The accountant’s job is not easy, and it’s even tougher in the largest accounting firms. The “up or out” promotion policy in these firms creates huge pressures for client development and retention, not to mention stresses to generate and maintain bonuses for managers and partners. The result: major incentives for accountants to “bend” the rules for clients.
Recently, we learned that KPMG let Motorola record revenue in the third quarter of 2006 even though the contract that originated the sale was not signed until the early hours of the 4th quarter. Without the deal, Motorola would have missed its third-quarter earnings target.
As we learn more about the large accounting firms’ role in the financial crisis of 2008, the news is not good:
And even more recently, we have Ernst & Young blessing Groupon’s aggressive “gross revenue” recognition policy despite its complete violation of generally accepted accounting principles. Apparently, the Securities and Exchange Commission agreed with us (see Groupon Finally Restates Its Numbers), as they required Groupon to restate their financial statements for this “accounting error,” and amend their S-1 yet again.
All of these are clear cases of “rule bending” to help the client! Apparently, the new regulations put in place after Enron that were supposed to make it easier for accountants to do the right thing are not working. Evidently, those laws just aren’t tough enough to deter large accounting firms from siding with their “paying” client, rather than their “real” client, the investing public.
Could inadequate governmental funding and political influence be exacerbating the problem? Consider the following:
So how much of this “rule bending” is related to lobbying clout? According to the Center for Responsible Politics (www.opensecrets.org) in an article entitled “Wall Street’s Campaign Contributions and Lobbyist Expenditures,” accounting firms spent $81 million on campaign contributions and $122 million on lobbying between 1998 and 2008. Accounting giants Deloitte & Touche, Ernst & Young, KPMG and PricewaterhouseCoopers spent, respectively, $32 million, $37 million, $27 million, and $55 million. In 2007 alone, accounting firms employed 178 lobbyists.
And the Big Four continue to poison the regulatory waters. Just as Goldman has been criticized for sprinkling their people into key positions at Treasury during the financial crisis of 2008, the Big Four have done exactly the same at the SEC and PCAOB, the very institutions that regulate them. A simple review of staff biographies for each of these organizations is confirmation enough. Additionally, we all can cite examples of former regulators join the Big Four as consultants when they retire.
These large accounting firms also are not shy at promoting their agendas. What are they interested in? They favor accounting rules that promote more judgment in the application of GAAP that reduce the likelihood of litigation, e.g., fair value and International Financial Reporting Standards. They also support caps on litigation costs for their malpractice, as well as continued protection from disclosure of their governmental inspection reports and disciplinary actions.
So, how can we solve this Big Four audit problem? Mark O’Connor, CEO and Cofounder of Monadnock Research provides some clues. We report his suggestions in bold below, and our thoughts on how to implement them in italics:
We have one other rather obvious suggestion: meaningful enforcement of existing regulations. No rule changes required…just make sure that auditors and accountants actually do their jobs. We need to demand meaningful consequences to accounting and audit malpractice.
The evidence suggests that accountants and auditors today can shirk their audit responsibilities to the public with little or no lasting harm to themselves, and surely, not as much hurt as they have caused the investing public (see Paper Tigers: The U.S Accounting Oversight Regime and Accountants Behaving Badly). The public should be outraged that few, if any, Big Four accountants actually lose their licenses permanently, and are free to prey on the trust of the unsuspecting investor.
So what can we do to wake people up to this lack of regulatory enforcement? We have an idea that likely will scare quite a few people: a Megan’s list for accountants that details all regulatory actions against accountants and auditors. Let’s let the public know that these fake auditors are still out there practicing. A bit too extreme you say? Okay, let’s just continue writing about all these cases and posting commentary on the information superhighway.
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