Audit Services – Who Benefits?

Over the years I have maintained a high regard for the Securities and Exchange Commission. In my dealings, I have considered them generally objective, and willing to listen while maintaining a professional perspective. In one particular meeting, however, there was a young lawyer out for blood. Finally, in a fit of exasperation at not getting his way, he turned to me and said – “you know, if it wasn’t for the Securities Acts of 1933 and 1934 requiring Registrants to file audited financial statements, you guys would be out of business.”

Having heard that before, I pointed out that his statement was not true. In fact, all but one of the Dow Industrials 30 listed companies had published audited statements well prior to the financial disasters of the ‘30s.

Why? They must have seen value in doing so.

I was reminded of that when I read on July 18th one of the worst articles ever published in the Wall Street Journal. It was authored by David Wessel, a noted economist and columnist, and entitled Paying Auditors for Honest Appraisals. He begins with the revelation that according to a New York University accounting professor the “accounting business … rests on ‘structural infirmity.’” — the fact that auditors’ fees are paid by the entity being audited, therein causing the firms to become “rating agencies.”

Therefore, according to economist Wessel, the firms are obviously biased in favor of those paying the bill. My problem with something as ludicrous as this is the credibility granted it by the Wall Street Journal. I would have expected this in the New York Times. But the Wall Street Journal?

Now, it gets really interesting. To make such a damning accusation, one would expect the author to cite well documented cases of major accounting firms were guilty of conspiring with their clients to mislead the public. The only one I can ever recall was a guy named Gonzales who took a $250K payment to sign fraudulent financial statements for a Florida S&L back in the ‘80s. He’s probably still in jail. No, Mr. Wessel cites as evidence some study in India of auditor reviews that found that their clients’ electrical usage was substantially less than that noted by government inspectors.

His solution is to create a fund from Registrant donations from which audit firms will be paid. Wow, what a great idea! And who is going to manage this fund? Who is going to decide what the “market price” of the services will be? What would be the incentive for the entity being audited to cooperate?

This is right up there with the media frenzy back in the 2002 era that determined that auditing firms were rolling over for clients in order to sell consulting services. Again, no evidence has ever been produced, but everybody just “knows it.” I can recall that renowned auditing industry expert, Chris Dodd , making the accusation on Sunday morning talk shows and everybody just nodding. Evidence – none!

What Mr. Wessel et al fail to note is that the client pays the fee because he is the one getting the benefit of the profession’s independent attestation that the financials are fairly stated, thereby ensuring investor and lender confidence that they may be relied upon.

That raises the obvious questions to those willing to assume a systemic lack of integrity on the part of the profession How would Mr. Wessel’s solution solve the problem? Would not unscrupulous auditors seek to curry favor with unscrupulous Registrants just to retain their appointment if nothing else? Notwithstanding the source of the fee, could not the co-conspirators just cut a side deal “bonus?”

More rationally, what firm in its right mind would willingly taint its reputation in a market buying integrity by conspiring with a Registrant to hype financial performance? Which Board of Directors would demonstrate its exercise of fiduciary responsibility by appointing one? In the world of risk management, what firm would expose itself to financial ruin for a short term gain?

Finally, Mr. Wessel’s comments are an insult to the principled men and women who spend their time, effort and professional diligence advising clients on proper accounting and ensuring that it is reflected in their financial statements.

The “so what” here is that having had this nonsense published in the Wall Street Journal rather than Rolling Stone, the profession will be under yet more intense scrutiny on the part of those out to “protect the investing public” from the unprincipled and incompetent auditing profession.

The end game will be to reduce the auditing profession to the ranks of government regulators, thereby ensuring that bright men and women will no longer seek the profession but take their talents to Wall Street where they will make a great living advising those who do wish to con the public.

That may solve Mr. Wessel’s problem, but what about the rest of us?

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