September 25, 2020

What’s in a (Big 4 Partner’s) Name? Maybe a Lot

On Friday, Francine McKenna provided a perfect example of what investors could learn about the audit partners for public companies should the PCAOB start requiring the naming of names. 

Francine, through her sources, was able to confirm that Linda McGowan was the partner for MF Global — something widely known amongst regulators, and lawyers involved in litigation — until the firm went bankrupt on October 31, 2011. With a little digging, she also discovered McGowan's involvement in the Drexel Burnham Lambert, Barings, and Knight Capital engagements, among others, including Madoff feeder funds that were audited by PwC. 

Here's a portion of the In Re Santander-Optimal Securities Litigation that mentions McGowan's role:

Starting at least as early as 2004, PwC Bermuda and PwC U.S. conducted procedures on Madoff which were then communicated in written form to the various PwC member firms that actually issued the audit opinions for the Madoff feeder funds, such as PwC Ireland for Optimal SUS. These procedures on Madoff were conducted at least twice, in December 2004 and again in December 2006.

…PwC U.S. and PwC Bermuda visited BMIS, in New York City, on at least two separate occasions and conducted cursory audit procedures of Optimal SUS’s assets being managed by BMIS…the attendees to the meeting with Madoff are disclosed as, Linda McGowan (“McGowan”) and Scott-Watson Brown (“Brown”). McGowan is a partner at PwC U.S., and based in PwC’s office in New York City at 300 Madison Avenue – about ten blocks from Madoff’s offices in the Lipstick Building. Brown was a partner at PwC Bermuda, based in Hamilton, Bermuda.
 
[…]

Neither McGowan nor Brown made any attempt to verify Madoff’s statements, and instead simply transcribed his unsubstantiated assertions into the Report and turned it over to PwC Ireland. PwC Ireland then, notwithstanding the cursory nature of the review, relied almost exclusively on PwC U.S. and PwC Bermuda’s December 2004 visit to BMIS, and the resulting Report, to sign-off on its 2004, purportedly comprehensive, audit of Optimal SUS. 

Imagine, if you can, the PCAOB having a policy in place that would have required the names of audit partners to be included the bottom of firm's opinion on public companies' financial statements and assessment of internal controls; a policy that is similar to what is practiced in the U.K. and something that is practiced voluntarily by one public company in the U.S. (with no pushback from their audit firm). Anyone interested to learn about Linda McGowan's professional history or, say, Scott London's professional history could investigate for themselves who their clients currently are and who they have served in the past. Would any of that information cause someone to make different investing decision? In London's case? Jon Weil has made an argument that it might. In McGowan's case? Dunno. Maybe. Francine's post certainly makes a compelling case.

Now, I know what a lot of you are thinking — "Caleb, you're an idiot. This knowledge would not increase audit quality one iota." 

And you're right! The name of a person at the bottom of an audit opinion does NOT change methodology, mandatory procedures, inquiries or anything else that make the engagement more rigorous. 

But that's really not the correct way to think about the purpose of disclosing the partner's name. Including the name of the partner encourges transparency, accountability, and, dare I say it, integrity. A gesture of goodwill (or something) on the part of firms who are to be trusted by the investing public. Of course the firms see things quite differently when their regulator is pushing their ideas about what those values embody a bit of those things, the firms like to split hairs as to what they actually entail.

As an example here's part of PwC's ten-page comment letter  to the PCAOB on its proposal on Auditor Transparency that Francine included in her post. 

We believe the most relevant and useful information for investors in assessing the quality and reliability of an audit is the identity of the firm itself, not the name of the individual engagement partner who is unlikely to be known to the public. To the extent investors need information to assess the quality of the firm and its audits, investors have available to them the information contained in the firm’s public filings with the PCAOB and the PCAOB’s inspection reports. Many firms also make public their own quality control reports pursuant to NYSE rules.

The rationale that investors will, over time, be able to assess the qualifications of individual engagement partners and thus be better equipped to evaluate the audit reports issued under a particular engagement partner’s supervision highlights the degree to which the proposal unduly elevates the significance of engagement partners and downplays the importance of other critical aspects of the audit process.

Rather, the firm suggests that the engagement partner, in addition to the firm's leader(s) be named on PCAOB Form 2. That's a nice compromise in a half-hearted sort of way, but it doesn't strike me as all that transparent. Maybe I don't speak for all users of financial statements when I say that I don't exactly pine for audit firms' annual registration with their regulator.

But if I wanted to know who the partner for MF Global was and what she said about the company's financial statemets for the most recent year, now that's something I, and everyone else, can use.   

PwC Partner At MF Global Has Long, And Mixed, Track Record [Forbes]

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