The dynamics at both the PCAOB and the Big Four are horrible. The incentive at the Big Four is to keep prices down to the point at which it’s impossible for a new entrant to break into their charmed group; after all, if it means they end up cutting corners, the worst that happens is that they get gummed by the toothless PCAOB. [Felix Salmon/Reuters]
Category: Audit
The Big 4 and the Revolving Door
Last week the bane of Big 4 auditors existence, the PCAOB, broke their cherry on releasing Part II of an inspection report for a Big 4 firm. The honor went to Deloitte, who sufficiently blew off the Board’s recommendations for 12 months, which led to the release of Part II.
Bloomberg‘s Jonathan Weil, who usually sits back with popcorn while these things go down before chiming in, got to it today but with a twist that you probably weren’t expecting:
board members had recused themselves from participating in meetings or discussions this year concerning Deloitte, because of past or current ties to the firm, according to three people with knowledge of the matter.The board members — Lewis Ferguson, Jay Hanson and the board’s chairman, James Doty — were appointed by the Securities and Exchange Commission in January. Doty had been a partner at the law firm Baker Botts LLP, where Deloitte is a client. Ferguson was a partner at the law firm Gibson Dunn & Crutcher LLP, which also represents Deloitte. Hanson, a former partner at the accounting firm McGladrey & Pullen LLP, has a daughter who works for Deloitte in its Phoenix office.
The board’s policy is to not disclose recusals, in spite of its mission to “further the public interest,” as if these are none of the public’s business. “Recusals are confidential,” Colleen Brennan, a board spokeswoman, said. Doty, Ferguson and Hanson declined to comment. A Deloitte spokesman, Jonathan Gandal, said: “The PCAOB itself does not comment on recusals, and as such it would be inappropriate for us to do so.”
It’s a pretty nice scoop by Jon and we’re all used to the silence from the PCAOB and Deloitte when someone gets the best of them but honestly, is anyone surprised? Does anyone care? The answer to the first question is “No.” The answer is the second question is “Maybe.”
With the exception of Mr. Hanson (family connection, we’ll give you that one), the recusals seem a little silly since neither Ferguson or Doty actually worked directly for Deloitte. Okay, so Baker Botts and Gibson Dunn have Deloitte has a client. Which Big Law firm doesn’t? It’d be pretty tough to find any DC lawyer who didn’t do some time at a firm that represented Deloitte. That goes for any Big 4 firm. They’ve all got deep pockets with lots of legal problems, of course they’re going to hire the best lawyers money can buy. Does that make guys like Ferguson and Doty unfit to make decisions with regard to that firm?
Well, for one year it does. Under the Board’s ethics code, Doty and Ferguson will be able to vote on matters involving Deloitte in January. Still, Weil doesn’t like the smell of it. And it doesn’t stop with the PCAOB:
[T]alk about being wired: The SEC’s chief accountant, James Kroeker, is a Deloitte alumnus. At the Financial Accounting Standards Board, which writes U.S. accounting rules, the wife of one board member, Russell Golden, is a Deloitte partner.
Look, we like Jon (even if he is a Colorado grad). But how do you find accounting policy makers who aren’t from the biggest, best connected firms that have the most resources? Should the Commission start appointing academics to develop policy? Eeek. Or maybe we’ll let the public make recommendations, “Yeah, my cousin’s a CPA out of Tulsa. Really knows his stuff. He’d be good.” Please.
Dan Goelzer’s seat is coming up and he’ll be replaced by a CPA. Weil hopes that the SEC will find “a qualified person without Big 4 allegiances” but with the revolving door spinning, he’d better hope for a wild card.
Goldman Sachs Envy Gains New Meaning at Big Four [Jonathan Weil/Bloomberg]
Brits To Give Big 4 the Full Monty
Britain’s top accountants are to have their own books scrutinised after the consumer watchdog referred the business of checking companies’ figures for a full-scale competition inquiry. The Office of Fair Trading (OFT) said it had been concerned for some time that the audit market is highly concentrated with low levels of switching and substantial barriers to entry. The watchdog estimates that in 2010 the “big four” firms, PwC, KPMG, Deloitte and Ernst & Young, earned 99% of audit fees paid by FTSE 100 companies, while between 2002 and 2010 only 2.3% of FTSE 100 firms changed their auditor. [UKPA]
PCAOB Publishes Part II of Deloitte’s 2008 Inspection Report, First Ever for a Big 4 Firm
They really, really, really don’t appreciate it when you blow off their recommendations. Here’s the statement from the Board:
The Public Company Accounting Oversight Board, in anticipation of questions about the publication of previously nonpublic portions of its May 19, 2008 inspection report on Deloitte & Touche LLP, issued the following statement today:
“The quality control remediation process is central to the Board’s efforts to cause firms to improve the quality of their audits and thereby better protect investors. The Board therefore takes very seriously the importance of firms making sufficient progress on quality control is n inspection report in the 12 months following the report. Particularly with the largest firms, which are inspected annually, the Board devotes considerable time and resources to critically evaluating whether the firm did in fact make sufficient progress in that period. The Board can and does make the relevant criticisms public when a firm has failed to do so.”
So to clarify, Deloitte had until May 19, 2009 to get their methods up to par but failed to do so. To put this into a little bit of context, Jim Doty was not yet the Chair of the PCAOB and Barry Salzberg was still the CEO of Deloitte’s U.S. firm. Does this mean that the PCAOB has been stepping up its game and this is the first instance of many to come? Hard to say but the audits that this inspection report cover are nearly five years old, so it’s debatable as to the value of Part II being made public now.
For Deloitte’s part, here’s current CEO Joe Echevarria’s statement:
“Deloitte is committed to the highest standards of audit quality and as newly elected CEO, it is my foremost priority. Our commitment extends from the top and cascades throughout our entire organization. We place great value on the PCAOB’s input and continue to work with the Board in support of our shared objectives. We recognize that audit quality is fundamental to protecting investors and ensuring the effective functioning of the capital markets.
“We have complete confidence in our professionals and the quality of our audits, and agree that there were and always will be areas where we can improve. In our drive for continuous improvement, we have been making a series of investments focused on strengthening and improving our practice, and will continue to do so to make Deloitte the standard for audit quality.”
In other words, a non-response response. However, it’s much more measured than Deloitte’s response to the initial release of the report. Their response letter spelled out their feelings quite clearly:
Professional judgments of reasonable and highly competent people may differ as to the nature and extent of necessary auditing procedures,conclusions reached and required documentation. We believe that reasonable judgments should not be second guessed and therefore disagree with a number of comments as indicated[.]
Deloitte’s letter is located Appendix C. You can read the full report, including all the details from Part II that were previously unpublished, on page 2.
Muddy Waters CEO: There Are Some Big 4 Partners in China Conspiring to Defraud Investors
As you probably heard, the PCAOB officially put out a proposal earlier this week for audit partners to be named in the annual reports of public companies. It would also require “registered firms to disclose the name of the engagement partner for each audit report already require the form” and “disclosure in the audit report of other accounting firms and certain other participants that took part in the audit.”
While most Big 4 audit partners are probably feeling a little chapped by this whole proposal, there is at least one person going on record (by way of PCAOB comment letter) that feels that it doesn’t go far enough. That would be Carson Block, the CEO and founder of research firm Muddy Waters. In Block’s letter (in full on page 2) to the Board he writes that not only should the engagement partner be identified but that he or she should be putting their name on the audit opinion because “[it] will decrease investors’ future losses to fraud and gimmicky accounting by billions of dollars.”
That on it’s own is enough to get more than a few people riled up. But as we indicated, there are some conspiracy and fraud accusations as well:
Even the most reputable auditors in China seem to be in a race to the bottom. We believe that there are particularly egregious situations in which some Big Four partners in China offices have actually conspired with their clients to defraud investors. Further, it is a reasonable proposition that the conflict of interest inherent in the Chinese auditors’ business model also affects the quality of US company audits.
Now before your knickers in a twist, don’t forget that this is the guy who called Sino-Forest a “Ponzi Scheme for the 23rd Century” which more or less looks to be accurate. Further, if you consider all the trouble Big 4 firms have had with Chinese companies listed in the U.S. and elsewhere, it doesn’t seem to be that much of a stretch that some partners would just say fuck it and work with their clients to keep a lid on the shenanigans than go through the pain of actually doing their jobs.
Regardless, with these accusations the PCAOB may try to make another run at getting the Chinese to play ball.
PCAOB Officially Proposes That Audit Firms Name Names
For some time now, the PCAOB has been talking about making audit partners famous (at least to investors that are paying attention) in ways that they aren’t too thrilled about. Earlier today the Board issued a proposal for comment that will do just that.
The proposed amendments would:
• require registered public accounting firms to disclose the name of the engagement partner in the audit report,
• amend the Board’s Annual Report Form to require registered firms to disclos gagement partner for each audit report already required to be reported on the form, and
•require disclosure in the audit report of other accounting firms and certain other participants that took part in the audit.
So if you can consider yourself an astute observer of auditing policy and regs, they’d love to hear your thoughts. However, it would be greatly appreciated if you didn’t take your cues from the FASB letters and kept things constructive.
All of the Board Members made statements, including PCAOB Chairman Jim Doty (full statement on page 2) who sees this latest proposal as good sense:
I fail to see why shareholders in BNP Paribas, listed on the Euronext Paris exchange, should be able to see the name of the engagement partner in the audit report, but shareholders in Citigroup, listed on the New York Stock Exchange should not. Indeed, the names of engagement partners for some European companies that are listed on the NYSE are disclosed in U.S. filings. Why are shareholders in France Telecom to be favored over shareholders in AT&T?
And then there’s Steven Harris’s statement (in full on page 3). Harris, who is known to speak frankly about auditors, finds the proposal okay enough but would really like to see the audit partners’ John Hancocks:
While I support an identification of the engagement partner, I continue to strongly support, and would have preferred, a requirement for the engagement partner to actually sign his or her name on the audit report. My views, which I stated when the Board last publicly discussed the issue in July 2009, have not changed. Very fundamentally, I believe that nothing focuses the mind quite like putting one’s individual signature on a document.
And for good measure, he threw in this:
Many find it ironic that auditing firms in the United States, whose business is providing assurance about the transparency provided by others, resist publicly providing their own financial statements. There is no apparent reason that the auditing firms that act as gatekeepers to our securities markets should not be as transparent to investors as the companies they audit.
If you agree with Mr. Harris and happen to have a copy of your firm’s financial statements, feel free to pass it along. Or if you’d rather not wait to make your thoughts known on the Board’s proposals, you may drop them in the comments below.
Center for Audit Quality Gets Serious About Investor Protection By Introducing PR Campaign Featuring Cartoon Noir
Frankly, I find Garfield’s Babes and Bullets more convincing:
Your reactions are welcome at this time.
[via The Summa]
Study: Investors Might Want to Tread Carefully Around Companies with High Audit Fees
[R]esearch finds auditing fees charged to companies to be significantly related to the their financial performance for as long as five years into the future: the higher the fees this year, the lower firms’ performance next year and beyond. In the words of the journal report by Jonathan D. Stanley of Auburn University, “Primary results indicate a significant inverse relation between audit fees and the one-year ahead change in clients’ operating performance… Further analysis reveals that the primary results extend to changes in operating performance observed up to five years after the fee is disclosed; are more pronounced for future negative versus positive chances; and [are] applicable to future changes in earnings unaccounted for by analysts’ forecasts.” Asked if these findings are likely to be of value to average investors, Prof. Stanley answers in one word: “Definitely.” [AAA]
CFTC Didn’t Think Too Much of McGladrey’s Audit of One World Capital Group
They were so unimpressed with it, in fact, that they are fining the firm $900,000 and partner David Shane $100,000 to settle up.
Mickey G’s issued an unqualified audit opinion for One World Capital Group’s 2006 financial statements and also stated that the company’s internal controls were just fine and dandy. Neither of these things turned out to be true. And when you read the CFTC’s press release, you really have to wonder if anyone was really auditing this company:
[T]he order finds that One World’s 2006 financial statements were materially misstated in various ways including: (1) the 2006 Statement of Financial Condition states that liabilities payable to all customers were over $6.9 million, when in fact information available in One World’s records showed that it may have owed at least $15 million just to forex customers alone, for whom One World served as the counterparty; and (2) the 2006 financial statements materially misstated the nature of One World’s business by failing to reflect that One World served as the counter party to its forex customers for over 90 percent of its business, according to the order.
In addition, McGladrey failed to report material inadequacies in One World’s accounting system and internal accounting controls, including the lack of a customer ledger, and an accounting system that did not properly identify the number of forex customers or the amount of customer liabilities, according to the order. These material inadequacies reasonably could, and did, lead to material misstatements in One World’s 2006 financial statements, the order finds.
No punch and cake for anyone after this fiasco.
[via CFTC]
Someone Is Curious About All Those KPMG Employees Working on General Electric’s Taxes
You may remember earlier this year when The New York Times broke a little story about General Electric’s tax savvy ways and the best tax law firm the universe had ever seen (aka the GE tax department).
The report�������������������� href=”http://www.goingconcern.com/2011/03/jon-stewart-reacts-to-ges-tax-savviness/”>a few people to get bent out of shape because the Times said GE was enjoying $14.2 billion in profit while “claim[ing] a tax benefit of $3.2 billion.” What that “benefit” really entailed was a mystery but many people jumped to the conclusion that it was a “refund” and ProPublica (possibly a little peeved that they got scooped) tried to set the record straight on the Times story.
Despite all the back and forth, everyone was pissed at GE. The company lost a Twitter joust with Henry Blodget and then a bogus press release went out claiming the company was returning the “refund” of $3.2 billion and the Associated Press ran it. Slightly awkward.
Francine McKenna also did a write-up on KPMG’s role in this little soap opera, as the firm has been the auditor for GE since Bill Taft was maxing out the White House bathtub.
The latest twist comes from a tip we received earlier about a “Preservation Notice” sent to all KPMG employees yesterday from the firm’s Office of General Counsel (“OGC”).
URGENT TARGETED PRESERVATION NOTICE: GENERAL ELECTRIC’S LOAN STAFF ARRANGEMENTS
Please be advised that until further notice from KPMG LLP’s (KPMG or firm) Office of General Counsel (OGC), you are hereby directed to take all steps necessary to preserve and protect any and all documents created or received from January 1, 2008 through the date of this Notice relating or referring to the loaning, assignment or secondment of tax or other professionals to General Electric Company and its direct and indirect subsidiaries, affiliates and divisions (collectively “General Electric’s Loan Staff Arrangements”).
As Klynvedlians know, these preservation notices come out so often that you barely even notice them. When you do notice them is when the partner in charge of your team informs you about it before it hits your inbox. What follows is basically the biggest CYA exercise you’ve ever seen. They roll in giant dumpsters and every last scrap of paper you’ve ever written on gets throw in and eventually it gets shipped off to OGC. Your life doesn’t really change all that much other than you’re not allowed to delete another email EVER. At least that’s how I remember it.
ANYWAY, this notice seems a little different. Why exactly? Here’s a excerpt from McKenna’s post:
In defiance of [Sarbanes-Oxley] provisions, KPMG – GE’s auditor – provides “loaned staff” or staff augmentation to GE’s tax department each year. These “temps” perform tasks that would be otherwise the responsibility of GE staff. Sources tell me KPMG employees working in GE tax have GE email addresses, are supervised by GE managers – there is no KPMG manager or partner on premises – and have access to GE employee facilities. They use GE computers because the software required for their tasks is GE proprietary software.
This type of “secondment” to an audit client is never allowed. KPMG should know better.
YEESH. So any documents going back to January of 2008 that relate or refer to someone being assigned under this allegedly dubious arrangement must be preserved. You don’t have to be John Veihmeyer to know that’s a METRIC ASSTON of documentation. It’s not that GE’s tax needs are seasonal; they’re more like “perpetual” or “infinity times infinity.” A company with the best tax law firm already in house that also has an arrangement with a their auditor to throw a few more people at the problem indicates that they are working on this shit 24/7. For KPMG, it amounts to a nice little revenue stream and it keeps lots tax staff busy throughout the year.
But what caused the notice? That’s the question. Our tipster speculated that the PCAOB and SEC might be up to something but per standard operating procedure, neither will confirm nor deny the existence of any investigation or inquiry. KPMG spokesman George Ledwith did not respond to an email seeking comment.
Like we stated previously, these preservation notices are a dime a dozen but because this one deals with General Electric and presumably their tax compliance it qualifies as outside the norm. If you’re in the know or know of someone in the know or have anything else to add, email us or comment below.
Audit Partners Are About to Get Famous
But probably not in ways they would prefer:
In a recently updated standard-setting agenda, PCAOB Chief Auditor Marty Baumann says the board is working on the proposal to address concerns about audit transparency. The board published a concept release in July 2009 that asked for feedback on whether the engagement partner should be required to sign the audit report. Based on feedback to that release and subsequent discussions with the board’s advisory groups, the PCAOB is preparing a new requirement for audit firms to say in their audit reports which engagement partner at the firm supervised the audit and who from outside the audit firm participated in the audit.
Who Has Thoughts on Mandatory Auditor Rotation?
Because the PCAOB is giving you until December 14th to make your views known.
“One cannot talk about audit quality without discussing independence, skepticism and objectivity. Any serious discussion of these qualities must take into account the fundamental conflict of the audit client paying the auditor,” said PCAOB Chairman James R. Doty.
“The reason to consider auditor term limits is that they may reduce the pressure auditors face to develop and protect long-term client relationships to the detriment of investors and our capital markets,” Chairman Doty added.
Don’t fret anti-rotaters, the Board did invite everyone to weigh in on the idea that they “should consider a rotation requirement only for audit tenures of more than 10 years or only for the largest issuer audits.”
[PCAOB]