I’ve gotten some crazy questions over the years but this one pretty much takes the cake. I’m not saying it’s stupid, nor am I saying it’s all that crazy, it’s just… well… out there, is all. Read on.
Dear Adrienne,
I’m a college student at the University of North Texas. Fraud has been a hot topic in my courses this month. We covered many scandals including Crazy Eddie, Barry Minkow, NextCard, Enron, and Bernie Madoff. This has got me thinking a lot about how I would react if I was in the shoes of the auditor. The students in my class always say to just report the fraud, however they never put themselves in the shoes of the fraudster to determine how the fraudster would act nor do they think about protecting the reputation o watched enough movies to know that if a fraudster finds out that somebody knows “too much,” then that person probably won’t make it home alive that night, unless they cooperate. I remember in that movie, “The Other Guys,” the auditing partner got killed because the fraudsters didn’t want him snitching out any information to authorities.
Another thing is that if it is found out that a partner is involved in fraud, this will ruin the firm’s reputation if this gets reported to the SEC. However, if the firm handles this internally, fire the partner, admit mistake, and let the public know that it doesn’t want anything to do with the partner, then perhaps only the partner would get in trouble and not the firm.
So exactly how are you suppose to act in situations of fraud? Of course AICPA tells us to first report it to your supervisor, then to the audit committee, and then the SEC. But still though, you got to get this out before someone kills you and you’ve got to handle it in a manner that best protects the reputation of the firm. Am I right? Also, have you ever heard of any auditors that were murdered because they knew too much? When you read about Enron or the Bernie Madoff scandal, there are talks about death threats, but you don’t necessarily hear about any murders involved. So it may be something that only happens in the movies.
Well, since you brought up Crazy Eddie, my first instinct was to pose this question to Crazy Eddie’s corrupt CPA, Sam Antar. Thankfully Sam obviously checks his Twitter account every five minutes and had some thoughts for me almost immediately.
“Yes, the potential is there. Depends on the client. Have that person contact me if worried,” he tweeted. Now isn’t that sweet? If anyone out there is feeling the heat, you know who to hit up.
His thought? It’s rare, if not impossible. Why would a fraudster whack the auditor? By the time the fraud is uncovered, it’s too late. The workpapers would likely document said fraud, so the fraudster would then be forced to whack the entire chain on up to the partner and who has time to do all that killing? “No logic in whacking outside auditor unless part of conspiracy,” Sam said.
That being said, does anyone remember Allen Stanford’s sketchy auditor C.A.S. Hewlett (“C.A.S.H.” get it?!)? He apparently kicked the bucket on January 1st (a real accountant would have kicked the bucket on December 31st, pfft), just a month before Stanford was charged with fraud (though he didn’t get arrested until June of that year). The circumstances surrounding his death were, uh, weird to say the least but I don’t think anyone is going to go so far as to say he got whacked.
Or how about Ken Lay? I mean, does anyone really believe he had a heart attack? There is even an entire website dedicated to exposing Ken Lay’s post-mortem life.
Now, here’s where it gets tricky, and I don’t expect you to know this since you haven’t made it out into the real world yet. What is an auditor’s job? Is it to uncover fraud? Or is it to verify with a minimum of certainty (a.k.a. “reasonable assurance”) that the financial information presented by a company is probably legit? If you answered the latter, you win. Forensic accountants dissect fraud, auditors simply check boxes. I’m sorry if this offends any of you hardcore auditors out there but in your hearts, even you guys know I’m right. Auditing is a joke, an intricate dance (read: performance) that exists more for entertainment than functionality. If you don’t agree with me, I’d be happy to name any number of companies that prove my point for me (let’s see… Enron, Worldcom, Overstock, Satyam, Olympus…).
What do you think the odds are that a first or second year auditor would even be able to detect fraud? Don’t you think the criminals behind it are at least clever enough to hide their wrongdoing from a bunch of fresh-faced kids with their SALY checklists? Look at the lengths Crazy Eddie went to – to success until their greed got the best of them and a chick ruined the whole scam. And that’s the thing, the auditors rarely uncover fraud, it’s usually the fraudsters themselves who end up exposing themselves though greed or just plain stupidity.
Whistleblowers don’t make friends but they don’t have to hire armed guards either. Like I said, by the time the fraud is exposed, it’s too late to start killing people to hide the truth.
And thanks to SOX, it is illegal to “discharge, demote, suspend, threaten, harass or in any manner discriminate against” whistleblowers, so a more likely scenario is that revelations of fraud will come from within the firm, not from the outside auditors who are pissed off to be doing inventory counts on New Year’s Day.
You watch too many movies, kiddo. Just check the list, collect the bank recs and call it a day.
The question I have is, if profitability and efficiency (antecedents to possible reductions in audit quality due to the overarching focus on engagement profitability) are high when partners want more profits, how will they be when third-party investors demand a return? I’d love to know what the SEC and the PCOAB think of this.
Maybe the next step is actually to have audit-only firms. Is GT McKinsey now? It appears the MBAs have taken over.
I couple of points I’ve seen elsewhere: (1) PE knows what they want to accomplish before buying, and (2) funds to acquire (ala FORVIS recently, but without PE money) other firms will result in a 5th “Big4” firm, based on revenue. So, consolidation could be on the way. The gap between KPMG and the #5 firm is about $8 billion, so there would need to be a couple of major business combinations to make it happen.
Again, what’s the focus when transactions are the focus? A peek into the PCAOB inspection reports just released provides a possible correlation between EY’s failed deal and the substantial increase in inspection findings for EY over that term.
How would it be good??
PE is going to do their best to increase Ebitda and then sell in 3-10 years depending on the PE firm. The easiest way to do this will be to mandate offshoring of hours. This is a cash out by the older partners and it will hurt younger partners as well as staff coming up. Look at the IT industry to see what’s coming. You have all this cheap labor replace the people working now and the next generation will only be outsourced staff. It’s bad for accounting and most of the offshored staff are not nearly as qualified.
Was at a consulting firm when P/E acquired us. Culture changed for the worse within a year or so. Bad for us. GT, on the other hand, had bad leadership and couldn’t raise tax revenues in the year of the biggest tax change since 1986. Probably good for that firm. Bad for firms who are already good.
The partnership model is dead outside of the Big 4. A small handful of soon to retire partners control the votes and leadership roles in all the 5+ firms. None seem to have a succession plan with an eye on continuity like the Big 4 do.
Short-term capital mindset as they do not have enough time left to invest in growth or platform investments and realize a return. Therefore, makes sense to cash out to the highest bidder.
5+ Firms that try to remain partnerships will not be able to keep up with increasing competition from the PE backed firms who can lever, merge, offshore and invest in scale (tech and training) without the baggage of partnerships blocking pure financial investment strategy.
The days of lifestyle inheritance are over. Time to operate CPA firms as businesses.
Perhaps the least unpleasant path amongst a host of almost uniformly bleak options. Only DT, PwC and possibly EY have the balance sheets, scale and operating models to fund the investments necessary to be competitive in a world of talent scarcity and technical disruption. I idea what the hurdle rate is for this fund, but as noted PE will do whatever is necessary to extract a return and the manager / GP will be ruthless. Will be interesting to see what the structure is going forward. By law, most if not all states require CPA firms to be majority CPA owned.
Personally, I just think it’s funny every time I hear about another firm getting bought and it’s not Marcum.
This is is more than just about the new pressures it could put on audit quality when PE investors demand higher profits, but about the whole value of the CPA in general. The CPA designation derives it’s greatest value from our independence and objectivity. That is what had lifted the CPA to higher status when it comes to tax and financial advice, not just audit. PE will suck the value of the CPA. This in turn will devalue the firms they have invested in. It’s a short sighted greedy play by these partners and will be the death of a once noble profession. Iwe were once the guardians of the free market system. Helping ensure everyone played fair as best as possible. Calling out the bad actors when we found them. No more, now we swim with the.
New Mountain Capital also acquired Citrin Coopermann, which I would imagine now will just merge into GT.
It may be good for an acquired firm in the short term, but don’t see how it can be long term. Don’t they have polar opposite objectives? PE…maximize value and cash flow in the short term, possibly some add-on acquisitions and exit within 4-7 years. PA….stewardship, stability, long term vision, develop future leaders, etc. With the current shortage of accounting students, younger folks leaving PA, cashing out the most seasoned partners, etc., the industry will be an even less attractive option than it is today. “Partner” will become the equivalent of a highly comped employee (but less comp than those partners are used to). PA will survive, but the shape of it in the future will look very different.
I beileve this is a 10-20 year change to the industry. Once the consolidation leads to a certain level you will then have the fat cats that cashed out from the first PE flip go and start boutique firms again with better service and cheaper fees. There can only be so many flips of a firm (2 max) so eventually the remaining partners will be stuck buying out the last standing PE firm.
My first thought on these PE deals is independence issues. Most of these deals are with firms that don’t have large public company audits, but I would think there could be some very murky waters with the confidential information that accounting firms have that could have meaningful impacts on share prices. I would think independence would dictate the PE firm couldn’t hold any investments in audit clients.
PE firms typically want a return on investments in 4-7 years like others mentioned, but if they are generating leads with insider information on future deals, that could be a very valuable avenue for the PE firms to gain a significant advantage on future M&A. However, doesn’t that lead to independence issues?