RE-ENGINEERING THE AUDITOR

We live in frighteningly uncertain times and more than anything else, globalisation is to be blamed for the situation. What started as a process to make this world a more manageable ecosystem gave rise to an unending need for growth. As a result, we have in place a system (not by default, but by design), which renders almost every checkpoint defunct. Billions of dollars are spent every year in organising conferences and round table meeting where thought leaders supposedly have a dialogue on how to fix this recurring mess. But as is evident, nothing happens. In fact, more scams and accounting frauds are unearthed everyday. I think – to start with – it is time that we actually sit up and reengineer the role of auditing firms.

The Madoff Scam would be a good case in point to understand what I’m trying to put forth. In December 2008, Bernard Madoff, the former Chairman of Nasdaq, was charged with fraud. His investment firm was running a Ponzi scheme and the size of the fraud is estimated to be around $64.8 billion. Madoff’s accounting firm – Friehling & Horowitz – had offices in a strip mall and was run by three employees. Given the size of this firm, it is quite obvious why there was no whistle blowing. After all, they had to be in business! But what is not so obvious is the fact that KPMG, PricewaterhouseCoopers, BDO Seidman and McGladrey & Pullen (the auditing firms for institutions that invested in Madoff’s company) also gave a clean chit to the funds that were invested with Madoff.

Not so surprisingly, the scenario in India is not different either. The Indian arm of PwC was fined with $7.5 million by the United States Securities and Exchange Commission on failing to reveal that Satyam Computer Services’ balance sheets were cooked up. If such instances are not enough to reconsider the role of auditing firms, then sample this. In a landmark report released by The Committee of Sponsoring Organizations (COSO) [an independent US body, which provides guidance on governance], it was revealed thus, “79% of companies found to be engaged in frauds were being audited by the Big Four (Ernst & Young, PwC, KPMG and Deloitte) between 1998 and 2007.”

Around 90% of companies in India are privately held. Big and small auditing firms alike are paid by them. The fact is, till the time this transactional relationship exists between corporates and auditing firms, such scams will continue to flourish. Further, auditors are regulated by ICAI guidelines. Most of the auditors survive on a handful of clients. Further, the remuneration they receive is not based on their ability to add to the business but to fill certain documents and add their signature. Therefore, such auditing firms are left with no choice but to help promoters circumvent the law. I feel that auditors must undertake assignments, which they can manage with resources at hand. Moreover, ICAI will have to take a stronger stand on this issue so that the system becomes more rewarding. In fact, in the prevailing system, I see these auditing firms as nothing more than image managers. Most Indian companies bring the likes of PwC and E&Y on board because they hope that such an association would enhance their image before investors. There are two choices from here on. Either turn a blind eye – let the auditors rake in billion of dollars for perpetrating frauds and allow the companies to fool investors – or bring in a regulatory body or make amendments in the Companies Bill to clamp down on these auditing firms. If not, then auditors will continue to act as voluntary puppets instead of the watchdogs they are supposed to be.

EVEN THE AMERICANS MISS THE RIGHT TO INFORMATION!

It was just a thought. But it had a powerful appeal, powerful enough to spread from Seattle to Gothenburg and Genoa, to lead to demonstrations & bloody protests, and to become a new movement that apparently labels itself as anti-capitalist.

The anger this time is against Wall Street and the quite obvious reason is the overstretched and persistent US economic crisis. As they see the situation, it’s all an offshoot of corporate greed. Corporations have, in a sense, infiltrated their way into the government and the way it makes policy. They were given undue advantages, including the legal means that were provided to the companies and their shareholders, but not to the consumers. But the question is – why has the whole of US suddenly risen to the anti-capitalism movement?

Well, consider this. The 400 richest families in the US now hold as much wealth as the bottom 50% combined & 1% of the people control 40% of the wealth. Since 2009, 88% of the income growth went to corporate profits and 1% went to wages. During this period, the US government bailed out banks and big corporate houses with huge amounts of ‘public money’ to boost growth and create jobs, but unemployment constantly remained at historic highs. For that matter, till September, it was still at 9.1% with little hopes of easing in the near future.

This is where the thoughts of the two German Economists Hayek and Mises comes into mind. In 1944, they wrote, “In the eyes of the public, not anti-capitalistic policies, but capitalism is the root cause of economic depression, unemployment, inflation and rising prices, of monopoly and of waste, of social unrest and of war.” Those who learned from this, did well. What can be a better example than Germany itself (one of the few countries in the world that has learned the lesson this century and has restrained spending), which is not only among the strongest remaining economies at present, but also, in a way, has become the growth (& hope) engine of the crisis-struck EU zone.

Moreover, policies that create a non-transparent wall between capitalists and the public add to the woes. For example, a promoter employee of a company gets both dividends and remuneration from a company. While the salary saves him in the bad days, he gets a double benefit in the good days. But what about a normal shareholder in the days of loss, when the stock prices don’t even offer positive returns under market pressure? Small disillusionments like this finally add up to bigger movements like the anti-capitalism movement we see today. And their incidence is all the more likely in a prolonged period of recession, joblessness, bankruptcy and high prices such as the one that is currently on in US.

A logical way out would be to become transparent. For example, all discussions and debates that take place before enactment of a law must come to the public domain and people should be given sufficient time to react to it & to express their concerns. This is even more important when it is about serious policy measures like bailing out the private sector on public money and then seeing them distributing hefty bonus packages in the board room, while continuing job cuts on the ground. It’s not only about the US. Nations across the globe must understand the very fact that if a movement that started in Egypt can go on to rock half a dozen nations, and bring about the end of a powerful dictator like Muamar Gaddafi, the furore over the anti-capitalism ideology has the potential to spread really wider and a lot faster.