The Disappearing Art of the Independent Audit

What is it with the accounting profession that now likes to be called professional services companies? Have they lost their way? Have they sacrificed the very value that makes them a profession – and historically a respected one at that – all for the sake of increased commercial behavior?

Independence is a lost art. Masked by the desire to produce more and more revenue year after year the Big-4 and other large firms are reverting to past behavior and engaging in activities that cross the line and compromise the independent audit. A basic tenet of audit independence is to avoid any relationship with a client that might make it appear in the mind of a reasonable observer that independence may, in fact, be influenced by that relationship. Some of these cases are bizarre to say the least.

Ernst & Young

On July 14, 2014, Ernst & Young agreed to pay more than $4 million to settle accusations by the SEC that it violated independence rules by lobbying on behalf of two of its audit clients. As far as I am aware this is the first case where an auditor lobbied on behalf of the client, an advocacy threat to independence.

The SEC investigated three companies – Amgen, CVS Caremark, and Verizon -- that used EY for both audit and lobbying services at the time, and three that had previously done so: AT&T, the Fortress Investment Group, and Transocean.  

In the case of one audit client the SEC alleged that EY had informed the client that a bill was scheduled to be voted on in the House and arranged for a letter supporting the legislation to be delivered to legislative staff members before the vote was taken. In the second effort, the firm sent a letter to legislative leaders recommending legislation the client wanted, and in the third case it sought an amendment to pending legislation.

Deloitte & Touche

On May 22, 2014, James T. Adams, a former chief risk officer for Deloitte & Touche, settled SEC civil charges alleging he accepted tens of thousands of dollars in "casino markers" while serving as an adviser on the audit of a casino gaming corporation, a violation of the independence rules. This is a new one on me as well.

Casino markers are used by gambling customers to receive gaming chips drawn against their lines of credit at a casino. The SEC said Adams opened a line of credit with a casino run by the client and used the markers to draw on the credit. Adams concealed his casino markers from Deloitte and lied to another partner when asked if he had casino markers from audit clients.

KPMG

On January 24, 2014, KPMG agreed to pay $8.2 million to settle charges by the SEC that the firm violated auditor independence rules by hiring an individual who had recently retired from a senior position at an affiliate of an audit client. KPMG then loaned him back to that affiliate to do the same work he had done as an employee of that affiliate, which resulted in the professional acting as a manager, employee, and advocate for the audit client.

In the case of Scott London, the former partner in charge of the KPMG’s Southern California’s regional audit practice, it seems greed and stupidity were the underlying causes of insider trading. On April 11, 2013, the SEC charged London with leaking confidential information to his friend, Brian Shaw, about Skechers, and Herbalife. Shaw, a jewelry store owner and country club friend of London, repaid London with $50,000 in cash and a Rolex watch, according to legal filings. 

PwC

Alarm bells went off in October 2013, when PwC announced it was acquiring the consulting giant Booz & Company. Back in 2002, PwC had sold its previous consulting business to IBM for $3.5 billion, as a response to restrictions on providing consulting services for audit clients that were created by the Sarbanes-Oxley Act. As a result of its acquisition of Booz, PwC added $9.2 billion in global consulting revenue and increased its consulting group's share of total global firm revenue of $32.1 billion to 28.5 percent, up from 21.7 percent in 2009. Lynn Turner, the former SEC chief accountant, raised an important question about the merger when he asked: "Are the auditors going to serve management, or are they going to serve the best interests of the investing public?"

Firms that conduct independent audits are held to higher standards but may become unduly influenced by the majority of their practice that provides non-attest services to a client. These include advisory services where the services are for the client’s benefit and the need for independence is not present since there is no direct public interest effect as would occur when the audit opinion is relied on by investors and creditors.

Foundation of the Accounting Profession

The accounting profession, professional services companies, or whatever they want to be called should never lose sight of why the independent audit provides the foundation for the existence of the accounting profession in the United States. It all goes back to the landmark Supreme Court opinion in United States v. Arthur Young & Co.

“By certifying the public reports that collectively depict a corporation’s financial status, the independent auditor assumes a public responsibility transcending any employment responsibility with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public. This ‘public watchdog’ function demands that the accountant maintains total independence from the client at all times and requires complete fidelity to the public trust.”

Fourteen years after the passage of Sarbanes-Oxley and I fear the “firms” have lost their way once again and it may be time to prohibit any and all non-attest services for attest clients. This wouldn’t prevent the firms from conducting those services; they just couldn’t do so while auditing a client.

An analogy can be made between the problems faced by the accounting profession with respect to the lost art of independence and mega-financial services companies like Citigroup. The barriers that used to protect the public under the Glass Steagall Act came down and that ushered in the great financial recession. In other words, like the banks that have become “too big to fail” the Big-4 may have reached the point of no return as well.

Blog posted by Dr. Steven Mintz, aka Ethics Sage, on May 19, 2016. Professor Mintz is on the faculty of the Orfalea College of Business at Cal Poly San Luis Obispo. He also blogs at: www.ethicssage.com.