A systemic global failure in all the major auditing firms

NOT GUILTY

Extracted from:

Bean Counters: The Triumph of the Accountants and How They Broke Capitalism

Enron was one of dozens of major accounting scandals to emerge in the early years of the twenty-first century, as an economic downturn exposed the 1990s numbers game for the accounting scam it was. The Houston oil company wasn’t even the largest. That distinction went to WorldCom, a telecoms company also audited by Arthur Andersen that brazenly misrepresented expenses as investments in assets before being exposed by another female accounting whistleblower, internal auditor Cynthia Cooper, who refused to be silenced by corrupt bosses. The company went bust eight months after Enron with the loss of 30,000 jobs and $180bn of investors’ money. Demonstrating how the fallout from accounting fraud could spread, its competitor AT&T had not long before sacked 20,000 people in order to match WorldCom’s bogus profits. Arthur Andersen & Co. could be blamed for those lost livelihoods too.

It wasn’t just Andersen clients either. Security company Tyco inflated income by $500m under PricewaterhouseCoopers’ nose. All were playing the same stock market numbers game. The chief executives of these three companies went to jail, as did their chief financial officers (who, incidentally, had all been garlanded by CFO magazine just like Andrew Fastow).

The other big firms had their disasters too, notably Deloitte at cable TV company Adelphia and power company Duke Energy; Ernst & Young at corrupt healthcare company HealthSouth; and KPMG at photocopier company Xerox.

They would, however, get away with paying some affordable civil penalties to the SEC without admitting wrongdoing. The regulator was typically damning and lenient at the same time in the Xerox case, finding that ‘KPMG permitted Xerox to manipulate its accounting practices to close a $3 billion “gap” between actual operating results and results reported to the investing public...

Most of Xerox’s topside accounting actions violated generally accepted accounting principles (GAAP) and all of them inflated and distorted Xerox’s performance but were not disclosed to investors.’ Deliberately breaking the accounting rules sounded pretty serious. But then came the generous resolution. KPMG had to cough up $22m in ill-gotten gains and penalties ‘without admitting or denying the SEC’s findings’. (43)

Apart from Andersen, all the (now) Big Four firms thus emerged from the numbers-game era without guilt. A handful of individuals were fined and some suspended from practice. But when it came to the firms themselves, the prospect of one of them joining Andersen in whichever circle of bean-counting hell it now inhabited – reducing the profession to an untenable Big Three – ensured that the regulators backed off from alleging law-breaking.

With the WorldCom fraud emerging so soon after Enron, and European and other scandals demonstrating a systemic global failure in all the major firms, it was impossible any longer to deny that major change was needed in the accountancy profession. A few new rules did indeed emerge. But they didn’t address the most dangerous fault line exposed and even entrenched by the age of scandal. Through their own misconduct and by selling out their heritage, the accountants had themselves become all but unaccountable. Responsibility-free bean counting was about to exact its heaviest price yet.

Notes:

43. ‘KPMG Pays $22m to Settle SEC Litigation Relating to Xerox Audits’, SEC press notice, 19 April 2005.