatory rotation, would the increased number of first- and second-year audits lead to a higher level of auditor skill in these circumstances and to a lower level of audit failure? Or, could a closer working relationship with the predecessor auditor limit early-year audit failures?

    Another issue relates to audit firms themselves. Given that the Big Four handle the bulk of the large publicly held corporations, will rotation involve only these four firms? Are non–Big Four firms able or willing to handle large SEC audits? Will audit firm incentives to specialize in specific industries be diminished because the possible future benefits do not outweigh the current costs of training auditors? Anecdotal evidence suggests that the Big Four will gain greater market share if rotation is mandatory, which will lead to a less competitive environment without addressing the related policy issues. Less competition will probably lead to substantially higher audit fees—firms estimate that first-year fees would increase by more than 20%—and significantly higher costs for companies. (Estimates are that the additional costs associated with selecting and assisting new auditors are at least 17% of a company’s current audit fee.)

    The idea of enhancing auditor independence through mandatory audit firm rotation appeals superficially to many, yet the net effects of rotation are far from certain. The impact of SOA reforms is not yet known. Safeguards are now in place to address many of the key concerns relating to the independence and objectivity of the audit firms. In addition, companies and their top management are taking a more active role in oversight of the system in place to prepare accurate financial statements and prevent abuse. Experience and further research related to both audit firm rotation and these changes may lead to a more informed decision on mandatory audit firm rotation than is now possible.

    "Mandatory Auditor Rotation: Evidence from Restatements," December 2003
    James N. Myers University of Illinois at Urbana-Champaign
    Linda A. Myers University of Illinois at Urbana-Champaign
    Zoe-Vonna Palmrose University of Southern California and
    Susan Scholz University of Kansas
    http://aaahq.org/audit/midyear/04midyear/papers/Myers.pdf

    Jensen Comment
    It would be interesting to know how these same authors feel about the current raging debate over mandatory audit firm rotation following the bigger audit firm scandals following the subprime loan disasters and failure of the large auditing firms to provide going concern doubts to thousands of failed banks.

    "Opinion: Market Transparency Demands Audit Rotation," by Lynn Turner, The Wall Street Journal, December 12, 2011 ---
    http://blogs.wsj.com/cfo/2011/12/12/opinion-market-transparency-demands-audit-rotation/

    Jensen Comment
    Normally I buy into Lynn Turner's opinions. But not this time.

     

    Bob Jensen's threads on the scandals of large auditing firms ---
    http://www.trinity.edu/rjensen/Fraud001.htm

    Bob Jensen's threads on audit firm professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

     

     


    "Arthur Andersen Ex-CEO: Enron, Europe Are Similar," by former Andersen CEO Joe Berardino, CNBC, December 2, 2011 ---
    http://www.cnbc.com/id/45521699

    A number of similarities exist between the collapse of Enron in 2001 and the current sovereign debt crisis in the euro zone, Joe Berardino, a managing director at Alvarez and Marsal and the former CEO of Enron's accounting firm, Arthur Andersen, told CNBC.

    "If you look at the Enron story at its most simplistic, you had a really successful company that was a bricks and mortar company, that became a trading company, that was very successful as a trading company… levered up," he said, using the term popular in business parlance for borrowing. "And then we found that leverage is really good, until it's bad," Berardino said.

    Enron filed for bankruptcy 10 years ago on Friday. The scandal surrounding the energy trading firm also effectively brought down Arthur Andersen as a going concern.

    Asked whether lessons had been learned since Enron filed for bankruptcy, Berardino said, "we're still learning" and pointed to the sovereign debt crisis currently engulfing the euro zone.

    "(Enron) ran out of time in terms of its liquidity and a lot of the same elements — leverage, the need for liquidity, crisis when you lose confidence — are repeated in all those examples. And I would argue we're now living through it with the sovereign crisis in Europe," he said. "There are a lot of the same elements."

    The 'Greed Path'

    Berardino said "it's easy to go down the greed path" in corporate America due to the nature of financial transactions and the rise of service sector industries, where what is "produced" is less tangible.

    "I think what complicates the matter is that we've gone more toward a service economy and years ago went off the gold standard… (now) you're finding you're trading pieces of paper, and when you're trading pieces of paper, the underlying issue is trust in your counterparty and trust in the system and transparency in the system. And so these two issues I think get intertwined," he said.

    He added that although he believed leverage was essentially a good thing, the real matter at hand for markets is a lack of liquidity.

    "What leverage does is it puts all your trades on octane, and it's great until it's not great and I think the real lasting issue there is also the need for liquidity which we lived through three years ago and we're living through now," Berardino said.

    Europe Crisis 'Solvable'

    Following a speech by German Chancellor Angela Merkel in which she warned the crisis in the euro zone would take years to solve, Berardino agreed it would take time, but the issue of sovereign debt was "largely solvable"

    Continued in article

    Jensen Comment
    Chicago Joe did not get into the criminal things that might've brought Enron down in spite of its liquidity problem --- things like manipulating energy markets fraudulently, especially when overcharging California power companies billions in excess rate hikes. Joe did not mention the fraudulent financial statements to which his company as both a consulting firm and an auditing firm was party to fraudulent financial statements, including overvaluing derivative financial instruments and over 3,000 SPEs, many of which were phony ---
    http://www.trinity.edu/rjensen/FraudEnron.htm

    Nor did he get into the things we've learned about auditing firms since the PCAOB started issuing audit inspection reports. One thing we've most certainly learned is that the Big Four charges much more for audits but often delivers worse audits than the smaller firms. For example, when KPMG took over the Countrywide Financial audit from Grant Thornton in 2004, the quality of Countrywide's audits headed south. This is also near the time when KPMG was fired from the Fannie Mae audit for incompetence. Ernst & Young and Deloitte were fined the maximum $1 million by the PCAOB for shoddy auditing.

     


    "PCAOB Sees Decline in Audit Quality," by Michael Cohn, Accounting Today, November 5, 2011 ---
    http://www.accountingtoday.com/news/PCAOB-Sees-Decline-Audit-Quality-60375-1.html?CMP=OTC-RSS

    . . .

    Investors are demanding changes in the audit report to provide more disclosures. In many cases during the financial crisis, investors were surprised that within months of receiving an unqualified audit opinion, many financial institutions either went out of business or would have gone out of business if not for the bailout money they received from the federal government. Investors have questioned the value of the audit and why there wasn’t better disclosure of problems such as the many mortgage loans that lacked proper documentation.

    “The bottom line is that investors are clamoring for changes in the audit report,” said Baumann. “It’s just not working.”

     
    "Audit Flaws Revealed, at Long Last," by Floyd Norris, The New York Times, October 20, 2011 ---
    http://www.nytimes.com/2011/10/21/business/deloittes-failings-revealed-but-only-after-3-years.html?_r=1
    Thank you Beryl Simonson for the heads up.

    Where Were the Auditors Before the 2007-2008 failure of thousands of businesses that were audited?
    http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms


    Don't wash out our SOX

    "Republicans for the Accounting Cartel:  GOP Members block Sarbox reform for small public companies," The Wall Street Journal, December 2, 2011 ---
    http://online.wsj.com/article/SB10001424052970204262304577068723458775202.html#mod=djemEditorialPage_t

    How is it that a Republican House that claims to be pro-jobs can't pass a regulatory reform so modest that even President Obama's jobs council endorses it? Part of the answer is that the accounting cartel fighting reform has one of its own in the Republican ranks. A GOP presidential candidate also can't be bothered to show up for a critical vote.

    In September we told you about Tennessee Representative Stephen Fincher's plan to relieve small public companies from Sarbanes-Oxley's most burdensome and duplicative accounting rules. "Useless" might be a better description for these rules, after MF Global became the latest company in the Sarbox era to hide catastrophic transactions outside its balance sheet—exactly what the law was supposed to prevent.

    On Tuesday night, the House Financial Services Committee had to yank the Fincher reforms from a scheduled Wednesday vote. With all committee Democrats expected to vote against reducing paperwork, the Republicans would need almost all hands to send the measure to the House floor.

    But House sources say Michele Bachmann wouldn't return from the campaign trail to vote. Meanwhile, California Republican John Campbell has been leading an effort to water down or kill the Fincher reforms. Mr. Campbell is an accountant carrying water for his former industry colleagues. New Mexico Republican Steve Pearce, who styles himself an opponent of federal regulation, is also blocking reform.

    Sarbox was supposed to punish accountants, but like much regulation in practice it guarantees a lucrative business to a cartel dominated by four big firms. The mandate for an external audit on top of the traditional financial audits has helped accounting fees rise as fast as the bureaucratic burden.

    Sarbox compliance runs into the billions of dollars annually, and the market for initial public offerings of young companies has never recovered since the law's 2002 enactment. In a report lauded by Mr. Obama, his independent jobs panel recently recommended allowing shareholders in companies below $1 billion in market capitalization to opt out of Sarbox's infamous section 404. Alternatively, the council suggested exempting all new companies from Sarbox compliance for five years after going public.

    Continued in article

    Jensen Comment
    For a few years John Campbell was a CPA with Ernst & Young after receiving a MS in Tax from USC. However, he then moved on to become a successful CEO of an automobile dealership before becoming a Congressional representative from California ---
    http://en.wikipedia.org/wiki/John_B._T._Campbell_III

    The above editorial is typical of the WSJ's disdain for SarBox. The WSJ seldom mentions the good things that SarBox did accomplish. More focus on internal controls by auditors did result in improved internal control systems, sometimes well in advance when corporations knew that the auditors would soon arrive on the scene. SarBox made auditing more profitable, thereby encouraging medium-sized CPA firms to become more competitive with the Big Four for smaller audit clients. And Sarbox created the PCAOB that has been surprisingly rigorous in its inspections of audit engagements and campaigns for audit reform.

     

     


    "Longing for the Days of the Big Eight," by Agnes T. Crane, The New York Times, October 27, 2011 ---
    http://www.nytimes.com/2011/10/28/business/longing-for-the-days-of-the-big-eight.html?_r=1&src=rechp

    Ten years ago this week, the accounting firm Arthur Andersen sealed its fate when a few partners in its Houston office decided to shred documents related to the collapse of one of its clients, Enron.

    The ensuing prosecutorial zeal, however, created another problem whose effects are becoming apparent today — moral hazard in the audit industry. With just four big firms left to comb through the accounts of the world’s multinationals, watchdogs are justifiably worried that they cannot afford to lose another firm. If unchecked, this could lead to shoddy auditing.

    Andersen’s criminal indictment sent a simple, deterrent message: help cook the books and your business is toast. Yet Andersen’s demise led to a concentration of the might of Deloitte & Touche, Ernst & Young, KPMG and PricewaterhouseCoopers. They scour the books of 98 percent of American companies with revenues over $1 billion, according to the Government Accountability Office. The industry qualifies as superconsolidated as measured by the Justice Department’s preferred gauge of competitiveness, the Herfindahl-Hirschman index.

    This lock on auditing hasn’t necessarily resulted in price gouging. While audit fees have risen substantially since Andersen went out of business, much of that can be attributed to the passage of new rules, like the Sarbanes-Oxley Act, rather than competitive dynamics. That legislation, passed shortly after the Enron debacle, required accountants to simply do more work before they, and the executives at their client companies, signed off on company financials. Fees in 2004 jumped more than 45 percent, according to Audit Analytics.

    But that makes it all the more perplexing that in the years after the corporate world adjusted to the changes forced upon it by Sarbanes-Oxley, audit fees actually started trending down.

    In 2009, fees averaged $569 per million dollars of revenue, down 6 percent from where they stood four years before, even though the workload required under Sarbanes-Oxley and other new regulations increased. If auditors aren’t raising rates in line with more laborious fact-checking, it raises the question of whether corporate accounts are getting the full treatment they deserve.

    Cutting corners is a surefire way to make a lower fee structure work. And though professional pride should keep auditors honest, there is no appetite among regulators, or indeed investors and audit clients, to see the Big Four firms become the Even Bigger Three. A belief that none of the remaining giant audit firms will ever be put out of business like Andersen could undermine effective risk management.

    In this context, it’s worth noting last week’s public censure of Deloitte & Touche. The Public Company Accounting Oversight Board, a watchdog set up after Enron’s collapse to police the audit industry, told the firm privately in 2008 that its quality controls weren’t adequate.

    The firm had 12 months to rectify the situation. It didn’t, so the oversight board went public with previously undisclosed findings. Among these, the board said Deloitte hadn’t done enough homework to give an opinion on some of its clients’ books.

    Public shaming is one thing. But in a highly consolidated, quasi-monopolistic, business there’s a hazard that members of the Big Four don’t have to worry as much about whether their actions will sink their company. The 2008 banking panic painfully exhibited the risk of creating institutions perceived as too big to fail. The European Commission could propose a new law in November that would ban the Big Four’s ability to audit while providing consulting services to their clients or face being broken up. The accounting oversight board is weighing mandatory auditor rotations to fend off complacency. These are starts.

    The optimal solution for companies and investors would be to encourage an increase in the number of firms capable of auditing big companies. More than two decades ago there were eight. Of course, as corporations become more global, the need for economies of scale may require fewer larger firms. Still, the right number is probably more than four.

    Continued in article

    Jensen Comment
    Since I'm a believer in capitalism and the wonders of competition, I certainly agree with Agnes and think there should be more than four giant international accounting firms.

    However, what Agnes does not get into is the magical "Number of Three" as capitalism gobbles up the competition.
    Rule of Three --- http://en.wikipedia.org/wiki/Rule_of_three_%28economics%29

    Under this rule we can expect that one of the Big Four will fall by the wayside. Francine and I differ as to which firm we're betting on to bite the dust. Of course neither one of us has a crystal ball. But we differ with respect to the firm that we think has been the least professional in recent years of lapses in professionalism of all the Big Four in recent years following the implosion of Andersen ---
    http://www.trinity.edu/rjensen/Fraud001.htm

     


    The International Ethics Standards Board for Accountants (IESBA) has released its 2011-2012 IESBA Strategy and Work Plan, which sets the direction and priorities for the activities of the IESBA.---
    http://www.ifac.org/news-events/2011-10/iesba-2011-2012-strategy-and-work-plan-approved


    2011 PCAOB Standards and Related Rules
    Published by the AICPA
    http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/AuditAttest/Standards/PCAOBStandards/PRDOVR~PC-057207/PC-057207.jsp


    If audit reform swaggered into a Luckenbach, Texas saloon, it would be "all hat and no horse"
    The ladies of the night would die laughing at that "itty-bitty thang" that walked in
    And it would need a ladder to peek over the top of the spittoon

    "Recent Comments On European and U.S. Audit Reform," by Francine McKenna, re:TheAuditors, October 4, 2011 ---
    http://retheauditors.com/2011/10/04/recent-comments-on-european-and-u-s-audit-reform/

    The topic of audit industry reform is hot again. OK, that’s relative to where you stand on what’s hot. But in the world of legal and regulatory compliance and auditors the only thing hotter would be a significant development in the New York Attorney General’s case against Ernst & Young.

    Here in the U.S. the PCAOB has been busy.  I’ll give them – mostly Chairman James Doty and the Investor Advisory Group led by Board Member Steve Harris – credit for that.  The Investor Advisory Group – rather, the boldest amongst them – recently sent a letter to the PCAOB to provide comments on the PCAOB’s June 21, 2011 Concept Release entitled Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements and Related Amendments to PCAOB Standards.

    It is worth noting that a number of other parties agree that the current form of the auditor’s report fails to meet the legitimate needs of investors.  First, the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP) called for the PCAOB to undertake a standard-setting initiative to consider improvements to the standard audit report.  The ACAP members support “… improving the content of the auditor’s report beyond the current pass/fail model to include a more relevant discussion about the audit of the financial statements.”

    Second, surveys conducted by the CFA Institute in 2008 and 2010 indicate that research analysts want auditors to communicate more information in their reports.

    Finally, even leaders of the accounting profession have acknowledged that the audit report needs to become more relevant.  In testimony before ACAP, Dennis Nally, Chairman of PwC International stated, “It’s not difficult to imagine a world where the … trend to fair value measurement — lead one to consider whether it is necessary to change the content of the auditor’s report to be more relevant to the capital markets and its various stakeholders.”

    Finally, leaders of the accounting profession have previously stated that changes to the audit report should reflect investor preferences.  In their 2006 White Paper, the CEOs of the six largest accounting firms stated, “The new (reporting) model should be driven by the wants of investors and other users of company information …” (their emphasis).

    Before we turn to a discussion of the IAG investor survey, we believe it is important to underscore the fundamental but often overlooked fact that the issuer’s investors, not its audit committee or management team or the company itself, are the auditor’s client. It is therefore not only appropriate, but essential, that investors’ views and preferences take center stage as the PCAOB considers possible changes to the format and content of the audit report.

    In the meantime, I’ve written two articles about the proposals on auditor regulation before the European Commission.

    In Forbes, I told you not to count on Europe to reform the audit model or auditors, in general.

    The audit industry is reportedly under siege in Europe and on the verge of being broken up, restrained, and rotated until all the good profit is spun out.

    This is neither a foregone conclusion nor highly likely.

    The European Commission’s internal markets commissioner Michel Barnier is talking tough, but the rhetoric should be no surprise to those who have been following the European response to the financial crisis closely…

    Please read the rest at Forbes.com, “Don’t Count On Europe To Reform Auditors And Accounting”.

    In American Banker, I focused on the impact of auditor reforms on financial services.  Why is the European Commission taking such strong action now? Why is the U.S. lagging so far behind?

    The clamor for accountability from the auditors for financial crisis failures and losses has been much louder, much stronger, and going on much longer in the U.K. and Europe, than in the United States. Barnier’s most dramatic proposals are viewed by most commenters as a reaction to the bank failures. “Auditors play an essential role in financial markets: financial actors need to be able to trust their statements,” Barnier told the Financial Times. “There are weaknesses in the way the audit sector works today. The crisis highlighted them.”

    There’s is a concern on both sides of the Atlantic over long-standing auditor relationships.

    The average auditor tenure for the largest 100 U.S. companies by market cap is 28 years. The U.S. accounting regulator, the PCAOB, highlighted the auditor tenure trap in its recent Concept Release on Auditor Independence and Auditor Rotation. According to The Independent, quoting a recent House of Lords report, only one of the FTSE 100 index’s members uses a non-Big Four firm and the average relationship lasts 48 years. Some of the U.S. bailout recipients — General Motors, AIG, Goldman Sachs, Citigroup — and crisis failure Lehman had as long or longer relationships with their auditors…

    Please read the rest at American Banker, “Bank Debacles Drive Europe to Raise the Bar on Audits”.

    Continued in article

    Bob Jensen's threads on auditor professionalism and independence are at
    http://www.trinity.edu/rjensen/Fraud001c.htm


    "WHO REALLY CARES ABOUT AUDITOR ROTATION? NOT US!" by Anthony H. Catanach Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, June 25, 2012 ---
    http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/688

    . . .

    But if you just can’t seem to buy into our proposal to address audit quality, here is one last suggestion that virtually retains the status quo.  Let’s just rename what we are calling “independent audits.”  Let’s simply call them “GAAP compliance certifications” and drop any pretense of independence or an audit.  Now wouldn’t that save everyone time and money!

    Bob Jensen's threads on professionalism in auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm


    "PCAOB Troubled by Increasing Audit Deficiencies," by Emily Chason, The Wall Street Journal, June 22, 2012 ---
    http://blogs.wsj.com/cfo/2012/06/22/pcaob-troubled-by-increasing-audit-deficiencies/?mod=wsjpro_hps_cforeport

    The rising number of audit deficiencies the U.S. auditor watch dog is catching in corporate audit inspections has provoked some anxiety, but it isn’t clear that audit quality can be fairly judged using that metric.

    In a speech this week in China, Public Company Accounting Oversight Board member Lewis Ferguson said he was “disappointed” that the frequency of audit deficiencies has increased in the past two years. But it is possible that the increase has simply been caused by the PCAOB successfully targeting areas for audit that are likely to expose problems.

    As CFOJ reported last month, the PCAOB has picked up a sharp increase in auditing errors around fair value measurement this year. Ferguson elaborated, saying:

    Some of these deficiencies, such as revenue and management estimates, have been consistently noted in our inspection reports over the last nine years.

    Other deficiencies have resurfaced in an area where we had previously seen improvements as firms are, once again, having difficulties performing appropriate substantive analytical review procedures. Finally, over the last two years, we have seen issues with firms’ testing of internal controls and with the procedures firms have performed to assess the reasonableness of fair value measurements for financial instruments.

    Ferguson also noted that audit regulators around the world have found issues with auditor independence, fair value measurements and going concern opinions. He said the International Forum of Independent Audit Regulators is preparing the first global report on audit findings.

    In 2011, the PCAOB said it inspected portions of 825 audits conducted by 213 firms based in the U.S. and overseas. But the board’s method for inspections focuses on areas it thinks it will turn up audit deficiencies. That makes it harder to tell whether these numbers are an actual indicator of a decline in audit quality, says Dennis Beresford, an accounting professor at the University of Georgia and former chairman of the Financial Accounting Standards Board. He believes it would be useful for the PCAOB to develop more standard methods of following trends in audit quality.

    “These inspection reports differ so dramatically because over time the PCAOB inspection teams gain experience and look at things more carefully,” said Beresford, who sits on the PCAOB’s standing advisory group and chairs the audit committees at Fannie Mae, Kimberly-Clark and Legg Mason Inc. “Many of these items are things that, by themselves, probably wouldn’t have resulted in an unfair presentation of financial statements, and they wouldn’t result in restating the financial statements or the audit opinion being incorrect.”

    "PCAOB Inspection of Deloitte Audit – 20% Error Rate?" The Big Four Blog, May 6, 2010 ---
    http://bigfouralumni.blogspot.com/2010/05/pcaob-inspection-of-deloitte-audit-20.html
    The other Big Four firms did not perform much better.

    Fair Value Adjustments for Marketable Securities:  Easier Said Than Audited

    The Survey of Fair Value Audit Deficiencies was released Wednesday by Acuitas, Inc., an Atlanta CPA firm that practices litigation and business valuation services. The analysis found that fair value measurement and impairment deficiencies accounted for 52 percent of all the audit deficiencies cited in the PCAOB’s 2010 inspection reports. The number of cited deficiencies has more than tripled since 2009. Fifty-two percent of audit deficiencies related to fair value measurement were the result of inadequate testing of asset prices provided by outside pricing services. In addition, 63.6 percent of impairment-related audit deficiencies related to the testing of management’s prospective financial information.
    "The Number of Financial Statement Audit Deficiencies Is Blowing Up," by Caleb Newquest, Going Concern, June 6, 2012 ---
    http://goingconcern.com/post/number-financial-statement-audit-deficiencies-blowing

     


    Fair Value Adjustments for Marketable Securities:  Easier Said Than Audited

    The Survey of Fair Value Audit Deficiencies was released Wednesday by Acuitas, Inc., an Atlanta CPA firm that practices litigation and business valuation services. The analysis found that fair value measurement and impairment deficiencies accounted for 52 percent of all the audit deficiencies cited in the PCAOB’s 2010 inspection reports. The number of cited deficiencies has more than tripled since 2009. Fifty-two percent of audit deficiencies related to fair value measurement were the result of inadequate testing of asset prices provided by outside pricing services. In addition, 63.6 percent of impairment-related audit deficiencies related to the testing of management’s prospective financial information.
    "The Number of Financial Statement Audit Deficiencies Is Blowing Up," by Caleb Newquest, Going Concern, June 6, 2012 ---
    http://goingconcern.com/post/number-financial-statement-audit-deficiencies-blowing

    Bob Jensen's threads on professionalism in auditing ---
    http://www.trinity.edu/rjensen/Fraud001c.htm

     


    Grumpy Old Accountants
    "Paper Tigers: The U.S. Accounting Oversight Regime," by Anthony H. Catanach Jr. and J. Edward Ketz, Grumpy Old Accountants Blog, August 2011 ---
    http://accounting.smartpros.com/x72497.xml

    Jensen Comment
    I really had more hope when the PCAOB took on many of the responsibilities of state CPA societies when it came to sanctioning audit firm bad behavior and negligence. And indeed the PCAOB's audit inspection reports are far more rigorous, and the largest auditing firms have been called on the carpet so many times that it's becoming clear that clients are not necessarily getting what they pay extra for to get a more expensive international auditing firms.

    Francine, Tony, Ed, Jim, Tom, David, and other leading bloggers are disclosing more and more problems with the new sheriff in town. Penalties for fraud and negligence that are handed down by the PCAOB and the SEC are becoming so lenient that they hardly discourage repeat auditor fraud and negligence.

    What's lacking is the rap sheet impact on punishment. I criminal courts, repeat offenders eventually find their punishments grow harsher and harsher with each new violation. Auditing firms, on the other hand, are merely brushing aside the latest marshmallows thrown at them by the oversight regimes.

    It may be time for punishments that match the crime, especially for repeat offenders.

    Meanwhile the PCAOB is contemplating a disastrous solution that will bring down the good guys along with the bad guys.  I'm talking here about the dangerous proposal being contemplated to require mandatory audit firm rotation. Go get the bad guys and make them pay even when they are among the good guys in a given firm. But don't make the good guys and clients pay for bad things they did not do.


    2010 PCAOB Annual Report --- http://www.iasplus.com/usa/pcaob/2010annualreport.pdf

    Registration

    The number of accounting firms registered with the PCAOB grew slightly in 2010. At the end of the year, 2,397 firms were registered with the PCAOB, including 1,503 domestic firms and 894 non-U.S. firms located in 86 jurisdictions.

    In 2010, registered firms began filing annual reports and special reports on certain events.

    Inspections

    In 2010, the PCAOB conducted inspections of nine public accounting firms that performed more than 100 audits of public companies traded in U.S. markets. Inspectors examined portions of more than 350 audits performed by these firms. The PCAOB also inspected 245 firms with 100 or fewer public company audit clients, including 64 non-U.S. firms located in 20 jurisdictions.

    In the course of those inspections, PCAOB staff examined portions of more than 600 audits.

    Standards

    In 2010, the Board adopted a suite of eight standards related to the assessment of and response to risk in an audit. The standards address many fundamental aspects of the audit, from the initial planning stages through the evaluation of audit results. Continued fallout from the financial crisis, as well as an increase in certain non-U.S. companies seeking capital in U.S. markets, prompted the PCAOB to alert auditors to existing standards relating to public companies’ use of unusual transactions; disclosure of potential liabilities related to mortgages and foreclosures; and reliance on the work of other firms or assistants engaged from outside the firm, including those based in non-U.S. jurisdictions, where the PCAOB may be barred from inspecting firms.

    The Board also proposed new standards for confirmation procedures by auditors and for communications with audit committees. In 2010, the Board laid the groundwork for possible changes to the auditor’s report. PCAOB staff began a comprehensive outreach program to gather information from investors, preparers, issuers and auditors about the content and format of audit reports and the implications of potential changes.

    Enforcement

    In 2010, the Board initiated 15 formal investigations, conducted a number of informal inquiries and continued investigations that began in prior years. At the end of December 2010, the PCAOB was engaged in 23 formal investigations. PCAOB investigations are, by law, confidential and nonpublic.

    The Board issued seven settled disciplinary orders in 2010, imposing sanctions ranging from censures to bars on association with registered accounting firms, as well as monetary penalties.

    Other disciplinary proceedings were approved by the Board in 2010 and are in active litigation. Unlike similar auditor proceedings brought by the SEC, Board disciplinary proceedings are nonpublic as required by the Sarbanes-Oxley Act.

    SEC Oversight

    The Sarbanes-Oxley Act gives the Securities and ExchangeCommission oversight authority over the PCAOB.

    Continued in article


    From The Wall Street Journal on October 7, 2011

    U.S.-Chinese Progress on Accounting Is Dealt Setback
    by: Michael Rapoport
    Oct 04, 2011
    Click here to view the full article on WSJ.com
     

    TOPICS: Auditing, Fraud, Fraudulent Financial Reporting, International Auditing, PCAOB

    SUMMARY: The Public Company Accounting Oversight Board (PCAOB) had previously announced that negotiations to allow U.S. auditing inspectors into Chinese accounting firms-those which audit U.S.-traded companies-would continue with a meeting in Washington this month. The talks began in Beijing in July and were to have continued with visitors from China's regulatory agencies coming to Washington. "No reason was given for the delay, [but it]...comes only a few weeks after the Securities and Exchange Commission's move to bypass Chinese regulators and take action directly against the Chinese arm of accounting giant Deloitte Touche Tohmatsu...." Chinese regulators have cited concerns over maintaining sovereignty as a reason for not allowing the U.S. regulators in for inspections. The article follows PCAOB issuance of a Staff Audit Practice Alert No. 8, Audit Risks in Certain Emerging Markets, on Monday, October 3, 2011. The link to this audit alert is given below and also in the questions. http://pcaobus.org/Standards/QandA/2011-10-03_APA_8.pdf

    CLASSROOM APPLICATION: The article is useful in auditing classes to cover the role of the PCAOB, international issues, and/or fraud concerns in financial statement audits.

    QUESTIONS: 
    1. (Introductory) What is the role of the Public Company Accounting Oversight Board (PCAOB) in the U.S.? When was this organization established?

    2. (Introductory) How does the PCAOB execute oversight responsibilities over the auditing profession in the U.S?

    3. (Introductory) Why does the PCAOB visit auditing firms in other countries? What limitations does the PCAOB face in doing so in China?

    4. (Advanced) Access the PCAOB Staff Audit Practice Alert issued Monday, October 3, 2011 (http://pcaobus.org/Standards/QandA/2011-10-03_APA_8.pdf). What is the purpose of an audit alert in general and of this audit alert in particular?

    5. (Advanced) What circumstances has the PCAOB observed that indicate risks of fraud in an audit? From what U.S. regulatory filings has the PCAOB observed these circumstances?

    6. (Introductory) What is the auditor's responsibility for detecting fraud in an engagement to audit financial statements? How does this information in this practice alert help auditors to fulfill that responsibility?
     

    Reviewed By: Judy Beckman, University of Rhode Island
     

    RELATED ARTICLES: 
    Norway and U.S. Strike Deal on Accounting Oversight
    by Michael Rapoport
    Sep 14, 2011
    Online Exclusive

    "U.S.-Chinese Progress on Accounting Is Dealt Setback," by: Michael Rapoport, The Wall Street Journal, October 4, 2011 ---
    http://online.wsj.com/article/SB10001424052970204524604576609183570744552.html?mod=djem_jiewr_AC_domainid

    U.S.-Chinese negotiations to allow American audit-firm inspectors into China suffered a setback Monday, as U.S. regulators indicated that a planned visit to Washington by their Chinese counterparts to continue the talks has been postponed.

    Regulators previously said the Chinese were slated to visit Washington this month for a second round of the talks, which began in Beijing in July. The two countries are negotiating on whether to allow inspectors from the Public Company Accounting Oversight Board, the U.S.'s auditing regulator, into China to scrutinize the work of Chinese accounting firms which audit U.S.-traded companies.

    But dates for the meeting "are not set," a spokeswoman for the accounting board said Monday. No new meeting date was disclosed. "We remain hopeful that we will be able to meet with the Chinese regulators in the near future," the spokeswoman said.

    No reason was given for the delay, and officials from the China Securities Regulatory Commission, one of the agencies that was to have participated in the talks this month, couldn't be immediately reached for comment.

    The delay comes only a few weeks after the Securities and Exchange Commission's move to bypass Chinese regulators and take action directly against the Chinese arm of accounting giant Deloitte Touche Tohmatsu to seek documents related to a former Deloitte client the SEC is investigating.

    Joseph Carcello, a University of Tennessee professor who serves on two advisory panels for the accounting watchdog, said he didn't know whether the delay was China's way of retaliating for the Deloitte matter. But he said "there has been great hesitation on the part of the Chinese to allow the PCAOB to do inspections. I think this is further indication a resolution of this issue is not close."

    Jacob Frenkel, a former SEC enforcement attorney now in private practice, said that because the SEC had "thrown down the gauntlet" against Deloitte, the Chinese may have decided it's better for them not to meet in the U.S. right now. From their perspective, "this is not a time when they want to be meeting and negotiating," he said.

    An SEC spokesman declined to comment.

    The accounting board's chairman, James Doty, has made it a priority to negotiate a China-inspection agreement, saying it is critical to protection of U.S. investors. Inspectors for the watchdog conduct regular evaluations of accounting firms that audit companies listed on U.S. markets, even if the firms and their clients are based overseas, but Chinese authorities haven't allowed U.S. inspectors into China, citing sovereignty concerns.

    Continued in article


    If audit reform swaggered into a Luckenbach, Texas saloon, it would be "all hat and no horse"
    The ladies of the night would die laughing at that "itty-bitty thang" that walked in
    And it would need a ladder to peek over the top of the spittoon

    "Recent Comments On European and U.S. Audit Reform," by Francine McKenna, re:TheAuditors, October 4, 2011 ---
    http://retheauditors.com/2011/10/04/recent-comments-on-european-and-u-s-audit-reform/

    The topic of audit industry reform is hot again. OK, that’s relative to where you stand on what’s hot. But in the world of legal and regulatory compliance and auditors the only thing hotter would be a significant development in the New York Attorney General’s case against Ernst & Young.

    Here in the U.S. the PCAOB has been busy.  I’ll give them – mostly Chairman James Doty and the Investor Advisory Group led by Board Member Steve Harris – credit for that.  The Investor Advisory Group – rather, the boldest amongst them – recently sent a letter to the PCAOB to provide comments on the PCAOB’s June 21, 2011 Concept Release entitled Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements and Related Amendments to PCAOB Standards.

    It is worth noting that a number of other parties agree that the current form of the auditor’s report fails to meet the legitimate needs of investors.  First, the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP) called for the PCAOB to undertake a standard-setting initiative to consider improvements to the standard audit report.  The ACAP members support “… improving the content of the auditor’s report beyond the current pass/fail model to include a more relevant discussion about the audit of the financial statements.”

    Second, surveys conducted by the CFA Institute in 2008 and 2010 indicate that research analysts want auditors to communicate more information in their reports.

    Finally, even leaders of the accounting profession have acknowledged that the audit report needs to become more relevant.  In testimony before ACAP, Dennis Nally, Chairman of PwC International stated, “It’s not difficult to imagine a world where the … trend to fair value measurement — lead one to consider whether it is necessary to change the content of the auditor’s report to be more relevant to the capital markets and its various stakeholders.”

    Finally, leaders of the accounting profession have previously stated that changes to the audit report should reflect investor preferences.  In their 2006 White Paper, the CEOs of the six largest accounting firms stated, “The new (reporting) model should be driven by the wants of investors and other users of company information …” (their emphasis).

    Before we turn to a discussion of the IAG investor survey, we believe it is important to underscore the fundamental but often overlooked fact that the issuer’s investors, not its audit committee or management team or the company itself, are the auditor’s client. It is therefore not only appropriate, but essential, that investors’ views and preferences take center stage as the PCAOB considers possible changes to the format and content of the audit report.

    In the meantime, I’ve written two articles about the proposals on auditor regulation before the European Commission.

    In Forbes, I told you not to count on Europe to reform the audit model or auditors, in general.

    The audit industry is reportedly under siege in Europe and on the verge of being broken up, restrained, and rotated until all the good profit is spun out.

    This is neither a foregone conclusion nor highly likely.

    The European Commission’s internal markets commissioner Michel Barnier is talking tough, but the rhetoric should be no surprise to those who have been following the European response to the financial crisis closely…

    Please read the rest at Forbes.com, “Don’t Count On Europe To Reform Auditors And Accounting”.

    In American Banker, I focused on the impact of auditor reforms on financial services.  Why is the European Commission taking such strong action now? Why is the U.S. lagging so far behind?

    The clamor for accountability from the auditors for financial crisis failures and losses has been much louder, much stronger, and going on much longer in the U.K. and Europe, than in the United States. Barnier’s most dramatic proposals are viewed by most commenters as a reaction to the bank failures. “Auditors play an essential role in financial markets: financial actors need to be able to trust their statements,” Barnier told the Financial Times. “There are weaknesses in the way the audit sector works today. The crisis highlighted them.”

    There’s is a concern on both sides of the Atlantic over long-standing auditor relationships.

    The average auditor tenure for the largest 100 U.S. companies by market cap is 28 years. The U.S. accounting regulator, the PCAOB, highlighted the auditor tenure trap in its recent Concept Release on Auditor Independence and Auditor Rotation. According to The Independent, quoting a recent House of Lords report, only one of the FTSE 100 index’s members uses a non-Big Four firm and the average relationship lasts 48 years. Some of the U.S. bailout recipients — General Motors, AIG, Goldman Sachs, Citigroup — and crisis failure Lehman had as long or longer relationships with their auditors…

    Please read the rest at American Banker, “Bank Debacles Drive Europe to Raise the Bar on Audits”.

    Continued in article

     

     


    Francine Alleges that the Largest Audit Firms Were All  "Mixed Up in the Mortgage Fraud"

    "Lehman, Bank of America Settlement Wins Court Approval," by Linda Sandler, Bloomberg, May 18, 2011 ---
    http://www.bloomberg.com/news/2011-05-18/lehman-bank-of-america-settlement-wins-court-approval-1-.html

    A bankruptcy judge approved a settlement between Lehman Brothers Holdings Inc. (LEHMQ) and Bank of America Corp. (BAC) today. Bank of America, previously ordered by U.S. Bankruptcy Judge James Peck to pay Lehman $500 million plus interest, said it would settle a remaining dispute by paying bankrupt Lehman $1.5 million, according to a court filing today.

    "Bank of America Says $500 Million Lehman Order Was 'Error'." SF Gate, June 30, 2011 ---
    http://www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2011/06/30/bloomberg1376-LNNZ9D6JTSEE01-6AKHB4QI433DHSII5JCVQ4FK5U.DTL 

    "Judge Clears $861 Million J.P. Morgan-Lehman Settlement," The Wall Street Journal, June 23, 2011 ---
    http://blogs.wsj.com/deals/2011/06/23/judge-clears-861-million-j-p-morgan-lehman-settlement/

    A judge on Thursday approved a settlement that calls for J.P. Morgan Chase to pay $861 million in cash and securities to customers of the defunct broker-deal business of Lehman Brothers Holdings.

    The settlement is the largest to date reached by the trustee winding down’s Lehman’s former U.S. brokerage business.

    “I’m satisfied that this is indeed an excellent result,” Judge James Peck of U.S. Bankruptcy Court in Manhattan said. He added, “This is obviously a very substantial step forward of the LBI liquidation.” LBI is the brokerage subsidiary, Lehman Brothers Inc.

    Hughes Hubbard & Reed LLP’s Jeffrey Coleman, a lawyer for the trustee, said the avoidance of long litigation and the fact that most of the money will be paid in cash made it a great deal.

    “The court’s approval of the J.P. Morgan agreement marks a milestone in the administration of the LBI Estate to recover assets to pay customer claims,” Giddens, also a Hughes Hubbard & Reed partner, said in a statement.

    Former Lehman customers will receive all of the $861 million, $755 million of which is in cash. No parties objected to the settlement.

    The deal largely settles the outstanding claims the trustee has against J.P. Morgan but doesn’t affect disputes between J.P. Morgan and Lehman Brothers Holdings. The holding company and J.P. Morgan are embroiled in two pending multibillion-dollar lawsuits.

    Continued in article

    "They’re Everywhere! Big Four Auditors Mixed Up In Mortgage Fraud," by Francine McKenna, Forbes Blog, June 30, 2011 ---
    http://blogs.forbes.com/francinemckenna/2011/06/30/theyre-everywhere-big-four-auditors-mixed-up-in-mortgage-fraud/

    When I’m not wondering, “Where is my coffee?”, I’m usually curled up in a ball in the corner of my little living room filled with Latin American art moaning, “Where were the auditors?”

    Me insufficiently caffeinated. Not a pretty picture.

    Ugly also are the blank stares from contorted faces glaring back at me when I talk about auditors and their “good crisis.”

    The largest global audit firms are everywhere – in every public company and working for the government agencies that regulate them. They’re about as welcome as a hard rain and, yet, officially necessary.

    Can anyone deny that there are four firms – KPMG, Deloitte, PricewaterhouseCoopers (PwC), and Ernst & Young (auditor to Lehman) who knew all along what was going on and never told a soul, including the SEC?

    The story Bloomberg’s Tom Schoenberg tells today of Fannie Mae’s complicity in the Taylor, Bean & Whitaker (TBW) $3 billion mortgage fraud scares the bejeezus out of me. That’s because, like the little boy in “The Sixth Sense” who sees dead people, I see complicit or, at the very least incompetent, auditors everywhere. What’s even more frightening is that there are only four firms of sufficient size to audit the largest public companies and they’re getting bigger and even more powerful.

    PwC, one of the four largest global audit firms, audited TBW. TBW Chairman Lee Farkas, who was just sentenced to 30 years for his crimes, testified,  “he was only trying to help keep his company stay afloat and that he did not believe that what he was doing was wrong. What he was doing was essentially bundling and selling the same mortgages that his firm had originated twice.”

    PwC was also the auditor of Colonial Bank, which Farkas and TBW wrapped into the the fraud that eventually led to the Colonial’s failure.

    Continued in article

    July 1, 2011 reply from Robert Bruce Walker

    I find what Francine writes to be both terrifying and depressing. What the hell has happened?

    I think a partial explanation can be found in a book by the recently deceased historian Tony Judt. His last book is entitled Ill Fares the Land. The title comes from poem written by Oliver Goldsmith called The Deserted Village (1770).

    It says:

    Ill fares the land, to hastening ills a prey,
    Where wealth accumulates, and men decay.

    Apparently the poem is about the destruction of a village to make way for the county estate of a newly enriched aristocrat.

    The book explains how our psychological and philosophical attitudes play out in our political and economic lives. It is the origin of individualism that surprises. It is an amalgam of left and right and, once pointed out, is obvious. It finds expression in ‘tune in etc.’ attitudes from the sixties. It finds expression in the Ayn Randism that grew popular in the eighties and which lasts to this day. I have believed both of those two things at different times in my life. Essentially they are fused in a deeply held belief in individualism.

    July 2, 2011 reply from Bob Jensen

    Hi Robert,

    I'm less philosophical about the behavior of greed and exploitation. In terms of the subprime mortgage scandals I attribute bad behavior to opportunity and lemming behavior. When opportunity arose, bad behavior followed the crowd like lemmings in terms of "our competitors are doing it" and "our supervisors are doing it" and the "guys in the surrounding cubicles" are doing it.

    The primary source of the opportunity for subprime mortgage fraud commenced in the Bill Clinton era when originators of mortgages on Main Street could sell those low-down payment mortgages downstream, without bearing any residual bad debt risk, to buyers in Washington DC (Fannie and Freddie) and Wall Street  (Bear Stearns, Lehman, Merrill Lynch, etc.). This was exacerbated by a real estate price bubble that nearly everybody thought would never burst in times of general price inflation.


    Jane Bryant Quinn once said something to the effect that, when corporate executives and bankers see billions of loose dollars swirling above there heads, it's just too tempting to hold up both hands and pocket some loose bill floating about.  I told my students that it's possible to buy an "A" grade in my courses but none of them can possibly afford it.  The point is that, being human, most of us are vulnerable to some temptations in a weak moment.  Fortunately, none of you reading this have oak barrels of highly-aged whiskey in your cellars, the world's most beautiful women/men lined up outside your bedroom door, and billions of loose dollars swirling about like autumn leaves in a tornado.  Most corporate criminals that regret their actions later confess that the temptations went beyond what they could resist.  What amazes me in this era, however, is how they want to steal more and more after they already have $100 million stashed.  Why do they want more than they could possibly need?


    The question that remains in my mind about the auditors is whether the mortgage audit scandals that are surfacing are the the tip of the Unprofessionalism  Iceberg or whether they are only small chunks of the Professionalism Iceberg that broke off due to intense heat of client pressures in unique circumstances of finding themselves in a sea of poisonous mortgages and CDO bonds laced with slivers of poison..

    Is this an outlier problem or does the melting extend to the very core of the auditing iceberg? I still tend to personally feel that this was and still is an outlier problem that the audit profession, standard setters, courts, and educators must deal with as if it is an outlier problem.

    Francine and I both tend to write about unprofessional outliers in auditing ---
    http://www.trinity.edu/rjensen/Fraud001.htm
    We don't write much about the everyday auditing successes where audit teams acted with commendable professionalism.

     If this is a complete meltdown then there's not much hope for my beloved profession. I do think there's a high probability that one or more of the Big Four will not survive the pending court settlements of class action lawsuits. Perhaps government will have to take over the auditing industry. I don't have much hope for such a government takeover since it's so easy for the bad guys to corrupt government.

    See Bob Jensen's "Rotten to the Core" document at
    http://www.trinity.edu/rjensen/FraudRotten.htm

    The exact quotation from Jane Bryant Quinn at
    http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

    Where Were the Auditors?
    I personally believe the auditors were among the hoards that believed that real estate values would just keep going up and up and up. And when the bubble did burst audit firms succumbed to banking client and brokerage firm client pressures to underestimate bad debt reserves.


    I'm glad I'm not young anymore!

    Respectfully,
    Bob Jensen

    Bob Jensen's threads on "Where Were the Auditors?" ---
    http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms


    These two items say a lot (bad) about Mary Shapiro's SEC --- http://en.wikipedia.org/wiki/Mary_Shapiro

    "Clawbacks Without Claws," by Gretchen Morgenson, The New York Times, September 10, 2011 ---
    http://www.nytimes.com/2011/09/11/business/clawbacks-without-claws-in-a-sarbanes-oxley-tool.html?_r=2&emc=tnt&tntemail1=y

    AFTER the grand frauds at Enron, WorldCom and Adelphia, Congress set out to hold executives accountable if their companies cook the books.

    Fair Game Clawbacks Without Claws By GRETCHEN MORGENSON Published: September 10, 2011

    Recommend Twitter Linkedin Sign In to E-Mail Print Single Page Reprints Share

    AFTER the grand frauds at Enron, WorldCom and Adelphia, Congress set out to hold executives accountable if their companies cook the books. Add to Portfolio

    Diebold Inc New Century Financial Corp NutraCea

    Go to your Portfolio »

    Under the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission was encouraged to hit executives where it hurts — in the wallet — if they certified financial results that turned out to be, in a word, bogus.

    SarbOx was supposed to keep managers honest. They would have to hand back incentive pay like bonuses, even if they didn’t fudge the accounts themselves.

    That, anyway, was the idea. The record suggests a bark decidedly worse than its bite. The S.E.C. brought its first case under Section 304 of SarbOx in 2007. Since then, it has filed cases demanding that only 31 executives at only 20 companies return some pay.

    In 2007 and 2008, most of the cases involved shenanigans with stock options and produced some big recoveries. In the wake of the financial crisis, the dollars recouped have amounted to an asterisk. Since the beginning of 2009, the S.E.C. has pursued 18 executives at 10 companies. So far, it has recovered a total of $12.2 million from nine former executives at five. The other cases are pending.

    “It seems like a dormant enforcement tool,” Jack T. Ciesielski, president of R. G. Associates and editor of The Analyst’s Accounting Observer, says of the SarbOx provision. “It was supposed to be a deterrent, but it’s only really a deterrent if they use it.”

    How assiduously the S.E.C. enforces this aspect of Sarbanes-Oxley is important. Only the S.E.C. can bring cases under Section 304. Companies can’t. Nor, it appears, can shareholders. In 2009, the Court of Appeals for the Ninth Circuit ruled that there was no private cause of action for violations of Section 304.

    Half the companies pursued by the S.E.C. during the past three years have been small and relatively obscure.

    For example, the commission sued executives at SpongeTech Delivery Systems (2008 revenue: $5.6 million), contending that the company had booked $4.6 million in phony sales that year. NutraCea, a maker of dietary supplements with 2008 sales of $35 million, was sued along with Bradley D. Edson, its former chief executive, over what the S.E.C. called its recording of $2.6 million in false revenue. An executive at Isilon Systems, a data storage company, was pursued because, the S.E.C. maintained, the company had inflated sales by $4.8 million during 2007.

    No money has been recovered in the SpongeTech or Isilon matters, which are still pending. Mr. Edson, who could not be reached for comment, returned his 2008 bonus of $350,000.

    In all cases when executives have returned money, they have neither admitted nor denied allegations.

    The S.E.C. typically recovers more money from executives at bigger companies. But top executives are rarely compelled to return all their incentive pay.

    In a case brought last year against Navistar, for example, the S.E.C. contended that the company had overstated its income by $137 million from 2001 through 2005. Daniel C. Ustian, who is Navistar’s chief executive and who was not charged with wrongdoing, returned common stock worth $1.32 million. He had received $2.2 million in incentive pay and restricted stock during the time that the S.E.C. says Navistar inflated its accounting. A company spokeswoman said Mr. Ustian would not comment.

    Robert C. Lannert, Navistar’s former chief financial officer, who also was not charged, gave back stock worth $1.05 million. His incentive pay consisted of only $828,555 during the years that the S.E.C. said the company misstated its results. He didn’t return a phone call seeking comment.

    ANOTHER case brought by the S.E.C. last year involved Diebold, a maker of automated teller machines. Contending that Diebold had overstated its results by $127 million between 2002 and 2007, the commission sued to recover money from three former executives. Walden W. O’Dell, who is a former C.E.O. and who was not charged, repaid $470,000 in cash, and 30,000 Diebold shares and 85,000 stock options. During the years that the S.E.C. alleged that results were overstated, he received bonuses totaling $1.9 million, in addition to restricted stock worth $261,000 and 295,000 stock options. Mr. O’Dell didn’t return a message seeking comment. The cases against the other Diebold executives are pending. A company spokesman said it had settled with regulators and declined to comment further.

    Continued in article

    "Commissioner slams SEC settlement," SmartPros, July 13, 2011 ---
    http://accounting.smartpros.com/x72323.xml

    One of the SEC's five commissioners has taken the extraordinary step of publicly dissenting from an enforcement action on the grounds that it was too weak.

    Commissioner Luis A. Aguilar said the Securities and Exchange Commission should have charged a former Morgan Stanley trader with fraud in view of what he called "the intentional nature of her conduct."

    The dissent comes weeks after the SEC took flak for negotiating a $153.6 million fine from J.P. Morgan Chase in another enforcement case but taking no action against any of the firm's employees or executives.

    Under a settlement announced Tuesday, the SEC alleged that former Morgan Stanley trader Jennifer Kim and a colleague who previously settled with the agency had executed at least 32 sham trades to mask the amount of risk they had been incurring and to get around an internal restriction.

    Their trading contributed to millions of dollars of losses at the investment firm, the SEC said.

    Without admitting or denying the SEC's findings, Kim agreed to pay a fine of $25,000.

    Aguilar said the settlement was "inadequate" and "fails to address what is in my view the intentional nature of her conduct."

    "The settlement should have included charging Kim with violations of the antifraud provisions," Aguilar wrote.

    Continued in article

    Jensen Comment
    Maybe Jennifer also did porn. SEC enforcers like porn (daily).---
    http://abcnews.go.com/GMA/sec-pornography-employees-spent-hours-surfing-porn-sites/story?id=10452544

    Bob Jensen's Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm


    Bob Jensen's thread on clawbacks in history followed by a new blog posting by Francine

    From Encylopedia Britannica --- http://www.britannica.com/EBchecked/topic/124928/Jean-Baptiste-Colbert
    (which in part provides early history of clawback return of gains to government, something the SEC is avoiding in the early 21st Century fraud convictions)
    Also note the stress on manufacturing regulation and quality controls.

    Colbert was born of a merchant family. After holding various administrative posts, his great opportunity came in 1651, when Cardinal Mazarin, the dominant political figure in France, was forced to leave Paris and take refuge in a provincial city—an episode in the Fronde, a period (1648–53) of struggle between the crown and the French parlement. Colbert became Mazarin’s agent in Paris, keeping him abreast of the news and looking after his personal affairs. When Mazarin returned to power, he made Colbert his personal assistant and helped him purchase profitable appointments for both himself and his family. Colbert became wealthy; he also acquired the barony of Seignelay. On his deathbed, Mazarin recommended him to Louis XIV, who soon gave Colbert his confidence. Thenceforth Colbert dedicated his enormous capacity for work to serving the King both in his private affairs and in the general administration of the kingdom.

    The struggle with Fouquet.

    For 25 years Colbert was to be concerned with the economic reconstruction of France. The first necessity was to bring order into the chaotic methods of financial administration that were then under the direction of Nicolas Fouquet, the immensely powerful surintendant des finances. Colbert destroyed Fouquet’s reputation with the King, revealing irregularities in his accounts and denouncing the financial operations by which Fouquet had enriched himself. The latter’s fate was sealed when he made the mistake of receiving the King at his magnificent chateau at Vaux-le-Vicomte; the Lucullan festivities, displaying how much wealth Fouquet had amassed at the expense of the state, infuriated Louis. The King subsequently had him arrested. The criminal proceedings against him lasted three years and excited great public interest. Colbert, without any rightful standing in the case, interfered in the trial and made it his personal affair because he wanted to succeed Fouquet as finance minister. The trial itself was a parody of justice. Fouquet was sent to prison, where he spent the remaining 15 years of his life. The surintendance was replaced by a council of finance, of which Colbert became the dominant member with the title of intendant until, in 1665, he became controller general.

    Financiers and tax farmers had made enormous profits from loansand advances to the state treasury, and Colbert established tribunals to make them give back (clawbacks) some of their gains. This was well received by public opinion, which held the financiers responsible for all difficulties; it also lightened the public debt, which was further reduced by the repudiation of some government bonds and the repayment of others without interest. Private fortunes suffered, but no disturbances ensued, and the King’s credit was restored.

    Financial and economic affairs.

    Colbert’s next efforts were directed to reforming the chaotic system of taxation, a heritage of medieval times. The King derived the major part of his revenue from a tax called the taille, levied in some districts on individuals and in other districts on land and businesses. In some districts the taille was apportioned and collected by royal officials; in others it was voted by the representatives of the province. Many persons, including clergy and nobles, were exempt from it altogether. Colbert undertook to levy the taille on all who were properly liable for it and so initiated a review of titles of nobility in order to expose those who were claiming exemption falsely; he also tried to make the tax less oppressive by a fairer distribution. He reduced the total amount of it but insisted on payment in full over a reasonable period of time. He took care to suppress many abuses of collection (confiscation of defaulters’ property, seizure of peasants’ livestock or bedding, imprisonment of collectors who had not been able to produce the due sums in time). These reforms and the close supervision of the officials concerned brought large sums into the treasury. Other taxes were increased, and the tariff system was revised in 1664 as part of a system of protection. The special dues that existed in the various provinces could not be swept away, but a measure of uniformity was obtained in central France.

    Colbert devoted endless energy to the reorganization of industry and commerce. He believed that in order to increase French power it would be essential to increase France’s share of international trade and in particular to reduce the commercial hegemony of the Dutch. This necessitated not only the production of high-quality goods that could compete with foreign products abroad but also the building up of a merchant fleet to carry them. Colbert encouraged foreign workers to bring their trade skills to France. He gave privileges to a number of private industries and foundedstate manufactures. To guarantee the standard of workmanship, he made regulations for every sort of manufacture and imposed severe punishments (fines and the pillory) for counterfeiting and shortcomings. He encouraged the formation of companies to build ships and tried to obtain monopolies for French commerce abroad through the formation of trading companies. The French East India and West India companies, founded in 1664, were followed by others for trade with the eastern Mediterranean and with northern Europe; but Colbert’s propaganda for them, though cleverly conducted, failed to attract sufficient capital, and their existence was precarious. The protection of national industry demanded tariffs against foreign produce, and other countries replied with tariffs against French goods. This tariff warfare was one of the chief causes of the Dutch War of 1672–78.

    Colbert’s system of control was resented by traders and contractors, who wanted to preserve their freedom of action and to be responsible to themselves alone. Cautious and thrifty people, moreover, still preferred the old outlets for their money (land, annuities, moneylending) to investing in industry. The period, too, was one of generally falling prices throughout the world. Colbert’s success, therefore, fell short of his expectation, but what he did achieve seems all the greater in view of the obstacles in his way: he raised the output of manufactures, expanded trade, set up new permanent industries, and developed communications by road and water across France (Canal du Midi, 1666–81).

    Continued in article

    Bob Jensen's threads on accounting history are at
    http://www.trinity.edu/rjensen/Theory01.htm

     

    "A Closer Look At Clawbacks," by Francine Mckenna, re:TheAuditors, October 23, 2011 ---
    http://retheauditors.com/2011/10/23/a-closer-look-at-clawbacks/

    On September 11, 2011, The New York Times published, “Clawbacks Without Claws,” by Gretchen Morgenson. The article meant to highlight a lackluster enforcement record by the Securities and Exchange Commission (SEC) on executive pay “clawbacks”. Under limited circumstances, the SEC can step in and force CEOs and CFOs to repay unearned bonuses and incentives – something those executives are supposed to do voluntarily if it turns out they were paid erroneously because of an accounting error or accounting manipulation.

    Section 304 of the Sarbanes-Oxley Act of 2002, which covers clawbacks, is, on its face, a strict liability provision but the SEC has been exercising “prosecutorial discretion” when applying the statute.

    The Dodd-Frank Act will expand the population of those potentially liable for clawbacks and the time period used to calculate the paybacks. The new law also drops the prerequisite under Sarbanes-Oxley that there has to be misconduct before paybacks are expected.

    I covered this, and other provisions of Dodd-Frank that expand, retract, or revise Sarbanes-Oxley statutes, in a recent OpEd at Boston Review.

    John White, a partner with law firm Cravath, Swaine & Moore LLP and a former Director of the SEC’s Division of Corporation Finance, believes the public and the media should focus on Dodd-Frank’s new Section 954 clawback provisions, not the SEC’s enforcement record under Sarbanes-Oxley:

    “Dodd-Frank is much broader than SOX 304 and it’s mandatory. All listed companies will have to have clawback policies and enforce them. No misconduct is required — just an accounting error and a restatement. All present and former officers are covered. This could have a big impact and alter how incentive compensation is structured.”

    As long as there’s a mismatch between what an executive should have earned under restated financial results and what they got based on errors or fraud, Dodd-Frank says they’re supposed to give back the excess to their companies. If not, the SEC can litigate to force them to return it. Although there is no private cause of action under Section 304 – only the SEC can bring a claim – under Dodd-Frank companies or shareholders could potentially sue a present or former officer to recoup compensation based on employment contracts that stipulate compliance with new mandatory company policies and procedures.

    Continued in article

    Bob Jensen's Fraud Updates are at
    http://www.trinity.edu/rjensen/FraudUpdates.htm

     

     


    "CAQ Reacts to SEC’s SOX Section 404(b) Study," Center for Audit Quality, April 25, 2011 ---
    http://www.thecaq.org/newsroom/release_04252011.htm

    The Center for Audit Quality (CAQ) issued the following statement from Executive Director Cindy Fornelli regarding the U.S. Securities and Exchange Commission’s (SEC) Study and Recommendations on Section 404(b) of the Sarbanes-Oxley Act of 2002 For Issuers With Public Float Between $75 and $250 Million, as required by the Dodd-Frank Act:

    “I am pleased that the SEC’s Office of the Chief Accountant’s thoughtful study recommends retention of Section 404(b) of the Sarbanes Oxley Act for companies whose market capitalization is between $75 and $250 million. Section 404(b) requires independent auditors to attest to management’s assessment of the effectiveness of its internal controls over financial reporting (ICFR).

    The study concluded that costs of Section 404(b) compliance have declined and financial reporting is more reliable when the auditor is involved with ICFR assessments. Importantly, the study found that investors generally view the auditor‘s attestation on ICFR as beneficial. Finally, we are happy to see that there is no conclusive evidence linking the requirements of Section 404(b) to listing decisions of the studied range of issuers.

    The CAQ, joined by the Council of Institutional Investors, filed a comment last September with the SEC fully supporting retention of 404(b). We hope this study will effectively discourage further discussions around ways to dilute the investor protections contained in Sarbanes-Oxley.”

    Continued in article


    "Can Value Be Brought Back to the Auditor's Report? A Tale of Two Systems," by Jim Peterson, re:Balance, May 19, 2011 ---
    http://www.jamesrpeterson.com/home/2011/05/can-value-be-brought-back-to-the-auditors-report-a-tale-of-two-systems.html

    Is it the best of times, in the struggle to re-introduce value into the traditional auditor’s report – or the worst of times? The age of wisdom or the age of foolishness?

    Latest to join the Dickensian-length of characters is the International Auditing and Assurance Board, which on May 16 released its consultation paper, “Enhancing the Value of Auditor Reporting: Exploring Options for Change” (here).

    Compared to the others, whom to list takes up three full pages of its appendix, the IAASB brings the essential combination of intelligence and technical skills. Well it should, charged with the promulgation of international standards on auditing (ISA’s), thus conversant with such abstruse but centrally relevant topics as the auditor’s responsibility for published information other than financial statements (ISA 720), and use of “emphasis of matter” and other paragraphs in an auditor’s report (ISA 706). 

    Among the most prominent of those heard from, and least likely to offer substantive contributions, is the United Kingdom’s upper legislative chamber, whose Economic Affairs Committee has this spring gotten its lordly knickers in a twist over the bogus suggestion of a malign influence of international accounting standards on the crisis-era reporting of the British banks (here), and also prodded the UK’s Office of Fair Trading into an inquiry as to the market dominance of the Big Four (here) – yet another tedious exercise destined to yield neither surprises nor constructive suggestions. 

    Joining the Lords in fullness of volume and emptiness of ideas has been EU markets commissioner Michel Barnier, whose “green paper” consultation served mainly to remind anyone interested of the capacity of European bureaucrats to sacrifice forests of trees to document the lowest-hanging fruit on a fragile bush (here). 

    Continued in article

    Jensen Comment
    This is a good article, although I would've changed the wording to "Can More Vlue Be Brought Back to ..." since I do not agree with Jim regarding the lack of value in present auditor reports.

     


    When we lavish praise for accomplishments we must be careful that we are simply overlooking the failures that critics for years have tried and tried and tried to get those in power to try to correct. The SEC has acted shamefully in some instances (Madoff, hedge funds, and financial risk accounting) and the FASB fumbled many opportunities to save the horses before they bolted from the barn (e.g., off-balance sheet financing in banks).

    More importantly, I think both the FASB and the SEC earn low grades in learning the lessons from Enron. Consider the following lessons to be learned at the turn of this century that are still with us a decade later because of FASB and SEC failures of accomplishment. And I'm ashamed to say that all too often members of this Academy get low grades for not doing more to help students learn these lessons:
    http://www.citizenworks.org/corp/reforms.php

    Frank Partnoy and Lynn Turner contend that Wall Street bank accounting is an exercise in writing fiction: Watch the video! (a bit slow loading) Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets:  Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy, Roosevelt Institute, March 2010 ---
     http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting 
    Watch the video!
    We cannot take great pride in an FASB that allows this kind of financial reporting fiction writing to take place in our largest banks in the nation (or any U.S. banks for that matter). Members of the FASB and SEC should hang their heads in shame when they watch the above video.

    How can the FASB take pride in allowing Lehman Brothers to follow the FAS 140 rules to the letter in an effort to cloud transparency and deliberately deceive investors and creditors about financial risk? How can the SEC take pride in letting Lehman and Ernst off the hook for such deliberate deceptive accounting?
    http://www.trinity.edu/rjensen/Fraud001.htm#Ernst

    How can the SEC take pride in giving Enron the green light to deceptive accounting?
    Here's part of a letter written by the then President of the Financial Executives International:
     

    "We're The Front Line For Shareholders,"  by Phil Livingston (President of Financial Executives International), January/February 2002 --- http://www.fei.org/magazine/articles/1-2-2002_president.cfm 

    At FEI's recent financial reporting conference in New York, Paul Volcker gave the keynote address and declared that the accounting and auditing profession were in a "state of crisis." Earlier that morning, over breakfast, he lamented the daily bombardment of financial reporting failures in the press.

    I agree with his assessment. The causes and contributing factors are numerous, but one thing is clear: We as financial executives need to do better, be stronger and take the lead in restoring the credibility of financial reporting and preserving the capital markets.

    If you didn't already know it and believe it deeply, recent cases prove the value of a financial management team that is ethical, credible and clear in its communications. A loss of confidence in that team can be a fatal blow, not just to the individuals, but to the company or institution that entrusts its assets to their stewardship. I think the FEI Code of Ethical Conduct says it best, and it is worth reprinting the opening section here. The full code (signed by all FEI members) can be found here.

    . . .

    So how did the profession reach the state Volcker describes as a crisis?

    • The market pressure for corporate performance has increased dramatically over the last 10 years. That pressure has produced better results for shareholders, but also a higher fatality rate as management teams pressed too hard at the margin.
    • The standard-setters floundered in the issue de jour quagmire, writing hugely complicated standards that were unintelligible and irrelevant to the bigger problems.
    • The SEC fiddled while the dot-com bubble burst. Deriding and undermining management teams and the auditors, the past administration made a joke of financial restatements.
    • We've had no vision for the future of financial reporting. Annual reports, 10Ks and 10Qs are obsolete. Bloomberg and Yahoo! Finance have replaced the horse-and-buggy vehicles with summary financial information linked to breaking news.
    • We've had no vision for the future of accounting. Today's mixed model is criticized one day for recognizing unrealized fair value contractual gains and alternatively for not recognizing the fair value of financial instruments.
    • The auditors dropped their required skeptical attitude and embraced business partnering philosophies. Adding value and justifying the audit fees became the mandate. Management teams and audit committees promoted this, too.
    • Audit committees have not kept up with the challenges of the assignment. True financial reporting experts are needed on these committees, not the general management expertise required by the stock exchange rules.

     

     

    The FASB and IASB do not hold up well against their most vocal critics, in which case I am more proud of the critics than I am of the people who could've done more but caved in to pressures of industry and Congress to do less.

    I think Tom Selling and others are correct in what I think is resistance to the course set by the FASB and the SEC to turn standard setting over to the IASB. We are being lulled into complacency by all the efforts of the FASB and IASB to jointly write convergence standards. The rest of the world has been silent while the U.S. for a time makes the IASB look puppets on our strings attached approach to convergence, but once we've made the final commitment there are 90+ nations of the world that will voice screaming complaints about continued U.S. condorser influence on the IASB. ]

    Lastly, sometimes Tom Selling does not know when to back off. He's been wrong to personally attack Bob Herz for no good reason that I can figure out. Let bygones be bygones and more importantly, in true academic spirit, admit to your own mistakes.

    But without our critics like Tom, Lynn, and sometimes me those having the power, authority, and responsibility might be lulled into complacency. I've recorded many tidbits that show a mismatch between the lavish praise this profession bestows upon itself in the midst of failures it glosses over all too often  In the years of building up my picture of this profession, I now conclude that the picture is quite ugly to date and is probably going to become more horrid before it gets better ---
    http://www.trinity.edu/rjensen/Fraud001.htm

     

    Lastly, I mention the post-Andersen speech of a former Andersen executive research partner:

    Art Wyatt admitted:
    "ACCOUNTING PROFESSIONALISM: THEY JUST DON'T GET IT" ---
    http://aaahq.org/AM2003/WyattSpeech.pdf 

    And they Still Don't Get It!

     

     


    Book:  Auditing Real-World Frauds: A Practical Case Application Approach
    Lynda M. Dennis, Ph.D., CPA, CGFO
    Publisher: AICPA for CPE Self-Study
    Price:  $174 discounted to $139 for AICPA members

    History and Theory of Auditing

    I would begin with some of the history references for which there are probably many in the Accounting Historians Journal ---
    http://www.olemiss.edu/depts/general_library/dac/files/ahj.html
    When I entered the search term "auditing" all sorts of interesting articles were listed. Some of the more recent articles are now free on line from the AHJ.
    .

    The Old Classic
    Auditing Theory and Practice
    Author: Montgomery, Robert Hiester, 1872-1953
    Subject: Auditing
    Publisher: New York : Ronald Press
    Possible copyright status: NOT_IN_COPYRIGHT
    Language: English
    Call number: nrlf_ucb:GLAD-328683
    Digitizing sponsor: MSN
    Book contributor: University of California Libraries
    Collection: cdl; americana
    This book has an editable web page on Open Library.
    http://openlibrary.org/books/OL7227622M/Auditing_theory_and_practice 
    .


    The somewhat newer classic
    The Philosophy Of Auditing (1961)
    by Robert K. Mautz and Hussein A. Sharaf
    I don't know if there is a free version online
    .

    I suspect auditing in Europe dates back to auditing of charge-discharge trusts managed by barristers and audited at the request of the courts ---
    http://www.trinity.edu/rjensen/Theory01.htm#AccountingHistory
    Going Concern and Accrual Accounting Evolved in the 1500s
    Venture accounting over the life of a venture with interim statements evolved in The Netherlands
    1673 Code of Commerce in France requires biannual balance sheet reporting
    Charge and Discharge Agency Responsibility and Stewardship Accounting in English trust accounting
    .

    Also take a look at http://www.accountant.org.cn/doc/acc200812/acc20081201.pdf 

    Various classic books by Dicksee are now available free online, including his auditing book.
    Search for "Dicksee" at http://books.google.com/ 

    Business Ethics --- http://en.wikipedia.org/wiki/Business_ethics
    Lots of Good Links

    Business Ethics by Business Week --- http://bx.businessweek.com/business-ethics/news/

    Advancing Quality through Transparency Deloitte LLP Inaugural Report ---
    http://www.cs.trinity.edu/~rjensen/temp/DeloitteTransparency Report.pdf 

    MIT OpenCourseWare: Ethics (updated)
    http://ocw.mit.edu/OcwWeb/Linguistics-and-Philosophy/24-231Fall-2009/CourseHome/index.htm
    Also see http://www.trinity.edu/rjensen/000aaa/updateee.htm#OKI


    "Audit quality at risk in Canada, regulator warns," by Janet McFarland, The Globe and Mail, April 18, 2011 ---
    http://www.theglobeandmail.com/report-on-business/audit-quality-at-risk-in-canada-regulator-warns/article1990133/
    Thank you Jerry Trites for the heads up.

    Canada’s accounting firms are facing growing pressure from companies to cut their audit fees despite a warning it could lower the quality of financial disclosure.

    Brian Hunt, chief executive officer of the Canadian Public Accountability Board, said companies in Europe and the United States have been demanding auditors make significant cuts to their annual fees, and the trend has shown up in Canada since the economic crisis in 2008 and 2009.

    “A lot of folks are feeling the company is under pressure, and one way we can save is to reduce the audit fee,” Mr. Hunt said in an interview Monday. “The audit committees [of boards] are just asking for an arbitrary 30- or 40-per-cent cut. … What audit committees have to do is step back and think about what they’re doing.”

    Mr. Hunt said CPAB, which inspects Canada’s audit firms annually, has no problem with companies negotiating lower fees in a competitive market, but said some companies have demanded cuts of up to one-third in their annual audit fees, sparking concern that audit quality will suffer.

    Audit firms cannot easily slash their services because they must meet acceptable standards or risk being sanctioned by CPAB, Mr. Hunt said. Instead, to absorb the lost revenue they will reduce staff training or hire fewer young auditors.

    The result, he said, is that a company’s audit may not suffer in the first year, but quality will degrade over time with reductions in training and staff.

    Continued in article

     


    “As I look at the deficiencies cited in the letter, taken as a whole, it appears that Citigroup had a material weakness with respect to valuing these financial instruments,” said Ed Ketz, an accounting professor at Pennsylvania State University, who reviewed the OCC’s letter to Pandit at my request. “It just is overwhelming by the time you get to the end of it."

    "How Did Citigroup’s Internal Controls Cut the Mustard with KPMG?" by Caleb Newquist, Going Concern, February 24, 2011 ---
    http://goingconcern.com/2011/02/how-did-citigroups-internal-controls-cut-the-mustard-with-kpmg/#more-25882

    Jonathan Weil writes in his column today about Citigroup and their “acceptable group of auditors,” (aka KPMG) and he’s having trouble connecting the dots on a few things. Specifically, how a love letter (it was sent on February 14, 2008, after all) sent by the Office of the Comptroller of the Currency to Citigroup CEO Vikram Pandit:

    The gist of the regulator’s findings: Citigroup’s internal controls were a mess. So were its valuation methods for subprime mortgage bonds, which had spawned record losses at the bank. Among other things, “weaknesses were noted with model documentation, validation and control group oversight,” the letter said. The main valuation model Citigroup was using “is not in a controlled environment.” In other words, the model wasn’t reliable.

    Okay, so the bank’s internal controls weren’t worth the paper they were printed on. Ordinarily, one could reasonably expect management and perhaps their auditors to be aware of such a fact and that they were handling the situation accordingly. We said, “ordinarily”:

    Eight days later, on Feb. 22, Citigroup filed its annual report to shareholders, in which it said “management believes that, as of Dec. 31, 2007, the company’s internal control over financial reporting is effective.” Pandit certified the report personally, including the part about Citigroup’s internal controls. So did Citigroup’s chief financial officer at the time, Gary Crittenden.

    The annual report also included a Feb. 22 letter from KPMG LLP, Citigroup’s outside auditor, vouching for the effectiveness of the company’s financial-reporting controls. Nowhere did Citigroup or KPMG mention any of the problems cited by the OCC. KPMG, which earned $88.1 million in fees from Citigroup for 2007, should have been aware of them, too. The lead partner on KPMG’s Citigroup audit, William O’Mara, was listed on the “cc” line of the OCC’s Feb. 14 letter.

    Huh. There has to be an explanation, right? It’s just one of the largest banks on Earth audited by one of the largest audit firm on Earth. You’d think these guys would be more than willing to stand by their work. Funny thing – no one felt compelled to return JW’s calls. So, he had no choice to piece it together himself:

    [S]omehow KPMG and Citigroup’s management decided they didn’t need to mention any of those weaknesses or deficiencies. Maybe in their minds it was all just a difference of opinion. Whatever their rationale, nine months later Citigroup had taken a $45 billion taxpayer bailout, [Ed. note: OH, right. That.] still sporting a balance sheet that made it seem healthy.

    Actually, just kidding, he ran it by an expert:

    “As I look at the deficiencies cited in the letter, taken as a whole, it appears that Citigroup had a material weakness with respect to valuing these financial instruments,” said Ed Ketz, an accounting professor at Pennsylvania State University, who reviewed the OCC’s letter to Pandit at my request. “It just is overwhelming by the time you get to the end of it."

    "What Vikram Pandit Knew, and When He Knew It: Jonathan Weil," by Jonathon Weil, Bloomberg News, February 23, 2011 ---
    http://www.bloomberg.com/news/2011-02-24/what-vikram-pandit-knew-and-when-he-knew-it-commentary-by-jonathan-weil.html

    Yet somehow KPMG and Citigroup’s management decided they didn’t need to mention any of those weaknesses or deficiencies. Maybe in their minds it was all just a difference of opinion. Whatever their rationale, nine months later Citigroup had taken a $45 billion taxpayer bailout, still sporting a balance sheet that made it seem healthy.

    “As I look at the deficiencies cited in the letter, taken as a whole, it appears that Citigroup had a material weakness with respect to valuing these financial instruments,” said Ed Ketz, an accounting professor at Pennsylvania State University, who reviewed the OCC’s letter to Pandit at my request. “It just is overwhelming by the time you get to the end of it.”

    One company that did get a cautionary note from its auditor that same quarter was American International Group Inc. In February 2008, PricewaterhouseCoopers LLP warned of a material weakness related to AIG’s valuations for credit-default swaps. So at least investors were told AIG’s numbers might be off. That turned out to be a gross understatement.

    At Citigroup, there was no such warning. The public deserves to know why.

    Continued in article

    Bob Jensen's threads on the good things and not-so-good things done by KPMG are at
    http://www.trinity.edu/rjensen/Fraud001.htm


    "An Honest Services Crisis: Professional Poison and a Chicago Connection," by Francine Mckenna, re:TheAuditors, March 30, 2011 ---
    http://retheauditors.com/2011/03/30/an-honest-services-crisis-professional-poison-and-a-chicago-connection/

    “Where do bad folks go when they die?  They don’t go to heaven where the angels fly.”

    This guest post is by Mark O’Connor, CEO and Cofounder of Monadnock Research.

    Phyllobates Terribilis, the golden poison dart frog (not to be confused with, or metaphorically associated with Nectophrynoides Deloittei), is the second most toxic creature on earth. Hold him in your hand and you’ll barely feel he’s there. But touch him and your heart will stop within minutes. This little guy normally sports a coat of batrachotoxin, an alkaloid neurotoxin, sufficient to quickly kill up to 10 mature adults. But take him out of his element and he’s just a cute harmless yellow frog – a frog with a latent capability to process poisonous plants and insects, and secrete deadly neurotoxins.

    Things are not always as they appear.

    Every time I hear allegations of professional services misconduct involving a Chicago accountant, consultant, or lawyer, I send Francine McKenna an email. The title of my first missive on the subject in August 2009 was, “Are You Living at Ground Zero for Criminals in Suits?”

    It appears to be a worry that Francine and I share. There also appears to be no other metro area on earth with such a high concentration of indictments and lawsuits in the last 10 years. We can only hope it’s an aberration. In Chicago’s defense, the city is also within an hour’s flight of a corporate headquarters concentration that has few rivals. Professional services is big business in Chicago. I would expect it to be one of the profession’s most active news hubs. I just wish it was better news for clients and the consulting profession.

    Our interest at Monadnock Research is primarily consulting and advisory services. The Big Four, off and on, have had some of the largest global consulting practices across most categories. Later I’ll share our view of the unique operational and strategic levers of the Big Four firms. But first I’d like to provide some background on the numbers from a recent piece of our research (Vol IV, No 9), and what I would characterize as today’s “honest services crisis.”

    Fiscal 2010 Big Four Consulting and Advisory Services Revenues

     

    Global non-audit advisory services reported by the Big Four firms, including tax, again broke the $50 billion (USD) mark in fiscal 2010 after retreating briefly in 2009, a 3.23 percent increase. Total non-tax advisory services of Deloitte, KPMG, PwC, and E&Y were $27.8 billion, an increase of 8.1 percent over ‘09. Deloitte tops the rankings as the largest global provider of advisory, including tax, with $14.9 billion, edging out PwC’s at a little under $13.3 billion. E&Y was third with $11.19 billion and KPMG finished its fiscal year with $10.72 billion.

    Continued in article

    Bob Jensen's threads on auditor independence are at
    http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism


    Dennis Huber gave me permission to share his article at
     
     
    "Does The American Accounting Association Exist? An Example of Public Document Research," by Wm. Dennis Huber, Journal of Forensic & Investigative Accounting, Vol. 3, Issue 2, Special Issue, 2011

    The purpose of this article is, in part, to illustrate and educate what forensic accountants do and how they do it with a step-by-step process. It demonstrates the kinds of simple research in which forensic accountants should engage and should help educate forensic accountants in the use of one of the basic tools of investigation – public records research using databases that are freely available. More information can, of course, be obtained from fee-based services, but one does not have to use fee-based services. This research can serve as a basis for showing forensic accountants where to look, what to look for, how to assemble various documents to tell a story, and how to arrive at conclusions based on the evidence obtained. Conducting a forensic accounting investigation typically leads to more questions as more facts are uncovered, which then leads the forensic accountant down other paths to discover other facts, and so forth, until a more complete picture is formed. This approach uses the American Accounting Association (AAA) as an example, looking at the AAA from a forensic accountant’s viewpoint.

     


    "Auditors and Consulting: Claims Of No Conflict Strain Credibility," by Francine McKenna, re:TheAuditors, February 14, 2011 ---
    http://retheauditors.com/2011/02/14/auditors-and-consulting-claims-of-no-conflict-strain-credibility/

    Big 4 audit firms are focusing on growth in their global consulting businesses but the conflicts that drove three out of four of the firms to sell them after Enron are a bigger problem than ever before. Deloitte was the only firm that held on to its consulting arm after abuses of the privilege of doing everything for clients resulted in prohibitions in the Sarbanes-Oxley Act of 2002 on the scope of services auditors could provide.

    Between 2000 and 2002, in response to the new rules, the IT consulting practices of four of the Big five accounting firms were either sold to public companies or spun off and IPO’d.

    - In February 2000, Ernst & Young Consulting was sold to Cap Gemini.

    - In February 2001, KPMG Consulting (later BearingPoint, Inc.) was floated with an IPO. (This IPO was delayed and re-priced several times in order to wait until more favorable market conditions after the millennium change, but finally took place and then went nowhere.)

    - In July 2001, Accenture (known as Andersen Consulting before its split from Arthur Andersen) also went through an IPO.

    - In October 2002, PricewaterhouseCoopers Consulting was sold to IBM. (They failed on their first attempt to sell to HP.)

    Only Deloitte Consulting did not, in the end, separate from Deloitte & Touche.

    Since the end of 2006, however, the audit firms have been rebuilding their consulting arms. All the largest accounting firms, including Deloitte, are making acquisitions and hiring to expand consulting practices. Fee increases from advising companies on Sarbanes Oxley started slowing down significantly in 2006 and other regulatory changes such as IFRS and XBRL mandates have seen repeated delays. M&A went into a slump that only now looks to be recovering slightly and the financial crisis caused significant contraction in the population of large financial services audit clients.

     

    Global highlights via CPA Trendlines and International Accounting Bulletin

    The report found that fee pressure is still widespread, but easing, and this has hit the audit sector hardest. However, revenues from audits have actually increased for most networks, with PwC taking the lead and Deloitte following.

    Tax was the strongest performer, buoyed by a strong demand in transfer pricing work and international tax advice and PwC led the way in this sector too. The mid-tier are starting to make more noise in the sustainability services market, which continues to grow, but corporate finance, IPO services and transaction support remain flat

    • Only four networks failed to grow revenue, a complete turnaround in fortunes from last year
    • Deloitte takes the mantle as the world’s largest professional services network for the first time in history
    • Deloitte reports $9 million more global revenue than PwC, the slenderest margin
    • Consulting growth alone (12%), including major acquisitions in the US (Bearing Point) and UK (Driver’s Jonas) help propel Deloitte to top spot
    • PwC is still the largest global audit firm and has the largest tax business. The steady growth in these core businesses in comparison to Deloitte places the network in a good position for 2011

    Service lines

    • Fee pressure still widespread in the developed economies although it is easing
    • Audit the hardest hit by fee pressure although audit revenue from most networks increased. PwC is the top audit firm followed by Deloitte
    • Tax was the strongest performer, buoyed by a strong demand in transfer pricing work and international tax advice. PwC leads tax followed by E&Y
    • Advisory/consulting was a mixed bag with some networks growing particularly well and others losing out. There is healthy demand for risk management, internal audit and due diligence services
    • Sustainability services continues to grow and the mid-tier are starting to become more involved

    One of the selectively booming non-audit businesses has been workouts or bankruptcy advisoryPwC’s huge long-term engagement with the Lehman bankruptcy in the UK is a prime example. Some of PwC’s financial services audit clients JPMorgan Chase and Bank of America also grew because of acquisitions during the crisis. Combined with their audit of Goldman Sachs and involvement in Treasury TARP activitiesnon-audit revenues are growing for PwC. But revenues and profitability are distributed unevenly by geography and service line in all the firms. Although Deloitte overtook PwC as the largest global firm in revenue this past year, those rankings are not only based on the firms own un-audited, self-reported figures, but show a definite emphasis on consulting and advisory services as a growth engine versus audit.

    Continued in article

    Bob Jensen's threads on audit professionalism and independence are at
    http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

    "Auditors’ Independence: An Analysis of Montgomery’s Auditing Textbooks in the 20th Century"
    by Hossein Nouri and Danielle Lombardi
    Accounting Historians Journal
    June 2009
    http://umiss.lib.olemiss.edu:82/articles/1038280.7113/1.PDF

     


    Tom Selling conjectures (tongue in cheek) that a CPA audit does not add total value to an audit client over and above the costs of an audit?
    He then asked me to find evidence to support the counter argument.

    After I posted what I thought was some evidence of the benefits of auditing, David Albrecht followed with a posting on his blog that takes a very negative view of the benefits of auditing ---
    "Audit Credibility," by David Albrecht, The Summa, January 31, 2011 ---
    http://profalbrecht.wordpress.com/2011/01/31/audit-credibility/

    I think my original posting that triggered David's reply was much more positive about the benefits of auditing and, unlike David, I did attempt to provide some various types of evidence of overwhelming auditing benefits. It should be especially noted that many organizations pay for voluntary CPA external audits even when not required to do so because they feel these audits add considerable credibility to their financial reports. For example, Trinity University pays Ernst and Young to audit its financial reports. Among other things, Trinity University wants to voluntarily add credibility to these reports as part of its stewardship assurances to past and future donors.

    To avoid any confusion I repeat my original posting to the AECM and CPA-L. In my opinion the writers that are extremely negative about the benefits of auditin (e.g., Francine McKenna, David Albrecht, and Jim Peterson) just do not put issue of CPA audits in the total perspective of the proportion of the tens of thousands of such audits that do not go bad. I'm reminded of the (hypothetical) Exxon billboard:

    "EXXON:  Why is the media never interested when we don't spill something?"

    Credibility?

    Question
    Do credible CPA audit firms add benefits to clients that exceed the audit costs?

    Tom Selling conjectures (tongue in cheek) that a CPA audit does not add total value to an audit client over and above the costs of an audit?
    He then asks me to find evidence to support the counter argument.
    I could pull a "Calvin" here and ask him to support his own conjecture, but I will resist a Calvinistic response in this case.

    This thread commenced when Patricia Walters questioned my assumption of the value of requiring credibility for numbers reported in financial statements? It appears that in her eyes unaudited fair values, such as real estate appraisals and management estimates of long-term executory contract fair values, are as valuable or even more valuable than more credible numbers that are attested to by auditing firms in financial statements. She does not seem to worry much about moral hazards of unaudited numbers that CPAs either will not or are not allowed to attest to on financial statements. I might add that at the moment fair values of financial contracts are required or soon will be required to be audited by independent CPA auditors. She, however, supports aggregating  non-audited fair values of non-financial items like real estate with the audited numbers like Cash, Accounts Receivable, and Notes Receivable.

    I don't mind when clients provide separate schedules of many unaudited fair values, but I think that all items in the main financial statements should be subject to attestation. In my opinion, separate schedules or columns are required when unaudited numbers are less credible. I think aggregating audited numbers with unaudited numbers presents clients with enormous moral hazards.

    Anecdotal Evidence
    Let me first provide anecdotal evidence where more concern with credibility of audited numbers might've prevent billions of dollars from being bilked in various hedge fund Ponzi schemes. The SEC has obscure jurisdiction over over hedge funds and completely failed public investors, in spite of receiving credible warnings at the SEC, while Bernie Madoff stole over a billion dollars in his infamous Ponzi scheme. The SEC and thousands of investors assumed that since Madoff engaged a CPA "auditor" that Madoff's stewardship over their investments was legitimate.
    Ponzi Schemes Where Madoff was King --- http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi

    The SEC did not bother to investigate whether this lone and obscure Madoff hedge fund auditor was even licensed to be a CPA auditor. Nobody, including the SEC, questioned whether the audit firm was credible --- it was not! The moral of this story is that there are degrees of credibility of a CPA auditing firms, and one test of credibility is to verify the licensure and general auditing reputation of that firm. Another test is to investigate the depths of the pockets of a CPA auditing firm in lawsuits and the proportion of its audits that end up in civil court. If Deloitte had been engaged by Madoff, investors would've lost much less even in the case where  Deloitte conducted an incompetent or fraudulent audit. And, contrary to what Francine and Tom would like us to believe, the proportion of Deloitte's audits that end up in civil court or are settled out of court is a miniscule in terms of the number of all audits conducted globally by Deloitte auditors.

    As a second piece of anecdotal evidence of non-cpa firm auditor lack of credibility we might lament why taxpayers do not question the credibility of government auditors in local, state, and federal agencies when it came to auditing public pension funds. It turns out that undetected accounting and accountability frauds, yes outright deliberate frauds, have now brought entire states to the brink of bankruptcy ---
    The Sad State of Governmental Accounting and Accountability --- http://www.trinity.edu/rjensen/Theory02.htm#GovernmentalAccounting
    Try suing California for pension reporting audit failures when California cannot even pay its public pension liabilities.

    Historical Evidence
    There is a long history of historical evidence that CPA certifications of GAAP conformance by credible auditors lowers a client's cost of capital. The evidence here is the voluntary choice of clients to pay for CPA audits of GAAP conformance prior to when such audits became required by the SEC in the 1930s. It would seem that if CPA audits did not lower costs of capital that clients would not of their own free will pay for such audits.

    There is also evidence today when clients like charities and universities, that are not required by the SEC to have CPA audits, still choose to pay for such audits --- such as when stakeholders feel that CPA audits will keep manager agents more accurate and honest.

    Empirical Evidence
    Hypothesis
    As the global reputation of an auditing firm declines a point is reached where engaging that firm as an auditor raises cost of capital relative to cost of capital when the client engages a more credible auditing firm.

    Loss of Reputation is a Kiss of Death for One Public Accounting Firm: 
    An Empirical StudyAndersen Audits Increased Clients' Cost of Capital Relative to Clients of Other Auditing Firms

    "The Demise of Arthur Andersen," by Clifford F. Thies, Ludwig Von Mises Institute, April 12, 2002 ---
    http://www.mises.org/fullstory.asp?control=932&FS=The+Demise+of+Arthur+Andersen

    From Yahoo.com, Andrew and I downloaded the daily adjusted closing prices of the stocks of these companies (the adjustment taking into account splits and dividends). I then constructed portfolios based on an equal dollar investment in the stocks of each of the companies and tracked the performance of the two portfolios from August 1, 2001, to March 1, 2002. Indexes of the values of these portfolios are juxtaposed in Figure 1.

    From August 1, 2001, to November 30, 2001, the values of the two portfolios are very highly correlated. In particular, the values of the two portfolios fell following the September 11 terrorist attack on our country and then quickly recovered. You would expect a very high correlation in the values of truly matched portfolios. Then, two deviations stand out.

    In early December 2001, a wedge temporarily opened up between the values of the two portfolios. This followed the SEC subpoena. Then, in early February, a second and persistent wedge opened. This followed the news of the coming DOJ indictment. It appears that an Andersen signature (relative to a "Final Four" signature) costs a company 6 percent of its market capitalization. No wonder corporate clients--including several of the companies that were in the Andersen-audited portfolio Andrew and I constructed--are leaving Andersen.

    Prior to the demise of Arthur Andersen, the Big 5 firms seemed to have a "lock" on reputation. It is possible that these firms may have felt free to trade on their names in search of additional sources of revenue. If that is what happened at Andersen, it was a big mistake. In a free market, nobody has a lock on anything. Every day that you don’t earn your reputation afresh by serving your customers well is a day you risk losing your reputation. And, in a service-oriented economy, losing your reputation is the kiss of death.

    The Total Benefits of an Audit are Impossible to Measure:  Errors and Frauds That Might've Transpired Without Audits

    If we exclude incompetent surgeons, the costs in 2010 of errors made by credible surgeons who made mistakes is enormous in terms of pain, suffering, costs of correcting mistakes, and death. But it would be absurd to conjecture that the total benefits of credible surgeons was less than the "costs" of their mistakes.

    Along a somewhat similar vein,  the costs in 2010 of errors made by credible auditors who made mistakes is enormous in terms of pain, suffering, costs of correcting mistakes, and possibly even death (yes some of Madoff's investors in despair committed suicide). But it would be absurd to conjecture that the total benefits of credible auditors were less than the "costs" of their mistakes and frauds.

    Tom and Patricia fail to mention the tremendous benefit from CPA audits in terms of GAAP errors and financial frauds that might've transpired if clients were not subjected to audits. I conjecture that it's impossible to measure benefits of error and fraud prevention.

    1.  Error Prevention
    The fact that external CPA auditors will be looking for GAAP errors makes clients more responsible in understanding GAAP and installing internal controls that prevent GAAP errors and embarrassments accompanying CPA auditor discovery of GAAP errors.
      .

    2. Fraud Prevention
    CPA auditors aren't generally engaged to detect frauds that do not significantly impact the numbers on financial statements. In truth they are usually not very good at even detecting such frauds even when engaged to do so. But existence of remote chances that frauds such as kiting will be detected by external CPA auditors probably prevents trillions of dollars from being pilfered by employees around the world.

    .

    Think of the cost and  trouble it took for Lehman to conspire (with auditor consent) a way of hiding poisoned assets in such a manner that its CPA auditors would go along with in the financial statements. If Lehman was not subjected to CPA firm audits Lehman  would've quite simply not disclosed the extent of the poison and would've not had to concoct expensive Repo 105/108 schemes required by its auditors.

    In other words, if we are to consider the "total benefits" of CPA audits we must consider the externalities as well as the direct benefits to clients who are seeking lower costs of capital by paying for CPA audits.

    This does not mean that there are no credible alternatives to CPA audits as we know them today.
    I think shifting CPA audits from the private sector to the public sector is a bad idea given the track record of public sector auditors over the years and the degree to which government auditors are pressured by politicians and lobby powers. But there are some other alternatives to private sector "auditing."

    Josh Ronen at NYU is a long-time advocate in replacing CPA assurance with insurance --- - http://pages.stern.nyu.edu/~jronen/ 

    CPA audit firms in essence would become insurance firms that reimburse investors and creditors for a client's violations of GAAP. Such insurance schemes would probably not totally eliminate client audits but insurance might change many auditing procedures, e.g., more analytical reviews and less detail testing. Presumably small auditing firms would not necessarily be driven out of business if they participated in insurance pools.

    But it would take many years of research and experimentation before insured CPA audits could be implemented. One of the biggest challenges lies in determining the insurance payoffs for violations of GAAP and the problems of moral hazards. If customers throw banana peelings on supermarket floors and then sue for spine injuries, there will also be employees in clients that cause GAAP violations to collect the insurance money for their girl friends and third cousins. As long as the law is lenient with offenders, insurance schemes are doomed to failure ---
    http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

     

     

     


    Questions
    Did auditing firms not warn that banks were failing "going concern" auditing rules based upon ill-advised speculation that governments would bail out failing banks?

    Did auditors not object to greatly underestimated loan loss reserves  based upon speculation that governments would bail out failing banks?

    Since well over a thousand banks failed in the U.S. immediately following the subprime scandal., this was not a very good alleged speculation on the part of CPA firm auditors..

    "Big 4 Bombshell: “We Didn’t Fail Banks Because They Were Getting A Bailout,” by Francine McKenna, re:TheAuditors, November 28, 2010 ---
    http://retheauditors.com/2010/11/28/big-4-bombshell-we-didnt-fail-banks-because-they-were-getting-a-bailout/

    Leaders of the four largest global accounting firms – Ian Powell, chairman of PwC UK, John Connolly, Senior Partner and Chief Executive of Deloitte’s UK firm and Global MD of its international firmJohn Griffith-Jones, Chairman of KPMG’s Europe, Middle East and Africa region and Chairman of KPMG UK, and Scott Halliday, UK & Ireland Managing Partner for Ernst & Young – appeared before the UK’s House of Lords Economic Affairs Committee yesterday to discuss competition and their role in the financial crisis.

    The discussion moved past the topic of competition when the same old recommendations were raised and the same old excuses for the status quo were given.

    Reuters, November 23, 2010The House of Lords committee was taking evidence on concentration in the auditing market and the role of auditors.

    Nearly all the world’s blue chip companies are audited by the Big Four, creating concerns among policymakers of growing systemic risks, particularly if one of them fails.

    “I don’t see that is on the horizon at all,” Connolly said.

    The European Union’s executive European Commission has also opened a public consultation into ways to boost competition in the sector, such as by having smaller firms working jointly with one of the Big Four so there is a “substitute on the bench.”

    “Having a single auditor results in the best communication with the board and with management and results in the highest quality audit,” said Scott Halliday, an E&Y managing partner.

    The Lord’s Committee was more interested in questioning the auditors about the issue of “going concern” opinions and, in particular, why there were none for the banks that failed, were bailed out, or were nationalized.

    The answer the Lord’s received was, in one word, “Astonishing!”

    Accountancy Age, November 23, 2010: Debate focused on the use of “going concern” guidance, issued by auditors if they believe a company will survive the next year. Auditors said they did not change their going concern guidance because they were told the government would bail out the banks.

    “Going concern [means] that a business can pay its debts as they fall due. You meant something thing quite different, you meant that the government would dip into its pockets and give the company money and then it can pay it debts and you gave an unqualified report on that basis,” Lipsey said.

    Lord Lawson said there was a “threat to solvency” for UK banks which was not reflected in the auditors’ reports.

    “I find that absolutely astonishing, absolutely astonishing. It seems to me that you are saying that you noticed they were on very thin ice but you were completely relaxed about it because you knew there would be support, in other words, the taxpayer would support them,” he said.

    The leadership of the Big 4 audit firms in the UK has admitted that they did not issue “going concern” opinions because they were told by government officials, confidentially, that the banks would be bailed out.

    The Herald of Scotland, November 24, 2010: John Connolly, chief executive of Deloitte auditor to Royal Bank of Scotland, said the UK’s big four accountancy firms initiated “detailed discussions” with then City minister Lord Paul Myners in late 2008 soon after the collapse of Lehman Brothers prompted money markets to gum up.

    Ian Powell, chairman of PricewaterhouseCoopers, said there had been talks the previous year.

    Debate centred on whether the banks’ accounts could be signed off as “going concerns”. All banks got a clean bill of health even though they ended up needing vast amounts of taxpayer support.

    Mr. Connolly said: “In the circumstances we were in, it was recognised that the banks would only be ‘going concerns’ if there was support forthcoming.”

    “The consequences of reaching the conclusion that a bank was actually going to go belly up were huge.”  John Connolly, Deloitte

    He said that the firms held meetings in December 2008 and January 2009 with Lord Myners, a former director of NatWest who was appointed Financial Services Secretary to the Treasury in October 2008.

    I’ve asked the question many times why there were no “going concern” opinions for the banks and other institutions that were bailed out, failed or essentially nationalized here in the US.  I’ve never received a good answer until now.  In fact, I had the impression the auditors were not there.  There has been no mention of their presence or their role in any accounts of the crisis.  There has been no similar admission that meetings in took place between the auditors and the Federal Reserve or the Treasury leading to Lehman’s failure and afterwards. No one has asked them.

    How could I been so naive?

    If it happened in the UK, why not in the US?

    Does Andrew Ross Sorkin have any notes about this that didn’t make it to his book?

    Will Ted Kaufman call the auditors to account now that he is Chairman of the Congressional Oversight Panel?

    Is there still time to call the four US leaders to testify in front of the Financial Crisis Inquiry Commission?

    What is the recourse for shareholders and other stakeholders who lost everything if the government was the one who prevented them from hearing any warning?

    Continued in article

    Bob Jensen's questions on "Where Were the Auditors?" ---
    http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

     

     


    October 12, 2010 message from Paul Clikeman

    Bob,

    I would be very grateful if you would look at my new website http://auditeducation.info . The site contains articles, cases, classroom exercises, videos and academic research related to financial statement auditing. I’d appreciate suggestions for improving the site and publicizing it.

    Paul M. Clikeman, Ph.D.
    Associate Professor of Accounting
    Robins School of Business
    University of Richmond
    Richmond, VA 23173

     

    October 12, 2010 reply from Bob Jensen

    Hi Paul,

    I welcome this exciting new site containing resources for auditing and the history of auditing. It selectively links to some of the best articles on an array of auditing topics, including auditing history.
    http://auditeducation.info 

    I linked your site in various Web documents including
    http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism
    However, until I get my new computer set up at Trinity University, I may not be able to update these files on the Web server.

    I will also announce your site on the AAA Commons.

    Hopefully other accounting bloggers will also announce your site.

    Good Work

    Bob Jensen


    Critics lamenting that Sarbox 404 is a waste of time and money have been wrong but may be correct in the distant future
    "This Is as Good as It Gets for Sarbanes-Oxley 404 Compliance," Going Concern, by Calib Newquist, Going Concern, November 5, 2010 ---
    http://goingconcern.com/2010/11/this-is-as-good-as-it-gets-for-sarbanes-oxley-404-compliance/

    In the sixth year of compliance with Sarbanes-Oxley Section 404 requirements, companies with a public float greater than $75 million reduced their rate of adverse opinions from 5 percent in the fifth year to only 2.4 percent in the most recent year. Even if companies that have missed their filing deadlines turn in adverse opinions, it would bump the rate to only 2.8 percent, said Don Whalen, director of research for Audit Analytics.

    Over the six reporting years that public companies have been filing the reports, adverse opinions have steadily fallen from a high of 16.9 percent for fiscal years ending after Nov. 15, 2004, to the current low of 2.4 percent, said Whalen. “It’s getting to the point where you wonder if it can even be reduced any more,” he said.

    Bob Jensen's threads on professionalism in auditing are at
    http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

     

     


    "New York Court of Appeals Stands By Corporate Man: In Pari Delicto Prevails," by Francine McKenna, re:TheAuditors, October 22, 2010 ---
    http://retheauditors.com/2010/10/22/new-york-court-of-appeals-stands-by-corporate-man-in-pari-delicto-prevails/

    The New York Court of Appeals decided on October 21, 2010, by a vote of 4-3, to “decline to alter our precedent relating to in pari delicto and imputation and the adverse interest exception, as we would have to do to bring about the expansion of third-party liability sought by plaintiffs here.”

     

    The decision is flawed, misguided and strongly biased towards corporate interests rather than shareholder and investor interests. Imputationa fundamental principle that has outlived its usefulness and that defies common sense and fairness – has been reaffirmed in cases of third-party advisor negligence or collusion.

    “A fraud that by its nature will benefit the corporation is not “adverse” to the corporation’s interests, even if it was actually motivated by the agent’s desire for personal gain (Price, 62 NY at 384). Thus, “[s]hould the ‘agent act[] both for himself and for the principal,’ . . . application of the [adverse interest] exception would be precluded” (Capital Wireless Corp. v Deloitte & Touche, 216 AD2d 663, 666 [3d Dept 1995] [quoting Matter of Crazy Eddie Sec. Litig., 802 F Supp 804, 817 (EDNY 1992)]; see also Center, 66 NY2d at 785 [the adverse interest exception "cannot be invoked merely because . . . .(the agent) is not acting primarily for his principal"]). [*12]

    New York law thus articulates the adverse interest exception in a way that is consistent with fundamental principles of agency. To allow a corporation to avoid the consequences of corporate acts simply because an employee performed them with his personal profit in mind would enable the corporation to disclaim, at its convenience, virtually every act its officers undertake. “[C]orporate officers, even in the most upright enterprises, can always be said, in some meaningful sense, to act for their own interests” (Grede v McGladrey & Pullen LLP, 421 BR 879, 886 [ND Ill 2008]). A corporate insider’s personal interests — as an officer, employee, or shareholder of the company — are often deliberately aligned with the corporation’s interests by way of, for example, stock options or bonuses, the value of which depends upon the corporation’s financial performance.

    And this is ok?

    A majority of the New York Court of Appeals bought the self-serving, selfish and unjust arguments of the defendants and their flunky amicus brief toadies supporting criminal corporate fraudsters and, get this, the shareholders of the accounting firms (!!). The New York Court of Appeals abandoned the shareholders and creditors of Refco and AIG for criminals and incompetents.

    I could not have imagined more contemptible excuses for judicial cowardice if I were writing this decision for a novel of corporate cronyism to the extreme in a Utopian nirvana for capitalist parasites.

    “In particular, why should the interests of innocent stakeholders of corporate fraudsters trump those of innocent stakeholders of the outside professionals who are the defendants in these cases?

    …In a sense, plaintiffs’ proposals may be viewed as creating a double standard whereby the innocent stakeholders of the corporation’s outside professionals are held responsible for the sins of their errant agents while the innocent stakeholders of the corporation itself are not charged with knowledge of their wrongdoing agents. And, of course, the corporation’s agents [*19]would almost invariably play the dominant role in the fraud and therefore would be more culpable than the outside professional’s agents who allegedly aided and abetted the insiders or did not detect the fraud at all or soon enough. The owners and creditors of KPMG and PwC may be said to be at least as “innocent” as Refco’s unsecured creditors and AIG’s stockholders.

    The doctrine’s full name is in pari delicto potior est conditio defendentis, meaning “in a case of equal or mutual fault, the position of the [defending party] is the better one” (Baena, 453 F3d at 6 n 5 [internal quotation marks omitted]).

    I have some other names for it:

    • Immunity from Prosecution for the “Duped” theory
    • Incompetent Professional service providers Defense
    • Invocation of Plausible Deniability doctrine

    Continued in article


    "Michel Barnier: The Big 4 Audit Model Is a Failure," by Caleb Newquist, Going Concern, October 13, 2010 ---
    http://goingconcern.com/2010/10/michel-barnier-the-big-4-audit-model-is-a-failure/ 

     

    Jensen Comment
    Something that sticks in my mind is Tom Selling's comment that the CPA "audit model is broken" I think Tom was mostly referring to the way clients themselves cherry pick their firms' CPA auditors and frequently pressure audit firms to veer from audit professionalism.

    There's nothing new in the way audits are being funded by clients. But since SarbBox audits are much much more costly and, contrary to the intent of SarBox, clients are pressuring auditors to cut corners, overlook internal control weaknesses, under estimate loan loss reserves, over value security portfolios, etc.

    In my opinion, however, the alternative of having government audits of private corporations is not the answer.

    Interestingly, the most serious pressure on clients for better accounting is the threat lawsuits from creditors and investors. Reley (William Bendix) of my generations would have said
    "What a revoltin' development that is." --- http://en.wikipedia.org/wiki/The_Life_of_Riley

    "EC proposes mandatory rotation of auditors," by Mario Christodoulou, Accountancy Age, October 13, 2010 ---
    http://www.accountancyage.com/accountancyage/news/2271438/audit-green-paper-proposes

    "EU to propose audit-only firms and mandatory rotation," by Rose Orlick, Accountancy Age, September 26, 2011 --- Click Here
    http://www.accountancyage.com/aa/news/2111953/eu-paper-proposes-audit-firms-mandatory-rotation?WT.rss_f=&WT.rss_a=EU+to+propose+audit-only+firms+and+mandatory+rotation+

    NEW EUROPEAN REGULATION looks set to turn auditing upside down, potentially forcing the biggest firms to choose between audit and non-audit services and ushering in mandatory rotation.

    A draft of the European Commission's green paper on audit seen by Accountancy Age indicates a tough line is being pursued by internal markets commissioner Michel Barnier (pictured).

    Accountancy Age - Finance, business and accountancy news, features and resources. Claim your free subscription today.

    At its most radical, the paper could force firms to specialise in either audit or non-audit services by outlawing the provision of consultancy and advisory services even to non-audit clients.

    In the draft's current form, the embargo covers tax advisory and consulting services, actuary, risk management, legal and valuation services, book-keeping and preparing accounting records, among others.

    This measure is likely to meet with the greatest objection, as it would threaten the business model upon which the vast majority of firms operate.

    Mandatory firm rotation would boost the quality of audit, the paper suggests, shattering the "perverse pressure" on partners not to lose long-standing clients.

    Current rules on the mandatory rotation of audit partners "do not address the threat of familiarity that results from the audited undertaking often appointing and re-appointing the same audit firm for decades," it added.

    The measure is likely to raise hackles, with critics claiming it will lower quality and ramp up costs.

    Other proposals include obligatory joint audits, audit quality certification, expanded audit reports and EU-level regulatory oversight.

    Using combative language, the commission said auditor independence is "neither assured nor demonstrable", and infrequent firm rotation has "deprived audit of its key ethos: professional scepticism".

    The commission underlined the €4,589bn (£2,985bn) of European taxpayers' money committed to bail out banks during the credit crisis, saying "robust" audit is key to re-establishing trust and market confidence.

    Comfortable relationships between auditor and client "clearly seem a refutation of the very essence of independence", it added.

    Joint audit of large public-interest entities would also be made obligatory, affecting companies with a wide range of stakeholders because of their commercial activity, size, number of employees or corporate status.

    The paper suggests this would "increase choice" and help combat the problem of "high concentration" at the top of the market.

    It concludes: "Joint audits would contribute to higher audit quality through complementary and combined expertise, applying the four eyes principle at all stages of the audit and also increase capacity at the top end of the large PIE market."

    Proposed limits on the proportion of income allowable from any one client might affect firms' portfolios, while new transparency regulations would usher in disclosure of audit fees and audit quality certification.

    One audit insider from a non-Big Four firm described the draft regulation as "forceful and far-reaching", welcoming Barnier's decision to "maintain a heavy line" on audit reform.

    While the proposals are "expected", the real surprise is that everything Barnier originally consulted upon remains in this draft - thought to be very recent - with a "heavy hand" being adopted for the audit of public-interest entities.

    Some expert observers are less impressed. One described the paper as a "concerted attack on the Big Four, lacking in evidential basis and mixing its messages".

    Firms of "significant dimension" are in focus for the complete ban on non-audit services and this could disproportionately affect the Big Four, forcing them to split and potentially discouraging other firms from growing past a certain size.

    "This will cause massive disruption in the audit market, just huge. You have to question whether Barnier is on a personal crusade," said the expert observer.

    Continued in article

    Jensen Comment
    This is happening because the EU got word that Tom Selling is headed that way --- on a bicycle.

    Bob Jensen's threads on auditing professionalism and independence ---
    http://www.trinity.edu/rjensen/Fraud001c.htm  

     

    Bob Jensen's threads on auditor professionalism ---
    http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism


    "Systemic Risk! Dominance! Momentum! Auditors In Crisis. Again," by Francine McKenna, re:TheAuditors, October 15, 2010 ---
    http://retheauditors.com/2010/10/15/systemic-risk-dominance-momentum-auditors-in-crisis-again/

    Politicians are again trotting out the same old ideas and suggestions for audit industry reform. Those proposals wither on the vine, abandoned, as soon as something else captures the public’s attention and after the firms have performed their public relations and political contribution magic. Forgive me for being a bit cynical, but does the UK also pop in new politicians every four years as we do here in the United States such that we get a fresh crop of potato heads every term, fresh from the field, with nary a clue about the history, legacy, machinations and pervasive influence of the largest global accounting firms?

    You may think this quote is a recent one. It’s not.  It’s from more than four years ago.

    Challenge to big four auditors grows

    By Barney Jopson, Financial Correspondent, Financial Times, September 11 2006 03:00. A movement to challenge the dominance of the big four auditors is gaining momentum with confirmation from regulators that many in the City back action to tackle the risks it has created.

    The Financial Reporting Council, the accounting watchdog, indicated that investors and companies, along with a significant number of accountants, had told it that the stranglehold of PwC, Deloitte, KPMG and Ernst & Young was unhealthy. Paul George, the FRC director responsible for its work on the big four, said: “There is enough consensus that there are risks associated with the current market structure and that there are things that can be done.”

    In the past 12 months concern has intensified in the UK and beyond about the pernicious impact of the big four’s dominance on choice and quality in the audit market and on financial stability. The big four audit all but one of the companies in the FTSE 100 and 97 per cent of the FTSE 250. Their dominance is replicated in each of the Group of Seven leading industrialised economies…

    Contrast that to the recent “outrage” expressed by UK and EU regulators and politicians during the past few months over the “dominance of the Big 4.”

    UK Lords take long hard look at Big Four By Rachel Sanderson Published: July 27 2010 20:18 | Last updated: July 27 2010 20:18 The Big Four accountants’ dominance of the audit industry is facing mounting international scrutiny after the UK’s House of Lords launched a review into the firms’ role in the financial crisis.

    But the debate is gaining renewed momentum in the US and Europe in the wake of the financial crisis amid questions whether the Big Four could have done more to alert investors about the risks in the banking system, and what effect any lack of competition might have had. The latest inquiry, by the influential Lords’ economic affairs committee, will be closely watched by regulators in US and in Europe, where Michel Barnier, EU internal markets commissioner, is holding a separate inquiry into audit competition.

    The market concentration of auditors PwC, Ernst & Young, KPMG and Deloitte, which audit most of the world’s biggest companies, has been a matter of concern for regulators and politicians since the collapse of Arthur Andersen in 2003.

    “Latest inquiry”

    “Mounting scrutiny”

    “Dominance”

    “Lack of competition”

    “Threatening quality”

    “Gaining momentum”

    “Systemic risk”

    Blah. Blah. Blah.

    Yadda. Yadda. Yadda.

    Same words.  Only the reporters have changed.  Probably so they don’t bore themselves to tears.  FT is now on their fourth accountancy reporter, Adam Jones, in as many years.  But at least they have a semi-dedicated one on the beat, unlike other major media. Stephen Castle is the NYT EU correspondent in Brussels. He doesn’t have an accounting industry focus. This is his first story on the auditors this year.

    Continued in article

    Francine's closing paragraphs read as follows:

    Made me nauseous.

    In the UK, the Big 4 have even convinced the “next tier” firms to beg for limitations on liability for the Big 4.  GT and BDO must have given up on ever bulking up enough to compete with the Big 4. Maybe they’re jockeying for a buyout.  Will we see more consolidation  - allowing Big 4 firms to buy BDO and GT, for example – rationalized by regulators as a way to insulate the industry from catastrophic claims?

    Unfortunately, in the US, all of these concerns are addressed via the “too few to fail” policy – no large firm will be indicted by the federal government for criminal offenses, but civil penalties and sanctions will be meted out to culpable individuals only and only after many years of investigation when the story and the deterrent effect have been significantly diluted. Civil penalties against audit firms as a whole will be severely rationed.  The private right of action against audit firms will be constrained by the PSLRA, the Stoneridge decision, obdurate judges, and archaic legal doctrines that perpetuate the “we can be duped because we are simply humble bean counters and bookkeepers” defense. Settling cases rather than going to trial means juries and the general public will never see “how the sausage is made.”

    It’s shameful.

     

    Bob Jensen's threads on independence and professionalism in financial auditing ---
    http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

     

     


    "PCAOB ISSUES RELEASE ON FAILURE TO SUPERVISE," by Andy Lymer, Accounting Education News ---
    http://www.accountingeducation.com/index.cfm?page=newsdetails&id=151186

    The US Public Company Accounting Oversight Board has issued a Release discussing the provision of the Sarbanes-Oxley Act of 2002 that authorizes the PCAOB to impose sanctions on registered public accounting firms and their supervisory personnel for failing to reasonably supervise associated persons.

    “Through its inspections and investigations, the PCAOB has observed that supervision processes within firms are frequently not as robust as they should be, and that supervisory responsibilities are often not as clearly assigned as they should be," said PCAOB Acting Chairman Daniel L. Goelzer. "This Release seeks to highlight the Board’s views on the scope for using the authority provided in the Act to address those problems."

    The PCAOB issued a two-part Release addressing matters related to the application of Section 105(c)(6) of the Sarbanes-Oxley Act, which authorizes the PCAOB to sanction registered firms and their supervisory personnel for failing to reasonably supervise associated persons who violate certain laws, rules, or standards.

    Part I of the Release serves to highlight the scope of the application of Section 105(c)(6) for the information of registered firms, their associated persons, and the public generally. Part I is not a rule or rule proposal, and the PCAOB is not seeking comment on Part I.

    Part II of the Release discusses concepts relating to possible rulemaking or standard setting that, without imposing any new supervision responsibilities, would require firms to make and document clear assignments of the supervision responsibilities that are already required to be part of any audit practice.

    The PCAOB is considering whether such rules would further the public interest and protect investors by increasing clarity about who, within a firm, is accountable for various responsibilities that bear on the quality of a firm’s audits.

    The PCAOB is soliciting public comment on the concepts discussed in Part II. The comment period is open until Nov 3, 2010.

    Related Items

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    PCAOB ANNOUNCES MEMBERS OF INAUGURAL INVESTOR ADVISORY GROUP
    EFFECTIVE DATE OF PCAOB RULES REQUIRING REPORTING BY REGISTERED FIRMS REVISED TO DEC 31 2009
    Auditing the auditors: Evidence on the recent reforms to the external monitoring of audit firms
    How should the auditors be audited? Comparing the PCAOB Inspections with the AICPA Peer Reviews
    PCAOB RELEASES INTERNATIONAL INSPECTIONS UPDATE
    The PCAOB Meets the Constitution: The Supreme Court to Decide on the PCAOB's Conformity with the Sep...

    A New PCAOB Shot at Auditor Professionalism or Lack Thereof --- http://pcaobus.org/Inspections/Documents/4010_Report_Economic_Crisis.pdf
    Besides standing in line collecting their fees, where were the CPA auditors just before the banks failed?
    Why did they agree to such understated loan loss reserves of big and small banks?
    See http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

    A New PCAOB Shot at Auditor Professionalism or Lack Thereof
    "PCAOB Fires Shot on Audit Issues, Calls for Enforcement," by Tammy Whitehouse, Compliance Week, September 30, 2010 ---
    http://www.complianceweek.com/blog/whitehouse/2010/09/30/pcaob-fires-shot-on-audit-issues-calls-for-open-enforcement/

    Regulators are taking auditors to task over their rigor around some of the accounting issues that proved especially volatile through the economic crisis.

    The Public Company Accounting Oversight Board has published a report summarizing its observations after inspecting audits performed while credit market seized and the economy plunged into depression. The report says auditors generally didn’t adhere adequately to PCAOB standards when it came to some of the toughest areas in financial reporting through the credit crisis – namely fair value measurements, goodwill impairments, indefinite-lived intangible assets and other long-lived assets, allowances for loan losses, off-balance-sheet structures, revenue recognition, inventory and income taxes.

    The report says firms have made some headway in responding to the increased risks that erupted with the economic crisis, but it also implores them to keep at it. Through future inspection cycles, the PCAOB says it will continue to focus on whether firms have adequately addressed quality control deficiencies that have been pointed out the past few years. The board is especially interested in how firms are focusing on audit risks raised by the ongoing effects of economic strife.

    The PCAOB also reveals in the report that it has referred a number of audit deficiencies to its enforcement office for further investigation, including cases involving financial services firms. However, the board is prohibited from discussing investigations until cases are settled in private.

    The secrecy of the PCAOB’s enforcement process is becoming increasingly frustrating to the board, in fact. Calling it “the most pressing issue” facing his office, Claudius B. Modesti, director of enforcement, joined the board in calling on Congress to amend the Sarbanes-Oxley Act to allow the PCAOB to conduct its enforcement proceedings publicly.

    In a recent speech, Mostesti said the concealed enforcement process denies investors information about allegations of misconduct and gives those who are accused an incentive to draw out the process to stall any public disclosures. That drains PCAOB resources and constrains the board from using the disciplinary process as a deterrent, he said.

    In addition to enforcement measures, the PCAOB also reveals in its report that it will take its findings into account as it conducts future inspections and considers new audit rules or new guidance for auditors. The board said audit committees should use the report in the meantime to guide dialogue with its financial reporting management and its external auditor.

    Internally, for example, audit committees might want to check with management on how the company handles the hot-button accounting areas that the PCAOB identifies as problematic, how the company documents its decisions and what type of information it provides to auditors, the board said.

    The report also suggests audit committees talk with their auditors about how the auditor is assessing audit risk in the areas raised by the PCAOB, what strategy the auditor is following to address those risks, and the results of audit procedures that are performed in relation to those risks.

    PCAOB Acting Chairman Daniel L. Goelzer said in a statement, “These inspection observations underscore the need for auditors to be diligent in assessing and responding to emerging areas of risk when economic and business conditions change.”

    Bob Jensen's threads on auditor independence and professionalism ---
    http://www.trinity.edu/rjensen/Fraud001.htm


    "Hidden In Plain Sight: Audit Failure And The Big 4 Audit Firm Response," by Francine McKenna, re:TheAuditors, October 5, 2010 ---
    http://retheauditors.com/2010/10/05/hidden-in-plain-sight-audit-failure-and-the-big-4-audit-firm-response/

    Significant criticism of the global audit firms and their poor performance before, during, and after the financial crisis of 2008-2009 is hidden in plain sight.  Recent reports from the UK Audit Inspection Unit (AIU under the FRC) and the US PCAOB (under the SEC) highlight several very serious issues that should force regulators and legislators to act on wholesale reforms and sanctions against firms and individuals.

    More importantly, these criticisms – that auditors failed to follow professional standards, were insufficiently skeptical of managements’ assumptions, and did not obtain sufficient evidence for their audit opinions – should first and foremost make investors furious.  Where is the outrage when government sponsored guardians of shareholder interests have failed the public so miserably?

    Today I’m going to summarize some of the findings by the UK regulator and the firms’ response to these findings. The rhetoric is at a much higher pitch and the firms are being pushed by journalists and politicians much more in the UK than in the US.

    Tomorrow I will summarize the PCAOB’s findings in light of subsequent bank and financial institutions failures, bailouts, and litigation.

    Accountancy Age has written several stories about the findings of the UK AIU:

    On PwC:

    On the majority of work reviewed by the Audit Inspection Unit, PwC auditors did not identify revenue recognition as a significant risk, a move the watchdog said was ” inconsistent with Auditing Standards.”

    “More needs to be done by the firm to change the behaviour of audit teams 
and to encourage them to exercise greater scepticism in this area,” the AIU said. However PwC shot down any suggestion that there was an issue with the firm being too easy on clients.

    Continued in article


    Re-Branding the CPA Profession

    September 20, 2010 message from Bob Jensen

    Hi Denny,

    Yes, I could access the PwC re-branding video directly without having to log in:
    http://www.pwc.ch/en/video.html?objects.mid=362&navigationid=3856

    I do have a PwC Direct password, but I really doubt that the Switzerland link is using a cookie.

    In any case the home page of PwC does not require any login --- http://www.pwc.com/
    The video is now on this home page.

    This takes me back to the days when Bob Eliott, eventually as President of the AICPA, was proposing great changes in the profession, including SysTrust, WebTrust, Eldercare Assurance, etc. For years I used Bob’s AICPA/KPMG videos as starting points for discussion in my accounting theory course. Bob relied heavily on the analogy of why the railroads that did not adapt to innovations in transportation such as Interstate Highways and Jet Airliners went downhill and not uphill. The railroads simply gave up new opportunities to startup professions rather than adapt from railroading to transportation.

    Bob’s underlying assumption was that CPA firms could extend assurance services to non-traditional areas (where they were not experts but could hire new kinds of experts) by leveraging the public image of accountants as having high integrity and professional responsibility. That public image was destroyed by the many auditing scandals, notably Enron and the implosion of Andersen, that surfaced in the late 1990s and beyond ---
    http://www.trinity.edu/rjensen/Fraud001.htm

    This is a 1998 lecture given by Bob Eliott before his world (the lofty public perception of CPA firm integrity) collapsed ---
    http://newman.baruch.cuny.edu/digital/saxe/saxe_1998/elliott_98.ht

    The AICPA commenced initiatives on such things as Systrust. To my knowledge most of these initiatives bit the dust, although some CPA firms might be making money by assuring Eldercare services.

    The counter argument to Bob Elliot’s initiatives is that CPA firms had no comparative advantages in expertise in their new ventures just as railroads had few comparative advantages in trucking and airline transportation industries, although the concept of piggy backing of truck trailers eventually caught on.

    I still have copies of Bob’s great VCR tapes, but I doubt that these have ever been digitized. Bob could sell refrigerators to Eskimos.

    September 21, 2010 reply from Roger Debreceny [roger@DEBRECENY.COM]

    Isn't interesting that the pwc video has nothing at all to say about protection of the investor or maintenance of the public interest. It is all about value for the client. The client gets mentioned at least a dozen times -- investors and the public, zero times.

    If these are truly the internalized values of the firm, we're sure to have more audit failures in coming years.

    <sigh>

    Roger

    September 22, 2010 reply from Bob Jensen

    Hi Roger,

     In 1998, Bob Elliott argued that financial audits were destined in the 21st Century to be money losing assurance services ---
    http://newman.baruch.cuny.edu/digital/saxe/saxe_1998/elliott_98.ht
    This is a great lecture that can be debated in various accounting courses, notably AIS, Ethics, and Auditing courses.

    Sarbox (Sarbanes, SOX) revived the profitability of financial audits but possibly not for long as worldwide lawsuits commence to take their toll on the auditing firms.
    http://www.trinity.edu/rjensen/Fraud001.htm

    A key point made by Bob Elliott is that expansion of assurance services (e.g., SysTrust and Eldercare) is levered on the public image of CPA firms’ high integrity and professional responsibility. After this shining public image of CPA firms’ integrity and professional responsibility was tarnished since the turn of the Century, the question becomes what comparative advantages do CPA firms have that gives them comparative advantage. If you believe Francine, there’s not much left for the largest auditing firms aside from an existing global network of offices, infrastructures, vast teams of lawyers, and whatever is left of a once-shining public image

    Bob Jensen

    September 22, 2010 reply from Francine McKenna re: The Auditors Blog [retheauditors@GMAIL.COM]

    Bob, it's all about branding. If you look at what Deloitte now says on their new boilerplate legal language- they recently converted from Swiss Verein to UK private firm structure - you'll see that brand is king. "Deloitte is a brand..." It begins.

    Deloitte has a consulting firm they never shed, PwC wants one bad and is counting on it to grow to pull the rest if the firm up. KPMG is trying to get back in. They were advertising their presence at Oracle Open World user conf. EY seems the only one laying low, but then again I predicted that. Time and money is being spent on lots of litigation and they have the whopper of the day-Lehman. Yes, we are back pre-2000 and no one is doing anything to stop it. In the UK the regulators and media are rattling sabers but in the US nada but me and a few others like Jim Peterson. The PCAOB has no powers to stop acquisitions like BearingPoint and Diamond by PwC that distract them and waste resources that should be spent on training and quality assurance.

    Francine


    "What Will Audit Firms Do On Their PCAOB Annual Reports?" Big Four Blog, June 18, 2010 ---
    http://www.bigfouralumni.blogspot.com/

    Jensen Question
    Is there a reason the wording is “do on” instead of “put on?”


    Question
    Has Francine gone a "bridge too far?"
    As I write this, Kenny Rogers is singing "You've got to know when to hold 'em and when to fold 'em"
    http://www.youtube.com/watch?v=D8o6Os0xQf8

    "Bigger, Stronger, Faster: The PCAOB After The Supreme Court Ruling," by Francine McKenna, re: TheAuditors, June 9, 2010 ---
    http://retheauditors.com/2010/06/09/bigger-stronger-faster-the-pcaob-after-the-supreme-court-ruling/

    Jensen Comment
    Although I love the intensity and investigative effort that Francine pours into her blog, she does have a tendency to make conjectures that are unsupported hypotheses that she considers "truth." These hardly satisfy this old academic.

    Example of an unsupported conjecture in the above blog post:

    This is not the way to treat a regulator. Although the inspection process is intense, time consuming and very expensive for the audit firms to comply with, they are clearly paying it only lip service. They view it as a necessary evil rather than a constructive or a deterrent force. This must change if the PCAOB is ever going to be an effective tool for protecting the investor public

    She has not convinced me that the inspections are failures to a degree that she repeatedly alleges in her posts. We need much more intensive research into how the audit firms are reacting to the inspection process before inspections take place and after inspection reports are released to the public ---
    http://pcaobus.org/Inspections/Pages/default.aspx

    From: Jim Fuehrmeyer [mailto:jfuehrme@nd.edu]
    Sent: Tuesday, March 23, 2010 9:21 AM
    To: Jensen, Robert
    Subject: FW: Deloitte

    Bob,

    I was the “Professional Practice Director”, that’s the audit quality control guy, for Deloitte’s Chicago office for the six years prior to my retirement in May 2007.  I got to experience first-hand everything from the absorption of AA’s people in Chicago to the advent of the PCAOB and its annual inspection process the first few years.  I don’t think most folks have any appreciation for the very real impact the PCAOB has had on the profession.  The quality of documentation, the increased amount of partner involvement, the added quality control processes, the expansion of detail testing – the PCAOB has had a huge impact.  Most folks also don’t have an appreciation for the impact of 404 not only on the audit process but on corporate cultures as well.  As you pointed out a few messages ago, we do see all the failings in the press, but what we don’t see is all the positives and all the improvements.

    Hope your wife is doing OK.

    Jim

     

    JAMES L. FUEHRMEYER, JR.
    Associate Professional Specialist
    Department of Accountancy

    . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    MENDOZA COLLEGE OF BUSINESS
    UNIVERSITY OF NOTRE DAME

    384 Mendoza College of Business
    Notre Dame, IN 46556
    office: (574) 631-1752 | fax: (574) 631-5255
    e: jfuehrme@nd.edu | w:
    http://business.nd.edu

      

     

    "UK audits beyond reach of US regulators: US audit regulator publishes list of companies it is being blocked from inspecting," by Mario Christodoulou, Accountancy Age, May 19, 2010 --- http://www.accountancyage.com/accountancyage/news/2263271/uk-audits-beyond-reach
    Thank you John Anderson for the heads up.

    US authorities are being blocked from inspecting the audits of more than 60 UK-based multinational companies, amid fears American investors are being put at risk.

    The US audit regulator, the Public Company Accounting Oversight Board (PCAOB), set up in the wake of the Enron scandal, inspects the auditors of US registered companies. The board, however, has been blocked from inspecting overseas auditors, which have US registrants as their clients, owing to a dispute over information sharing.

    The PCAOB said no legal obstacle prevents a non-US regulator from coming to the United States to inspect a US audit firm and that it would will assist them, “to the extent of our authority”. However it is restricted by law from handing over internal working papers.

    Reforms are currently being put before the US congress to free the PCAOB to share its papers with authorised authorities - including foreign regulators.

    Today, the PCAOB raised the stakes publishing a list of more than 400 companies whose audits it has been unable to inspect.

    The UK contained one of the largest proportions of companies, second only to China and Hong Kong.

    In a statement the board said it published the list to alert investors of companies whose audits are not subject to US oversight.

    “As long as those obstacles persist, however, investors in US markets who rely on those firms' audit reports are deprived of the potential benefits of PCAOB inspections of those auditors,” the board said in a statement.

    Among the UK companies are Vodafone, BHP Billiton, HSBC, Barclays and BT. The PCAOB is hoping new legislation, traveling through congress as part of the vast US financial reform bill, will allow it to share information with its EU counterparts.

    If a solution can not be reached the PCAOB has the option to revoke the licenses of overseas audit firms, which will stop them from auditing US registrants.


    AICPA Hotline Questions and Answers on Ethics for Your Accounting Students
    "Test Your Knowledge of Professional Ethics," by Jason Evans,  Journal of Accountancy, June 2010 ---
    http://www.journalofaccountancy.com/Issues/2010/Jun/20102778.htm 

    I filed this under "Things That Rankle Tax Professor Amy Dunbar at the University of Connecticut"
    "Supreme Court Declines to Hear Textron Work Product Privilege Case," Journal of Accountancy, June 2006 ---
    http://www.journalofaccountancy.com/Web/20102952.htm

    Another item filed under "Things That Rankle Tax Professor Amy Dunbar at the University of Connecticut" is the announced retirement of Brooks and Dunn ---
    http://www.associatedcontent.com/article/2047767/boot_scootin_boogie_hitmakers_brooks.html?cat=33

    Boot Scootin’ Boogie --- http://www.youtube.com/watch?v=d05tQrhNMkA

    I filed this under "Thinks That Rankle Tax Professor Amy Dunbar at the University of Connecticut"
    "Supreme Court Declines to Hear Textron Work Product Privilege Case," Journal of Accountancy, June 2006 ---
    http://www.journalofaccountancy.com/Web/20102952.htm

    Another item filed under "Thinks That Rankle Tax Professor Amy Dunbar at the University of Connecticut" is the announced retirement of Brooks and Dunn ---
    http://www.associatedcontent.com/article/2047767/boot_scootin_boogie_hitmakers_brooks.html?cat=33

    Boot Scootin --- http://www.youtube.com/watch?v=d05tQrhNMkA


    "The Auditors And Financial Regulatory Reform: That Dog Don’t Hunt," by Francine McKenna, re: The Auditors, May 31, 2010 ---
    http://retheauditors.com/2010/05/31/the-auditors-and-financial-regulatory-reform-that-dog-dont-hunt/

    It’s not every day that a regular girl from Chicago has a chance to talk with a sitting US Senator about the subject most important to her.

    No… I’m not talking about Rosie, my Rottweiler.

    I’m talking about the auditors’ role in the financial crisis and their place in the regulatory reform bills now being considered. Through a series of wonderful and kind acts, namely the efforts of one particular journalist, I was invited to talk with Delaware Senator Ted Kaufman (D) and his staff about accounting industry reform.

    The conversation was wide ranging and opinions expressed off-the-record.  The meeting happened on the same day as Representative Barney Frank’s speech to the Compliance Week conference and we talked about his remarks.  I expressed my disappointment with several things especially Rep. Frank’s capitulation on a Sarbanes-Oxley exception for smaller companies and his rambling response to the question about a Department of Justice implied “too few to fail” policy.

    The Kaufman team is led with mucho gusto by the Senator. It was great to have a chance to meet them, but I realize it’s probably too late to get anything that addresses audit industry reform in this bill. There’s a lot of compromise going on with what’s already there.

    Health care reform took some of the fight out of more than a few on both sides of the aisle and in both legislative bodies. Rep. Frank mentioned it a few times during his speech. He described advantages and disadvantages from a legislative perspective of the pure focus on financial regulatory reform now that health care is “a done deal.”  It makes it both easier for media to spotlight an individual politician’s positions without the clutter of other major legislation and harder for that politician to hide behind multiple major initiatives when it comes to supporting or voting for controversial or dramatic change.

    I came to the meeting with a few points to make.  I think I did that but, as usual, a discussion of the issues facing the audit industry can get a little depressing, even for me.

    However, this meeting, as well as the ones at the PCAOB, made me realize the time has come to make proposals and suggestions for industry change instead of just pointing out the issues, problems and need for change.

    Most regulators and legislators avoid talking about wholesale change to the structure of the accounting/audit industry.  It seems too big a task and untenable.  The refrain I hear most often both when attending conferences and events and on this site is, “We can’t get rid of the audit opinion. It’s required.”  I’ve also written about the strong and steady political contributions the accounting industry makes, party-agnostic, dictated primarily by the politician’s position and influence over the audit firms’ interests.

    Lack of vision and loads of cash. These are the fundamental obstacles to serving investors and other stakeholders with financial reporting that can be trusted.

    But it’s also true that Big Oil has spent years deluding itself and others into thinking that this kind of spill was impossible and that preparing for one wasn’t necessary. Indeed, BP once called a blowout disaster “inconceivable.” Certainly, if you can’t conceive of a disaster, you’ll become more and more lax, more and more reckless, until one happens. You’ll cut corners on backup systems and testing. And you certainly won’t pre-build and pre-position any relevant equipment for staunching the flow. Since a disaster can’t happen, you and your allies in Congress will block all serious safeguards and demagogue all efforts to oversee the industry as “Big Government interference in the marketplace that will raise the price of gasoline for average Americans.”

    This quote comes from Salon and refers to the oil spill disaster.  But it could have just as easily been said about the litigation threats against the largest global accounting firms and doubts about their viability and credibility post-financial crisis. If legislators and regulators can’t imagine a world without the audit firms and the audit report in their current form, then they can’t work towards something better for investors and the capitalist system.

    The firms are broken and their basic product is worthless. The auditors were completely impotent to warn investors of over-leverage and risky business models, to prevent erroneous and potentially fraudulent financial reporting and to mitigate the impact on everyone of these errors, misstatements, obfuscations and subterfuge by executives of the failed, bailed out and nationalized financial institutions.

    It wasn’t such an intellectual leap for media, regulators and legislators to see the inherent conflicts in the ratings agencies’ business model post-crisis and to essentially, with the stroke of a pen, destroy that business model.

    New York Times, The Caucus Blog,
    May 13, 2010: One amendment, sponsored by Senators George LeMieux, Republican of Florida and Maria Cantwell, Democrat of Washington, would remove references to the credit agencies in major financial services laws, including the Securities Exchange Act of 1934, the Investment Company Act of 1940 and the Federal Deposit Insurance Act. It was approved by a vote of 61 to 38.

    Additional reform legislation sponsored by Senator Al FrankenI kid you not – puts the government in the middle between ratings agencies and the securities issuers. The ideas is to take the “pleaser” part out of how the credit raters make their living.

    The Atlantic,
    May 13, 2010: “The new legislation calls for every new ABS bond issue to have a rating by one agency assigned by a new board, instead of being chosen by the investment bank creating the security. The board will consist of mostly investors along with a few other industry participants. Although the underwriter can solicit additional ratings, it cannot escape the verdict of the assigned agency, so it cannot shop around for whichever agency has the most favorable view.”

    Wouldn’t it be funny if the audit firms took advantage of the credit ratings agencies’ weakness and swooped in to do that business?  After all, the auditors have the trust and integrity thing down pat. But there’s no way the audit firms would have the nerve to even float that idea post-EY/Lehman

    Nobody disagrees when I remind them that audit firms have the same inherent conflict of interest as ratings agencies. The audit firms have a business relationship with Audit Committees who are selected by the corporations’ executives.  Audit partners are “pleasers.” The audit fees for the largest financial institutions are in the $100,000,000 annually range but it’s been a challenge to grow that business in the current economic environment. The Sarbanes-Oxley gravy train has pretty much derailed.

    Is it such a stretch to think about taking the control over appointment and renewal of auditors away from the corporations – the corporate executives are the true corrupting influence on the poor, innocent auditors –  and give it to the SEC or PCAOB? Corporations could  be required to pay the auditor regardless of the audit opinion or how many exceptions are found or hard the auditor has to push back on aggressive accounting.  All this can happen under the watchful eye of their regulator who can put the firms on a “good list” and can effect limited or general “debarment” type actions if an audit firm or audit partner rolls over and plays dead too often.

    Continued in article

    Bob Jensen's threads on the survival threats of large auditing firms ---
    http://www.trinity.edu/rjensen/2008Bailout.htm#Auditors


    "Auditors Under Fire. In The UK. That Is All," by Francine McKenna, re: TheAuditors, June 7, 2010 ---
    http://retheauditors.com/2010/06/07/auditors-under-fire-in-the-uk-that-is-all/

    It seems as if the British are paying attention more closely to the audit industry and their complicity in the financial crisis and other failures than the media, legislators and regulators in the US.

    Well… there was that blip of interest when the Lehman Bankruptcy Examiner called out Ernst & Young for their malpractice in that colossal failure.

    But the stories mentioning Ernst & Young have mostly stopped for now. There were a few floating into my inbox the last few days mentioning EY’s request for a motion to dismiss in some Lehman litigation. Let’s hope there’s no judge in New York who wants to be known as the one who let EY or anyone else involved in that mess off the hook too early and too easily.

    It’s not surprising to me that the dialogue about auditor failure along with others in the crisis is loudest in the UK. It was the British Prem Sikka, Richard Murphy and Dennis Howlettwho first took notice of what I was writing here, three years ago, before anyone else.  They were so surprised to find someone in the US who was free to write so so critically.

    “In a separate statement, the [Accountant's Joint Disciplinary Scheme] said the case also gave rise to concerns about the dominance of the Big Four accountancy firms.

    The JDS said it had found it difficult to get any expert evidence for its investigation because specialists were confined “almost exclusively” to the Big Four, and because of conflicts of interest, these were unable to comment.”

    It is a dialogue. The audit firm leadership in the UK actually talk back and speak their mind. In their own voice, it seems. Sometimes to comic effect.

    There are so many corks popping the UK, hitting them in the eyes, audit firm leadership is actually trying to preempt. They’re shaking in their £1000 bespoke leather slip-ons.

    Well, not really.

    Maybe their bottom lips are quivering a bit in quiet indignation.

    Mr Powell, 54, also has plans to continue to grow the business, in particular to double the revenues of the [PwC] consultancy practice against a backdrop of scything cuts in UK and European government spending.

    The response of the affable and youthful-looking Mr Powell to this mounting in-tray is softly spoken and mostly diplomatic, although there are flashes of steel, as perhaps expected from the boss of a firm which counts 90 per cent of the FTSE 100 as its clients in one capacity or another across audit, tax and consulting.

    He tells the Financial Times in an interview in his offices overlooking the River Thames that it is “time to turn up the heat in the organisation”.

    However, on regulatory inquiries he wants a debate. First with Vince Cable, the business secretary, about changing “ground rules” for auditors and then with investors and regulators about the desire for more subjectivity in the audit report.

    In what context were the “affable and youthful-looking” Mr. Powell’s comments made, whilst sipping tea in his “offices overlooking the River Thames” ?  PwC is being skewered in the UK press over its complete and utter lack of competence in the JP Morgan “billions in client funds in the wrong accounts” debacle.

    Didn’t hear about it?  It’s a British thing.

    Mr Powell’s comments come as PwC’s audit practice may face a separate inquiry by the Financial Reporting Council, which oversees auditors, after the Financial Services Authority last week revealed the firm had failed over a seven-year period to spot that JPMorgan had accidentally placed as much as $23bn (£16bn) of client funds into the wrong bank accounts. PwC has declined to comment.

    His comments also follow government plans to cut public sector spending on consulting services, an area that contributes up to 40 per cent of PwC’s £450m consulting and advisory business. PwC aims to at least double revenues and staff in its consulting business in the next five years, and has seen “well into double-digit” growth in its UK consulting practice in the past 11 months, Mr Powell said.

    Big Four efforts to aggressively expand their consulting practices have attracted some controversy, as they had scaled them back after the Enron crisis amid concerns it could affect the independence of their audit reports.

    Indeed. I must say old chap… Getting a little squidgy for you?

    Remember, PwC is not only long time auditor for JP Morgan Chase but also Bank of America, AIG, Freddie Mac, Northern Rock, Goldman Sachs and several Madoff feeder funds.  And don’t ever forget Glitnir and Satyam.

    How’s that for an all-star lineup of litigation?

    Ernst and Young, for its part, had a long, protracted and quite embarrassing run with the Equitable Life litigation.  But as that immortal Brit once said, “All’s well that ends well.”

    Ernst & Young’s statement about the official disciplinary investigation into its role in the Equitable Life affair may well lead the casual reader to think it had come away triumphant…It was still fined £500,000 with costs of £2.4m. But it now crows that the most serious allegations – that it lacked objectivity and independence – have been thrown out. The firm also comments that the appeal tribunal took the view that Equitable and E&Y were right to think it “very unlikely” the insurer would lose the court case, and that there was no requirement to disclose a “remote contingency”…It is true that the disaster at Equitable was primarily the doing of its former executives, and that auditors cannot be expected to discover all management folly and incompetence. But shouldn’t any audit firm worth its salt be embarrassed by failing to spot a scandal of this magnitude?

    Ernst & Young apologized to the policy holders.  Apologized.   It’s all behind us now. The audit partner in question has since retired.  Just like Bally’s.

    Ease of abdication of responsibility by the firms is the lamentable downside of proceedings that take forever and a day to conclude.

    In a statement, Ernst & Young said: “Any lessons from our audit of Equitable have long been learned and embedded in our audit systems and procedures. We extend our sympathies to the policyholders of Equitable Life, who have been impacted by the near-collapse of the society, following events which lay well outside of our control and the remit of our role as auditor.”

    This fine was handy pocket change for EY and nothing compared to what they face potentially in the Lehman litigation.  It’s only unfortunate for EY it lasted so long and cost them so much in solicitor fees.

    So why hasn’t the same contained outrage over the auditors role in the crisis and other failures crossed lips like spittle in the US?  Why hasn’t Congress demanded EY or one of the others testify over their role in the crisis? Why hasn’t mainstream media stayed on the story and written about the pile of steaming lawsuits suffocating each and every one of the Big 4 audit firms in the US?

    Will the media, regulators and legislators wait until the New Century v. KPMG case finally comes to trial?  I’d better brace myself for the calls from newbie journalists all over again.

    Or maybe we’ll putter along with updates as Satyam, Glitnir, Lehman, Anglo Irish and others play out in the New York courts.

    The Deloitte SAP case in Marin County is pretty sexy.  Michael Krigsman rightly calls it a game changer for systems integrators.  Who dares to call a spade and spade and accuse a Big 4 of fraud for the bait and switch which is putting junior folks on a big SAP engagement when you promised experienced ones?

    Municipalities hungry for cash, that’s who.

    Continued at http://retheauditors.com/2010/06/07/auditors-under-fire-in-the-uk-that-is-all/

    June 7, 2010 reply from Robert Bruce Walker [walkerrb@ACTRIX.CO.NZ]

    Here is Accountancy’s report on the JP Morgan client accounting fiasco. You will see that PwC was actually engaged to provide some sort of specific certification in that respect. Whilst trust account auditing can be tricky, you don’t need to be an audit ‘expert’ to track GBP 16 billion. A few simple tracing tests ought to do it.

    "PwC in potential inquiry over client money breach: FSA fines JP Morgan record £33m," by Pat Sweet

    PricewaterhouseCoopers could face an inquiry by accounting regulators over its repeated certification that JP Morgan Securities Ltd (JPMSL) kept clients' funds separate from its own - a certification which is now in contention after the bank was discovered to have breached the rules.

    The role of PwC - also the bank's auditors - in the certification of how the investment bank handled client funds is now under scrutiny, following a record £33.3m fine on the bank by the Financial Services Authority, which discovered that JPMSL had mixed its own funds with those of clients.

    Under the FSA’s client money rules, firms are required to keep client money separate from the firm's money in segregated accounts with trust status. This helps to protect client money in the event of the firm's insolvency.

    The FSA fined JPMSL after it found to have mixed client funds with its own cash over a seven year period. Up to £16bn of clients’ money went into the wrong bank accounts.

    The FSA plans to pass on the details of its investigation to both the Financial Reporting Council and the ICAEW, which will then determine whether any further action is necessary, according to the Times.

    In addition to serving as principal auditor, PwC was retained by JP Morgan Securities Limited to produce an annual client asset returns report, to confirm that customers’ funds were being effectively ring-fenced and therefore protected in the event of the bank’s collapse.

    However, PwC signed off the client report even though JP Morgan was in breach of the rules.

    The money at risk in this case consisted of funds held by customers of JPMSL's futures and options business — a sum that varied from £1.3bn to £15.7bn between 2002 and July 2009, when the breach came to light.

    PwC has declined to comment.

    Jensen Comment
    One of the most consistent advocates of the “insurance” alternative is Josh Ronen at NYU --- http://pages.stern.nyu.edu/~jronen/ 

    Financial Statements Insurance ---
    http://pages.stern.nyu.edu/~jronen/articles/December_final_Version.pdf

    A proposed corporate governance reform: Financial statements insurance ---
    http://pages.stern.nyu.edu/~jronen/articles/Journal_of_Engineering.pdf

    Financial Statements Insurance Enhances Corporate Governance in a Sarbanes-Oxley Environment ---
    http://pages.stern.nyu.edu/~jronen/articles/FSI_enhances_int.pdf

    Financial Statements Insurance ---
    http://pages.stern.nyu.edu/~jronen/articles/Forensic_Accounting.pdf

    Other papers listed at
    http://pages.stern.nyu.edu/~jronen/

    Bob Jensen's Fraud Updates are at
    http://www.trinity.edu/rjensen/FraudUpdates.htm

    Bob Jensen's threads on PwC Litigation are at
    http://www.trinity.edu/rjensen/Fraud001.htm

    Bob Jensen's threads on auditing professionalism and independence are at
    http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism


    From: The Summa [mailto:no-reply@wordpress.com]
    Sent: Saturday, June 26, 2010 1:14 AM
    To: Jensen, Robert
    Subject: [New comment] Economic Consequences and the Political Nature of Accounting Standard Setting

    Tammy Buck added a new comment to the post Economic Consequences and the Political Nature of Accounting Standard Setting.
    http://profalbrecht.wordpress.com/2010/01/06/economic-consequences-and-the-political-nature-of-accounting-standard-setting/comment-page-3/

    Tammy Buck said on Economic Consequences and the Political Nature of Accounting Standard Setting June 3, 2010 at 5:19 pm Prof Albrecht – Thanks for the thought provoking article! I would like to point out that your statement – “First, financial statements are intended to provide information to investors for making investment decisions.” – is itself a value judgment of what accounting standards/financial statements are & ought to do. If this is “true” (or rather, more desirable), then certain accounting standards ought to be chosen over others. But if isn’t desirable (maybe financial statements have another purpose?), then conservatively biased standards might not be appropriate. Who decides this focus? Investors, professors, the SEC, FASB, Fortune 500 firms? Maybe it’s the open process of democratic process. So of course accounting standards aren’t pure theoretical truth. But shouldn’t some independence be desirable? Should (there I go with a value judgment!) the FASB be independent from both the Big 4 & the big public companies? Do you really want Goldman Sachs having a significant influence over GAAP (for instance)? Just some questions. Maybe I just think accounting standard setter independence sounds theoretically better, but my position is naive.

    thanks,
    Tammy Buck

    Jensen Comment
    I think independence is a goal we should strive for in standard setting, and I think that making FASB members sever their previous financial ties with employers is probably a good but overrated idea. One cannot so easily sever relationships with former employers, colleagues, and friends. I was more disturbed by the reduction of the FASB’s numbers of members such that biased board members have much more clout. There’s a certain amount of democratic strength in numbers on the IASB. If the FASB was not self destructing I would work much harder to plug for a larger FASB.

    Having said this, I will now give you my subjective opinion on the number one cause of new or revised standards/interpretations that add great complexity to accounting rules. The number one cause is the creative effort that clients use to circumvent the spirit and intent of accounting “rules” and “guidelines.”

    One needs only to look carefully at the contracts being written to find clues about efforts to deceive. When companies (like Avis, Safeway, and all the airlines) were forming unconsolidated lease holding subsidiaries to hide enormous amounts of capital lease debt from their consolidated balance sheets, the FASB rewrote the consolidation rules. In the 1980s when companies were keeping increasing amounts (trillions) of derivative financial instruments debt off the books (interest rate swaps were not even disclosed let alone booked), the FASB was forced to write FAS 119, 133, and all the ensuing amending standards and complicated DIG interpretations. When Andy Fastow, with the help of Andersen consultants, invented ways to keep over a billion dollars worth of debt off Enron’s books using over 3,000 SPEs, the FASB rewrote more complicated rules for SPEs.

    More recently Lehman Bros. took advantage of a loophole in the spirit of FAS 140 that allowed Lehman to mask debt with repo sales rules that have always been inane in my viewpoint. Belatedly, Lehman’s debt masking is leading to new rules about repo accounting “sales” that are deceptive and not really sales at all.

    And, like Francine, I don’t trust the dependency of auditors on the CEOs and CFOs of their largest clients. Just as Andersen auditors caved in to Enron’s proposed deceptions, I think E&Y auditors caved in to Lehman’s proposed deceptions. As Tom Selling stated, “the audit (financing) model is broken.” However, unlike Francine, I firmly believe that public sector auditing would exacerbate the problem. Hence I view the “independence problem” as being much more critical with audit firms than with standard setters.

    For audit firms, the long-run answer might be the replacement of assurance with insurance, although there are many unresolved questions about insurance in this context.

    For standard setters, the long-run answer might be more research funding, larger boards, faster turnover of board members, and more serious lobbying rules.

    Hence my conclusion is that the never-ending efforts of some clients to deceive investors is the primary instigator of complicated new standards and interpretations. Perhaps that’s as it should be. I’m not in favor of watering down complicated standards on the naïve assumption that auditors will one day get tougher, on “principle,” with the hosts that feed them. And I think that today’s database technology is up to the task of auditing with complicated standards and interpretations.

    Perhaps the DIG should be expanded to a SIG for helping auditors and clients with questions about any standard in problematic circumstances. One thing that really continues to bother me, however, is how Ken Lay manipulated the SEC into a ruling that officially allowed Enron to embark on some of Enron’s most deceptive accounting. Can a DIG or a SIG be similarly manipulated by big corporations?

    The FASB and IASB processes of setting standards are far from perfect, but perhaps you’re too young to remember the really bad old days of the ARB, APB, and IASC --- historic standard setters that ducked controversial issues opposed by audit clients and issued rulings only about milk toast issues.

    Bob Jensen's threads on accounting standard setting are at
    http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

    Bob Jensen's threads on auditing independence and professionalism are at
    http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

     


    "Will Auditors Ever Answer To Investors For Aiding And Abetting?," by Francine McKenna, re: TheAuditors, June 16, 2010 ---
    http://retheauditors.com/2010/06/16/will-auditors-ever-answer-to-investors-for-aiding-and-abetting/

    The House – Senate Wall Street Reform and Consumer Protection Act Conference reconvened on Tuesday, June 15 and Compliance Week says a version of the Specter Bill – to repeal the Supreme Court’s Stoneridge decision – will not be included in whatever comes out of the process.

    Bruce Carton in Compliance Week: As this process gets underway, auditors, lawyers, bankers and other advisers to public companies are quietly breathing a sigh of relief that one of the items no longer on the table is an amendment proposed by Sen. Arlen Specter that would have overturned the U.S. Supreme Court’s 2008 ruling in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., thereby permitting “aiding and abetting” liability for a company’s auditors and others. The final version of the financial reform bill that passed the Senate did not include the Specter amendment.

    However, a coalition of state regulators, public pension funds, professors, consumers and investors and the attorneys who advise them, are still working to put something back in the bill as an amendment to restore the right of investors to defend themselves and hold white collar criminals accountable.

    Their email to me states:

    The amendment brought by Senators Arlen Specter (D-PA), Jack Reed (D-RI), Dick Durbin (D-IL) and many other senior Democrats would have enacted one simple change in current anti-investor law – law that was “legislated” by a conservative Supreme Court rather than the U.S. Congress. The reform would have restored the right of pension funds and other investors to hold accountable in courts those who knowingly aid and abet securities fraud.

    This legal right of investors, which for fifty years helped white collar crime victims recover their losses while also deterring future fraud enablers, was stripped from shareholders and bondholders by the radical Stoneridge Supreme Court decision of 2008, which expanded upon an earlier misguided Court decision in order to throw out thousands of remaining meritorious fraud claims brought by retirement funds and individual investors against investment banks and others who helped design the Enron fraud – the largest financial crime in U.S. history.

    Earlier this Spring, a Federal appeals court cited the “Supremes” and threw out the legitimate claims of ripped-off shareholders and bondholders in the billion dollar Refco, Inc. derivatives fraud.  In Refco, a now criminally convicted corporate lawyer had worked with Refco’s senior execs to execute fake transactions as a paper trail leading to falsified financial statements that were issued to investors and the public.

    Both Congressman Barney Frank and Senator Ted Kaufman responded to questions about the Specter amendment during my visit to Washington DC for Compliance Week’s Annual Conference.  House Financial Services Committee Chairman Frank said at the conference that he was in favor of bringing the amendment back in the bill.  Senator Kaufman, although a co-sponsor of the original amendment, is in favor but does not think it’s likely.

    I’ve written quite a bit about the impact of third party liability on the auditors in fraud claims and the Stoneridge decision.

    In February of 2008 , I wrote about Treasury’s attempt to address the nagging issues of viability and sustainability of the accounting profession.

    They punted.

    I have consistently disagreed with the Big 4’s claim that auditor liability caps are necessary to avoid losing one of the remaning firms to catastrophic litigation. I have lamented the fact that the auditors don’t get sued often enough for my tastes and, when they do, they often settle. I’ve also said that they don’t deserve our pity, as they are less than transparent regarding their true financial capacity to address ongoing litigation…

    “The Treasury Department established the Advisory Committee on the Auditing Profession to examine the sustainability of a strong and vibrant auditing profession.”

    John P. Coffey, the Co-Managing Partner of Bernstein Litowitz Berger & Grossmann LLP… agrees with what I have been saying on this blog all last year.

    It is with this perspective that I address one of the questions the Committee is considering, namely, whether there ought to be a cap on auditor liability. I respectfully submit that the case for such a cap has not been made…

    …the fact that, in today’s environment, auditors are rarely named as defendants in these actions. In a three-year period immediately before the PSLRA was enacted – April 1992 through April 1995 – auditors were named as defendants in 81 of 446 private securities class actions filed, for an average of 27 suits per year, or 18% of all private securities class actions. As the reforms of the PSLRA and the concomitant jurisprudence took hold, that number dropped precipitously. Auditors were named as defendants in only five suits in 2005, and only two cases in each of 2006 and 2007.

    The number for 2007 is especially telling because approximately one out of every eleven companies with U.S.-listed securities – almost 1200 companies in all – filed financial restatements in 2007 to correct material accounting errors. Further, an analysis of securities actions filed in 2006 and 2007 demonstrates a significant decline in the number of cases alleging GAAP violations, appearing to suggest “a movement away from the focus in recent years on the validity of financial results and accounting treatment.”

    Well, that’s changed post-financial crisis.  In addition to the big frauds like Satyam, Glitnir, the Madoff feeder funds and garden variety accounting malpractice claims, the auditors are named in high profile subprime cases where fraud is alleged such as New Century and Lehman.

    It’s still not a deluge, since the PSLRA makes it damn difficult to draw the auditors in without a smoking gun or, actually, a rogue mechanical pencil. Even with a top notch bankruptcy examiner’s reportI’m talking Refco here – it’s not easy.

    July 11, 2007, Bloomberg

    Refco Inc.’s tax accountant, Ernst & Young, and a company law firm may have helped the defunct futures trader defraud investors, according to an examiner’s report unsealed today.

    Ernst & Young, the second-biggest U.S. accounting firm, and Mayer Brown Rowe & Maw, a Chicago-based law firm, might face claims by Refco for aiding and abetting the fraud, examiner Joshua Hochberg said in a report filed in U.S. Bankruptcy Court in New York. Grant Thornton, the sixth biggest U.S. accounting firm, might face claims of professional negligence for work it did before Refco’s bankruptcy, Hochberg said.

    Contrast that seemingly slam-dunk assessment with this report on August 22, 2009:

    Two accounting firms and a law firm won dismissal of a lawsuit on behalf of former Refco Inc currency trading customers who lost more than $500 million when the defunct futures and commodities broker went bankrupt.

    U.S. District Judge Gerard Lynch on Tuesday said Marc Kirschner, a trustee representing the customers, failed to show that Ernst & Young LLP [ERNY.UL], Grant Thornton LLP and the law firm Mayer Brown LLP knew of or substantially assisted in the fraudulent diversion of assets that led to Refco’s demise.

    The Manhattan federal judge, however, gave permission for Kirschner to file a new complaint. Citing the trustee’s access to a “substantial trove” of Refco documents, Lynch said: “It is far from clear that repleading would be futile.”

    In his 35-page opinion, Lynch said Grant Thornton’s work gave it “a complete picture of how Refco and the Refco fraud, functioned.”

    He also said Mayer Brown “actively participated in carrying out Refco’s fraudulent misstatement of its financial position,” while Ernst performed to work for Refco “despite apprehending the scope of the fraud.”

    Judges, even while granting motions to dismiss, have more than once bemoaned the fact that the law does not allow them to act differently. In case after case, the judges are forced to let culpable third-party actors in these frauds off the hook.

    Continued in article

    Bob Jensen's threads on auditing firm litigation woes ---
    http://www.trinity.edu/rjensen/fraud001.htm

    Bob Jensen's threads on professionalism and independence in auditing --- a
    http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

     

     

     


    Why must we worry about the hiring-away pipeline?

    Credit Rating Agencies ---- http://en.wikipedia.org/wiki/Credit_rating_agency

    A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings. In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-profit organizations, or national governments issuing debt-like securities (i.e., bonds) that can be traded on a secondary market. A credit rating for an issuer takes into consideration the issuer's credit worthiness (i.e., its ability to pay back a loan), and affects the interest rate applied to the particular security being issued. (In contrast to CRAs, a company that issues credit scores for individual credit-worthiness is generally called a credit bureau or consumer credit reporting agency.) The value of such ratings has been widely questioned after the 2008 financial crisis. In 2003 the Securities and Exchange Commission submitted a report to Congress detailing plans to launch an investigation into the anti-competitive practices of credit rating agencies and issues including conflicts of interest.

    Agencies that assign credit ratings for corporations include:

     

    How to Get AAA Ratings on Junk Bonds

    1. Pay cash under the table to credit rating agencies
    2. Promise a particular credit rating agency future multi-million contracts for rating future issues of bonds
    3. Hire away top-level credit rating agency employees with insider information and great networks inside the credit rating agencies

    By now it is widely known that the big credit rating agencies (like Moody's, Standard & Poor's, and Fitch) that rate bonds as AAA to BBB to Junk were unethically selling AAA ratings to CDO mortgage-sliced bonds that should've been rated Junk. Up to now I thought the credit rating agencies were merely selling out for cash or to maintain "goodwill" with their best customers to giant Wall Street banks and investment banks like Lehman Bros., AIG., Merrill Lynch, Bear Stearns, Goldman Sachs, etc. ---
    http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze
    But it turns out that the credit rating agencies were also in that "hiring-away" pipeline.

     Wall Street banks and nvestment banks were employing a questionable tactic used by large clients of auditing firms. It is common for large clients to hire away the lead auditors of their CPA auditing firms. This is a questionable practice, although the intent in most instances (we hope) is to obtain accounting experts rather than to influence the rigor of the audits themselves. The tactic is much more common and much more sinister when corporations hire away top-level government employees of regulating agencies like the FDA, FAA, FPC, EPA, etc. This is a tactic used by industry to gain more control and influence over its regulating agency. Current regulating government employees who get too tough on industry will, thereby, be cutting off their chances of getting future high compensation offers from the companies they now regulate.

    The investigations of credit rating agencies by the New York Attorney General and current Senate hearings, however, are revealing that the hiring-away tactic was employed by Wall Street Banks for more sinister purposes in order to get AAA ratings on junk bonds. Top-level employees of the credit rating agencies were lured away with enormous salary offers if they could use their insider networks in the credit rating agencies so that higher credit ratings could be stamped on junk bonds.

    "Rating Agency Data Aided Wall Street in Deals," The New York Times, April 24, 2010 ---
    http://dealbook.blogs.nytimes.com/2010/04/24/rating-agency-data-aided-wall-street-in-deals/#more-214847

    One of the mysteries of the financial crisis is how mortgage investments that turned out to be so bad earned credit ratings that made them look so good, The New York Times’s Gretchen Morgenson and Louise Story report. One answer is that Wall Street was given access to the formulas behind those magic ratings — and hired away some of the very people who had devised them.

    In essence, banks started with the answers and worked backward, reverse-engineering top-flight ratings for investments that were, in some cases, riskier than ratings suggested, according to former agency employees. Read More »

    "Credit rating agencies should not be dupes," Reuters, May 13, 2010 ---
    http://www.reuters.com/article/idUSTRE64C4W320100513

    THE PROFIT INCENTIVE

    In fact, rating agencies sometimes discouraged analysts from asking too many questions, critics have said.

    In testimony last month before a Senate subcommittee, Eric Kolchinsky, a former Moody's ratings analyst, claimed that he was fired by the rating agency for being too harsh on a series of deals and costing the company market share.

    Rating agencies spent too much time looking for profit and market share, instead of monitoring credit quality, said David Reiss, a professor at Brooklyn Law School who has done extensive work on subprime mortgage lending.

    "It was incestuous -- banks and rating agencies had a mutual profit motive, and if the agency didn't go along with a bank, it would be punished."

    The Senate amendment passed on Thursday aims to prevent that dynamic in the future, by having a government clearinghouse that assigns issuers to rating agencies instead of allowing issuers to choose which agencies to work with.

    For investigators to portray rating agencies as victims is "far fetched," and what needs to be fixed runs deeper than banks fooling ratings analysts, said Daniel Alpert, a banker at Westwood Capital.

    "It's a structural problem," Alpert said.

    Continued in article

    Also see http://blogs.reuters.com/reuters-dealzone/

    Jensen Comment
    CPA auditing firms have much to worry about these investigations and pending new regulations of credit rating agencies.

    Firstly, auditing firms are at the higher end of the tort lawyer food chain. If credit rating agencies lose class action lawsuits by investors, the credit rating agencies themselves will sue the bank auditors who certified highly misleading financial statements that greatly underestimated load losses. In fact, top level analysts are now claiming that certified Wall Street Bank financial statement were pure fiction:

    "Calpers Sues Over Ratings of Securities," by Leslie Wayne, The New York Times, July 14, 2009 --- http://www.nytimes.com/2009/07/15/business/15calpers.html

    Secondly, the CPA profession must begin to question the ethics of allowing lead CPA auditors to become high-level executives of clients such as when a lead Ernst & Young audit partner jumped ship to become the CFO of Lehman Bros. and as CFO devised the questionable Repo 105 contracts that were then audited/reviewed by Ernst & Yound auditors. Above you read that:  "In fact, rating agencies sometimes discouraged analysts from asking too many questions, critics have said." We must also worry that former auditors sometimes discourage current auditors from asking too many questions.
    http://retheauditors.com/2010/03/15/liberte-egalite-fraternite-lehman-brothers-troubles-for-ernst-young-threaten-the-big-4-fraternity/

    Credit rating of CDO mortgage-sliced bonds turned into fiction writing by hired away raters!
    Frank Partnoy and Lynn Turner contend that Wall Street bank accounting is an exercise in writing fiction:
    Watch the video! (a bit slow loading)
    Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
    "Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy, Roosevelt Institute, March 2010 ---
    http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
    Watch the video!


    "The Big 4 Audit Report: Should the Public Perceive It as a Label of Quality?" by Ross D. Fuerman,," Accounting and the Public Interest 9 (1), 148 (2009) ---
    http://aaapubs.aip.org/getabs/servlet/GetabsServlet?prog=normal&id=APIXXX000009000001000148000001&idtype=cvips&gifs=Yes&ref=no

    ABSTRACT:
    There has been little research comparing the relative performance of the Big 4 CPA firms. Users of audited financial statements often practically have no other CPA firms to choose from for auditing services in the large public company auditing services market and thus desire more of this information. In 1,017 financial reporting lawsuits against Big 5 auditees filed from 1999 through 2004, the auditor litigation outcomes are used to proxy for the likelihood of audit failure and thus for audit quality. Control variables significant in prior empirical work were used in polytomous regression and in logistic regression. Ernst & Young has comparatively better auditor litigation outcomes, which proxy for a lower likelihood of audit failure and a stronger level of audit quality. The Ernst & Young results are robust; they are insensitive to the use of ten different model specifications. There is also evidence suggesting that PricewaterhouseCoopers may be a comparatively high quality auditor, but these latter results are sensitive to the model specification. Clearly, the null hypothesis of consistency in audit quality among the Big 4 CPA firms is rejected. ©2009 American Accounting Association

    Bob Jensen's threads on auditing professionalism are at
    http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

    Bob Jensen's threads on auditing firm litigation ---
    http://www.trinity.edu/rjensen/Fraud001.htm

     


    The Dark Side:  Hiring Secrets of the Big 4
    The suit claims Ernst & Young offers job contracts to graduating college seniors that “compel” them “to work for EY to the exclusion of all other employers,” but allow the company “to legally renege or cancel the offer of employment” if the senior does not maintain a vague “strong academic standing.”

    "Taking a Louisville Slugger: Lawsuits Against E&Y, PwC Show Ugly Side of Big 4,″ written for Going Concern magazine by Francine McKenna, re: theAuditors, May 13, 2010 --- http://retheauditors.com/2010/05/13/going-concern-taking-a-louisville-slugger-lawsuits-against-ey-pwc-show-ugly-side-of-big-4/
    With a video clip from The Untouchables

    Robert DeNiro as Al Capone in The Untouchables:

    “A man becomes preeminent, he’s expected to have enthusiasms. Enthusiasms, enthusiasms… What are mine? Baseball! A man stands alone at the plate. This is the time for what? For individual achievement. There he stands alone. But in the field, what? Part of a team. Teamwork…”

    It must be heartbreaking to one day feel you’re part of a team, a big wonderful, eminent, respectable team and the next get cold-cocked.

    Two new Big 4 lawsuits – one against Ernst & Young and the other against PwC – reminded me how many times professionals have written to say their firm had just knocked the stuffing out of them. They had been fired suddenly or a student’s offer was pulled at the last minute.

    They were crushed. Humiliated. Confused. Betrayed.

    It must be heartbreaking to one day feel you’re part of a team, a big wonderful, eminent, respectable team and the next get cold-cocked.

    Two new Big 4 lawsuits – one against Ernst & Young and the other against PwC – reminded me how many times professionals have written to say their firm had just knocked the stuffing out of them. They had been fired suddenly or a student’s offer was pulled at the last minute. They were crushed. Humiliated. Confused. Betrayed.


    Ms. Yunjung Gribben, 43, is the lead plaintiff in a class action lawsuit against EY in California. Ms. Gribben says Ernst & Young offered her a job with a starting annual salary of $50,000, then pulled the offer, after she graduated, because of “a couple of C grades she had received in accounting during her senior year at CSUF.” Ms. Gribben says she graduated from Cal State Fullerton with a 3.6 grade point average. The case seems to be more about age discrimination – she says younger candidates kept their jobs – than it is about contracts.

    The suit claims Ernst & Young offers job contracts to graduating college seniors that “compel” them “to work for EY to the exclusion of all other employers,” but allow the company “to legally renege or cancel the offer of employment” if the senior does not maintain a vague “strong academic standing.”

    I’ve written about the one-sided contracts and the high pressure recruiting tactics of the Big 4 audit firms at re: The Auditors. When the economy started to turn in 2007, the Big 4 began to slow the pipeline of recruits by offering fewer internships, offering fewer interns full time jobs, delaying start dates, and rescinding offers for vague, supposed breaches of their one sided agreements.

    Candidates felt helpless since, like Ms. Gribben, once they had decided amongst all offers – many of the best students used to have a choice of all four of the largest firms and more – they were left with few choices if their selected firm reneged. Not only had the other firms moved on and given their slot to someone else, but the taint of having their offer fall through intimidates many students. Complaining might end up on their “permanent record” and “blacklist” them for the rest of their career. Many were locked in a stasis that sometimes only corrected itself after a call or email to me.

    I have spoken to former Big 4 partners. They tell me getting fired after twenty years, their whole post-undergraduate degree career, is like getting whacked in the knees with a baseball bat. One day you’re leading engagements at prestigious Fortune 500 clients, smoking cigars and drinking single-malt scotch at parties, buying the McMansion in a “better” suburb and putting the BMW in the driveway and the next day you’re putting a profile together on “Linked In” and setting up an LLC in case you have to do independent consulting for an extended period.

    Read the rest of the article at http://goingconcern.com/2010/05/taking-a-louisville-slugger-lawsuits-against-ey-pwc-show-an-ugly-side-of-the-big-4/

    Bob Jensen's threads on lawsuits and settlements of CPA firms ---
    http://www.trinity.edu/rjensen/Fraud001.htm

     

     


    Questions
    How is bright-line-rule Repo accounting in 2008 like the bright-line-rule “1% Solution” of a decade earlier?
    Answer is suggested below.

    How do we simultaneously award PwC for being the world’s Number 1 financial management consulting firm and the Number 1 financial auditing firm?
    Question is raised below.

    First Let’s Talk About 2010

    PwC is the auditor of Goldman Sachs, and we really don't know if and how long PwC will be off the hook on Goldman’s 2010 lawsuits. The former Treasury Secretary, Hank Paulson, was previously the CEO of Goldman. He made it his number one priority to save Goldman in the Bailout, which in turn made it necessary to bail out AIG since billions in AIG credit derivative obligations were owed to Goldman. The net effect was to bail out AIG, which of course is also audited by PwC.

     

    Ernst & Young, the audit firm, had a long and lucrative relationship with Lehman Brothers. Lehman Brothers has paid EY more than $160 million in audit and other fees since fiscal year 2001.  Although this isn’t nearly as much as Goldman Sachs and AIG pay PwC – almost $230 million a year combined in 2008 – it was still a huge amount and represented a significant client relationship for Ernst & Young
    Francine McKenna,
    "Liberté, Egalité, Fraternité: Big Lehman Brothers Troubles For Ernst & Young," re: The Auditors, March 15, 2010 ---
    http://retheauditors.com/2010/03/15/liberte-egalite-fraternite-lehman-brothers-troubles-for-ernst-young-threaten-the-big-4-fraternity/

    Also see
    The Continuing Saga of Auditing, Independence, Consulting, and Professionalism and Fees
    "The Great American Financial Sandwich: AIG, PwC, and Goldman Sachs," by Francine McKenna, re: The Auditors, February 2, 2010 ---
    http://retheauditors.com/2010/02/02/4151/

    If and when shareholders lose money in 2010 because of proven Goldman frauds, it’s inevitable that Goldman’s shareholders and creditors will file lawsuits against the PwC auditors as well as Goldman Sachs itself and the credit agencies that fraudulently gave Goldman’s toxic CDO bonds AAA ratings when they should’ve been junk. The credit rating agencies in turn will sue PwC claiming they were misled by Goldman’s golden financial statement.

    The 2010 lawsuit merry-go-round is barely beginning since the SEC’s lawsuit against Goldman is hot off the presses. Worse, the Justice Department has yet to decide whether it will pursue criminal prosecution of Goldman. I doubt that this will happen since hauling Goldman into criminal court might greatly upset the Administration’s economic recovery plan and create massive unemployment and economic disruption.

    Thus it’s become a waiting game for PwC in 2010. Meanwhile PwC can bank hundreds of millions in a war chest, much of it earned from the administration of the Lehman Bankruptcy. It’s also not clear that PwC is as culpable for any Goldman audit failures as much Ernst & Young is culpable, in my opinion, for the alleged Lehman audit failures --- http://www.trinity.edu/rjensen/fraud001.htm#Ernst

    PwC does have other legal battles pending ---
    http://www.trinity.edu/rjensen/fraud001.htm#PwC

     

    Goldman and PwC might well survive the 2010 legal battle like they survived a huge 2000 legal battle:

    A History Lesson on Goldman that Sounds a Bit Like Repo Accounting Issues with the “1% Solution

     

    Question
    How can you "PUT" away your cares about clear-cut (bright line) rules of accounting?

    Answer
    See how AOL did it in conspiracy with Goldman Sachs

    With the AOL-Time Warner deal due to close in just three months, Bertelsmann needed to reduce its AOL Europe holding -- pronto. But the obvious buyer, AOL, didn't want to own more than 50% or more of the venture, either. Going above half might trigger a U.S. accounting rule that would force AOL to consolidate all the struggling unit's losses on its books when AOL was already grappling with deteriorating ad revenues and a declining stock price. Enter Goldman Sachs Group Inc. (GS ) Business Week has learned that the premier Wall Street bank agreed to buy 1% of AOL Europe -- half a percent from each parent -- for $215 million. AOL Europe, in return, agreed to a "put" contract promising Goldman that it could sell back the 1% by a specific date and at a set price. That simple transaction solved Bertelsmann's EU problem without trapping AOL in an accounting conundrum -- a perfect solution.

    "Goldman's 1% Solution," by Paula Dwyer, Business Week, June 28, 2004 --- http://www.businessweek.com/@@ajkOUmUQQWvg7RMA/premium/content/04_26/b3889045_mz011.htm?se=1 

    Goldman's 1% Solution
    In 2000, it cut a questionable deal that smoothed the AOL-Time Warner merger. Will the SEC take action?

    In more ways than one, the news from the European Union was bad. It was October, 2000, and the EU's executive arm, the European Commission, had just jolted America Online Inc. with a ruling that its pending acquisition of Time Warner Inc. (TWX ) could harm competition in Europe's media markets, especially the emerging online music business. The EC was concerned that AOL was a 50-50 partner with German media giant Bertelsmann in one of Europe's biggest Internet service providers, AOL Europe. Now the EC was ordering Bertelsmann to give up control over AOL Europe.

    With the AOL-Time Warner deal due to close in just three months, Bertelsmann needed to reduce its AOL Europe holding -- pronto. But the obvious buyer, AOL, didn't want to own more than 50% or more of the venture, either. Going above half might trigger a U.S. accounting rule that would force AOL to consolidate all the struggling unit's losses on its books when AOL was already grappling with deteriorating ad revenues and a declining stock price.

    Enter Goldman Sachs Group Inc. (GS ) Business Week has learned that the premier Wall Street bank agreed to buy 1% of AOL Europe -- half a percent from each parent -- for $215 million. AOL Europe, in return, agreed to a "put" contract promising Goldman that it could sell back the 1% by a specific date and at a set price. That simple transaction solved Bertelsmann's EU problem without trapping AOL in an accounting conundrum -- a perfect solution.

    LEGAL HEADACHES 

    Or so it seemed at the time. But the deal also may have violated U.S. securities laws. The Securities A: Exchange Commission and the Justice Dept. have construed some deals involving promises to buy back assets at a specific time and price as share-parking arrangements designed to mislead investors. The former chief executive of AOL Europe says the Goldman deal may have kept up to $200 million in 2000 losses off of the combined AOL-Time Warner financials -- enough, he says, that Time Warner might have tried to change the terms of the $120 billion merger, since AOL wouldn't have looked as healthy. But as the deal moved toward consummation, the Goldman arrangement was never disclosed in public documents to AOL or Time Warner shareholders.

    The AOL Europe transaction threatens to create problems for Goldman Sachs. But it could also prolong the legal headaches of Time Warner Inc., as the AOL-Time Warner combine is now called. For the past two years, Time Warner has been in heated negotiations with the SEC over AOL's accounting for advertising revenues (BW -- June 7). Just as the SEC is wrapping up that case -- it could warn Time Warner as early as this summer that it intends to bring civil fraud charges -- the Goldman transaction raises troubling new questions about AOL's financial dealings prior to the merger.

    The SEC has not brought charges over the 1% solution, and an SEC spokesman would not comment on whether the agency is probing the deal. Time Warner spokeswoman Tricia Primrose Wallace says the company will not comment on any part of the Goldman arrangement. A lawyer for Stephen M. Case, AOL's chairman and CEO at the time of the deal, referred questions to Time Warner. Thomas Middelhoff, who was Bertelsmann's chairman at the time of the deal and negotiated the AOL Europe joint venture with Case in 1995, says through a spokesman that the sale of a 0.5% stake was "purely a financial technique" handled by others. And Lucas van Praag, a Goldman Sachs spokesman, says: "We handled this entirely appropriately. We don't believe there is anything untoward here."

    Continued in the article

     

    "University of California, Bank Sue AOL:  Lawsuit claims firm lied about finances, cost them," by Pamela Tate, The Wall Street Journal, April 15, 2003 --- http://www.yourlawyer.com/practice/printnews.htm?story_id=5448 

    The University of California has joined with Amalgamated Bank to file a lawsuit against AOL Time Warner Inc., claiming their stakes have lost more than $500 million in value because the media company allegedly lied about its financial condition.

    The University of California, which dropped out of a federal class-action suit against AOL earlier this month, filed the complaint Monday in the Superior Court of California in Los Angeles. The university and co-plaintiff Amalgamated Bank, a New York institution that manages funds for several dozen union pension funds, are being represented by Milberg Weiss Bershad Hynes & Lerach.

    The plaintiffs allege that AOL Time Warner materially misrepresented its revenue and subscriber growth after the merger of AOL and Time Warner in January 2001. In two separate restatements in October and March, AOL slashed nearly $600 million from previously reported revenue over the past two years.

    The University of California and Amalgamated allege that AOL's admissions so far have been "too conservative," and that the company may have overstated results by almost $1 billion.

    In a March 28 filing with the Securities and Exchange Commission, AOL Time Warner said it faces 30 shareholder lawsuits that have been centralized in the U.S. District Court for the Southern District of New York. The company said in the filing it intends to defend itself "vigorously." The lawsuit filed by the University of California and Amalgamated names several current and former AOL Time Warner executives, as well as financial-services giants Citigroup and Morgan Stanley.

    Citigroup is the parent of Salomon Smith Barney, now called Smith Barney, which with Morgan Stanley allegedly reaped $135 million in advisory fees from the AOL and Time Warner merger.

    Defendants include Stephen Case, who resigned as chairman in January; former Chief Executive Gerald Levin, who left the company in May; current Chairman and Chief Executive Richard Parsons; and Ted Turner, who recently stepped down as vice chairman.

    The lawsuit claims they and more than two dozen other insiders sold off $779 million in stock just after the merger closed but before the accounting revelations that would cause the stock price to plummet.
    The suit also names AOL's auditor, Ernst & Young.

    The University of California claims it lost $450 million in the value of its AOL Time Warner shares, which were converted from more than 11.3 million Time Warner shares in the merger. At the end of 2002, the value of the university's portfolio was at $49.9 billion.

    Continued in the article

     

    And so the beat goes on a decade later with Goldman raking in billions in profits and PwC thriving like never before in assurance services and consulting.

    "PricewaterhouseCooopers Gains Top Rating From Gartner," Big Four Blog, January 20, 2010 --- http://www.bigfouralumni.blogspot.com/ 

    We see from a recent press release that PricewaterhouseCoopers has received a “Strong Positive” rating in Gartner’s Global Finance Management Consulting Services MarketScope Report, which was published recently on December 21, 2009.

    This is the highest possible rating in the Marketscope, a "Strong Positive" shows a provider who can be considered "a strong choice for strategic investments" where customers can continue with planned investments and potential customers can consider this vendor a strong choice for strategic investments.. The research assesses the global capabilities of nine leading finance management consulting service providers on customer experience, market understanding, market responsiveness, product/service, offering strategy, geographical capabilities and vertical-industry strategy.

    Congratulations to PwC for this select honor.

    Jensen Comment
    Unfortunately, there is a stiff price to see the contents of this report (US$1,995), so we can’t say who the other 8 providers are, but very likely some of the Big Four firms would be on that list, and somewhat curious why PwC should feature this as a big release on their global website, but other firms are quite silent on this point.

    At times it may be difficult for the world's largest auditing firm to also be rated as the top firm for "Global Finance Management Consulting Services." Nobody seems to question financial consulting since the Andersen destruction gave rise to new independence rules, notably Sarbanes-Oxley. In the past decade the Big Four auditing firms, except for Deloitte, shed themselves of their consulting divisions and then commenced to selectively build them back up once again. However, more care is being devoted to the independence bounds of computer systems and tax consulting.

     

    From: THE Internet Accounting List/Forum for CPAs [mailto:CPAS-L@LISTSERV.LOYOLA.EDU] On Behalf Of Jim Fuehrmeyer
    Sent: Friday, January 22, 2010 10:07 AM
    To: CPAS-L@LISTSERV.LOYOLA.EDU
    Subject: Re: PricewaterhouseCooopers Gains Top Rating From Gartner

    Despite the SEC/Sarbanes-Oxley rules that severely limit the non-audit services that auditors can provide to their audit clients, the re-growth of consulting should still be a concern.

    I think Art Wyatt’s article on the cultural impact of consulting at Arthur Andersen that appears in the March 2004 Issue of Accounting Horizons sums it up best.

    It’s required reading for all my undergraduate CPAs to be.

     Jim Fuehrmeyer

    JAMES L. FUEHRMEYER, JR.
    Associate Professional Specialist
    Department of Accountancy

    . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    MENDOZA COLLEGE OF BUSINESS
    UNIVERSITY OF NOTRE DAME

    384 Mendoza College of Business
    Notre Dame, IN 46556
    office: (574) 631-1752 | fax: (574) 631-5255

    e: jfuehrme@nd.edu | w:
    http://business.nd.edu

     

    Art Wyatt asserted:
    "ACCOUNTING PROFESSIONALISM: THEY JUST DON'T GET IT" ---
    http://aaahq.org/AM2003/WyattSpeech.pdf 

    Bob Jensen's threads on auditing professionalism and independence are at
    http://www.trinity.edu/rjensen/fraud001.htm#Professionalism


    Accountants Claim Immorality is Acceptable if It Fails to Pass the Materiality Test
    Bedtime Lesson 1 for Children:  Only Steal a Little Bit at Any One Time and Stay Below Your Materiality Limit
    Bedtime Lesson 2 for Children:  The Materiality Limit is Higher for Thieves Who Are Already Rich
    Bedtime Lesson 3 Attributed to Prize Fighter Joe Lewis:  Being Rich is Better Than Being Poor

    From The Wall Street Journal Accounting Weekly Review on April 23, 2010

    Case Hinges on Vital Legal Concept
    by: Ashby Jones, Kara Scannel, and Susanne Craig
    Apr 19, 2010
    Click here to view the full article on WSJ.com
    Click here to view the video on WSJ.com WSJ Video

    TOPICS: Fraud, Materiality, SEC, Securities and Exchange Commission

    SUMMARY: The Securities and Exchange Commission's civil case against Goldman Sachs Group Inc. hinges in large part on the concept of materiality. The WSJ article gives a casual definition of this concept. Students are asked to provide the definition of the accounting concept of materiality and compare its use to that described in this case. The related article is the main page article with a clear graphic describing the transaction which led to the SEC case again Goldman Sachs.

    CLASSROOM APPLICATION: The article is designed to expand students' understanding of the concept of material beyond a numerical threshold for financial statement adjustments.

    QUESTIONS: 
    1. (
    Introductory) The WSJ article indicates that materiality is central to the case against Goldman Sachs that was brought this week by the SEC. How is this concept defined in the WSJ article?

    2. (
    Introductory) Also refer to the WSJ video of Ashby Jones discussing the legal issues entitled SEC v. Goldman. How does he define this concept?

    3. (
    Advanced) Identify the accounting concept of materiality in the conceptual literature behind U.S. GAAP or IFRS. Does this accounting definition differ from that provided in the WSJ article? From the WSJ video of Ashby Jones discussing the legal issues? Explain.

    4. (
    Introductory) Refer to the related print article and especially the graphic associated with it, entitled "Middleman: How Goldman Sachs structured the deal under scrutiny." Describe the transaction that has triggered the SEC's case against Goldman Sachs.

    5. (
    Introductory) What was the potentially material fact that was kept from investors who bought the Abacus CDO designed by ACA Management and sold by Goldman Sachs?

    6. (
    Advanced) Refer again to the accounting definition of materiality. How does this example from outside accounting make it clear that the nature of a given item may create materiality concerns as much as the dollar value of that item?

    Reviewed By: Judy Beckman, University of Rhode Island

    RELATED ARTICLES: 
    Goldman Sachs Charged with Fraud
    by Gregory Zuckerman, Susanne Craig and Serena Ng
    Apr 17, 2010
    Page: A1

     

    SEC versus Goldman Sachs
    "Will Wall Street (or the Rest of Us) Ever Learn?" by Bill Taylor, Harvard Business Review Blog, April 19, 2010 ---
    http://blogs.hbr.org/taylor/2010/04/will_wall_street_or_the_rest_o.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE

    The SEC's decision to file civil-fraud charges against Goldman Sachs over one of the synthetic securities the investment bank issued during the subprime-mortgage bubble has generated major headlines, roiled the stock market, and otherwise created a flurry of shock and awe from Wall Street to Washington, DC. What I find surprising, though, is how surprised people seem to be by the charges. We still can't seem to come to terms with just how badly so many "blue-chip" institutions behaved over the last few years, and how easily so many high-profile executives got caught up in the speculative frenzy to turn a quick buck (or, in this case, a quick billion).

    I might have been surprised, too, had I not just finished Michael Lewis's remarkable new book, The Big Short. This account of the subprime-mortgage fiasco, the small band of eccentrics who made billions betting against it, and the army of highly educated, well-dressed, overpaid investment bankers who engaged in a march of folly to the very end, left me angry, shaken, and depressed. It was as if I were reading a bigger, badder account of all the financial booms and busts that had come before--from the junk-bond craze to the LBO wave to the Internet bubble.

    As I read the last page and sighed, one question nagged at me: How is it that so many allegedly brilliant people (just ask the folks at Goldman, they'll tell you how smart they are) never seem to learn? Why do the self-satisfied "lords of finance" keep making the same self-inflicted mistakes, whether they are matters of bad judgment, fraudulent conduct, or outright criminality?

    I woke up the next morning, checked out The New York Times, and saw a different version of the same story played out yet again! A front-page article explored how the much-celebrated phenomenon of micro-lending, offering small loans to individuals and entrepreneurs in the poorest countries as a way to lift them from poverty, is facing a global backlash. Muhammad Yunus, the Bangladeshi economist who won the Nobel Peace Prize in 2006 for his work in the field, was watching in horror as powerful, hungry, often-reckless banks were rushing in to generate big profits from an idea they either didn't understand or didn't care about. "We created microcredit to fight the loan sharks; we didn't create microcredit to encourage new loan sharks," Professor Yunus fumed. "Microcredit should be seen as an opportunity to help people get out of poverty in a business way, but not as an opportunity to make money out of people."

    I love innovation as much as the next person--probably more so. But this makes me crazy! The story of finance over the last 25 years has been the story of innovation run amok--and of our systematic failure, as a society, as companies, as individual leaders, to learn from mistakes we seem determined to keep making. It might be condo loans in Miami, synthetic derivatives in London, or credits to yak herders in Mongolia, but it's déjà vu all over again: good ideas gone disastrously wrong, genuine steps forward that ultimately bring markets crashing down.

    As I fumed once more, I thought back to some words of wisdom from Warren Buffet, who continues to amaze with his common-sense brilliance. Buffet gave the best explanation of this phenomenon I've ever heard in an interview with Charlie Rose. The PBS host, talking to the billionaire about the same disaster Michael Lewis writes about, asked the obvious question: "Should wise people have known better?" Of course, they should have, Buffett replied, but there's a "natural progression" to how good ideas go wrong. He called this progression the "three I's." First come the innovators, who see opportunities that others don't. Then come the imitators, who copy what the innovators have done. And then come the idiots, whose avarice undoes the very innovations they are trying to use to get rich.

    The problem, in other words, isn't with innovation. It's with the bad behavior that inevitably follows. So how do we as individuals (not to mention as companies and societies) continue to embrace the value-creating upside of creativity while guarding against the value-destroying downsides of imitation and idiocy? It's not easy, which is why so many of us fall prey to so many bad ideas. "People don't get smarter about things that get as basic as greed," Warren Buffett told Rose. "You can't stand to see your neighbor getting rich. You know you're smarter than he is, but he's doing all these [crazy] things, and he's getting rich...so pretty soon you start doing it."

    That's some pretty straight shooting and a pretty fair approximation of the delusional, foolish, and downright stupid behavior that Michael Lewis chronicles in such detail. It's also a central challenge for innovators everywhere. Sometimes, the most important form of leadership is resisting an innovation that takes hold in your field when that innovation, no matter how popular with your rivals, is at odds with your values and long-term point of view. The most determined innovators are as conservative as they are disruptive. They make big strategic bets for the long term and don't hedge their bets when strategic fashions change.

    Can you distinguish between genuine creativity and mindless imitation? Are you prepared to walk away from ideas that promise to make money, even if they make no sense? Do you have the discipline to keep your head when so many around you are losing theirs? Those questions are something to think about. The answers may be the difference between being an innovator and an idiot.

    Bob Jensen's threads on banking and investment banking fraud ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking

     


    "Fraud Happened. The No-Account Accountants Stood By," by Francine McKenna, re: The Auditors, April 18, 2010 ---
    http://retheauditors.com/2010/04/18/fraud-happened-the-no-account-accountants-stood-by/

    The financial crisis is now about fraud.

    The word that dared not be uttered, even behind closed doors, has now disturbed the peace of a nascent “recovery.”  Why did it take so long for the media, the regulators and the legislators to acknowledge what some of us have known for a while?

    “Gentlemen, not one of you could have done this on your own. This was a team effort.” Casey Stengel after the Mets 40-120 season.

    Why didn’t the Big 4 audit firms warn that these obscenely over leveraged institutions threatened our financial future? Why didn’t the auditors question, push back, or raise objections to illegal and unethical disclosure gaps? Every one of the failed or bailed out financial institutions carried non-qualified, clean audit opinions in their wallets when they cashed the taxpayers’ check.

    Lehman Brothers. Bear Stearns. Washington Mutual. AIG. Countrywide. New Century. Citigroup. Merrill Lynch. GE Capital. GMAC. Fannie Mae. Freddie Mac.

    The largest four global audit firms – Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers – have combined revenues of almost $100 billion dollars and employ hundreds of thousands of people. There’s no hard proof they’re completely corrupt, but they’ve proven themselves to be demonstrably self-interested and no longer singularly focused on their public duty to shareholders.

    Something is rotten with the accounting industry.

    America’s public accountants – in particular, the Big 4 audit firms – aren’t protecting investors. And no one is holding them accountable.

    The crisis that culminated in the near-collapse of the global financial system is still the subject of Congressional hearings.

    Almost every player has been called to account.

    Except one.

    The auditors.

    Last month the Lehman Bankruptcy Examiner’s report told us that there’s “sufficient evidence exists to support colorable claims against Ernst & Young LLP for professional malpractice arising from [their] failure to follow professional standards of care.”

     

    This week the Securities and Exchange Commission charged Goldman Sachs and one of its vice presidents with fraud for misleading investors by “misstating and omitting key facts about a financial product tied to subprime mortgages.”

    That financial product was a structured collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). Goldman Sachs, according to the SEC, failed to disclose vital information about the CDO to investors. In particular, John Paulson’s hedge fund, a Goldman client, played a leading role in the portfolio selection process and the hedge fund took a short position against the CDO, without disclosure to Goldman’s other clients.

    In one of the most egregious cases of auditor complacence during the financial crisis, Pricewaterhouse Coopers LLP (PwC), the firm that audits both AIG and Goldman Sachs, sat on the sidelines for almost two years while their clients disputed the value of credit default swaps (CDS).

    There’s been no public explanation of how PwC presided over the dispute between AIG and Goldmana dispute eventually pushed AIG to accept a bailout – without doing something decisive to help resolve it. This long-running “difference of opinion” between two of its most important global clients was arguably material to at least one of them. Why didn’t PwC force a resolution sooner based on consistent application of accounting standards?

    PwC was paid a combined $230 million by the two firms for 2008 and remains the “independent” auditor to both companies.

    Gatekeepers? Or foxes in the hen house?

    The auditor’s role is to be a gatekeeper. A watchdog. An advocate for shareholders. This is their public duty.

    This public trust is subsidized by a government-sponsored franchise. All companies listed on major stock exchanges must have an audit opinion. Audit firms are meant to be shareholders’ first line of defense, and they are hired by and report to the independent Audit Committee of the Board of Directors.

    And yet the same audit firms that stood by and watched Bear Stearns and Lehman Brothers fail  – Deloitte and Ernst &Young – are recipients of lucrative government contracts to audit or monitor the taxpayers’ investment in the bailed out firms.  Deloitte, the Bear Stearns and Merrill Lynch auditor, works for the US Federal Reserve system.  Ernst & Young, Lehman’s auditor, is working for the US Treasury on the original $700 billion TARP program and with the Fed on the AIG bailout.

    Who are we kidding?

    America’s auditors serve themselves. Focused on “client service” not shareholder advocacy, they’ve remained above the financial crisis finger-pointing fray.  Call it skillful lobbying or targeted political contributions…  Either way, regulators and legislators have been afraid of getting on the auditors’ bad side.

    Investment banks, mortgage originators, commercial banks, and ratings agencies have all been questioned about their role in the crisis. And the Big 4 public accounting firms work for all of them.

    But when accused of negligence, malpractice or complicity, the audit firms frequently claim to have been duped. Do you believe them? The industry is an oligopoly. That’s a $10 word for what happens when a market or industry is dominated by a small number of sellers who discuss their strategies in order to achieve common objectives.

    The Sarbanes Oxley Act of 2002 (SOx) was enacted after the Enron debacle to restore confidence in the audit profession. Instead, accounting firms reaped huge financial rewards while enforcing SOx, until the tremendous cost to America’s businesses forced regulators to lighten up and the auditors to stand down.

    But SOx had another insidious byproduct: the misplaced belief that after Arthur Andersen’s implosion, the remaining four global public accounting firms were too important, and too few, to fail.

    This fear of auditor failure precludes any regulatory or legislative actions that might precipitate the loss of another large accounting firm. What do you get when there’s no timely or significant regulatory consequence to repeated auditor malpractice and incompetence? Moral hazard. “Too few to fail” has been as detrimental to capital markets as the notion that some financial institutions are too big to fail. Shareholders are harmed and investors lose confidence.

    Every one of the audit firms is a defendant in lawsuits for institutions that failed, were taken over, or bailed out, in addition to several $1 billion plus malpractice, fraud and Madoff-related lawsuits. Any one of these “catastrophic” matters could threaten their viability. However, regulators and the worldwide business community are ignoring this threat or, worse yet, promoting liability caps. Limiting liability only exacerbates moral hazard.

    Can a crisis caused by “catastrophic” disruption in audit service delivery be any worse than the one they never warned us about? Why not face fears head on and start re-writing the audit blank check – ineffective audit opinions – before the plaintiffs’ bar does it for us?

    Continued in article=

    Where Were the Auditors ---
    http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

    Bob Jensen's threads on auditing professionalism ---
    http://www.trinity.edu/rjensen/fraud001.htm#Professionalism


    April 19, 2010 message from Francine McKenna [retheauditors@GMAIL.COM]

    This is a great article by Jennifer hughes in FT, from early in the process that describes PwC's approach to the (Lehman bankruptcy administration( engagement.

    http://www.ft.com/cms/s/2/e4223c20-aad1-11dd-897c-000077b07658.html

    Francine


    Andersen's demise didn't solve the broader problem of the cozy collaboration between auditors and their corporate clients. "This is day-to-day business in accounting firms and on Wall Street," says former SEC Chief Accountant Lynn Turner. "There is nothing extraordinary, nothing unusual, with respect to Enron." Will Congress and the SEC do what's needed to restore trust in the system?
    See "More Enrons Ahead" video in the list of Frontline (from PBS) videos on accounting and finance regulation and scandals --- http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/


    "What Is the Auditor's Role in Finding Fraud? The PCAOB is trying to figure out how to explain the answer to the public," by Sarah Johnson, CFO.com, April 13, 2010 ---

    In the standard audit reports that accompany corporate financial statements, the auditor's responsibility for detecting fraud is not discussed. Indeed, the word fraud isn't mentioned at all. Yet whenever an accounting deception is uncovered, one of the first questions investors ask is, "Where were the auditors?"

    The auditing profession calls the discrepancy between what investors expect and what auditors do an "expectations gap." In recent years, audit firms have attempted to close the gap by educating the public on their role. Last May, for instance, the Center for Audit Quality, the trade group for audit firms, issued a brochure on public-company accounting that said auditors consider potential areas of misconduct for a particular company when deciding what areas of a business to review. However, the CAQ cautioned, "because auditors do not examine every transaction and event, there is no guarantee that all ma­terial misstatements, whether caused by error or fraud, will be detected."

    Now, the Public Company Accounting Oversight Board (PCAOB) is also trying to close the expectations gap, based on a recommendation made more than a year ago by a Treasury Department–appointed advisory group that studied the auditing industry. The advisory group suggested that the audit report — which is the sole communication between auditors and investors on a particular company — explain the auditors' role and their limitations in finding fraud.

    Such a clarification had been demanded by observers of the advisory group. "If the discovery of material errors and fraud is not a major part of what the audit is about, it is not clear what value-added service the auditor offers the investor and capital markets," wrote Andrew Bailey, University of Illinois accountancy professor emeritus.

    Officially, the PCAOB's rules require auditors to provide "reasonable assurance" that the financial statements they've reviewed "are free of material misstatement whether caused by error or fraud." However, the language auditors use in their reports doesn't match the text of the rules. In a meeting last week, the PCAOB's own advisory group suggested that auditor reports be revised to add the phrase "whether caused by error or fraud" to indicate that auditors do have some responsibility for noticing fraud.

    On their own, audit reports don't tell investors how auditors reached their conclusions beyond stating the general scope they worked under and that they followed generally accepted auditing standards. Written in boilerplate language, the reports are instead short summaries expressing that the financial statements under review fairly present the company's operations and cash flows.

    Many years ago, auditor reports included the term certify as if to guarantee the reviewed financial statements with an external stamp of approval. But that wording stopped being used in the 1930s, according to the PCAOB. Since then, the reports have been considered to be opinions. However, the reports do "not adequately reflect the amount of audit work and judgment" that go into drawing those opinions, the Treasury advisory group concluded.

    Some investors, such as those who responded to a 2008 CFA Institute survey, would like auditors to identify their clients' key risks as well as highlight areas that could possibly have questionable estimates made by management. "Investors want to know where the high risks are," said Mary Hartman Morris, a California Public Employees' Retirement System investment officer, at the PCAOB meeting.

    However, except for its investor members, the PCAOB's advisory group — which also includes finance executives, accounting-firm representatives, and accounting professors — generally refrained from recommending that audit reports move in a more detailed direction. The group cited the complexity of amending existing auditing standards, the possibility of increased liability, and the uncertainty over whether doing so would provide true value to investors. The group also largely passed over the idea of going beyond the current "pass/fail" model for the audit report, such as by instituting a grading system.

    For the most part, the advisory group discouraged the regulator from changing auditors' responsibilities or adding new procedures to their workloads. However, they seemed to agree that the public needs a more realistic view of an auditor's job. For example, "some people seem to confuse falsified documents, which the auditor can't authenticate, and falsified accounting records, which auditors should authenticate," said Douglas Carmichael, an accountancy professor at Ziklin School of Business at Baruch College.

    As the PCAOB contemplates a solution, the board may need to think more about investors' wants rather than their expectations, suggested PCAOB board member Charles Niemeier. "Investors are not satisfied with the status quo," he said, "and I think that is justified, considering the disclosure of financial problems tends to come after the fact."

    In the meantime, the PCAOB is working on establishing a financial-reporting fraud center for collecting information on preventing and detecting fraud. The regulator published a job posting for a director last month.


    Are Auditing Firms Getting the Professionalism Message?

    April 12, 2010 message from David Albrecht [albrecht@PROFALBRECHT.COM]

    Bob, in the same way that not all auditors always act properly, it is just as fair to say that not all auditors always act improperly. I think that almost all act improperly at some time, and almost all act properly sometime. To say otherwise is to deny human nature.

    As a critic of the current system, my position is that (1) it doesn't take too many improper acting auditors crossing the line for the system to be broken, and (2) if the line hasn't been crossed, it is being tap danced on. Supporting my position is the recognition that significant economic incentives exist for auditors to act improperly in certain circumstances.

    I recall reading Arthur Young's speech, "They still don't get it." After the dot-com crash and AA's flameout, I was of a mindset that indeed the line had been crossed by all of the Big 5, and probably GT. Many were getting to that mind-set. I've even heard you say that SOX saved the audit industry. If that's the case, then it must have been in danger.

    I have written a couple of posts which you have forwarded here, posts that say "they" really still don't get it. Coupled with the reasonable question, "Where were the auditors?" during the past crisis, and I'm ready to start looking for alternatives. Yes, a majority of auditors do the right thing, more likely than not. However, the business/auditor mindset is such that improper audit actions are rationalized away. Although this rationalization doesn't occur to every auditor every day, it does occur to a majority of auditors at least once in a blue moon.

    When you combine the risk-averse nature of investors with their realization that the audit game is rigged, I think it a loser's game to play.

    Let me use an analogy. There's a husband and wife. Both are at party, clothed, and in close proximity. A temptress appears and suggests that the husband accompany her to a bedroom for some mind-boggling (and illicit) sex. Does the wife fear that the husband will do the wrong thing? Probably not. Even if the husband wants to he isn't going to leave in full sight of his wife. The husband will probably do the right thing and refuse the temptress, thereby acting in the best interest of the wife. Now, shift some circumstances. The husband got tired, went up to bed, removed all clothing and tries going to sleep. The temptress sneaks up to the bedroom, removes her clothing, slides under the covers and placing a hand on the husband's genitals, asks, "can we do it now?" In this case (with the wife being somewhere else), will the wife fear that her husband will do the wrong thing? Yeah! Husbands have the capacity to let their wives down at just the wrong time.

    It's the same way with auditors. Most of the time investors don't fear that auditors will let them down. It's just that the auditors tend to let the investors down at just the wrong time. The wrong times destroy trust and break the system.

    I think that major structural changes need to be made. That the SEC has decided to change the game by destroying GAAP through the convergence process to me means that the traditional auditor model is no longer relevant. The traditional audit model might very well be salvageable if only bright lines hadn't been replaced in so many instances by "company judgment". As Tom Selling has written, who can audit that and produce results that could be achieved with bright-line rules and auditors willing to identify and speak up about non-compliance? If auditors are not willing to speak up against non-compliance when there are bright lines,then what value will auditors supply when there are no bright lines and little to speak up about?

    Besides, you have the comparison group wrong. If you are comparing auditors acting in the public interest, then you need to compare their performance to some other group acting in the public interest. Pick your group. The SEC? broken or perilously close to it. Although legislatively charged with establishing accounting standards, it views this charge with such disdain that it is farming it out to a foreign group over which it has no control and probably little influence over the long-run. Law enforcement groups such as police? Oh my is there lots of corruption here. DA's? There are lots of stories of innocents being sacrificed in order to keep conviction rates up. Congress? The presidency? Give me a break.

    If we remove auditable accounting standards, then I say that the system is broken and we need to put the auditors out of our misery.

    David Albrecht

    April 13, 2010 reply from Bob Jensen

    Hi David,

    One minor correction. It was Art Wyatt who gave the “They Just Don’t Get it Speech” at an AAA Annual Meeting plenary session ---
    Art Wyatt admitted:
    "ACCOUNTING PROFESSIONALISM: THEY JUST DON'T GET IT" ---
    http://aaahq.org/AM2003/WyattSpeech.pdf 

    Art Ramer Wyatt has an interesting and remarkable history as a University of Illinois Professor who became the lead research partner for Andersen and, after Andersen imploded, returned to the University of Illinois. Along the way he became a member of the FASB, President of the AAA, and has many other honors bestowed upon him as reported by the Accounting Hall of Fame ---
    http://fisher.osu.edu/departments/accounting-and-mis/the-accounting-hall-of-fame/membership-in-hall/arthur-ramer-wyatt/

    Art’s been one of the most active and long-time volunteers on the auditing standards executive committee of the AICPA.

    I’ve shared a number of speaking platforms with Art over the years. One thing I greatly admire about Art over his entire professional career is the war he’s conducted on off-balance-sheet financing. I’m certain in my own mind that Art was not aware of the bad stuff taking place at Enron and Worldcom. He might’ve worked more proactively to centralize some Andersen’s Executive Office powers after the Waste Management scandal early on where Andersen got one of its first real warning signals that the Chicago Executive Office should’ve been more involved in Andersen’s largest audits. Auditing quality control at Andersen was not the number one Executive Office priority. Apparently Art, like Art’s Executive Office colleagues, did not “get it” at Andersen.

    After Enron, when he returned to teaching, Art “got it” whereas the practicing profession, in his viewpoint, did not get it as well as it should be getting it.

    I put Art on the same pedestal as Denny Beresford in my personal accountancy heroes platform.

    I agree with you, David, about the many unpublicized competent and professional audits that take place. And you can tell that I admire Francine’s informative blogs about the audits that failed. I tracked the failures in my own archives for an even longer period of time at http://www.trinity.edu/rjensen/fraud001.htm

    And I agree with Francine that the PCAOB has been doing its job. But I do not agree with her that “nobody is paying attention to the PCAOB.” This is easy to refute just by talking with Deloitte’s former quality control partner Jim Fuehrmeyer (now at Notre Dame) and another one of my heroes Paul Pacter with Deloitte and the IASB. I think the insiders will tell you that they are paying attention to the PCAOB.

    From: Jim Fuehrmeyer [mailto:jfuehrme@nd.edu
    Sent: Tuesday, March 23, 2010 9:21 AM
    To: Jensen, Robert
    Subject: FW: Deloitte

    Bob
    I was the “Professional Practice Director”, that’s the audit quality control guy, for Deloitte’s Chicago office for the six years prior to my retirement in May 2007.  I got to experience first-hand everything from the absorption of AA’s people in Chicago to the advent of the PCAOB and its annual inspection process the first few years.  I don’t think most folks have any appreciation for the very real impact the PCAOB has had on the profession.  The quality of documentation, the increased amount of partner involvement, the added quality control processes, the expansion of detail testing – the PCAOB has had a huge impact.  Most folks also don’t have an appreciation for the impact of 404 not only on the audit process but on corporate cultures as well.  As you pointed out a few messages ago, we do see all the failings in the press, but what we don’t see is all the positives and all the improvements.
    Jim


    Jensen Comment
    As an auditor it would be reckless to ignore the PCAOB, especially in the United States where the plaintiff’s tort lawyers are pouncing on every weakness in an audit firm’s defense. Unlike Francine, I think that the PCAOB has been doing its job and that the people that count have been listening. That does not mean that the auditing firms have been pointing to each others’ PCAOB audit deficiencies when recruiting our new graduates. But I would not expect them to do this since the deficiencies arose on particular audits relative many other audits that were not deficient or caught being deficient. 

    In retrospect I think the auditing firms are “getting it” just like I think worker/product safety is truly a priority in the majority of our mining and manufacturing operations in America. But there are failures, some of them criminal, that simply reinforce the adage that no person and no organization is perfect all of the time. Some are just worse than others at times, and we must strive to minimize the imperfections.

    Auditing is essential for detection and prevention of many bad things in any economic system ranging from communism to capitalism. Until people are perfect, we will need auditors.

    But like Art Wyatt and the rest of the Executive Office folks at Andersen, perhaps the executive offices of the surviving large international accounting firms are "not getting it" as well as they should be "getting it." This may be what Francine has in mind, although I think she's not been giving sufficient credit where credit is due on the great audits taking place and the bad stuff the mere act of auditing is preventing.

    But like Art Wyatt and the rest of the Executive Office folks at Enron, perhaps the executive offices of the surviving large international accounting firms are "not getting it" as well as they should be "getting it." This may be what Francine has in mind, although I think she's not been giving sufficient credit where credit is due on the great audits taking place and the bad stuff the mere act of auditing is preventing.

    Bob Jensen


    What is the world is going to happen to private sector versus public sector auditing?

    The big difference between private sector auditors versus government auditors is that we can sue the private sector auditors over and over and over until they make serious efforts to get it right. Virtually nothing is being done to make the government’s auditors get it right.

    What my inside contacts in the large firms are telling me is that more than ever efforts are now being made to make their auditors independent to a point where they will stand up to their largest and most lucrative clients and demand that there be better GAAP and GAAS conformance ---
    Advancing Quality through Transparency Deloitte LLP Inaugural Report --- 
    http://www.cs.trinity.edu/~rjensen/temp/DeloitteTransparency Report.pdf  

    I think the PCAOB audit reviews have contributed in a small but marked way to improve audits. But there’s a long way, miles and miles, to go before we sleep --- http://www.trinity.edu/rjensen/fraud001.htm

    It’s Market Versus the Government!
    The question is what’s the alternative? Those that want a Government’s Central Planning Board to allocate resources in the economy (in place of markets) are aiming the world economy for disaster, confusion, and disruption. And who keeps the government honest? At the moment the GAO declares that it’s impossible to audit our largest government agencies like the Pentagon, the IRS, etc. Government accountability, accounting, and auditing are in much worse shape than our far less-than-perfect private sector accountability, accounting, and auditing.
    The Sad State of Government Accounting --- http://www.trinity.edu/rjensen/theory01.htm#GovernmentalAccounting
    The Sad State of Private Sector Accounting --- http://www.trinity.edu/rjensen/fraud001.htm

    No Resource Allocation System Can Exist Without Accountability, Accounting, and Audi