Friday, October 07, 2005

The Enron scandal destroyed two great (or at least large) American companies: Enron itself, and their auditors, the venerable firm of Arthur Andersen, who turned a blind eye to the rot at Enron, and then got into trouble themselves for shredding papers concerning their own prior blindness.

What has the accounting profession learned from this? Well, here's a bit of news coverage which is behind the "New York Times Select" pay wall, because a columnist happened to write it. A recent white paper issued by the American Institute of Certified Public Accountants discusses how accountants should act in due diligence meetings for potential underwriters of a company's stocks and bonds. And it poses the following question:

Is it appropriate for an auditor to address questions from the underwriters regarding the auditor's awareness of any instances of fraud or illegal acts?

According to the Times's Floyd Norris

The answer was no. The paper adds that is true even if the company authorizes the auditor to disclose confidential client information. The answer suggests the question be referred to the company's management, which may not help if they are the ones suspected of fraud.

The white paper also says auditors should keep quiet if they hear management issue misinformation to underwriters, and should not tell them much of anything that is not already public information.

So this, evidently, is the lesson of the Enron scandals: keep your head down, bury the evidence, and maybe you won't get hurt. And if Andersen had acted like that... well, I guess they did.

Times Select article here, for those with access. It turns out that a lot of people are upset about this proposal, and a couple of them, at two different trade associations, were upset enough to leak this to Norris. Of course, this may be a case where the leakers are just as happy with the pay wall; the less potential scandal like this gets out to the hoi polloi who might ultimately be buying those stocks and bonds, the better, as far as the underwriters are concerned...


Blogger alkali said...

I agree that this looks unpleasant, but in fairness I'd guess the AICPA has the following concerns in mind:

1) Before the auditor answers the underwriter's question, is someone required to review the audit workpapers and/or to interview the audit team? For just the current year, or how many years back?

2) If the auditor answers the underwriter's question "no," but in fact there was fraud of which the auditor was not aware, could the underwriter sue the auditor for negligence? How about people who buy stock or debt in an offering from the underwriter?

3) Assuming there is some risk of a lawsuit, shouldn't the auditor be compensated in some way for taking on the risk of answering the question?

Until those questions are resolved, I can understand why an auditing firm might want to keep its lips zipped.

12:45 PM  
Anonymous Anonymous said...

It ain't the hoi polloi that's buying the stocks -- most people who are already have subscriptions, so I'm not sure that the pay wall has any effect on the circulation of the leak.

1:09 PM  
Blogger charles said...

Alkali --- passing judgment on the truth or falsity of management's statements is an auditor's job. It's what they're paid to do. They do incur certain risks in doing that job --- just as, say, a plumber incurs the risk of a tort action if they wind up taking out a block's electrical service. That's not an excuse for failing to do the job.

In short, if the auditors aren't there to call bullshit on management, what's the point of having them around at all?

3:41 PM  
Blogger alkali said...

Alkali --- passing judgment on the truth or falsity of management's statements is an auditor's job. It's what they're paid to do.

Agreed, but auditors are paid by the company to give an opinion (1) to the company (2) as of a specific date. If the underwriter wants its own opinion, it can hire its own auditor.

This seems like splitting hairs, but there are literally four major independent auditing firms left, and auditing isn't all that high-margin a business. If there aren't some limitations on auditors' liability, the field is rapidly going to become empty.

3:41 PM  

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