 The
scandals that rocked the accountancy profession show no sign of
dying away.Over the last few years public confidence in the auditing
of company accounts was seriously shaken by corporate scandals such
as Enron in the US, Dutch retailer Ahold, Italian Parmalat and
Societe Generale in France.In response to these scandals and as part
of the preparations for a broader action plan on corporate
governance the EU Commission has conducted a number of studies. One
such study has concluded four key areas. These covered the
international market for statutory audits of large and very large
companies as this is highly concentrated and dominated by the Big-4
networks. As a result of pressures from accounting and corporate
governance scandals the EU Commission implemented a new audit
directive. This includes inter alia mandatory audit committees at
listed companies and the need for compulsory rotation of audit firms
on a seven year term. This is a heavy piece of legislation
concerning the regulation of auditors.As members of the EU once this
directive is implemented then rotation of auditors of quoted
companies at Malta Stock Exchange may start.
In practical terms this means we shall see the banks and insurance
companies rotating their auditors like musical chairs among the big
four audit firms. Realistically the revised Eight Directive the EC
is not seeking to alter the fundamental mechanics of the
relationship between the auditors and the market-but merely to
ensure that these mechanics are based on high international
standards. They are perceived to be more transparent and are subject
to greater external oversight.Independence proposals include
auditors being banned from taking up jobs that pose a threat to
their independence and from being involved in management decisions
in their client firms. It will also stress that audit fees should be
adequate as in some case these are low balled on purpose being amply
compensated by the provision of lucrative non-audit services.
The proposals are close to be
approved by EU ministers and the European parliament yet these
provisions have already attracted considerable criticism from senior
accountants. But to its defence internal market commissioner Frits
Bolkestein said “auditors are our major line of defence against
crooks who want to cook the books” so that Parmalat was a reminder
of what happens when that defence fails. But if the present heavy
risks associated with in the profession continue uncapped then the
likelihood of new entrants into this market is very limited in the
coming years. Additionally, under the current circumstances,
middle-tier firms are unlikely to become a major alternative if a
Big-4 network fails. Naturally the risk of a failure is reduced if
the authorities agree to a limitation on auditor liability. The
possibility of the big four becoming three in the event of another
Andersen –style collapse may well be a frightening enough prospect
facing the inevitability that no insurance company will take on
auditors risks.
 On
the insurance front one finds that the level of auditor liability
insurance available for higher limits has fallen sharply in recent
years. The remaining source of funds to face claims may essentially
be the income of partners belonging to the same international
network. Such a consequence of the resultant failure of a large
network could lead to difficult consequences for the wider economy
like a significant reduction in large company statutory audit
capacity possibly creating serious problems for companies whose
financial statements need to be audited.All this culminates in the
post Enron debacle where we witnessed the demise of the then fifth
largest global firm Andersen. History has shown us that the
Andersen’s case was not the only rotten apple in the barrel.
Regulators in various countries must improve public perception to
understand the way the accountancy profession is being the most
heavily regulated sector. Having said that what safeguards are in
place to avoid repeating the recent bad image that the profession
received in the past out of the Shell’s overstatement of its oil
reserves. The impact on earnings averages around $100 million per
year, less than 1% of earnings in the period 2000-2003. The
statement follows the completion of a report by Shell’s group audit
committee into how the oil reserve figures were overstated and is
being accompanied by a review of the company’s corporate governance
processes. In Milan the spectre of Parmalat and its subsidiary
companies around the world looms large but this pails in comparison
with the $4.9 billion black hole in Societe Generale .This was
suddenly revealed last month in the nefarious workings of a rogue
trader.
The Financial Times revealed Société Générale is to call in
independent auditors to examine events leading to the rogue trading
scandal. By a twist of faith Societe Generale illustrated the case
of auditor’s liability .Turning to the Netherlands the collapse of
Ahold illustrates that there could still be scandals lurking in a
corporate Pandora’ s box waiting to be unleashed. Seven years ago,
Ahold bought US Foodservice, which sells catering supplies to
restaurants, schools and prisons. The accounting profession in
Netherlands has never had this kind of negative exposure. Critics
refuse to draw a parallel to what happened three years ago in
America when blowing the whistle on Andersen, it imploded after
facing intense scrutiny for its role as auditor of Enron. The Wall
Street Journal said that Andersen officials admit the audit
documents were shredded after federal regulators requested
information.
The key issue identified for the
accounting profession, and its clients, to consider is whether to
agree to a proportional limit on liability, or a monetary cap.
Reputational risk is a bigger issue for auditors, and limited
liability does not protect against that. The greatest priority for
the business, however, is audit quality and maintaining a healthy
relationship with its audit firm, which should be considered before
replacing a trusted provider. There is a common misconception that
in a corporate collapse when the company, its directors and
shareholders may be all be wiped off , the auditors are the only
ones with deep pockets. Creditors and litigants then focus entirely
on the auditor and seek full compensation from the audit firm .
There is also a real fear that unless auditors liability is capped
then there will soon be a situation that the big four firms will
start refusing risky audit work.
 Critics
argue against limiting auditors liability yet the stark truth is
that auditing some companies may simply become so risky that no
audit firm will oblige. Caps on auditors liability have been heavily
criticised, with some arguing that they would only be used by firms
looking to abdicate their financial responsibility for a dodgy job.
Some audit firms would argue that a cap does not impact on quality
or efficiency, but the next question would be where to set the
limit. Would you choose an auditor because it offered the highest
cap? How does that guarantee, or impinge on the level of quality of
the audit? The answer is not easy to fathom but to bolster the
credibility gap arising out of recent scandals the Auditing
Practices Board in Britain has decided to adopt six new standards on
auditing. These cover areas on audit risks, fraud and quality
control. The new standards are designed to enable auditors to more
clearly focus on areas where there is greater risk of misstatement
and increase the linkages of audit procedures and assessed risks.
The adoption of the new standards will require some audit firms to
make significant changes to their audit approaches. Having seen
auditors woes and witnessed the baffling collapse of the supermarket
group PriceClub in our midst we act recklessly if we expect that
Malta is immune to the scary stories of Societe Generale.
The writer is a partner in PKFMALTA
& Co. an audit and business advisory firm
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