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Ethical Responsibilities in Government Auditing

Outside Auditors and Local Government Ethics

From time to time I re-post blogs of others when I believe the message is relevant to readers of my workplace ethics blog. Today’s posting is one such occasion. The blog comes from Robert Wechsler, Director of Research for City Ethics at: cityethics.orgIt was originally posted on June 12, 2012.

Mr. Wechsler writes that despite writing his blog for six years, he keeps finding important areas of government ethics not previously discussed. One such area involves dealing with the possible conflicts of outside auditors. Here are his thoughts on the matter.

Despite writing this blog for six years, I keep finding important areas of government ethics that I have not discussed. One such area involves dealing with the possible conflicts of outside auditors. Large cities and counties have internal auditors or comptrollers, but most local governments employ the services of external auditing firms, just as companies do. These auditors have special duties toward their clients, that is, to the community, not to the individuals who hire them and with whom they work. And yet these auditors owe their contracts to the individuals they work with. If they ask too many questions, investigate too carefully, or are too critical of what they find, they have reason to believe that their contract will be given to a competitor. Therefore, even more than outside attorneys, they are caught between their professional obligations, their personal relationships with officials, and their commercial interest in not rocking the boat.

Bell CA Auditor's Disciplinary Proceedings
This issue has arisen with respect to last year's most famous government ethics scandal, the huge salaries of Bell, CA officials. According to a recent article in the L.A. Times, California's Board of Accountancy filed disciplinary charges against Bell's outside auditing firm for failure to detect financial irregularities, including the overcharging of residents and businesses more than $6 million in taxes and fees and the placing of $23.5 million in bond funds in a non-interest-bearing checking account.

These charges followed a report in December from the state controller, which "excoriated" the auditing firm's work in Bell, calling its audits little more than a "rubber-stamp."

The auditing firm could be fined $1 million, and it could even lose its license. It audits dozens of California local governments.

It is unlikely that it will be required to do anything more than pay a sizeable fine. Considering the publicity given to the Bell case, it would be hard to simply slap it on the hand. But without this publicity, it is unlikely that charges would have been brought at all.

It is difficult to prove that an auditing firm was extremely negligent in its oversight. The state controller found that following auditing standards would have led to the identification of at least some of the misconduct that occurred. But it could have been that officials did a good job of hiding their activity, or that they lied in their answers to the firm's questions.

In my area, an accounting firm was brought before the Connecticut Board of Accountancy in 2008 relating to the auditing of four different towns and cities (including my own), and each matter was dismissed based on a finding that there was "no significant deviation from standards" and "not enough evidence in this case alone to sustain probable cause." Those words "in this case alone" are ridiculous considering that all four proceedings were dismissed at the same time. A disciplinary board that is incapable of dealing with a pattern of problems is not to be taken seriously, either by the public or by auditing firms subject to its decisions.

The Outside Auditor's Role
Auditors play too important a role in preventing ethical and criminal misconduct in local governments to be left to the self-regulation of disciplinary boards. Local and state governments need to make it clear to them that they are expected not simply to follow minimal accounting standards, but to act as the eyes of the community looking into the government's books. Their obligation is to alert the community, not just its officials, to anything that appears improper, and to investigate it. Perhaps an ethics commission or inspector general should be given the authority to approve such investigations, so that the city's financial office, which may be responsible for errors or improprieties, is not in a conflicted position, concerned about protecting its reputation instead of protecting the city.

A new administration in one of the four Connecticut cities asked for all working documents relating to the relevant audits of its city. The auditing firm said that working documents are not the property of the client, but of the firm. Local governments should include in their contracts that all working documents are public documents and, therefore, property of the local government. In addition, outside auditors, like internal auditors, should be made expressly subject to state transparency laws as well as local and state ethics laws (including an obligation to report possible misconduct).

Rotation of Auditors (see my previous post on this matter for additional information)
It's important that the threat of disciplinary penalties are there, at least if they are actually employed. But from the government ethics point of view, what is most important is to prevent auditing firms from having cozy, dependent relationships with local officials. The Sarbanes-Oxley Act of 2002  created valuable standards for corporate auditors, which have been applied by many local governments. These standards include:  (1) required rotation of the lead partner every five years; (2) prohibiting the performance by the auditing firm of non-audit services to audit clients; and (3) a five-year cooling off period for auditors before working for an audit client.

I would take the rotation rule a step further with respect to local governments. Most local government auditing firms are relatively small, while most of the corporate auditing firms are huge. Therefore, it is not enough to rotate the lead partner; the entire firm should be rotated. This will mean that auditing firms will not feel dependent on the officials they work with, but will have the confidence to rock the boat when necessary, because they will lose their contract soon anyway. And by the time the firm gets another auditing contract with the same local government, the personnel on both sides will likely have changed a great deal. Personal relationships and auditing do not mix well.

Blog re-posted by Steven Mintz, aka Ethics Sage, on July 5, 2012