For once I disagree with Francine

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I admire the way Francine McKenna keeps focused on the Big Four and their deficiencies but I disagree with her first central thesis that avoiding RIF could come by:

Refocus on the true client – the shareholders and investors of the public firm

It’s the ‘shareholders and investors’ where I have an issue. Francine has not defined who these are except by reference to a 1984 Supreme Court definition though she acknowledges that the US (and UK) taxpayer is part of that group. Including the taxpayer changes the dynamic of what it means to be an investor, broadening the scope to include a social dimension that cannot be avoided. As she says:

The client, the shareholder, is often now the taxpayer.

And the taxpayers are mad as hell.

The taxpayer is not motivated in the same way as the traditional shareholding investor. There isn’t the same sense of ownership because among other things, as a taxpayer, you don’t get a share certificate, nor a copy of the annual accounts. Instead, you entrust the stewardship to management that is accountable to the government on the taxpayer’s behalf.

Second, the 1984 case was determined in a different era where the training to which Francine refers was meant to provide an unspoken moral compass driven by the concept of the profession as a vocation. By her own detailed accounts, Francine will know, as do many of us who critique the worst excesses, those days are long gone. At least for the partners at the top who seem more driven by sales than any attention to client affairs.

There are other problems that need addressing. Past attempts at making this system of public ownership work have been fraught with problem. In the UK, that was largely because the regulations under which publicly owned bodies were audited was very different to that of the business community. The needs of one group are not necessarily aligned to the needs of the other. As far as I can tell, there doesn’t seem to be a plan in place to resolve that issue and even if there was, recent events indicate that government is far from qualified to make proposals upon which the profession can rely.

That leaves us in a dangerous no-man’s land where guidance is thin on the ground, just at a time where – in the US at least – there is an intention to bring sweeping changes to the way accounts are drawn. This last problem could be alleviated through a fresh sharing of intelligence among the Big Four from Europe. They’ve been through the IFRS mill and know what’s involved. That alone would send a strong message that they’re serious about operating globally rather than as the rag bag of partnerships that happen to trade under the same name. It would allow knowledge transfer and a possible creation of centres of expertise upon which the profession as a whole might draw. Whether that is feasible is another matter. If Francine’s analysis is correct then the chaotic state of the Big Four alone would suggest there is a mountain to climb. Even then, there is no guarantee that the Big Four could avoid RIF.

Francine and I have discussed the potential for the emergence of a new style of audit firm. ‘Old school’ ethics, an attention to modern technology practices and a commitment to greater rigour and oversight in some of the key audit processes could act as differentiators. But…there needs to be a different framework that sets a different tone for what it means to ‘audit.’ A continuation tempered by the current climate is not enough. You can bet that as soon as the economy turns, the old ways will return. In my view, Francine’s definition of ‘the client’ is incomplete in the current climate and needs review.

One of Francine’s commenters makes the observation that:

The irony here is that SOX and all the post-enron regs have actually had the OPPOSITE effect-some years ago these firms were actually in the business of -looking out for the shareholders of public companies

I’ve never been convinced of that argument though I’m aware that many see SOX as a significant dampener to investment. What I do see though is a rules based system that is fundamentally flawed. While you can never stop determined fraudsters – as Satyam has amply demonstrated – you can operate a system where the exercise of judgment means something of value. That is far different from systems that implicitly encourage workarounds designed to present the most optimistic of results instead of reality. Or, to put it bluntly – if there are rules, you can be sure someone will try break them.

That is independent of the ownership issue but core to the way in which audit is undertaken. It requires an altogether different skill set that in theory at least, depends on a deep understanding of business segments and practices that has to be shared with those on the ground.

Until very recently, I’ve not been an advocate of liability caps and even now I am not entirely sure. But…if auditors are to commit to a set of principles that encompass the exercise of judgment, then protection is needed. The US and UK are way too litigious for my taste. Daytime TV in both countries is littered with adverts for lawyers willing to sue anybody and anything. It’s insane and has to be stopped. You can’t expect people to honestly follow a vocation while at the same time holding the sledgehammer of the law over them. the current climate creates an atmosphere of attrition that is unhealthy and unhelpful.

However, you can insist on a quality of audit that allows for a reasonable level of certainty. I know all the arguments about sloppy lawmaking but if the problem isn’t addressed then the profession remains at risk even under the best scenarios. Embracing that within the laws and regulatory framework would encourage a higher level of skills required to conduct an audit. In turn, that would require investment by the firms. Something in which they have been sorely lacking.

If the banking meltdown has taught us anything it is that putting a freshly minted MBA up against PhD’s who think in statistical algorithms is a non-starter. Where needed, the profession has to be far smarter in its exercise of judgment, drafting in subject matter experts where appropriate. While that might temporarily complicate the audit process, there is no reason why this form of collaboration should not enhance reputation. After all, it is better to say: “I don’t know” and find someone who does than turn a blind eye and hope that you don’t get caught out.

All that could go by the board as the economy contracts and the general sense that 20% RIF should be the norm becomes a reality. I am for example aware that ICAEW is watching very closely to see what happens in the summer recruitment season. All indications are that contrary to what usually happens in a recession, the Big Four won’t be recruiting in large numbers. If recruitment is substantially reduced then continued RIF will likely be unavoidable.

In closing I could be pre-empting some of what Francine has to say about the solutions she believes are appropriate but since we’ve not had that discussion, I don’t know. Even so, I believe her arguments miss an opportunity to explore the deeper issues that beset the profession operating in a world where it is far from clear what finance and audit will mean going forward.

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Tagged as: big four, Francine McKenna, ICAEW