July 17, 2018

WHY CAN’T WE FIX REGULATION?

Open ItemsCategory: AuditWHY CAN’T WE FIX REGULATION?
Jdbig4partnerJdbig4partner asked 2 months ago

I am a Big 4 audit partner, a veteran of a firm for over 25 years, but I cannot voice concerns like this with my name publicly as I’d lose clients and likely my job.
Much is going on with KPMG and other accounting firms that should be highlighted by business news, but they really don’t focus or care about much of what I’ll share below – largely because there are not many people that truly understand how governance and auditing work hand in hand.

What I see as Obvious issues:
Audit Committees and Boards of most public companies are friends of management. Shockingly, many don’t focus upon this, including the SEC and the PCAOB. Boards, including audit committees, are often paid in the common stock of the entity that they oversee. Why is that not a conflict of interest? Not an independence issue for the Board? Yet, independent auditors cannot own shares or execute many business dealings with companies they audit. This makes no sense, and many in government should be concerned by this – but this systematic conflict has not been explored by the SEC, the PCAOB or the stock exchanges. The strength of an audit can be solidified if the audit committees are truly independent (at least as independent as the external auditors), and some form of reasonable oversight by either the SEC or the PCAOB. The current structure does nothing to ensure that committees are independent or competent. No continuing education or oversight at all. But they get paid so well, and for what?

I’ve seen excellent Audit Committees, but largely I have seen committees that act as management advocates that fight for lower auditor fees (despite potential less effective audits) and less messy audit committee meetings. The committee never wants to see disagreement between the auditor and management. It is viewed as immature and inconvenient. This is somehow viewed as the norm; yet, audit committees should be encouraging the messy conversations. Further, executive sessions with audit committees need to be kept confidential. Frequently, the auditor and the audit committee tell management what was discussed so that they protect everyone’s behind from being spanked by management. You can verify my assertion with others in the accounting industry…this is often the case.

European and other governance bodies focus upon auditor tenure as being of greatest concern around auditor independence and objectivity. I contend that auditor tenure is not the true root of potential independence issues, but the tenure of Board and Audit Committee Members should be examined by the SEC and/or the Stock Exchanges. The Big 4 have thousands of clients. The Board Members only have a few boards they can sit on as individuals… and those relationships are very important to them. The issue of Board Member tenure would be less of a concern if Board Members were paid in cash only, and not stock. They should be forbidden from owning company stock so that they are clearly independent stewards for the shareholders, and on equal independence footing with the independent auditor. It just seems to make good sense to me. But, my profession won’t bring this up for fear of being in contention with our clients. It is a weak position by the Big 4 and CPAs in general, that I am honestly ashamed about. But, like with many business and political scenarios, the accounting industry picks their battles carefully. We also justify this thinking that we can still do more good by being trusted by management.

Less Obvious Issues, but BIG INDEPENDENCE issues nonetheless:
While my profession is one of high integrity, we gladly are competitive and we seek ways to serve clients with distinction. We must, however, always deliver tough news and be the independent advocate for transparency and appropriate financial disclosures. Many corporate controllers and CFOs are challenged with this concept, and they like to have lead partners that are EASY TO MANAGE. I have seen instances where financial management use this for their convenience. Partners are labeled as “too detailed,” “in the weeds,” or having “poor chemistry” with client management. Given the Big4’s fears of needing to go through a tendering process, partners will be changed out of the accounts, in favor of a partner that is more client friendly. Mind you, all clients typically see THREE OR MORE CANDIDATES for interviews prior to a 5 year lead audit partner rotation in order to GAUGE THE CHEMISTRY with the proposed new partner. So in all too many cases, public companies are holding leverage over the accounting firms by threatening a tendering process or proposing a change in partners. So…to be clear, the Lead Partner on Audit engagements know very well that if the CFO and/or Controller are unhappy with the partner’s decisions, they can be tossed from the account. The big 4 accounting firms then typically sideline partners who have been tossed; they are labeled as “risky” for future client relationships. This fosters a poor cultural attitude toward client service in the audit profession. It becomes a balancing act of doing what is right, and self preservation. This is the true independence challenge for the auditor, management, and the Board, and frequently, the partner (he or she) cannot turn to any advocate, as the audit committee always sides with management in proposed changes. Again, this is a common truth known among the big 4, so please feel free to verify this with another source. It will not be a shock to most within our profession. However, the PCAOB and the SEC have not dealt with this very core issue. They don’t touch it, and its wrong. Instead, they focus upon things like changing the standard auditor’s report. By the way, that will not impact our work at all. Our lawyers will manage that process to the “nth” degree – we will be protected, and management will need to sign off on everything we put in that report.

Advisory and Consultancy Practices within the Big 4:
Audit practices are still viewed as the big regulatory practices that dampen the true economic value of the talent, knowledge and experience of the tax, advisory and consultancy practices. Largely, this is because large corporations typically view audits as a commodity. This issue does not impact our independence at all; however, it does impact our war for talent, the morale of our partners and people, and the equal footing and influence that auditors have in managing the Big 4 firms that the auditors themselves created. This is most exacerbated at Deloitte, where the consulting practice eclipses the revenue of all other functions at that firm. And, the firm has quietly changed their own internal rules to allow the top CEO of the firm to be a consulting partner; this had previously been forbidden by that firm’s partnership documents. However, the consultants forced this issue to be resolved at the risk of the firm’s continued discontent between the consulting partners and the audit partners. Therefore, Deloitte no longer requires the CEO of the U.S. firm to be a CPA. That is significant; yet, States, the SEC and the PCAOB have not focused upon this. The consultants are itching to increase the size of their footprint into other companies that are audited by Deloitte – and it won’t be long before the consultancy seeks to spin off the rest of the operations to go out on their own. All firms seek to bring a unified culture across the functional divides, but it hasn’t worked well – and there is no sign that this will change. What is frequently forgotten, is that the Big 4 firms were built by accounting professionals that grew up in apprenticeship cultures valuing the ethical requirements of our profession. Our firms have protected the capital markets for years. Unfortunately, our consulting practices – that we developed – have little to no respect for our culture and history.

KPMG:
How can it be that a company that has audited GE for over 100 years missed a $15 billion required infusion into their insurance subsidiary. The requirement came from discontinued business in the Long-Term Care Insurance Industry. This is a product that has been losing money for over a decade! We cannot forget that GE spun off Genworth, which would have been in liquidation with the exception for a purchase from a Chinese entity. So how can it be that the auditors, with help of their actuaries, never brought up a problem with the retained portfolio at GE? By the way, the audit committee chair at GE IS A FORMER SEC Chairman, Mary Shapiro. Did Mary ask KPMG to look at the liabilities closely? If she spoke with them more often, and more candidly, she may have prompted them to look harder at these liabilities. Heck, she may have even just spoken about the risks in the business overall in comparison to the economic environment, right? Mary may have in fact done that – but the relationship between Mary and GE is probably unclear to the auditor. They don’t know where the true allegiance of an audit committee chair lies. This needs to be fixed; she should have been warned.

Overall view:
The auditing profession really needs help from regulators – the SEC is in charge of the PCAOB, and I’m hoping the new PCAOB members are asked to take up the challenge of Audit Committee independence with the help of the SEC. The PCAOB cannot do this on their own, as they have no real oversight over corporate America, but only through their auditors. Audit Committee members should be closer to the auditors than management, partners should be selected by the accounting firms and stay for their 5 year rotation without threats of removal; the Big 4 should be more supportive of their partners when making tough decisions that their clients don’t like. Audit firms and consultancies are stronger together; however, auditors need to retain the true leadership of the Big 4 in order to make sure an appropriate independent view of clients is maintained. The moment a consultant becomes a CEO of one of these firms, audit partners will truly be viewed as the least important aspect of these firms. This will reduce the effectiveness of the audit, and lose the attractiveness of this profession to potential future entrants into the industry. You all may help shed light on this for the Corporate Community and our

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