Accounting reform NOW!
Every time we have some minor, or major, financial economic meltdown, accountants seem to be involved. With Enron, it was Arthur Andersen. In the Madoff scandal, we find that the multi-billion dollar scheme was audited by a two-person outfit, and nobody thought that odd. Now there is report that one of India’s major corporations has been struck by fraud.
First of all, it demonstrates the pathetic lack of oversight by just about any and every “regulator” of any consequence out there.
In addition to India, Satyam has been listed on the New York Stock Exchange since 2001, and on Euronext since January of 2008.
You would think that at least one of the countless regulators overseeing the three exchanged would have done its job, but no.
But what I really want to vent on is the auditors.
The company has been audited by PricewaterhouseCoopers since its listing on the New York Stock exchange.
And how badly did PwC do their job?
Mr. Raju said Wednesday that 50.4 billion rupees, or $1.04 billion, of the 53.6 billion rupees in cash and bank loans the company listed as assets for its second quarter, which ended in September, were nonexistent.
Revenue for the quarter was 20 percent lower than the 27 billion rupees reported, and the company’s operating margin was a fraction of what it declared, he said Wednesday in a letter to directors that was distributed by the Bombay Stock Exchange.
Let me expand on that with a quote from another article.
The Indian affiliate of PricewaterhouseCoopers was the company’s auditor. It appears to have certified the company had $1.1 billion in cash when the real number was $78 million.
In other words, PwC thought the company had 14 times the cash they actually had. Or to put it yet another way, the company actually had just $0.07 for every dollar they claimed to have.
As a former auditor, I know that it can be extremely difficult to uncover a fraud being perpetrated at the highest levels of management. They have a great deal of control over the company and its operations, as well as having the ability and opportunity to recruit collaborators, through inducements or pressure. But it’s hard to see how how you mistake $78 million for $1.1 billion without someone at PwC not doing their job.
Thing is, anyone who has worked in public accounting can tell you exactly how something like this could have happened. I might have ranted about it in previous posts, so I won’t detail them here. But the fact of the matter is that many, if not most, large audit accounts (as well as the smaller ones) are performed in a manner that just begs fraud and malfeasance to go undetected. Most auditors know, if they’re truly being honest with themselves, that something like this could easily happen to them on any number of clients, but for the Grace of God.
Just as many sensible people are calling for the reform of the ratings systems, where agencies like Moody’s and S&P are paid by the bond issuers, regulatory agencies need to seriously consider changing the entire system of “independent” audits. How independent is an audit when the management of companies pick their own auditors and pay them to tell the public that their books are straight? How successful in business do you think will be the auditor that keeps finding problems with clients’ accounts?
The current system of regulations is designed to regulate on the cheap. And like most cheap things, it only works when the planets are perfectly aligned and it has wind behind its back. In this particular case, auditors only ever catch mistakes, rarely frauds or other criminal acts. And they often miss the mistakes too.
If regulators were serious about audits, they would make auditors agents of the regulators and send them in with investigative powers, backed by powers of criminal sanction. Sure, that system would be onerous. And it would be expensive. But here’s the thing:
You have enough Enrons, Madoffs, and Satyams, and even the slowest person will realise that investors have no real protection in the market. At some point, their fear of being ripped off will outweigh their greed. And then the companies will be praying that they can entice investors back into the market with just the measures I’ve mentioned.
More likely, they will have to accept even more draconian measures at that point to attract investors, and then only the very few and the very best companies will be able to attract money. And as every good capitalist should know, that isn’t good for the market, the economy, or society at large.
P.S. – If you’re still not convinced, I present my final exhibit for the prosecution. This kind of fraud can be extraordinarily hard for audits to uncover. But then an audit, as it stands today, doesn’t seem to have too much utility now, does it?
