If I've got this right…

@Dennis: I'm not one to debate the merits of rules vs. principles based accounting standards. I think either will work as long as you have a sufficiently educated (vs. trained) and exceptionally professional team. It's these two issues, narrowly trained vs. broadly educated accountants and the loss of professionalism (in the formal sense of licensed accountants being professionals like a doctors or a lawyers), which have had a large impact on the quality and ethics of the practice of external audit.

OK - glad we cleared the first one up. I understand the problem of the emasculated internal audit department. I've never felt that was a particularly smart idea in the first place for the reasons you outline.

However - and it is a long time I admit since I was in any audit position or had to deal with external auditors - but my experience doesn't jibe with yours. In my day, audit was taken seriously but also, we've always worked on judgments based on a principles framework rather than rules which I see as a recipe for continuing disaster. Rather than throw all the brickbats at the profession, would you agree that rules based systems encourage deviance? I am convinced they contribute mightily to the problem because the moment you have rules, there is an expectation of them being broken, somewhere, somehow.

@Dennis: Public accounting firms can no longer provide both external and internal audit support to their SEC reporting clients. It is forbidden by Sarbanes-Oxley. The point is that internal auditors (whether they are employees of the company or outsourced) are also being restricted in scope by the privilege issue. This renders them impotent as a primary internal control for the organization, which Sarbanes-Oxley intends them to be. A poor, ineffective internal audit department can result in a material weakness for the complnay and an adverse opinion on their internal control report.

External auditors have always had a classic independence porblem - one that everyone accepts as part and parcel with the current model. They are responsible for independently and objectively judging the accuracy, validity and completeness of financial disclosures of the same management that is hiring and paying them. They have a vested interest in making that client happy if they want to continue earning their fee and therefore will compromise and avoid conflict unless they are ready to resign, which they do rarely and reluctantly when they do.

The fact that Sarbanes-Oxley strongly encourages the relationship of the auditors to be with the Audit Committee of the Board of Directors is no consolation when so many Boards of Directors are beholden to the CEO or are themsleves CEOs at other clients or potential clients. See my posts regarding Hollinger.

I'm still slightly confused. Are you trying to tell me the Big 4 are supplying both external AND internal audit teams to the same client? If so then there's an automatic conflict of interest.

To the point about public interest and 'for profit' - there is NO conflict if the ethical guidelines are followed. It's like saying you can't make profit and be ethical. That's not true. Co-operative Bank in the UK is a sterling example of a competitive commercial entity that thrives on its ethical stance.

@Dennis: The brouhaha in the legal profession, especially amongst General Counsels is about external auditors. External auditors are the ones that have to to play both sides - being independent auditors who serve the shareholders' and public's interest and being businessmen who serve a client for profit.

However, in the case of internal auditors, the situation is even worse. In many cases, they do not have the stature or the respect of senior management and outside counsel sufficient to include them in confidential discussions. Including them later by giving them a copy of a report or having an audit report document issues or problems that are illegal or actionable is a timebomb.

In the case of the Big 4, they would rather not have the regulators know they have internal audit teams that are writing reports about compliance or independence issues. They also don't want to give their internal auditors privileged information, because then the regulators could ask to see their internal audit reports and so could those suing the firms for negligence or fraud. They may also be effectively waiving privilege by showing privileged information to their internal auditors.

I'm slightly confused here. Are we talking internal/external or both? More to the point - if there are issues, then surely the fact auditors cannot get the information they might otherwise seek is enough to qualify to management at the very least? If not then they're a bunch of cowards flying in the face of everything I was ever taught.

To your point about AA. OK - so mine is a UK based experience. OK, so they were a bunch of arrogant a**holes. OK I know mine is not a popular view. Fact is many in the profession looked up to them and I certainly admired their ethical position in deals we did together. I'd argue strongly the profession has gone downhill in a BIG way since their demise.

Dear Dennis,

It's the companies that are using attorney-client privilege as an excuse to limit the scope of what their auditors can look at and, therefore, include in their opinion. It's an unfortunate "Hobson's Choice", since by limiting their scope and restricting them from knowing about confidential investigations, stock options backdating and such, they risk the auditor giving a qualified or disclaimer of opinion. Not a good result.

More likely, the auditors are treading carefully and accepting the limitations of scope in the interest of keeping their client. That's where the problem is. We get half-assed opinions that are based on only what the client wants the auditor to know, since they are fearful of waiving the privilege by telling their auditor and, therefore, opening up the information to adversarial parties.

By the way, what's all this about Anderson being a great, ethical firm that had just a few rotten apples that spoiled things for the whole bunch? You obviously never spent much time here in Chicago, where AA was based and where they harvested and grew their talent. Many former AAs are still perpetuating an air of impenetrable superiority at their subsequent firms. This is part of the problem, not part of the solution. See my posts on Refco.

When Anderson went under there was suddenly more air for the rest of us to breathe here in Chicago. Some of their fat heads took up so much space that it was a relief to see many of them finally deflated. Like the helium filled balloons after the Macy's Thanksgiving Day parade, they aren't bobbing around anymore acting as if they're above the fray.

City activists I'm talking to agree with Francine 100%