Academics Sell Out To The Big 4

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Two articles dealing with the Big 4's relationship with higher education caught my eye these past few days. One seems like a clear-cut attempt to buy recruits. I was sorry to see it, since a friend recently joined their faculty. The other is truth stranger than fiction, as a recently disgraced firm picks the one topic they are least (or perhaps most) qualified to teach - Ethics.

It's bad enough the business schools have sold out to corporate interests, with names changing to reflect big donations.

I wondered if the law schools had sold out too. A simple Google search told me that, although a fairly recent phenomenon and not universal, the dilution of academic independence by law firms endowing chairs has spread to even some of the most prestigious schools. Notre Dame has an interesting practice. They allow endowed chairs, but it looks like they all are sponsored by foundations and individuals with strong ties to the school, rather than a crass commercial enterprise, interested in influencing scholarship, co-opting professors as paid expert witnesses and buying recruits.

Deloitte Establishes Endowed Professorship in Accounting at Texas A&M University's Mays Business School

Professor James Benjamin will serve as the first Professor at A&M to hold the endowed position

Continuing a tradition of support for Mays Business School at Texas A&M University, the people of Deloitte and the Deloitte Foundation, a non-profit organization of Deloitte & Touche USA, has established the Deloitte Foundation Leadership Professorship in Accounting. This endowed professorship marks the largest individual gift of the 25-year relationship between Deloitte and the university. The $500,000 endowment was made possible through a combination of Deloitte partner and employee contributions and matching gifts from the Deloitte Foundation.

Supporting the professorship, the endowment will provide financial support to enhance the teaching, service, and professional development activities of the head of the accounting department situated within the Mays Business School.

..."Mays Business School has had a long and mutually beneficial relationship with Deloitte," said Ricky Griffin, interim Dean of the Mays Business School...Professor Benjamin acknowledged the committed teamwork between the university and Deloitte, noting, "Deloitte has been very involved with the development of our program, including service on our advisory council, since its inception in 1982, and has continued to provide significant financial support for our programs," he said. "Just as important, Deloitte is also significant as a leading recruiter of our students."

D'Andrea and Chris Patton, Deloitte's partner in charge of recruiting at Texas A&M, also recognized the alliance, and said, "We've found there to be a great fit between Mays students and Deloitte culture. We hire more candidates out of the Mays School than any other school in the area."

In addition to this professorship, Deloitte has also endowed both a professorship in support of the Director of the Professional Program in Accounting at Mays and a significant scholarship fund for accounting majors.

Business Ethics: Program emphasizes importance of honorable behavior

Clearing the fog around business ethics is the goal of a partnership between a national accounting firm and Wake Forest University.

KPMG LLP recently started a program aimed at helping business students find their “ethical compass.” The program is being taught at the Calloway School of Business and Accountancy, the latest extension of KPMG’s academic relationship with Wake Forest.

The program involves role play and emphasizing six principles of conduct “that call for an unswerving commitment to honorable behavior,” Scott Szabo, a partner at KPMG’s office in Charlotte, told Calloway students yesterday.

Business ethics has been defined by academics as representing the agreed-upon rules of a profession or industry, which don’t always coincide with more generally expressed ethical or moral concerns.

Szabo said that the program’s goal is “not necessarily to give you the right or wrong answers, but to give you some help in recognizing situations that may compromise ethical behavior. We emphasize ethics in the recruiting of students and ingrain it in our training.

“As accountants, we are dependent upon the public’s trust in what we do, so it’s very important that we maintain that trust.” Especially in the Internet age, Szabo said, where questionable behavior or conflicts of interest can be posted on YouTube or personal Web pages.

The accounting sector is particularly sensitive to questions about ethics in the post-Enron Corp. era of corporate America. The Enron scandal took down one of the nation’s top-five accounting firms, Arthur Andersen LLP.

KPMG itself is not immune from ethical scrutiny. Two former employees pleaded guilty in a two-year-old case over questionable tax shelters, and four former employees, including a partner, face trial in the case. KPMG resolved its part of the case by agreeing to pay a $456 million fine.

...Lee Knight, an accounting professor at Calloway, said that the KPMG program “helps us do a better job of helping students recognize the need for keeping their ethical antennas up for themselves and the companies they work for.”

Walker Saik, one of the role players, ...said. “I would hope that having good ethics as a company factors into the long-term health of any company, especially an accounting firm.”

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Everson's Happiness Short Lived

Update: I'm getting a lot of hits on this. It seems many people, including everyone at the IRS, are searching Google for the answer to the question - How, exactly, did Mr. Everson become pregnant? Was he such a cold fish at the IRS?
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Mark Everson was one of the most vocal critics of KPMG while he was at the IRS. Unfortunately, KPMG will have the last laugh as the former IRS Commissioner, and most recently head of the American Red Cross, has made a big boo-boo.

Red Cross Ousts CEO Everson Citing Relationship With Subordinate, Agency Acts Quickly
The American Red Cross ousted President and Chief Executive Mark W. Everson after learning he had an affair with a female subordinate.

Mr. Everson, the former commissioner of the Internal Revenue Service who took the top job at the relief agency in May, was asked to resign by the board after it learned the woman had become pregnant, said a person familiar with the situation.

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Auditors Get Tough On Banks, Banks Say "Huh?"

It looks like the pressure has gotten to them, or maybe their "industry group" suggested this would be a good PR move. Unfortunately it's too little too late. For example, there's Citi. When, or really will, KPMG ever make them put the crap on the balance sheet? If they ever do, they'll have to resign and then turn the clean slate over to one of their compadres.

Call me skeptical. But, I have to ask... Where was this toughness before?

But the most telling quote comes from the original FT article:

“We don’t see ourselves as the right people to provide guidance, but we can provide the context, that’s our role,” said Pauline Wallace, a partner at PwC and the co-ordinator of the project.

If the audit firms are not there to provide guidance, who's keeping an eye on the CEOs? I think you know the answer to that question:

No one, Nadie, Ninguém

Big 'Six' draw up bank audit blueprint

Top firms come together to create 'consistency' in audit of subjectively valued sub-prime related derivatives

The Big 'Six' accounting firms are sharing their approaches to the auditing of bank assets, in an extraordinary attempt to create calm over the highly-fraught area of valuations of sub-prime related derivatives.

The Financial Times, which has seen a paper outlining the approach, says it will be published next month, pulling together all the relevant parts of International Financial Reporting Standards, in the process of being adopted by more than 100 countries worldwide.

The valuation of bank assets has become more and more subjective as the market for the derivatives concerned has collapsed. But a collective approach could also invite criticism if the audit firms are collectively wrong in their approaches.
The FT said it was clear the audit firms intended to take a ‘tough line’ like demanding persuasive justification if a bank were to turn to model-based calculations where market prices, however unfavourable, existed. The paper is also designed to allay fears the continued market turmoil would lead banks and their auditors to different conclusions about how they valued holdings and what was a fair price, the FT said...

'Given the importance to the market of consistency in times like these, it's good that the large firms are coming together to make sure we have that,' said Jan Babiak, managing partner for regulatory and public policy at Ernst & Young.

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The Privilege Of Giving My Opinion

There have been a few comments on my post yesterday on auditors and attorney-client privilege. Dennis Howlett over at his blog has also taken up the topic. He and I have engaged in a spirited discussion and may have gotten off topic... Find it here.

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Auditors and Privilege - Ask Me No Questions, I'll Tell You No Lies

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Back in the summer of 2005, I joined the team that audits PwC the Firm, itself. I was thrilled. Although I was giving up being on my own and spending most of my time on Mexico and South America, I was joining what I thought at the time was a world-class firm, I had been told I was on the partner track, and I was going to be privileged to see the firm from the inside out. For someone like me, interested in how the business side of the firms work, it was going to be a dream job.

Unfortunately, as I have mentioned before, what we were able to do during my tenure was much less than I had expected, partially due to the fact that the team was fairly new in its latest incarnation and so had not yet gotten itself organized the way a world class internal audit function at one of our clients would have been set up. The other challenge was the firm itself, its management structure, management style and the expectations of the senior partners for this team. My expectations and the reality of what we were going to be able to do and how we were going to have to do it were way out of synch.

Post-Enron, the audit firms are all very litigation conscious. Although they may publicly tout openness, transparency and accountability, as if they were a public company like their clients, they instead wallow in secrecy, revert to pettiness and hide behind their lawyers more often than not, especially when addressing their own internal failings.

Many of their clients are also hugely litigation conscious. That extreme aversion to potential litigation is having an impact on the development of their internal audit functions. Many public companies still have not clearly and strongly defined the position of the internal audit function in the organizational hierarchy and the realistic range of responsibilities and involvement of this function in issues such as investigations, risk management, litigation, C-level executive compensation and external financial reporting. Many companies now have Chief Risk Officers, Chief Compliance Officers, newly empowered General Counsels, and Chief Financial Officers that still see the head of Internal Audit as a second or third class citizen, reporting "administratively" to the CFO, with direct access in name only to the Audit Committee. Many Audit Committee Chairs still can't be bothered to meet with the Chief Audit Executive separately and more often than absolutely necessary.

As such, activities such as an Enterprise Risk Assessment, with the purpose either directly or via risk self-assessment questionnaires, of documenting the organization's risks and vulnerabilities across all aspects of the business, are being conducted under the auspices of the Law Department.

The reason is privilege.

At PwC, I ran into this and was flummoxed. I was planning an audit of a particularly interesting firm activity and the management team for the activity was resistant to spend time or answer more questions. They had already undergone an extensive interview process conducted by members of the firm's Risk Management team earlier in the year. The process had been conducted at the behest and under the direction of the firm's Law Department.

Based on my own independent research, I surmised that the review was conducted in this way to maintain attorney-client privilege over the results and disclosures made by the management teams across the firm. The theory would be that such a firm is always under the threat of litigation so this activity and its results were obtained under the threat of one lawsuit or another, considered work-product and, therefore, privileged.

I never found out the official theory, because I was told to live without this report. I had to duplicate the interview effort, a process which was both time consuming and frustrating for all involved.

I was reminded of this legal strategy, one I felt was a bit of a stretch at the time, when I saw the New York Times article today about the growing conflict between external auditors and their clients with regard to confidential information generated often as the result of internal investigations or impending litigation.

...Companies are increasingly concerned that (external) auditors could be required to turn over confidential records to outsiders, exposing corporations and executives to lawsuits from shareholders or whistle-blowers and unwanted scrutiny by regulators.

...the post-Enron standards also force companies to do more to prevent fraud, by examining confidential areas like pending litigation, internal investigations, tax reserves and tax shelters, stock option plans and exposure to environmental liabilities.

To comply, corporate lawyers have been generating large amounts of confidential documents on issues that could affect a company’s bottom line. Those company lawyers want to keep the information from becoming ammunition in lawsuits — but not at the risk of withholding it and losing an auditor’s seal of approval, a red flag to shareholders and regulators.

“The number of internal investigations conducted in response to whistle-blower allegations and other matters has increased substantially in recent years,” said Thomas Riesenberg, Ernst & Young’s general counsel. And with that, he said, has come a greater need for requesting materials in an audit that could be considered confidential.

Well-established rules that are a bedrock of the American legal system protect the confidentiality of communications between lawyers and clients, a concept known as attorney-client privilege. The rules also protect from disclosure a lawyer’s written impressions, conclusions, opinions and research, known as work-product privilege.

The trend of auditors looking further behind the corporate curtain is a major shift from the “don’t ask, don’t tell” mentality of the years before Enron, when they typically signed off on financial statements without asking to see confidential documents...

Lawyers typically say that such legal opinions are confidential. Legal rules dictate that if confidential documents are shown to any outside party, including to auditors, they are no longer confidential and are thus fair game in proceedings like lawsuits.

This is just another good reason why your external auditor should not be involved in any special investigations as an investigator rather than a monitor or an entity that gets a copy of the final report. In addition to the fact that then they know everything in detail from the beginning, they may have also been part of the original problematic behavior or condoned it.

There are so many other reasons that the standard audit report and internal control report prepared by a public accounting firm is now essentially worthless. If auditors are also now considered outside the circle of privilege, then what they are told, if anything, about confidential company activities will be worth even less.

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Falling In Line

Every once and a while I have to take off my re: The Auditors hat and put on the fancy dress of a typical member of a large urban, Catholic, ethnic, up-from-the-working-class, family. We celebrate the traditional holidays like anyone else, although like anyone else, they have become inextricably tied, in most cases, to some form of consumerism. As our family has grown, we've outgrown the traditional gathering at Mom and Pop's for something more planned and formal. We are blessed with immediate family members who belong to country clubs and, I confess, I have become an elitist snob and prefer going to the club on holidays rather than to some one's house.

It has something to do with being single, since it does make for an easy exit afterward and limited exposure to thousands of children under the age of 14 high on sugar looking for something to do after we've force fed them meat they only eat once a year. It also means no clean-up and no fake interest in football. I'd rather talk to the men in my family rather than watch them watch football.

The only thing I miss is the lasagna. When my mother cooked Thanksgiving and Christmas, there was always more lasagna than turkey and always more food taken home afterward than eaten that afternoon. Take-away trays of lasagna, home-made ravioli, manicotti or stuffed shells were the huge benefit of growing up half-Sicilian. Unfortunately, those days are gone unless I'm willing to make the trek out to my Aunt Concetta and Uncle Salvatore's and deal with even more small children and more distant relatives that don't have much interest in the future of the Big 4 and my critique of their global regulatory infrastructure.

After having spent so much time in Mexico (especially Chiapas) and South America, I also have become sensitized to the anti-Thanksgiving and anti-Columbus Day movements. I'll leave you with this quote from an alternative history of the celebration of Thanksgiving.

Lies, Half-Truths, and What a Nation Will Tell Itself

Perhaps, given the patent falsehood of the Story of Thanksgiving, one of the better questions to ask as the holiday approaches is what, in fact, it really stands for. As a Cherokee, I have never felt much like celebrating an event that essentially commemorates one of several stages in the genocide of Native Americans by European settlers, a process which continues to this day in the form of environmental racism, structural poverty, and lack of educational resources. There were times, to be sure, when I appreciated sitting with my family and devouring an embarrassment of culinary riches. But those I hold separate from the holiday itself.

For me, this now agreed upon Thanksgiving symbolizes first and foremost the alarmingly subjective nature of history, which, as Howard Zinn reminds us, is almost always written by the winners. It symbolizes the triumph of football over religion, and of American commercialism over virtually everything standing in its wasteful path. And perhaps most importantly, it symbolizes the lies and half-truths on which a profoundly diverse country must depend in order to prop up the specious concept of a broadly shared civil religion or national identity.

Thanksgiving, then, symbolizes that there is still great work to be done before a nation that readily prides itself in its goodness, honesty, and wholesome relationship with Divine Grace will actually resemble the stories it tells itself.

Thank God for all blessings. God bless all creatures on his greenish earth.

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Update - Wal-Mart Feeling Annoyed and Oppressed Now That Everyone Knows Everything

Who else tries to seal documents?

Update:
Judge Rejects Wal-Mart Effort To Block Public View of Documents
A North Carolina state judge rejected an attempt by Wal-Mart Stores Inc. to block public access to certain court documents in a tax dispute with state authorities.
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In a further development in the case of Wal-Mart, E&Y their external auditor, and the special relationship they had and still have with regard to avoiding state taxes....

Wal-Mart has asked the North Carolina court to seal the documents that Wal-Mart’s lawyer Jasper L. Cummings, Jr. at Alston & Bird says, “...the posting of [which] business correspondence on public websites causes unreasonable and undue annoyance and oppression of a party that is attempting to litigate a serious dispute with a public agency. The Chief Justice of North Carolina has determined this to be an exceptional case . . . It is important that this case go to decision and not be unfairly influenced by outside forces.”

Oppression and annoyance are actionable issues, I guess, in Arkansas and Atlanta. Funny though that Wal-Mart has agreed to do E&Y's dirty work in trying to get all this juicy info, including the RFP, their proposal, invoice and other similar documents sealed. It seems to me that the documents, although damaging to Wal-Mart in this particular case, are really more embarrassing to E&Y. It's rare that such documents get outside the firm and don't fall under some kind of a confidentiality agreement.

As the WSJ law Blog states, it's sort of an academic argument since the documents have been sitting in a public court file for months. The cat's out of the bag... The milk is spilt... Public information is public information.

That reminds me... Where's my answer from the New York Attorney General about the documents related to the re-selection of PwC as external auditor at AIG? Maybe someone needs to sue AIG over that sham so that the documents are "discovered?"

In terms of the ongoing relationship between E&Y and Wal-Mart, it's interesting to note that audit fees to E&Y have skyrocketed in the last seven years. Although less and less are shown to be non-audit related, we have said before that the definitions of how fees are categorized in the proxies and what constitutes audit related activities is dynamic and getting more so under Auditing Standard 5 and Proposed Rule 3525 – Audit Committee Pre-approval of Services Related to Internal Control .

Overall, total fees paid to E&Y by Wal-Mart have gone up 192% since 2001 and 73% since 2003, the first full year after Sarbanes-Oxley passed. The highest year for pure tax fees paid to E&Y was 2002, the first year of their agreement, when they were more than double the audit fees. Pure audit fees have gone up 321% since 2003.

E&Y’s fees were as follows: (All data per proxy documents)

Fiscal 2007
Audit Fees $12,236,000
Audit-Related Fees $ 1,290,000
Tax Fees $ 407,000
All Other Fees $ 0
Total Fees $13,933,000

Fiscal 2006
Audit Fees $10,563,000
Audit-Related Fees $ 1,909,000
Tax Fees $ 487,000
All Other Fees $ 0
Total Fees $12,959,000

Fiscal 2005
Audit Fees $7,050,000
Audit-Related Fees $1,526,000
Tax Fees $795,000
All Other Fees $0
Total Fees $9,371,000

Fiscal 2004
Audit Fees $4,053,000
Audit-Related Fees $959,000
Tax Fees $3,220,000
All Other Fees $125,000
Total Fees $8,357,000

Fiscal 2003
Audit fees $2,909,000.
Audit related fees $1,808,000 and
Non-audit fees $3,352,000 (Non-audit services were primarily tax services.)
Total fees $8,069,000

Fiscal 2002
Audit fees $2,675,000.
Audit related fees $698,000
Non-audit fees $5,585,000. (Non-audit services were primarily tax services.)
Total fees $8,958,000

Fiscal 2001
Audit fees $2,754,200.
Audit-related services of $465,900 and
Non-audit fees of $1,559,200. (Non-audit services were primarily tax services. )
Total Fees $4,779,300

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Getting Structural - There's Money For The Big 4 In Those Funds

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I found this interesting because of the mention of "commissions" for helping corporate clients attract EU structural funding for projects in Romania. How many other firms in other countries which will receive funds (they range from developing countries like Romania to developed countries like the UK) are setting up such practices?

The business model, where the consultant is paid on a "commission" basis for helping the client do whatever is necessary (lobbying or just paperwork?) in order to win approval for EU funding of their project, sounds a little off the beaten path for an audit firm. How will the US firm police this when their Romania office is helping a US-based multinational that's a statutory audit client with a potential investment opportunity in Romania? What about a US-based or foreign-based multinational, (a foreign based multinational audited under SEC rules by a non-US office poses a more difficult monitoring challenge for the PCAOB) or one that is part of a joint venture that wants to attract funding and Deloitte Romania charges a commission that is "several percentage points of the value of European funding"?

Can the firm advise a public sector client on attracting funds and take a "commission" too?

Deloitte launches consulting department for European funds

Deloitte Romania, an audit and consultancy company, has launched a department to attract structural funds, George Mucibabici, company chairman said yesterday.

"Through this new service, we will advise our clients who seek European structural funds, a sector that we predict will have significant growth potential in the coming period," explained Mucibabici. He believes the structural funds consultancy market is quite large, with consultants' commissions standing at several percentage points of the value of European funding attracted for each project.
Within the next seven years, Romania will be able to access structural funds worth over 17bn euros, according to estimates made by Deloitte's chairman, because the market has a high potential for players in this field.

The majority of the funds are targeted at the public authorities (in the case of which the European funds can cover up to 98% of the project's funding), with the remaining funds being accessible to the private sector (where European funding can cover up to 50% of the value of each project).
Consulting services for European funds are the latest line of business launched by Deloitte Romania, whose other departments include: audit, fiscal and legal consultancy, financial advisory and management consultancy.

Deloitte posted business worth 18.3 million euros last year, up 36% against 2005, and registered the fastest growth rate among the Big Four (the top 4 auditing companies worldwide). In the fiscal year ending May 31, 2007, Deloitte saw turnover increase by over 40%, a rate the company forecasts will continue next year, as well.

The 40% growth rate is in excess of the average rate of the players in the Big Four group, which includes PricewaterhouseCoopers at No. 1, Ernst&Young at No. 2, KPMG at No. 3, and Deloitte at No. 4. Big Four's cumulated business increased 16% last year, to 97 million euros.

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Hey PwC - Practice What You Preach

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Thanks to Leon over at Sox First for bringing this list to my attention. PwC has put out a list of questions that Leon said were for asking at shareholder meetings.

With all the talk about shareholder access and restricting activist investors and limiting what and how anyone but management can get something on the proxy, I think it's a little disingenuous for PwC to be encouraging the average shareholder to bring a list of curve ball, tough questions to their next shareholders' meeting and start firing away.

It's particularly galling since PwC doesn't seem to hold themselves to the same standards when deciding to re-up as auditor of a client that's suing them or to continue serving as external auditor of more than one that could have benefited from their asking a few curve ball, tough questions for a change instead of going along for the ride.

I especially like these covering Corporate Governance and the External Auditor:

138. How often do the external auditors meet with the audit committee? Does management participate in the meetings? Does the audit committee meet separately with the external auditors without management present?

139. Does the audit committee review the scope of external audit activities in advance? Does it meet with the external auditors at the conclusion of the audit? What mechanism ensures that the committee follows up on audit recommendations?

140. Does the audit committee appoint the external auditors? What process does the audit committee go through to determine whether to reappoint the existing auditors or select new auditors? Why isn't the selection subject to shareholder ratification?

141. Does the agreement with the external auditors include any limits on potential liability by the auditors or contain an agreement on the processes that will be used by the company in case of disputes with the auditors?

142. What steps does the audit committee take to oversee or help ensure the independence of the external auditors? Has it received the communications from the auditors about their independence? Have there been any independence infractions by the auditors? How has the board/audit committee satisfied itself that the auditors are independent?

143. Do the external auditors have any relationships with management or the board of directors that may be viewed as a conflict of interest?

144. Did any members of management come from the external audit firm? How many worked on the audit prior to joining the company? Has this information been disclosed to the audit committee? Have any offers of employment been made to members of the current audit engagement team?

145. Is the audit committee responsible for the external auditors’ compensation for audit and nonaudit services? Does the audit committee have a policy for preapproving audit and nonaudit services? Is the audit committee’s preapproval policy compliant with the requirements of the Sarbanes-Oxley Act and SEC rules and regulations?
146. What process does the audit committee use in considering whether the provision of nonaudit services by the external auditors was compatible with maintaining the auditors’ independence?
147. What nonaudit services were provided by the external auditors? Why are the nonaudit fees so high in relation to the audit fees? How do the nature and relative amount of nonaudit fees compare with other companies in the industry?

148. For services provided by the external auditors, has there been a competitive bid process or other means to ensure services are priced and performed at market prices and under standard professional practices? What fees are paid to other consulting firms and what percentage of total consulting fees do the external auditors receive?

149. Do the external auditors audit the company's benefit plan(s)?

150. Did/does the external auditors provide services in relation to the company’s readiness under Section 404 of the Sarbanes-Oxley Act? Has the audit committee considered any potential independence issues resulting from these services?

151. Do the external auditors advise the company on income tax planning strategies? Has the audit committee considered any potential independence issues resulting from these services? What controls are in place to ensure the external auditors are not providing prohibited tax services?

152. Do the external auditors provide advice on the accounting treatment of various financial structures (e.g., mergers, acquisitions, and divestitures) to the company? Are these transactions reported to the audit committee? Have there been any disagreements with the external auditors over the company's accounting treatment for these complex transactions?

153. How many years have the external auditors been auditing the company? Has the company considered periodic rotation of auditors? What impact has the company seen as a result of the mandatory partner rotation rules required by the Sarbanes-Oxley Act?

154. Has the company experienced any significant changes in its relationship with the external auditors under the auditing oversight of the PCAOB?

155. Have the auditors undergone a peer review or internal quality control inspection? What were the results of their latest (AICPA-mandated) peer review or internal quality control inspection?

156. What were the results of inspections by the PCAOB of the external auditors?

157. What assessments, if any, has the company made regarding the litigation record of its external auditors? Has the company evaluated the effect of any litigation that the auditors are involved in?

158. Are the company’s external auditors named a defendant in any recently publicized litigation class-action suit? If so, is the company joining this suit for any settlement?

159. Why were the company's former external auditors dismissed/replaced? Why did the auditors resign or not stand for reappointment?

160. Were there any accounting disagreements with the company's former external auditors preceding the change? What was the nature of the disagreements?

161. Has the audit committee consulted with its own counsel or another auditing firm? What circumstances gave rise to the consultation? Does the audit committee expect to have similar consultations in the future?

162. Does the company use different auditing firms for any subsidiaries? Are all company operations audited? Was the auditors’ report on any subsidiary's financial statements qualified? If so, why doesn't the principal auditors’ report disclose this?

163. Do the external auditors investigate and report on all acquisitions?

164. Do the external auditors visit the company’s major locations on a regular basis?

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Maintaining Independence Can Be A Sticky Wicket

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Jennifer Hughes' Accountancy column in the FT this morning reminded me that the Big 4 think they are consultants again. In the UK, (Anyone know what the best comparable figures for the US are???) strong fee growth at the consulting arms of the top tier accounting firms have pushed them back into the top 10 of UK consultancy.

Remember... three of the four – KPMG, PwC and Ernst & Young – sold their consultancy businesses in the wake of the Enron scandal and the regulatory scrutiny that then turned upon perceived conflicts of interest between the firms’ auditing core and their consulting interests. Only Deloitte held on to its operations.

Now, the non-compete agreements related to the business sales have all passed and this year, according to Accountancy Age, all four are back in the top 10 of UK consulting fee earners. The returnees posted exceptional growth: 25 per cent, 14 per cent and 11 per cent respectively at PwC, E&Y and KPMG, and 10 per cent for Deloitte. The growth picture is little different worldwide; this has been a bumper year for their consulting arms.

But they are keen to stress how this time, it is different.

For one thing, no longer are they the systems implementation behemoths of the past – excepting Deloitte, they tend to dismiss that as low-margin “commodity” work. Instead, they emphasise their ability to bring together a number of services from tax to accounting and actuarial skills. Deloitte is also dismissive of its rivals’ strategy regarding information technology work.

“We don’t see them very much in IT, apart from IT assurance and some high-level advisory work,” says John Reeve, a partner in the consulting practice at Deloitte. “They haven’t rebuilt capacity in development and implementation [and] in our view, this severely reduces their credibility as IT consultants and is reminiscent of the scope of services of audit firms in the mid-80s.”

However, has anything really changed with regard to concern over real or perceived conflicts of interest and the required regulatory scrutiny of potential independence violations? I've pointed out that thorny issues still exist when a company uses their auditor as a major tax advisor. Those fees can quickly dwarf the audit fees and, perhaps, compensate for them not going up as quickly or as much as in other clients, Sarbanes-Oxley bonanza or not. And then there's Northern Rock, a case that should be a huge embarrassment for PwC and a wake-up call for regulators.

The only thing that has changed is the current lack of enforcement of the independence restrictions by the PCAOB and SEC. If there were any concerns coming out of PCAOB inspections, we'd never know it. That part of the report is private. And the SEC has been too busy with options backdating (scrutinizing everyone but the Big 4, who always settle), tax shelter prosecutions (and implementing the "too few to fail" policy) and other securities litigation. The SEC has been focusing on the corporate bad guys, leaving the auditors to be sued by shareholders.

So who's making sure that we don't have another EY/PeopleSoft episode, E&Y/American Express or a PWC equity-lapalooza, or PWC/IBM kickback party, or an EY/AIG/PNC self-interested round-robin or a perceived independence violation based on alliance relationships?

As I mentioned yesterday, one of the more common ways for the Big 4 to do the kind of business that they can't do officially or openly is to allow their professionals to freelance, such as helping the "Kite Runner" boy actors escape from Afghanistan in advance of the movie opening.

They can also subcontract.

When the Big 4 is the prime contractor on a large project, whether defense or corporate related, it's difficult for them to skip the risk management and other independence and conflicts checking that the firms now employ in order to keep their client lists clean and organized. The up-front risk assessment process required when taking on a new client, or a new engagement for an existing client, vets the independence issues, hopefully before a contract is signed. But this task is challenging in even this simplistic example, however, if the project involves multiple countries or if the client is a multinational that may be doing business directly with a local office of the firm rather than working through their global relationship partner. In that case, the right hand may not know what the left hand is doing.

As I have said before, the firms have a hard time keeping track of what their foreign offices are doing. Even if they know what they are doing, they have few tools to enforce rules that, in the end, foreign offices often perceive as being only for the benefit of the US firm.

When money talks, partnership and brotherhood walk out the door...

An even more difficult but increasingly common scenario, especially for Deloitte, is when the Big 4 firm is the subcontractor, rather than the prime, or lead, contractor.

Neither Deloitte nor any of the others are too proud to be a subcontractor, working under the likes of a Lockheed Martin, SAIC or Northrup Grumman.

But when the relationship with the ultimate is once removed, it's difficult for the Big 4 firm to initially identify and effectively monitor independence conflicts with subsequent ultimate clients. That's because their client, the one they bill and set up on their systems and vet from a conflicts and independence perspective is the prime contractor, not the ultimate client. If the ultimate client ends up being is another corporate entity or the federal government, there may be an independence conflict.

Another example is when a Big 4 firm goes into business with a software company. Sometimes it's just a joint marketing alliance and sometimes the Big 4 firm has sold their software to another company. There may have been existing or perceived restrictions on that type of business activity or maybe they just can't manage and invest appropriately in software. It gets even more complicated when those companies are acquired again and erase all ties to their Big 4 legacy.

Recently, PwC sold their Teammate software, used for audit workpaper preparation to a firm called Wolters Kluwer.

The article boasts of the number of clients and users that the software already has, a very big installed base that PwC developed and, perhaps, are charging the acquirers quite a bit for. However, another nice sweetener often put into this type of contract is the continuing royalty opportunity. PwC may have asked for the ability to continue to benefit from the license fees paid by customers they developed and served all these years as well as allowing the acquirer to pay them the purchase price over time. There may be some offset given the fact that Wolters Kluwer is also acquiring the Teammate business team staff and putting them under their roof.

When the acquisition is structured as a contract purchase, where the acquirer pays PwC over time and/or based on the revenues from the existing client base, it can get messy. At some point Wolters Kluwer will seek to develop their own clients and will want to sell to whomever wants to buy the product, regardless of PwC's independence restrictions.

This is a very real and very dangerous situation for the Big 4, especially as they seek to expand their consulting businesses and team up or align with other firms like Accenture, CSC, EDS and other system integrators and software firms that have no independence constraints regarding with whom they do business. All of those consulting types they've been hiring back don't usually care that they really work for an audit firm, not a consulting firm. When a conflict arises, audit cmes first. Let's hope the consultants fess up to who they're really doing business with before they start sending the bills.

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No Doubt - Blackwater and Deloitte

Oh black water, keep on rolling
Mississippi moon won't you keep on shining on me
Photo Source

There's no doubt many of you have read my post about Deloitte's interesting activities in extraordinary parts of the world. Although their spokeswoman denied direct involvement by Deloitte in places like Iraq, I have had emails and calls since those posts from individuals who confirmed such activities. These individuals were verified by me as capable of having the connections and knowledge of such activities within Deloitte.

The catch is that a firm like Deloitte does not get involved directly and send an invoice to Baghdad on their letterhead. Their US-based professionals, for example, have had experience in any number of law enforcement and military organizations prior to joining Deloitte, (CIA, FBI, various military branches, Pentagon, NCIS and other military investigative groups, etc.) They often continue to have the relationships and connections to those agencies and the contractors they use, such as Blackwater. Because of, and as a result of those ties and, of course, to protect Deloitte, they sometimes freelance on special missions in Asia, the Arab world and South America. These are places where no typical Deloitte professional, if there is such an animal, typically goes.

Proof of how deep Deloitte's ties with the US presidential administration and the administration of Bush Père is found every day, in the campaign contributions, in the none-too-subtle messages from their leadership and from the never ending involvement in international politics and policy of their advisors and former leaders.

No doubt you have also heard about Blackwater and the investigation of the September 16 episode in which Blackwater security personnel shot and killed 17 Iraqi civilians. FBI investigators have found that at least 14 of the shootings were unjustified and violated deadly-force rules in effect for security contractors in Iraq.

The Deloitte connection centers on the Krongard brothers — who have carried childhood nicknames, Buzzy and Cookie, through long careers — and are tied up in the tangled story of Blackwater.

Alvin Krongard, 71, who left a $4 million-a-year job in investment banking to serve in top posts at the Central Intelligence Agency from 1998 to 2004, played what he describes as a routine role as an intermediary in helping Blackwater get its first big security contract from the agency for guards in Afghanistan in 2002.

Meanwhile, Howard Krongard, 66, a former general counsel at the accounting firm of Deloitte & Touche who took the State Department job in 2005, was grilled this week by House Democrats. They accused Mr. Krongard (who does not use his nickname professionally, as his brother does) of alienating his staff and improperly interfering in investigations, including a Justice Department inquiry into allegations of weapons smuggling by Blackwater employees.

“We have now learned that Mr. Krongard’s brother, Buzzy Krongard, serves on Blackwater’s advisory board,” Mr. Waxman declared, saying the inspector general had “concealed this apparent conflict of interest.”

At the hearing, Howard Krongard, who did not respond to a request for an interview for this article, described himself as an apolitical auditing lawyer whose reforms have met resistance from subordinates who resent supervision.

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Google Search Follies

It used to be in the old days... Indulge me. Although I am not that old in people years, I am old in accountant years. In the old days, when you wanted to research something, you looked in big books, like the IRS Code or GAAP or IIA Standards. If you did a legal search you used WestLaw, Lexis, Nexis, casebooks, etc.

Nowadays, if you want to know something, you Google it. Business people search for the funniest things; things you could ask your boss, things you could check around the office on, things you could ask another expert about. Instead they trust the World Wide Web to give them a definitive answer to their myriad of questions, some of which in and of themselves reveal a lot. Over 95% of the users who came to me via a search engine came to me via Google or Google Blog Search. Which is why Google shares trade at 1pm today at US$ 634.33 after going public in August of 2004 at US$ 100.
Who audits Google? The answer is here.

Today a few examples that brought folks to my site:

From someone at a Big 4 firm in Mexico City:
Auditor nearly finished with an engagement discovers that the director of marketing has gambling habit...

Notice the full sentence structure. Notice fear inherent in being near the end of the engagement balanced by the calm of making sure it's mentioned that it is the marketing director, not the CFO or CEO. My question - Do you know if it's a winning habit or a losing habit? Makes a big difference.

This one from an unidentified searcher:
ernst young offer letter background check

Hope they don't have the same issue as this guy who wants to work at Deloitte...One thing about Gen Y accountants - More of them have more colorful backgrounds at age 23 than we did (well, than you did...) at that age. They're fearless.

Someone from PwC, via their server in New York:
arizona state board of accountancy consent order 2006 pricewaterhousecoopers

What? Can't find it already? It's probably thumbtacked to Sam B's bulletin board in the Independence Compliance Command Center in Jersey City.

And also from PwC on April 23, 2007:
PWC mckinsey layoff
What? You didn't get the email? This morning you showed up at the office and you weren't able to reserve a cubicle because you name was no longer listed in the electronic directory at the door? You've been on the road too long, dude. Better hope you get paid for those extra days at the client.

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The Music's Stopped For Some CEOs - What About Their Auditors?

So why do their auditors still get to dress up everyday and act like Cinderella?

In my earlier post, A World Without The Big 4 - It's Closer Than You Think, I said,

..."But what profit? If their internal systems and processes are broken, how can you trust any numbers they produce? Isn't the experience of any of these banks and their multi billion dollar writedowns enough to tell you that it's all smoke and mirrors and investors are just playing a game of musical chairs. When the music stops, one of you will be holding the worthless paper."

Today's FT column by John Gapper, Wall Street’s bruising musical chairs, Gapper quotes Chuck Prince, Citicorp's deposed CEO as saying,"“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” July 10.

I have the shivers.

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PwC Does Sweetheart Deal For Vietnam Headhunting Services

You have to wonder whose sweetheart Tieu Yen Trinh is? (She is a Manager.) The audit firms are getting as wily as the financial services companies in setting up offshore joint ventures to obscure who really is in charge, who really gets the profits, who really pays the taxes, who the clients really are.

Oh, I forgot! It's the audit firms that are advising the financial companies on complex SIVs and SPAs.

And has has been discussed before specifically about PwC, alliances are funny things and this doesn't look like it's moving too far from under the watchful eye, strong influence and potentially profitable benefit of PwC Vietnam.

According to Lan Lydall, Managing Director of PwC Vietnam, the recruitment division has been bringing high profit and making a great contribution to the company’s success. However, PwC needs to shut down its labour supply service as of October 31.

Did someone blow the whistle on an independence conflict? Is there an SEC investigation of PwC Vietnam doing some headhunting for a US audit client? There had to be a precipitating action for them to make this change so suddenly. They're not that strategic with their own business.

But what about all the other places they provide HR and other services that are potentially in conflict if provided for an SEC registered client? Are they moving these off to JVs using insiders too?

We've also talked about how PwC, via its UK arm, has gone full speed ahead trying to drive manufacturing business to Vietnam. That's manufacturers, not service sector businesses, because, as everyone knows:

The incomes of Vietnamese people remain relatively low, ...As a result, Vietnam's score in terms of the attractiveness in the service sector is lower than the manufacturing index...

US auditor giant to transfer services to local JV

Leading global auditor PricewaterhouseCoopers has transferred its Vietnam head hunting services to a local Australian joint venture as new US regulations do not allow auditors to operate in both sectors.

The TalentNet Joint-Stock Corporation officially received the transfer from PwC last week, said Tieu Yen Trinh, TalentNet’s chief executive officer.

Trinh added that the joint venture also received personnel, technology and clients from PwC.
PwC has halted its human resources services as U.S auditing regulations have become more strict, she said.

Trinh, former head of PwC Vietnam's head hunting service department, said auditors which providing HR services create a “conflict of interest.”

The corporation has not paid for the transfer, but Trinh said Monday that the two companies were “working with each other to reach some conditions for the transfer.” She refused to give further details about the conditions.

Besides head hunting services, Trinh says TalentNet will also provide other services that PwC is now unable to supply due to the new regulations.

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BDO Challenges Big 4 - Big 4 Says, "Huh?"

New chief of BDO challenges Big 4

BDO International could be a "credible challenger" to the Big 4 accounting firms, according to its new head. Jeremy Newman, newly appointed chief executive of the company, told the Financial Times that he sees a large opportunity in the market but that becoming a fifth tier to the dominating Big 4 "would be a sign of failure".

"Being a credible alternative doesn't mean being the same. There's no doubt the Big 4 are essentially global corporations driven out of head offices. We're more adapted to the local market," he said.

...BDO ...has over 600 offices in 100 countries.

You've got to wonder what this guy is smoking...The FT article goes on to quote Mr. Newman, "...there are invisible barriers to entry to the market for top-level company audits (for the non-Big 4)." The article also states, "In the UK, for example, all the FTSE 100 are audited by the Big Four and only eight of the FTSE 250 are non-Big Four, shared between BDO Stoy Hayward and Grant Thornton, its biggest rival."

Recent UK research by BDO Stoy Hayward showed nearly half of investors would be concerned if a company switched to a non-Big Four auditor and a third would review their investment decisions. But of those with concerns, a quarter were unable to say why and a third could only cite lack of reputation.

“A lot of these perceptions are based on assumptions that have been there a long time,” said Mr Newman. “We’ve managed to displace those in the UK and the US..."

Why would the FT print such incredible crap? It's PR, not news. Where's the critique? That sounds like some good reasons for lack of credibility. I'm not sure the US firm will be much help to BDO International or that anyone has displaced those concerns here. On the contrary, the statistics and their reputation are not much better with US based companies.

Per Ames Research Group International:

BDO Seidman US Marketshare
With BDO Seidman’s future in the US audit market now the subject much speculation and discussion, it might be useful to look just how big their US marketshare is.

BDO Seidman audits approximately 305 US-based “public” companies—meaning they file a 10K with the SEC. Not all of that number are currently trading. Furthermore, this excludes mutual funds and benefit plan audits. By that measure, BDO Seidman is the the 2nd largest 2nd tier firm, behind Grant Thornton with about 50 more clients.

KPMG is the closest Big Four firm, with almost 3 times more clients.

For another view on why the next-tier firms are "not ready for prime time", go to Jim Peterson at the IHT.

In June of 2006, the last time this report was published in this form by Compliance Week, the statistics were startling.

This Internal Control Report Scorecard, developed by Compliance Week, tracks the "Pass/Fail" grades of public companies on Section 404 of The Sarbanes-Oxley Act of 2002. The data are from the 10-Ks of the Russell 3000, and are derived from the section titled: Report of Independent Registered Public Accounting Firm.
The Big Four

Deloitte & Touche, LLP
10-Ks Audited 488
10-Ks Passed 442 Percent Passed 90.57%
10-Ks Failed 46 Percent Failed 9.43%

Ernst & Young, LLP
10-Ks Audited 756
10-Ks Passed 708 Percent Passed 93.65%
10-Ks Failed 48 Percent Failed 6.35%

KPMG, LLP
10-Ks Audited 530
10-Ks Passed 484 Percent Passed 91.32%
10-Ks Failed 46 Percent Failed 8.68%

PricewaterhouseCoopers, LLP
10-Ks Audited 618
10-Ks Passed 571 Percent Passed 92.39%
10-Ks Failed 47 Percent Failed 7.61%

All Big Four
10-Ks Audited 2392
10-Ks Passed 2205 Percent Passed 92.18%
10-Ks Failed 187 Percent Failed 7.82%

The "Second Six"
BDO Seidman, LLP
10-Ks Audited 57
10-Ks Passed 44 Percent Passed 77.19%
10-Ks Failed 13 Percent Failed 22.81%

BKD, LLP
10-Ks Audited 4
10-Ks Passed 3 Percent Passed 75.00%
10-Ks Failed 1 Percent Failed 25.00%

Crowe, Chizek & Company, LLC
10-Ks Audited 9
10-Ks Passed 8 Percent Passed 88.89%
10-Ks Failed 1 Percent Failed 11.11%

Grant Thornton, LLP
10-Ks Audited 57
10-Ks Passed 44 Percent Passed 77.19%
10-Ks Failed 13 Percent Failed 22.81%

McGladrey & Pullen, LLP
10-Ks Audited 8
10-Ks Passed 8 Percent Passed 100.00%
10-Ks Failed 0 Percent Failed 0.00%

Moss Adams, LLP
10-Ks Audited 4
10-Ks Passed 4 Percent Passed 100.00%
10-Ks Failed 0 Percent Failed 0.00%

All "Second Six"
10-Ks Audited 139
10-Ks Passed 111 Percent Passed 79.90%
10-Ks Failed 28 Percent Failed 20.10%

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A World Without The Big 4 -It's Closer Than You Think

Photo Source

Jim Peterson of the International Herald Tribune has imagined the unimaginable. (Well, unimaginable to those who are not too bright...) His column today asks the question: What would a world without the current external audit model look like? His ideas are grounded in vast experience, great contacts and a sharp mind. I may have a few other ideas and a few doubts. I don't see super charged internal audit functions developing so quickly and easily and I don't think you're going to be able to reduce securities litigation much, but the article is worth a close read, at least to start a dialogue.

It's a shame that the establishment, being so insular and inbred, can not imagine a model that works better than the one we have now. I agree with Jim that it's broken. I agree that the external audit report and now the internal control report are not worth the paper they're printed on, especially when they can be taken back so easily or when failures and "sudden downturns" can happen so soon after a firm says everything's perfect.

The opposite is true, too. When a report actually tells a story about fraud, mismanagement, poor internal controls and continual lack of attention by management to the business fundamentals, the market generally ignores it if the company is still making a profit. But what profit? If their internal systems and processes are broken, how can you trust any numbers they produce? Isn't the experience of any of these banks and their multi billion dollar writedowns enough to tell you that it's all smoke and mirrors and investors are just playing a game of musical chairs. When the music stops, one of you will be holding the worthless paper.

Despite the threat to the survival of the Big Four accounting firms, none of the players - not the Big Four leaders, regulators or politicians, or the community of financial information users - will say it straight out: The large auditors' business model is broken, and their risks are unsustainable. The next large-firm failure will take down the other Big Three as well, just as fast as Arthur Andersen crashed in 2002, leaving large companies unable to obtain the current form of audit report from any source.

And why is nobody willing to ask what life will be like after the Big Four?

...Whatever the fear of speaking the unthinkable about the next era of large-company assurance, it is now on the table. There is a broad-based symposium, waiting to be convened by a top global regulator, under the title, "The Future of Auditing After the Big Four." If the boy wizard Harry Potter could name, face and overcome his nemesis, a group of adults should be able to do no less.

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Just As I Was Starting To Feel Less Nauseous...

re: The Auditors has been feeling a little under the weather the last few days, and therefore less inclined to write. This morning, just as I was starting to feel a little better and ready for some warm oatmeal and apple juice, I saw this story in the Financial Times. It was enough to send me back to my bed.

This is so wrong in so many ways. Haven't the auditors been using any judgement under the "rules based" system? If not... If they've only been "ticking the boxes" out of fear of litigation, that would explain a lot and will explain even more when we see the deluge of Sarbanes-Oxley 404 litigation that is down the road due to failures after clean opinions.

They're also getting very good at throwing very specific legal terms like "safe harbor" into every interview. Must be the influence of the group of lawyers that defend them instead of the group of lawyers that sue them. Or maybe their lobbying organization is holding media training seminars.

It's been my experience that one of the Achilles' heels of the current audit firm model is this assumption, within the firms and by those who believe it's brain surgery to memorize GAAP and regurgitate it in rote form during audits, of infallibility on the part of audit partners. Like the Pope, they want us to believe, without questioning, whatever they pronounce. Boy, do they hate anyone second-guessing them. Lawsuits, as well as interns and experienced hires, that question their decisions are greeted with utter disdain and incredulity.

How dare you?

Now they're looking for this imperiousness to be codified in regulation, globally. My question is - Who has the nerve, the stature, the political will, the cojones to declare that, "The Emperors are wearing no clothes!"

At one time it could have been Arthur Levitt, but he's sold out.

Richard Breeden? No, he's too busy playing both sides for maximum return.

Charles Schumer or Christopher Dodd? You must be joking! They're signed, sealed and delivered, bought like Guernsey cows, mooing occasionally that something must be done, but most of the time batting their eyelashes at the firms in return for cash.

Paul Volcker? Way past his local, state and federal "sell-by" date.

Don Nicolaisen? I thought at one time he still had the fire in his belly, but he seems to have become fat and sassy too, enjoying the fruits of his long labors.

We need a superhero. Someone with no fear. Someone willing to smote dragons and crush corrupt captains of industry as well as ruin the lives of insular, inert, out-of-touch politicos.

I nominate Patrick Fitzgerald to take on the Big 4.

They'll never know what hit them.

Deloitte urges new guidelines
James Quigley, Deloitte's chief executive, has called for regulators to draw up new guidelines for the auditing profession to fit in with an emerging "principles-based" approach so firms have a basis for defending themselves if they are sued for making mistakes.

The hea