Select Committee on Treasury Minutes of Evidence

Further Memorandum submitted by Professor Prem Sikka



  In modern societies, external auditing is promoted as a technology that enables stakeholders to manage, control and prevent risks. However, a steady stream of audit failures shows that it is also a technology that harms people. Audit failures are routinely implicated in the loss of jobs, homes, savings, pensions, taxes and investment. The institutionalisation of audit failures draws attention to the culture and values prevalent within accountancy firms. This paper provides some illustrations to argue that the organisational practices of accountancy firms are geared towards advancing their narrow economic interests, often at the expense of wider social interests.

  In everyday life, people encounter varieties of auditors ranging from immigration control officers, Inland Revenue, Customs and Excise, Health and Safety inspectors and many more. In no case does the auditee appoint and remunerate the auditor. However, that is the normal position in company audits. The basic audit model expects one set of capitalist entrepreneurs (accountancy firms) to regulate another (company directors). Profits, income and appeasement of clients measure the success/failure of both. Serving the public interest does not form any part of this equation.

  In pursuit of profits, accountancy firms have been using audits as a market stall to sell consultancy. The internal organisation of accountancy firms encourages falsification of audit work. The absence of "duty of care" to individual stakeholders affected by audits dilutes the economic incentives to deliver good audits. The longevity of auditor appointments encourages personal relationships with company directors. Frequently, audit staff are auditing their one time senior now enjoying a directorial position in a client company.

  In principle, the legal, educational and regulatory environments could check such predatory practices, but they are weak. Accountancy trade associations rather than an independent regulator regulate auditors. The main responsibility for the poverty of auditing practices rests with the Department of Trade and Industry (DTI). However, it continues to pass the buck to the accountancy trade associations. It has done little to check the poverty of auditing practices.

  Overall, the paper argues that in the current UK environment, audit failures are inevitable and will continue to hurt innocent stakeholders. The paper suggests some public policy alternatives and reforms.


We need courage, not so much to endure as to act. All resignation stunts us. We have to have courage, to take future in our hands. If the law is oppressive, we must change the law. If the tradition is obstructive, we must break the tradition. If the system is unjust, we must reform the system" (Winifred Holtby, in South Riding)


  In modern societies, people enter into transactions (eg investments, pensions, savings, food and transport) with faceless strangers. There is a recurring danger that strangers may be untrustworthy and may abscond with the resources and/or indulge in harmful activities. As part of modernity's concerns about managing risks[26], people are increasingly encouraged to value surveillance technologies and place trust in socially accredited experts with expert knowledges (Power, 1997). Following a spate of 19th century financial scandals that had a capacity to undermine confidence in capitalism, the state invested in systems of surveillance and external auditing came to be institutionalised as a trust engendering technology (Sikka et al, 198). Auditing increasingly functions as a political technology enabling the state to regulate banks, insurance companies, pension funds and markets (Arnold and Sikka, 2001; Mitchell et al, 2001).

  Auditing has been a real boon for accountancy firms. There are no state guaranteed monopolies for engineers, scientists, mathematicians, designers, computer experts and other wealth creators, but audit work is reserved for accountants belonging to a handful accountancy trade associations. Nearly 600,000 limited companies plus hospitals, universities, local authorities, pension funds, schools, trade unions, housing associations and charities need to have their books audited by an accountant. Not surprisingly, accountancy is an attractive career. Britain has around 250,000 qualified accountants, more than rest of the European Union put together. Between 10 per cent and 20 per cent of all university graduates are making a career in accountancy. Despite this huge investment in economic surveillance, Britain does not have superior corporate governance, freedom from frauds, better protection for stakeholders or business accountability.

  Today accountants rather than Parliament decide what counts as solvency, liquidity, asset, liability, equity, debt, income, expense, profit and loss. Their decisions affect shareholders, creditors, employees, pension scheme members and other stakeholders. The huge social investment in economic surveillance gives accountants security of income, job and status. On the back of the state guaranteed market of auditing, accountancy firms, have become consultancy supermarkets.

  Major firms earn less than 40 per cent of their fees from auditing and accounting services. In pursuit of higher fees they use audits to sell executive recruitment, internal auditing, advice on mergers, downsizing, trade union busting and tax avoidance/evasion. For a fee they will front shell companies, act as company directors, post boxes, print T-shirts and badges, lay golf courses, launder money and engage in bribery and obstruction of legitimate inquiries (Mitchell et al, 1998; 2002). Parliament passes legislation to curb tax avoidance/evasion, only for major firms to find new ways of avoiding/evading taxes. They are transparently and even self-consciously engaged in creative accounting and rule avoidance. Paralleling a fateful remark of Gerald Ratner's to the effect that his shops sell "crap", the chairman of Coopers and Lybrand (now part of PricewaterhouseCoopers) openly stated that "there is an industry developing, and we are part of it, in [accounting] standards avoidance" (Accountancy Age, 19 July 1990, p 1).

  In the pre-Enron world, just five firms dominated the global accountancy scene. Their income is greater than the Gross National Product (GNP) of many nation states.

FirmUK Fee Income
Global Income
US$ billions
PricewaterhouseCoopers2,120 22.3
Deloitte & Touche796 12.4
Ernst & Young626 9.9
Arthur Andersen6199.3

  Sources: Accountancy Age website (accessed on 4 April 2002); Accountancy, February 2002, p 13.

  Rather than being regulated by a single independent regulator, accountancy business is regulated by 23 overlapping regulators (see Appendix 1). Even then there is no independent complaints investigation procedure and no ombudsman to provide speedy and cost effective adjudication of complaints. None of the regulators owes a "duty of care" to any individual affected by their activities.

  Despite making decisions that affect the daily lives of people, accountancy firms are not required to publish any information about their affairs or their relationship with audit clients. Unlike the producers of sweets and potato crisps, auditors do not owe a "duty of care" to any individual stakeholder affected by their negligence. It is as though their accountability has been organised off the political agenda. It is noticeable that accountancy firms hire MPs to advance their economic interests (for example, former MPs Tim Smith and Jeremy Hanley were on the books of the ICAEW and accountancy firms. Stuart Bell MP and Peter Mandelson MP act as consultants for Ernst & Young). A weak legal, regulatory and accountability environment has failed to persuade accountancy firms to reflect upon the consequences of their failures. Their failures have caused loss of homes, jobs, savings, pensions, investments and tax revenues (for example, see Mitchell et al, 1991; Sikka and Willmott, 1995a, 1995b; Edwards and Shaoul, 1999; Sikka, 2001).

  The damage done to people's lives by audit failures is well documented. Audit failures played a part in a crisis for 30,000 Maxwell pensioners (House of Commons Social Security Committee, 1992). Audit failures played a part in the closure of Polly Peck and the loss of 17,227 jobs (Mitchell et al, 1991) and losses to 11,000 shareholders of Sound Diffusion Plc (Department of Trade and Industry, 1991a). Auditors failed to note that frauds that led to the conviction of five officials of the Baptist Foundation of Arizona on 32 counts of fraud, racketeering and theft. 11,000 investors lost £400 million (Daily Mail, 2 April 2002). The US Senate's report on the closure of the Bank of Credit and Commerce International (BCCI) concluded, "there can be no question that the auditing process failed to work" (US Senate, 1992, p 253). The audit failures were associated with the loss of 14,000 jobs and losses to some one million bank depositors with deposits of US$ 1.85 billion (US Senate, 1992, p 75). The Senate Report accused auditors of being a party to a "cover up" (US Senate, 1992b, p 276) and causing "substantial injury to innocent depositors and customers [emphasis added] of BCCI" (US Senate, 1992, p 5). In the aftermath of the 1970s audit failures at secondary banks, property and insurance companies, the UK taxpayer had to spend £3,000 million to bail out the sectors (Reid, 1982). The frauds and audit failures at Barlow Clowes required the British taxpayer to spend £153 million in compensation to investors (Department of Trade and Industry, 1995; Parliamentary Commissioner for Administration, 1989). The real/alleged audit failures in the US Saving and Loans industry may have cost the taxpayers between $400-$500 billion in bailouts (Pizzo et al, 1990). The collapse of Enron, the world's largest bankruptcy, is associated with audit failures in which the audit firm devised corporate structures, created numerous subsidiaries (including 900 offshore) and financial transactions. Enron auditors, Arthur Andersen, performed consultancy services, including internal audit[27], and just as the regulators were poised to examine the failures, the firm allegedly shredded a number of relevant electronic and paper documents[28]. (Financial Times, 11 March 2002).

  Almost every week, newspapers report some new incidence of audit failure. These are brought to public attention by whistleblowers, investigative journalists or by victims of frauds rather than by auditors, accountancy trade associations or any government department. In response, the Department of Trade and Industry and the auditing regulatory merely wring their hands. The standard response to audit failures is to blame someone else, individualise audit failures, revise auditing standards, codes of ethics, regulation and calls for better training of accountants (Sikka and Willmott, 1995a; US Department of Labor, 1997). Little attention is paid to the regulatory failures, conflicts of interests and the culture of accountancy firms. As a result, audit failures continue unabated and are firmly institutionalised.

  This paper argues that the ability of accountancy firms to cause substantial injury to depositors, customers, employees, creditors, shareholders, pension scheme members and other stakeholders is, amongst other things, the product of their organisational values and cultures[29]. The prime responsibility for scrutinising the organisational practices of accounting firms and curbing their capacity to do social harms rests with the government, especially as it has granted a monopoly of the external auditing function to accountancy firms. However, successive UK governments have shown little willingness to undertake such investigations. They have delegated the responsibilities to the accountancy trade associations, which act as sponsors, promoters, defenders and regulators of the UK auditing industry (Sikka and Willmott, 1995a, 1995b). The auditing regulators pay little attention to the role of organisational practices and values in institutionalising audit failures and social harms.

  This paper is divided into four further sections. The first section argues that modernity generates risks and calls for regulation. Due to the systemic limits on expert knowledge and the private economic interests of the experts, the negative consequences of reliance upon experts (eg auditors) are institutionalised. The second section provides some illustrations that raise questions about the organisational culture and practices of auditing firms. They suggest that in pursuit of profits, auditing firms are rarely concerned about the consequences of their practices for the welfare of audit stakeholders. In principle, educational, legal and other regulatory arrangements could check the harmful effects of the organisational culture of accountancy firms. However, the third section argues that the legal and institutional arrangements for regulating auditing are weak. The regulatory bodies have a cosy relationship with auditing firms and are more concerned to defend and advance the economic interests of auditing firms rather than those who might bear the negative consequences of auditing. The fourth section concludes the paper with a summary and discussion.


  Auditing is frequently promoted as a risk management technology. The very idea of "risk", in a modern context, assumes that nothing is preordained and fixed and that the social arrangements are the outcome of human action rather than the invisible hand of fate. Modernity creates the feelings that future misfortunes, threats, harms, hazards and dangers can be prevented, controlled or managed by investment in suitable technologies, modes of government, forms of surveillance, accountability, bureaucracy, institutional structures and trust engendering technologies. Modernity encourages the belief that the social world can be controlled by investment in modes of objective knowledge and rational thinking and that the risks can be calculated and predicted.

  Many of the risks associated with modern life are not directly accessible to the senses. They cannot easily be seen, smelt, observed, or felt by human bodies. Rather than relying upon local knowledges, traditions, habits, or observations, the construction of risks is mediated and regularised by reliance upon expert knowledges and experts that people rarely meet or encounter in everyday life. By appealing to their socially constructed credentials, experts solicit "trust" and seem to hold out the promise of certainty and bringing the future under control. People are encouraged to look to the assumed experts to diagnose problems and offer advice. As a result, "risk" analysis, risk management and surveillance is big business, providing employment for thousands of consultants, advisers, auditors and experts.

  The limitations of expert knowledge are often highlighted by unexpected events (eg diseases, corporate failures) which show that the concepts and theories advanced by experts cannot adequately grasp reality. As modernity is accompanied by intense fractures and fragmentation of daily life, it also produces social conflicts. In societies marked by social divisions and antagonisms emanating from inequalities relating to class, gender, age, ethnicity, wealth and income, the significance and meaning of expert knowledge cannot be fixed in any permanent sense. The meanings are open to intense struggles, especially by those who claim to have a direct interest in promoting particular interpretations of risk objects and practices. The experts often deflect public criticisms by engaging in "politics of blame" by placing the critics/victims in negative spaces and arguing that the public expects too much, or that they had been misled by someone else.

  In modern societies, expert knowledges and experts reside in capitalist organisations that generate pressures to prioritise fees, income, profits and market shares over compassion, care and social responsibility. In pursuit of private gains, some organisations facilitate technologies and expertise that cause death and genocide (Black, 2001) and generally promote profit over people (Chomsky, 1999). In pursuit of private gains, food experts have sanctioned the consumption of unfit food (Schlosser, 2001; House of Commons, 2000), financial experts have sanctioned the sale of undesirable pension schemes (House of Commons Treasury Committee, 1998), accountants have laundered money (Mitchell, Sikka and Willmott, 1998), and auditors put appeasement of company directors above the interests of employees, pension scheme members and shareholders (Department of Trade and Industry, 2001). The reliance upon experts is double-edged. It oils the wheels of economy and society, but it also generates "new ignorance with knowledge" (Douglas and Wildavasky, 1983, p 49) and facilitates physical, economic and social injuries to a large number of people and society generally. Seemingly, the social production of wealth, certainty and regulation is systematically accompanied by social production of risks (Beck, 1992). It is rarely accompanied by reflections upon the organisational values and practices of the assumed experts. As the potential for harm is institutionalised, a recurring question is who can be trusted? Such questions lead to calls for (re)regulation or the (re)establishment of trust.

  Modernity's concerns about risk and regulation are mirrored in the process of auditing. There is a strongly held view that audit risks can be managed or minimised by the development of objective knowledge in the shape or probabilities and statistical sampling (for example, see Auditing Practices Board, 1995a, 1995b). Auditors are encouraged to make predictions about the future by using past accounting numbers[30] and mathematical models (Altman, 1968; Altman and McGough, 1974; Auditing Practices Board, 1995c) and shield themselves from threats through insurance cover. Alternative forms of knowledge and social understanding have been driven off the educational schema and rulemaking considerations. No amount of sampling, analytical review, or predictive models require auditors to reflect upon the social consequences of their actions. These technologies may help to minimise audit effort, increase profits, and possibly protect audit firms/partners from the consequences of real/alleged audit failures, but rarely encourage reflections upon the negative social consequences of the organisational practices of accountancy firms.

  In market economies, company audits are performed by capitalise organisations whose success/failure is measured by fee income, profits and number of clients and market share. Within accountancy firms the emphasis is "firmly on being commercial and on performing a service for the customer rather than on being public spirited on behalf of either the public or the state" (Hanlon, 1994, p 150). Accountancy firms enjoy a monopoly of the state guaranteed market of external auditing, but the procurement of clients and fee income is heavily dependent upon personal relationships with company directors who need to be persuaded to hire a particular firm of auditors. Securing the office of the auditor is important because it also enables the firm to sell lucrative consultancy services. Accountancy firms are part of an "enterprise culture" that persuades many to believe that "bending the rules" for personal gain is a sign of business acumen. Stealing a march on a competitor, at almost any price, to make money is considered to be an entrepreneurial skill, especially where competitive pressures link promotion, prestige, status and reward, profits, markets, niches with meeting business targets.

  The expansion of the entrepreneurial accounting firm has not been accompanied by moral constraints that require consideration of the social consequences of their organisational practices. In such an environment, numerous practices are considered to be acceptable as long as they generate private profits. The "failure" resides not in instituting dishonourable, predatory or anti-social practices but in being exposed or caught, as it can damage the carefully cultivated veneer of respectability and professionalism and limit the possibilities of securing fees and profits. The likelihood of being caught and punished can stimulate reflections upon organisational practices. Such possibilities can be created by the formulation of strong regulatory arrangements enforced by the state. However, the state's ability to intervene is constrained by the deregulationist discourses that seek to limit its ability to monitor the internal practices of accountancy firms. The increasing reliance of political parties and governments upon private monies also constrains the state's ability to institute regulation that is opposed by major businesses (Chomsky, 1999; Monbiot, 2000). Faced with material and ideological constraints, the state has delegated the regulation of auditing to accountancy trade associations. Following the Companies Act 1989, the accountancy trade associations are expected to regulate the auditing industry and investigate real/alleged cases of audit failures. They are expected to promote, defend, regulate and prosecute auditing firms, but have no independence from the auditing industry. Rather than examining the organisational values and cultures giving rise to the audit failures the accountancy bodies individualise the failures (Joint Disciplinary Scheme, 1999) and campaign to secure liability, tax and other concessions for the firms. This way attention is deflected away from the organisational practices and values of accountancy firms. In a weak regulatory environment, organisational practices of accountancy firms go unchecked, audit failures remain institutionalised and their capacity to do harm[31] to people has become the subject of newspaper headlines.

  The remainder of this paper draws attention to some auditing practices that offer insights into the organisational culture and practices of accountancy firms. These may help to increase profits and revenues, but are rarely accompanied by reflections upon their consequences for the welfare of audit stakeholders.


Pursuit of Profits

  In common with other commercial enterprises, auditing firms exert pressures on audit managers and partners to increase revenues, profits and number of clients. Major firms have used their weight to intimidate audit clients in an effort to win consultancy work. Angered by a client who decided to use the services of an independent consultancy company to value its brands for accounting purposes, the audit firm threatened the client suggesting that audit costs would rise if the independent consultancy company was used in preference to the firm's consultancy division (Accountancy Age, 14 February 1991, p 1 and 17; Accountancy, March 1991, p 11). The consultancy company complained to the ICAEW by arguing that "We find attempts to cajole clients into using consultancy services by threat of `problems' exceptionally seedy and unpleasant" (Accountancy Age, 14 February 1991, p 17). Naturally, the ICAEW did not take any action. A myth promoted by the accountancy industry is that the purchase of auditing and non-auditing services from the same firm somehow results in lower costs. Such myths are not supported by research (Simunic, 1980) which shows that when management invite competitive tenders, shop around and purchase auditing and non-auditing services from two separate firms, they get a lower price. Besides, by acting as consultants auditors end up auditing the transactions and controls which they themselves have created and violates their independence.

  Accountancy firms are desperately keen to win business (Accountancy, June 1991, p 1). Lowballing is rife, with the big firms sometimes undercutting the medium-sized firms by as much as a third (Accountancy Age, 9 May 1991, p 1; Accountancy Age, 23 May 1991, p 1; Accountancy Age, 9 January 1992, p 1). Audits continue to be used as loss-leaders to secure non-auditing work (Accountancy Age, 6 June 1991, pp 1 and 4). Some firms have been offering free audits in the hope of picking up lucrative consultancy work (Accountancy Age, 20 June 1991, 1; Accountancy Age, 24 October 1991, p 1). As audit quality is not visible to the public, nor effectively monitored by an independent regulatory agency, poor work only comes to the surface when an inquiry follows a company collapse/fraud or some investigative journalist pursues a story.

  Faced with competition, competitive tendering and lowballing, firm partners and senior managers are assigned income generation targets. Those successfully negotiating the pressures are rewarded with status, bonuses and other rewards. To maximise profits, firms impose tight time budgets on audit staff even though time constraints have played a major part in audit failures and incompleteness of audit work (Department of Trade and Industry, 1995). However, the time budgets are squeezed in the hope that audit teams would work free on evenings and week-ends to finish the work (for examples see Accountancy Age, 24 March 1994, p 1; Accountancy Age, 24 March 1994, p 1; The Times, 2 November 1995, p 30). Fearful of retaining their jobs and study leave, some oblige, but large numbers of audit trainees either use short-cuts, irregular practices or resort to falsification of audit working papers (Otley and Pierce, 1996). A survey by Willett and Page (1996) found that due to time pressures large proportion of audit staff rejected awkward looking items, accepted doubtful audit evidence, failed to test the required number of items in a sample, or simply falsified the audit working papers to give the impression that the work has been. Such practices were carried out by senior and junior members of the audit teams. As the audit review process cannot completely re-perform the audit, irregular audit practices rarely come to light.

  The DTI report on Rotaprint noted that "[Arthur Young's] audit team was composed of relatively inexperienced trainees led on a day-to-day basis by an unqualified senior" (DTI, 1991). Commenting upon audit failures at the Milford Docks Company, the inspectors noted that "neither Mr Jones nor Mr Harrison [Cooper & Lybrand partners] should have played a major role in compiling the report" (DTI, 1992). The DTI report on the collapse of London united Investment concluded that "It was a mistake by KPMG not to have obtained third party confirmations . . . it was a conscious decision by KPMG not to obtain third party confirmations . . .. We disagree with this decision" (DTI, 1993a). The report accused the partners of behaving in an unprofessional way. The DTI report on Edencorp concluded that "Ernst & Young as auditors of the group signed an unqualified audit report on Edencorp's 1989 group accounts without apparently considering the accounting implications of the significant invoice issued . . . We are therefore surprised that the accounting treatment adopted for the transaction was given so little attention by the finance director and auditors" (DTI, 1993b).

  In an environment of tight time budgets, competition and pursuit of higher profits, auditing firms look for ways of achieving efficiency. One of the common practices is to use checklists for controlling, planning and recording an audit. Such devices standardise audits and also make the process much more mechanical, predictable and possibly boring. The checklist mentality encourages irregular practices. In a radio programme (BBC Radio 4—File on Four, 9 (October 2001), an auditor with 10 years experience said,

    "If you pitch for an audit of certain value, obviously you have to try and do it within that price, so you skip lots of corners. I mean, you've got lots of checklists to fill in—have you seen this? You just end up ticking "yes I've seen this, I've seen this", even though you haven't ... So you end up with piles of checklists on your audit working papers, which basically are a complete fabrication, because you actually haven't done the work. It's so easy to just sit there and fill in checklists, even back in your hotel room, not even at the client's premises, just so that when the partner rings up the next morning and says, "I hope you're at least three quarters of the way through the audit", you can say, "Yes, I am". The public doesn't know what an auditor actually does. They don't know the mechanics of an audit, so they are not aware of how much work has actually gone on to verify and authenticate the figures in the accounts. If the public were aware of, you know, sometimes how little work goes on, I think they'd be quite surprised and would be less inclined to take a clean audit report as being gospel that the accounts are actually accurate."

  In folklore, final audit opinion should be based upon the audit evidence collected and evaluated. However, in practice the economic interests of auditing firms, including the desire to sell non-auditing services, often prevail. According to an auditor,

    "There can be various times when you'd want to qualify an audit, when you are not happy with things. The partners or partner responsible would be less inclined than yourself to qualify the report, mainly because they want the continuing business, or they already have a relationship with the client, or to keep the client on board, because there's other aspects to the job as well, not just the audit. There's also the accounts, all the directors' tax returns, there might be a lot of tax planning and financial planning services going on as well, and management consultancy. All those sort of things are being provided to the client, which really ruins any independence you've got as far as being an auditor is concerned, because of all the background services that are also being provided. So there's enormous pressure not to qualify the report, because you don't want to lose the client.

    [An example] The client was being very uncooperative indeed about stock, wouldn't give us any stock records or stock level, and indicated that cooperation would only be given once he was aware of what our draft profit figures were. I told the partner that this was unacceptable and really we should qualify the report. However, the partner and the client were friends and, following a, I suspect a dinner or a drink or whatever, I was informed by the partner that this particular stock figure had been agreed and that there would be no qualification on the report. I have to say I was very unhappy about that, because it was obvious that the figure couldn't be validated in any way. [Reporter: So they just went out to dinner together and cooked the books?]. Yes, you could say that. They basically agreed a figure which was put in the accounts, and the audit was signed off . . . In a sense they're defrauding anyone that's lent money to them, you know, their bankers, obviously the creditors, people doing business with them. Obviously also the Inland Revenue. If the tax liability is based on the accounts and those accounts are incorrect—for whatever reason—the correct liability is not being collected" (BBC Radio 4—File on Four, 9 October 2001).

  The commercial considerations have persuaded auditing firms to remain silent about questionable clients. For example, in January 1990 BBCI pled guilty to charges of money laundering (United Stated, Senate Committee on Foreign Relations, 1992, p 61), but this did not prompt its auditors, Price Waterhouse, to resign or qualify the accounts.

  In pursuit of fees, accountancy firms also accept clients with "danger" written all over them. For example, Coopers & Lybrand (now part of PricewaterhouseCoopers) accepted Robert Maxwell as a client even though he had previously been described as a person "who cannot be relied upon to exercise proper stewardship of a publicly-quoted company" (Department of Trade and Industry, 1973, 1972, 1971b). From 1972 (almost a year before the publication of the final damning DTI report) Coopers & Lybrand became auditors and business advisers to most of the Maxwell controlled companies and pensions funds. The auditors valued assets of the Maxwell business and then reported on the reasonableness of the same. Maxwell (committed suicide in November 1991) systematically plundered the pension funds to the tune of £458 million (House of Commons Social Security Committee, 1992). Some parts of the Maxwell empire did not keep proper accounting records but auditors continued to issue unqualified audit reports. The DTI inspectors' report showed that the relationship between the audit firm and Maxwell was close. The appeasement of Maxwell was a major priority for the audit team (Department of Trade and Industry, 2001).

  Some auditing aspects of the Maxwell debacle were examined by the Joint Disciplinary Scheme (JDS). Its report (Joint Disciplinary Scheme, 1999) concluded that the audit firm "lost the plot", "got too close to see what was going on" and "failed to consider whether there was evidence of fraud, other irregularities, defaults or other unlawful acts" (The Times, 3 February 1999, p 21; Bower, 1999; Financial Times, 3 February 1999, p 10; The Observer Business, 7 February 1999, p 6; Daily Mail, 27 May 1999, p 5). The audit firm and its partners admitted 57 errors of judgement, including inadequate work, incompetent performance, undue acceptance of management representations, deficient consideration of the interest of third parties and deficient partner review[32] (Chitty, 1999). Despite rules and regulations about auditor training, one of the partners claimed that he had never encountered fraud before. In response, the JDS individualised audit failures. Rather conveniently, most of the blame was allocated to the Coopers & Lybrand audit partner Peter Walsh, who died (in 1996) whilst the JDS was making its inquiries. The JDS did not investigate the organisational practices and values of the audit firm.

Walking Quietly

  Auditing firms have a history of "disclosing considerably less than what they actually know" (Woolf, 1986, p 511). Such suspicions are further supported by the practices of resigning auditors. Since the UK's Companies Act 1976 (now consolidated into the Companies Act 1985), resigning auditors have been required to make public statements, addressed to shareholders and creditors of companies, to draw attention to the circumstances, if any, of their resignation.

  Section 394(1) of the Companies Act 1985 states that "Where an auditor ceases for any reason to hold office, he shall deposit at the company's registered office a statement of any circumstances connected with his ceasing to hold office which he considers should be brought to the attention of the members or creditors of the company, or if he considers that there are no such circumstances, a statement that there are none". Such legal requirements were developed in the aftermath of corporate collapses and scandals where the silence of the auditors was considered to be detrimental to the interests of the stakeholders (Dunn and Sikka, 1998).

  The legislation was introduced in the aftermath of the frauds at Pinnock Finance Group (DTI, 1971a) where the "asset figures in the balance sheets were not merely unrealistic but blatantly false" (p 249). The auditors were described as "tame and negligent" and decided to walk away quietly. The provisions of the Companies Act 1976 were designed to "strengthen the position of auditors" (Hansard, House of Lords Debates, 23 March 1976, col 550), and particularly "strengthen the hand of the weaker brethren" (Hansard, House of Lords Debates, 23 March 1976, col 578). The legislation is accompanied by immunities from "libel" [33] and the hope that it will "give a strong auditor a very powerful and effective threat in the event of a dispute with the directors and will force even a weak auditor to face up to his responsibilities as he will no longer be able to evade a difficult situation by quietly resigning and saying nothing" (Hansard, House of Lords Debates, 23 March 1976, cols 554-555).

  Despite a proliferation of auditing standards, ethical statements and regulation, auditors seem reluctant and/or unwilling to discharge their obligations (Dunn and Sikka, 1999). For example, consider the case of the Queens Moat Houses Plc, once the third largest hotel chain in the UK. Through an aggressive acquisition policy, it expanded and its profits grew from £24.8 million in 1987 to £94.1 million in 1990. The company's accounts carried unqualified audit reports until 1991. In 1993, just a week before its 1992 financial statements were to be published, the company asked (on 31 March 1993) the London Stock Exchange to suspend trading of its shares (The Times, 1 April 1993, p 23). Major banks were asked to devise a financial package to rescue the company (The Times, 8 April 1993, p 25). Grant Thornton were asked to investigate the company's affairs. This investigation revealed (April 1993) that the company was likely to report a substantial loss (The Observer, 23 May 1993, p 30). A large number of directors either resigned or left.

  Amidst these events, on 18 May 1993, Queens Moat Houses auditors, Messrs Bird Luckin, resigned and stated,

    "we confirm that there are no circumstances connected with our resignation which we consider should be brought to the notice of the members or creditors of Queens Moat Houses plc".

  The company's financial statements for the year to 31 December 1992 were finally published on 29 October 1993. In it, the 1991 pre-tax profit of £90.4 million was restated as a loss of £56.3 million. The £146.7 million difference included £50.9 million of depreciation that the group had not previously provided for and maintenance expenditure which had been capitalised. Other changes related to overstatement of profits on fixed sales, expenses which had been capitalised and misclassification of finance leases. Whilst analysts were predicting a profit of some £90 million for 1992, the actual published accounts revealed that the company made a pre-tax loss of £1.04 billion. Much of it was due to exceptional items and a write-down of property values. The 1992 balance sheet showed net debt to be £1.17 billion and a negative net worth of £388.9 million.

  For the two previous years the company had been operating with virtually no financial controls (Financial Times, 30-31 October 1993, p 8). It was alleged that the company had paid unlawful dividends for 1991, 1992 and 1993 (Financial Times, 30-31 October 1993, p 1; The Observer, 31 October 1993, p 2). The finance director's report explained that "there were no monthly consolidated management accounts to enable the board to monitor the progress of the group". In particular there were minimal group cash forecasts and no clearly defined treasury function. It was reported that one of the company's directors was a former partner of the audit firm.

  On 12 November 1993, the Department of Trade and Industry appointed inspectors under section 432 of the Companies Act 1985 to investigate the affairs of the company. A report is yet to be published.

  Take another example of MTM Plc, which through an aggressive acquisitions policy became the second largest fine chemicals company in the UK. In 1992, it collapsed with debts of £250 million (The Independent, 4 February 1997, p 16). The Company had issued two profit warnings and its share price plummeted from 286 pence to 26 pence (Financial Times, 1 May 1992, p 20). There were considerable disagreements between auditors, BDO Binder Hamlyn, and the Board and the announcement of the 1991 financial results was delayed. Richard Lines, MTM's chairman and founder, resigned early in March 1992 over disagreement with the auditors "over application of accounting policy" (Financial Times, 11 March 1992, p 11). An internal report prepared by auditors BDO Binder Hamlyn suggested that the company boosted its 1991 (and also in earlier years) sales and profits by "incorrectly recorded" transactions (Financial Times, 14 May 1992, p 22). In May 1992, it was reported that MTM was "co-operating fully with the SFO [Serious Fraud Office] and the North Yorkshire police in an investigation being carried out concerning matters relating to that shortfall" (Financial Times, 14 May 1992, p 22).

  MTM's auditors, BDO Binder Hamlyn, gave an unqualified audit opinion (dated 5 June 1992) on the financial statements for the year to 31 December 1991. On 8 September 1992 they resigned and stated that:—

    "There are no circumstances connected with our resignation which we consider should be brought to the attention of the members or creditors of the company".

  The very next day, the company announced an interim loss of £28 million and its new chief executive claimed that the previous year's accounts were materially overstated (Financial Times, 10 September 1992, p 20). The new chief executive sought to restructure the company and looked for a substantial cash injection (Financial Times, 10 September 1992, p 20).

  Price Waterhouse took over the audit. The firm's first audit report, dated 28 April 1993, related to the financial statements for the year to 31 December 1992. It referred to the fact that "the company is co-operating with the Serious Fraud Office and the North Yorkshire Police in relation to an investigation being carried out concerning matters relating to the profit shortfall announced in the 1991 Reports and Accounts . . .".

  The SFO inquiries continued in 1993 (Financial Times, 10 April 1993, p 10) and in 1994. Richard Lines and Thomas Baxter, another former MTM director, were formally charged with false accounting, conspiracy to commit false accounting or furnish false information, and making false and misleading statements under the Financial Services Act. It was alleged that they recorded bogus transactions for 1990 and 1991 in order to meet profit forecasts. According to the prosecuting QC, the directors, "assisted by others, cooked the books, in order to give the impression that the company was a good deal more profitable that was, in fact, the case" (Financial Times, 4 February 1997, p 12). Amongst other things directors sold company's plant and machinery to a supplier for a profit of £700,000 with an agreement to repurchase the assets so that there was no net cost to the supplier. Both former directors were convicted of fraud and Richard Lines was sentenced to two years imprisonment and Thomas Baxter to six months (Serious Fraud Office Report, 1996-97). In relation to the auditors, the judge said, "It may be that BDO had become far too cosy with MTM" (Financial Times, 4 February 1997, p 12).

We don't like Talking

  The history of auditing draws attention to the organisational practices of auditing firms and their potential to do material harm to people. Woolf (1983) draws attention to audit failures that show "the ease with which eminent firms of auditors turned a blind eye on the wholesale abuse by client company directors of [legal] provisions. [The directors] operated these public companies for the principal benefit of themselves and their families; and most regrettable of all, on the virtual complicity of their auditors, whose efforts are seen to have amounted to a whitewash at best, and a fatuous charade at worst". In response, without any investigation of the organisational practices of accountancy firms or the their lack of accountability that gives rise to audit failures, the UK government has strengthened the statutory rights and powers of auditors.

  Ever since the Companies Act 1948 (Section 160), auditors have been empowered to speak at all Annual General Meetings (AGM) and express their concerns about anything relating to financial statements. However, auditors appear to be more concerned to appease company directors, their effective paymasters. Consider the case of Ramor Plc, a company audited by Price Waterhouse (now PricewaterhouseCoopers). To prepare for the possibility that someone attending the AGM might ask searching and unwelcome questions, the auditors reached a prior agreement with the company to be "economical with information", as evidenced by a letter exchanged between the chairman of the company (Mr Smith) and the Price Waterhouse audit partner (Peter Ainger). The letter said (Department of Trade and Industry, 1983, p 283),

  Dear Mr Smith,

  As arranged I am writing to let you know in advance of the Annual General Meeting on 26 July the replies I will give if I am asked by a shareholder for the reasons why my firm is not seeking re-election as auditors. If no questions are asked, then of course, no further information in addition to that contained in the Annual Report need be provided.

  However, if a shareholder asks further information I propose to reply as follows:

    "In recent years we have experienced certain difficulties in obtaining necessary information for our audit and being sure that all relevant explanation have been provided to us. In the final outcome we have been satisfied that we have received all such information and explanation; otherwise this would have been reflected in our audit report. However the situation created by these difficulties caused us to agree with the directors that we would not seek re-election at this meeting, a step we are permitted to take under the provisions of the Companies Act."

  If there should be a follow-up question asking for more information about the difficulties referred to in the foregoing statement I would propose to reply as follows:

    "There was no one matter which in itself caused us to reach this agreement with the directors. In view of this, there is nothing more that can be added to the answer that has already been given.

    I would not intend to give any more information nor to respond to any other question".

  Following allegations of frauds, the Department of Trade and Industry appointed inspectors (Department of Trade and Industry, 1983). The interim report[34] of the inspectors concluded that:

    —  "Price Waterhouse's conduct as regards the non-executive directors and incoming auditors is indefensible" (p 286).

    —  "Price Waterhouse's acceptance of the position and of the manipulation is both surprising and disturbing" (p 79).

    —  "at the AGM itself Mr Ainger Price Waterhouse partner despite having notice of . . . questions, answered them in terms which gave the shareholders less than the full picture and conveyed an impression of certainty . . . which was not justified" (p 278)

    —  ". . . we have no hesitation . . . and have no doubt that Price Waterhouse attempted to play down the situation" (p 285).

  The DTI inspectors criticised Price Waterhouse for resigning the audit and going too quietly (Department of Trade and Industry, 1983, chapter 14). The public face was that "By mutual agreement our Auditors Price Waterhouse and Co are not seeking re-election . . ." (DTI, 1983, p 283), but the inspectors concluded, "there was nothing mutual in Price Waterhouse's decision to go" (p 284).

  Auditing firms seem to be more concerned about protecting their flow of profits than answering questions about their own and corporate conduct, which could arguably enable some to manage their risks and call organisations to account.


  In pursuit of profits, accountancy firms have long been using audits as a market stall to sell non-auditing services (Accountancy, June 1995, p 13; Mitchell and Sikka, 1993). Unlike other auditors (eg Inland Revenue, Customs and Excise, Health and Safety Executive), financial auditors hire company directors, value assets, create business transactions, internal control systems, accounting systems, perform internal audit functions and then claim that they can somehow audit the same without any detrimental effect on their independence.

  Rather than ensuring that auditors act exclusively as auditors, the regulators support the auditing industry. They spread false information. For example ICAEW Deputy President and PwC partner, Peter Wyman, claimed that "Independent investigations have not shown the provision of consulting services to have been the cause, or even a contributory cause, to any audit failure[35]". (Financial Times, 21 January 2002, p 14).

  Auditors of Roadships were criticised for their failure to adequately check the amounts for creditors, accruals, purchase and profit forecasts (DoT, 1976a). The audits were not independent as auditors acted as consultants for the company. The inspectors (one of whom is usually a partner from a major accountancy firm) argued that:

    "Independence is essential to enable auditors to retain that objectivity which enables their work to be relied upon by outsiders. It may be destroyed in many ways but significantly in three; firstly, by the auditors having a financial interest in the company; secondly, by the auditors being controlled in the broadest sense by the company; and thirdly, if the work which is being audited is in fact work which has been done previously by the auditors themselves acting as accountants" (para 243).

  After examining the quality of audits performed by auditors who also provided non-auditing services, the inspectors concluded:

    "We do not accept that there can be the requisite degree of watchfulness where a man is checking either his own figures or those of a colleague. . . for these reasons we do not believe that [the auditors] ever achieved the standard of independence necessary for a wholly objective audit" (paras 249 and 250).

  The DTI report on Hartley Baird found that the company was having difficulties in repaying loans. But the financial problems were covered-up by manipulation of the account. The report stated that the auditors were ineffective because of their close connections with company directors and suggested rotation of auditors (DTI, 1976b).

  The Department of Trade and Industry (DTI) inspectors' report on Burnholme and Forder (DTI, 1979a) was critical of audit work and once again felt that auditor independence was compromised by the provision of non-auditing services to audit clients. They concluded:

    "in our view the principle of the auditor first compiling and then reporting upon a profit forecast is not considered to be a good practice for it may impair their ability to view the forecast objectively and must endanger the degree of independence essential to this work" (p 271).

  In 1978, the collapse of the Grays Building Society reminded people of the ineffectiveness of external auditors. The resulting investigation (Registry of Friendly Societies, 1979) found that the same firm had been auditing the building society for nearly forty years. Its partners became friends of directors and frequently took holidays together. The auditors failed to perform the simplest of checks and did not spot frauds of more than £7.1 million, carried out over a period of some forty years. The frauds only came to light when the chairman committed suicide. The report was highly critical of auditors and noted that their "independence" had been compromised by the longevity of their term in office and the personal relationships with company directors which had developed as a consequence.

  The report on Kina Holdings (DTI, 1981a) criticised auditors and noted that the same firm had been providing auditing and non-auditing services to a major quoted company for a number of years. This relationship resulted in a considerable part of the firm fee income coming from one client and created difficulties with perceived independence of auditors.

  Audit failures continue to raise questions about auditor independence. For

example, Stoy Hayward acted as auditors and consultants to Polly Peck for a period of fifteen years. The firm always issued unqualified audit opinions.

  The House of Commons Select Committee on Social Security recommended that pension fund auditors should not be allowed to carry out non-auditing services for their audit client (Accountancy Age, 12 March 1992, p 1; Accountancy, April 1992, p 18). Such recommendations followed consideration of frauds perpetrated by Robert Maxwell, an episode which once again raised questions about the desirability of auditors auditing the balance sheet figures that they themselves had created. In 1991, the Maxwell Group of Newspapers was floated with £625 million value attaching to newpaper titles in the balance sheet. The titles made up a bulk of the shareholders' funds shown at £840 million. The valuation of the titles was undertaken by Coopers & Lybrand who also audited the accounts and reported on, the flotation prospectus. The same firm had been auditing Maxwell businesses for the last twenty years without ever issuing a qualified audit opinion.

  The issue of conflict of interest is again raised by the case of BCCI, a fraud infested bank that had been forcibly closed down (US Senate, 1992). In this Price Waterhouse simultaneously acted as auditor, eyes and ears of the regulators and advisers to BCCI management. BCCI bank hired the Consultancy Division of its auditors, Price Waterhouse (UK), to tackle losses from its treasury operations. The consultants completed their work in 1986 and the auditors [Price Waterhouse] reported that they were satisfied and that their recommendations for improving Treasury controls had been implemented. As a result of its review of the Treasury operations in 1985, the auditors also discovered a potential tax liability to the UK government, and subsequently advised BCCI to move its Treasury operations out of the United Kingdom to avoid payment (Arnold and Sikka, 2001). In Price Waterhouse's words,

    "In our report dated 28 April 1986, we referred to the control weaknesses which existed in respect of the group's Central Treasury Division ("Treasury"). During 1986 management engaged the services of the Consultancy Division of Price Waterhouse, London, to assist them in implementing recommendations contained in our earlier report. We reviewed the progress made by the bank on the implementation of revised procedures during the year and in a report dated 5 August 1986 we were able to conclude that most of our significant recommendations had been implemented. A further feature arising from the review of Treasury operations in 1985 was the potential liability to UK Corporation Tax arising from the Division's activities in the period 1982-85. Following advice from ourselves and from the Tax Counsel during 1986 it was determined that this liability could be significantly reduced if the Bank ceased trading in the United Kingdom and claimed a terminal loss". (US Senate, 1992, p 175).

  BCCI's Treasury was moved from London to Abu Dhabi in 1986 with Price Waterhouse assisting with the transfer. The audit firm was simultaneously acted as private consultants and advisors to BCCI management to further their "private" interests. Yet at the same time the state was expecting them to perform "public interest" functions by acting as an external monitor and quasi-regulator[36]. After the closure of BCCI (in July 1991), investigations into BCCI's criminality have been hampered by the fact some crucial documents had been transferred from London to Abu Dhabi.

  The relationship between the management of BCCI and its auditors was so close that the US Senate concluded that "there can be no question that the auditing process failed to work" (US Senate, 1992, p 253). The US senate Report also noted that.

    "BCCI provided loans and financial benefits to some of its auditors, whose acceptance of these benefits creates an appearance of impropriety, based on the possibility that such benefits could in theory affect the independent judgement of the auditors involved. These benefits include loans to two Price Waterhouse partnerships in the Caribbean. In addition, there are serious questions concerning the acceptance of payments and possibly housing from BCCI or its affiliates by Price Waterhouse partners in the Grand Caymans, and possible sexual favors provided by BCCI officials to certain persons affiliated with the firm" (United States Senate Committee on Foreign Relations 1992b, pp 4-5)"

  The typical response to any revelations about the audit firm conflicts of interests is to call for more professional pronouncements and ethical rules rather than statutory rules and independent enforcement mechanisms. However, in pursuit of profits accountancy firms are rarely constrained by any codes of conduct or ethical statements issued by the accountancy trade associations (Mitchell et al., 1994).

  The DTI inspectors' report on Aveley Laboratories Limited (DTI, 1981b) noted that in pursuit of fees, the audit firm showed no regard to the ethical guidelines issued by the accountancy trade associations. Auditors were criticised for conflicts of interests arising out of the acceptance of the office of the receiver for their former clients. Conflicts of interests arising from financial relationship with the company and its directors also drew critical comments from the DTI inspectors' report on Scotia Investments Limited (DTI, 1981c). Yet the issues were to be repeated again.

  Coopers & Lybrand (now part of PricewaterhouseCoopers) violated the so called "ethical" rules to secure the lucrative administration, receivership and liquidation of Polly Peck, a company with whom they had previous and on-going links (Mitchell et al., 1994). The ethical guidelines of the profession stated that firms should not accept such a position where "there is a continuing professional relationship" with the client. In accepting the position of the administrator, Coopers did not reveal its prior relationship with Polly Peck and its Chairman. The firm had acted as joint reporting accountants when Polly Peck originally went public; it had consultancy links with the company; advised the company chairman; played a role in the appointment of the company's finance directors and it had audited Polly Peck's Far East operations. After two years of public ridicule, the ICAEW found the partners guilty of violating the guidelines. The punishment for guilty partners was a fine of £1000 (maximum possible) whilst the firm is estimated to have made around £30 million from its insolvency assignment.

  In pursuit of profits, accountancy firms continue to have deep organisational and cultural problems in complying with the rules. Some support for this view is provided by an investigation by the Securities Exchange Commission (SEC). On 4 January 1999, the US regulator, the SEC, censured PricewaterhouseCoopers (PwC) for "violating auditor independence rules and improper profession conduct" (SEC press release, 6 January 2000) and ordered an internal review of PwC's compliance with the rules of auditor independence. As part of the review, PwC staff and partners were asked to self-report independence violations, and the independent reviewers were asked to randomly test a sample of the responses for completeness and accuracy. The review revealed more than 8,000 violations, including those from partners responsible for overseeing and preventing violations. The report concluded that there was.

    "widespread Independence non-compliance at PwC despite clear warnings that the SEC was overseeing 77.5 per cent of partners and 8.5 per cent non-partners selected for audit in the Random Sample Study failed to report at least one violation. Many of the partners had substantial number of previously unreported violations. A total of approximately 86.5 per cent of partners and 10.5 per cent of non-partners in the Random Sample Study had at least one reported or unreported Independence violation. These results suggest that a far greater percentage of individuals in PwC's firmwide population had Independence violations than was revealed by the self-reporting process. The number of violations reflected serious structural and cultural problems (emphasis added) that were rooted in both its legacy firms (Price Waterhouse and Coopers & Lybrand merged to form PwC)" (Securities Exchange Commission, 2000, pp 122-123)."

  PwC is not alone in having serious structural and cultural problems. In June 2000, the SEC started a "look back" program and required major accounting firms to review their independence procedures and violations (SEC press release, 7 June 2000). As part of this, KPMG was admonished (SEC press release, 14 January 2002). The findings showed that contrary to the "independence" rules, KPMG had a substantial investment in Short-Term Investment Trust (STIT), part of the AIM Funds, a collection of mutual funds audited by the firm. After the initial investment of $25 million, KPMG made 11 additional investments and by September 2000, its investment constituted some 15 per cent of the STIT's net assets. The audit firm issued reports stating that it was "not aware of any relationships between (KPMG) and the (AIM) Funds that, in our professional judgement, may reasonably be thought to bear on our independence".

  The violation of the auditor independence rules was highlighted by third parties, as KPMG did not have the necessary organisational procedures. As the SEC put it,

    "KPMG lacked adequate policies and procedures designed to prevent and detect independence problems caused by investment of the firm's surplus cash. The failure constituted an extreme departure from the standards of ordinary care, and resulted in violations the auditor independence requirements imposed by the Commission's rules" (SEC press release, 14 January 2002, p 6).

  In principle, there is possibility that an understanding of the context of audit failures may be enhanced by investigation of the files of accountancy firms. However, as the next part shows the affairs of accountancy firms are organised in such a way that they obstruct investigations by regulators.


  Accountancy firms have been in the vanguard of globalisation. Increasingly, they secure audits of major corporations by parading their "global" credentials (US Senate, 1992). With the aid of private sector organisations, such as the International Accounting Standards Board (IASB) and the International Auditing Practices Committee (IAPC), the firms have sought to develop standards and pronouncements that might reduce their training costs, dilute liabilities and hence increase profits. The same vigour appears to be missing in developing organisational structures that would enhance accountability or require accountancy firms to co-operate with local/global regulators. Four examples illustrate the arguments. These relate to US$10 billion frauds resulting in the closure of the Bank of Credit and Commerce International (BCCI), audit failures at Barings and US$1 billion at International Signal and Control Group, part of Ferranti plc, a major UK defence contractor.

  In July 1991, amidst allegations of fraud, the Bank of England closed down the Bank of Credit and Commerce International (BCCI), considered to be the "world's biggest fraud" (Killick, 1998, p 151). At the time of its closure, BCCI operated from 73 countries and had some 1.4 million depositors. Whilst there has been no independent investigation of the real/alleged audit failures in the UK, an inquiry by the US Senate concluded that "Regardless of the BCCI's attempts to hide its frauds from its outside auditors, there were numerous warning bells visible to the auditors from the early years of the bank's activities, and BCCI's auditors could have and should have done more to respond to them. The certification by BCCI's auditors that its picture of BCCI's books were "true and fair" from 21 December, 1987 forward, had the consequence of assisting BCCI in misleading depositors, regulators, investigators, and other financial institutions as to BCCI's true financial position"[37] (US Senate, 1992, p 4).

  An examination of the working papers and files of the BCCI's auditors, Price Waterhouse (PW), had a considerable potential to provide public information about the organisational practice of auditing firms. It could also have provided some pointer for possible reforms. The US Senate sought access to auditor files. Despite claiming to be a "global firm" Price Waterhouse remained reluctant to co-operate with international regulators. An investigation of BCCI by New York state banking authorities was also frustrated by the auditors' lack of co-operation. The New York District Attorney told the Congress that

    "The main audit of BCCI was done by Price Waterhouse UK. They are not permitted, under English law, to disclose, at least they say that, to disclose the results of that audit, without authorization from the Bank of England. The Bank of England, so far—and we've met with them here and over there—have not given that permission.

    The audit of BCCI, financial statement, profit and loss balance sheet that was filed in the State of New York was certified by Price Waterhouse Luxemborg. When we asked Price Waterhouse US for the records to support that, they said, oh, we don't have those, that's Price Waterhouse UK.

    We said, can you get them for us? They said, oh, no that's a separate entity owned by Price Waterhouse Worldwide, based in Bermuda." (US Senate 1992, p 245)

  BCCI's auditors also refused to co-operate with the US Senate Subcommittee's investigation[38] of the bank (US Senate 1992, p 256). Although the BCCI audit was secured by arguing that Price Waterhouse was a globally integrated firm (US Senate, 1992, p 258), in the face of a critical inquiry, the claims of global integration dissolved. Price Waterhouse (US) denied any knowledge of, or responsibility for the BCCI audit which it claimed was the responsibility of Price Waterhouse (UK). Price Waterhouse (UK) refused to comply with US Senate subpoenas for sight of its working papers and declined to testify before the Senate Subcommittee on the grounds that the audit records were protected by British banking laws, and that "the British partnership of Price Waterhouse did not do business in the United States and could not be reached by subpoena" (p 256). In a letter dated 17 October, Price Waterhouse (US) explained that the firm's international practice rested upon loose agreements among separate and autonomous firms subject only to the local laws:

    "The 26 Price Waterhouse firms practice, directly or through affiliated Price Waterhouse firms, in more than 90 countries throughout the world. Price Waterhouse firms are separate and independent legal entities whose activities are subject to the laws and professional obligations of the country in which they practice. . ..

    No partner of PW-US is a partner of the Price Waterhouse firm in the United Kingdom; each firm elects its own senior partners; neither firm controls the other; each firm separately determines to hire and terminate its own professional and administrative staff . . . each firm has its own clients; the firms do not share in each other's revenues or assets; and each separately maintains possession, custody and control over its own books and records, including work papers. The same independent and autonomous relationship exists between PW-US and the Price Waterhouse firms with practices in Luxembourg and Grand Cayman" (US Senate, 1992, p 257).

  Accountancy firms have no difficulty in making claims of being "global" to win business. But in the face of questions about accountability such claims are easily dissolved. The same is encountered in other episodes as well. Enron is known as the world's biggest bankruptcy. The US authorities have alleged that the London Offices of auditors, Arthur Andersen' shredded key documents to escape prosecution. In response to lawsuits and request for documents, the firm is now saying that Arthur Andersen is not global. An official statement said that "Arthur Andersen LLP [the US firm], an autonomous member firm of the Andersen Worldwide SC organisation, contracted with, performed the audits of, and signed the audit opinions on Enron's financial statements. Accordingly, Arthur Andersen LLP is the only proper defendant in claims relating to that audit opinion". John Ormerod, managing partner of Andersen in the UK, said: "Naming our firm as a defendant has no legal basis. While we have sympathy for those affected by Enron's failure, Andersen in the UK has no obligation to satisfy the legal liabilities of other member firms." [39]

  The third example looks at Barings. On 26 February 1995, amidst revelations of £827 million frauds, Barings Plc collapsed (Bank of England, 1995). For many years prior to the collapse, Barings had been audited by Coopers & Lybrand (C & L). The Singapore office of C & L was appointed to audit the affairs of Baring Futures (Singapore) Pte Limited (BFS) for the year to 31st December 1994. The 1992 and 1993 accounts of BFS were audited by the Singapore office of Deloitte & Touche (D & T) who reported to C & L London for the purposes of its audit of the consolidated financial statements of Barings plc C & L audited all other subsidiaries of Barings in 1992, 1993 and 1994 either through its London office or other offices spread around the world. As part of its inquiry, the Bank of England (BoE) sought access to the auditor files but the audit firms did not cooperate The BoE noted,

    "We have not been permitted access to C & L Singapore's work papers relating to the 1994 audit of BFS (Baring Futures (Singapore) Pte Limited) or had the opportunity to interview their personnel. C & L Singapore has decline our request for access, stating that its obligation to respect its client confidentiality prevents it assisting us" (Bank of England, 1995, p 15).

    "We have not been permitted either access to the working papers of D&T or the opportunity to interview any of their personnel who performed the audit. We do not know what records and explanations were provided by BFS personnel to them" (Bank of England, 1995, p 153).

  The organisational structures and practices of accountancy firms also came under scrutiny in the aftermath of the financial problems at Ferranti, caused by the US $1 billion fraud at one of its subsidiaries, International Signal and Control Group Plc (ISC). The company was primarily engaged in the design and manufacture of military equipment. In 1987, the ISC and its subsidiaries, including a company called Technologies, were acquired by Ferranti. Technologies had factories head office in the US and was audited by Peat Marwick Mitchell (PMM), subsequently part of KPMG. The balance sheet of Technologies included some suspect contracts. Over a period of time $1 billion worth of fraudulent contracts had been placed on ISC's balance sheet. Some directors of ISC had been engaged in a massive fraud and money laundering operation through shell companies Panama, Switzerland and the US. The company's directors allegedly laundered $700 million through the network of Swiss and US bank accounts. Fictitious contracts and transactions were created through offshore companies to boost profits. Following an investigation in 1988, ISC's founder and director was prosecuted. He pleaded guilty and was given a prison sentence. Ferranti bought the company without any knowledge of the frauds and sued auditors for negligence. An out of court settlement of £40 million was reached.

  In response to complaints, the Joint Disciplinary Scheme (JDS), an organisation operating on behalf of the UK accountancy trade associations, was asked to investigate the matter. It sought sight of the audit working papers for the period 1986-89. Its report noted that.

    "It quickly became clear that a substantial part of the audit work for Technologies had been undertaken on behalf of PMM in London by the American firm of the same name . . . considerable difficulties were experienced in gaining such access . . . I was informed that it was not that firms' policy to make papers available in situations of this kind. . .. Copies of the American firm's working papers were eventually made available, "exceptionally and in order to assist the investigation", at the offices of a law firm in New York. . .. The copy files produced in New York were inadequate for the purposes of the investigation and it was necessary to arrange access to be gained to the original files. I was told that these were in the possession of the US Attorney in Philadelphia. My investigating accountant went there to examine them. They discovered that many of the files relevant for my purpose had remained in the possession of PMM. The firm had considerable difficulty in locating these files. Once they had been found a third visit to America was arranged. My investigating accountants were not permitted to photocopy relevant material or any of American firm's files, rendering extensive note-taking necessary" (Joint Disciplinary Scheme, 1996, p 7).

  The auditing industry and its regulators seem to be aware of the culture of non-cooperation, but have been reluctant to scrutinise the practices and policies that give rise to them.


  In market economies, auditing is regulated through a variety of formal and informal processes. These include the education and training of accountants, the legal environment and the formal regulatory arrangements, often involving the state and accountancy trade associations. However, little attention is directed at the capacity of organisational practices and cultures of accountancy firms to facilitate audit failures and harms to a wide variety of people.


  Most of the auditing education, especially professional education, is primarily technical in nature. Considerable attention is paid to learning the official auditing standards and other pronouncements without a study of the practical politics of auditing. Such studies can show that auditing standards are often driven by the auditing industry's concerns to minimise its responsibility and liability (Sikka, 1992). They rarely pay any attention to the organisational practices of accountancy firms, or open them up to public scrutiny. Auditing education rarely focuses upon the theories underpinning auditing knowledge, far less consider its limitations and failures (Sikka, 1987; Puxty et al., 1994). Almost every week, newspapers highlight new audit failures. Yet students are forced to learn knowledge that has already explicitly failed. No questions are raised about the domination of auditing standard setting by the auditing industry, its patrons, its values and business interests. The consequences of auditing knowledge and practices could be analysed by discussing audit failures, but such matters rarely form part of auditing education. There is rarely any discussion of the relationships, tensions and consequences arising out of the auditing arrangements that expect capitalist organisations (accountancy firms) to perform social surveillance. The same pattern continues in the post-qualification education. Thus auditing education is neither theoretical nor practical.


  The law has the capacity to affect changes in organisational practices so that the delivery of socially desirable audits and stakeholder welfare is prioritised. It is common practice to require producers of sweets and potato chips/crisps to owe a "duty of care" to third parties, but the same does not apply to producers of audit opinions. The legal position, as summed by the Law Lords in the case of Caparo Industries plc v Dickman and Others (1990) 1 All ER HL 568 is that, generally, auditors only owe a "duty of care" to the company, as a legal person. They do not owe a "duty of care" to any individual shareholder, creditor, pension scheme members or any other stakeholder[40]. A recurring feature of the auditing industry is that the regulator (eg the accountancy bodies) routinely campaign to demand liability and other concessions for auditing firms (Cousins et al., 1998). However, they rarely campaign to secure any concessions for the audit stakeholders, or consider the consequences of their campaigns for the institutionalisation of audit failures.

  Interestingly, the government found time and resources to enact the Limited Liability Act 2000 and grant further liability concessions to auditing firms. However, it could not find time or the political will to reverse the Caparo judgement. More recently, the DTI undertook a review of corporate legislation. As a part of this it delegated the review of auditor liability and accountability to a working party chaired by a PwC partner. Naturally enough, the working party opposed any change to the liability position and did not come with a single suggestion for making audit firms accountable to stakeholders. It failed to consider why in the absence of a "duty of care" auditing firms would have any economic incentives to reflect upon the negative social consequences of their activities.


  The overall responsibility for regulating the UK auditing industry rests with the Department of Trade and Industry (DTI). From time to time, it appoints inspectors to examine unexpected corporate collapses and frauds. As part of the inquiries, the inspectors may focus upon the conduct of company audits. The DTI does not have an adequately resourced in-house investigation unit. Instead, it appoints partners from major accountancy and law firms to act as inspectors. The inspectors rarely examine the impact of organisational culture and values on audit failures. Some of the inspectors reports have been suppressed whilst others take many years to publish (Sikka and Willmott, 1995b; Department of Trade and Industry, 2001). For example, the Maxwell report appeared some ten years after the event and the report on Queens Moat Houses (authorised in 1993) is yet to see the light of the day. The DTI has failed to appoint an inspector to investigate frauds at BCCI, Polly Peck, Levitt, Resort Hotels and other cases.

  By holding out the threat of punitive action, the DTI could create the economic incentives for accountancy firms to reflect upon the consequences of their anti-social practices. However, it has rarely prosecuted any auditing firm or its partners for delivering poor audits, or mounted a fuller investigation into the organisational culture of the firms implicated in audit failures.

  Since the Companies Act 1989, the accountancy bodies have been formally empowered to act as regulators of the UK auditing industry. As part of their regulatory obligations, they licence, monitor and discipline auditors and also investigate instances of real/alleged audit failures. As part of their monitoring duties, the regulatory bodies could specifically examine the impact of organisational practices upon audits, but they seem unwilling or unable to scrutinise the organisational context and practice of auditing. Instead, they claim that "the main purpose of practice monitoring is to monitor compliance with auditing standards, rather than to obtain statistical information about the quality of work being done" (Page 25 of the ACCA's 1992 annual report on Audit Regulation) and that the "principal purpose of monitoring is to enable the ARC's (Audit Registration Committees) to satisfy themselves that registered auditors comply with the Audit Regulations" (page 5 of the 1992 ICAEW, ICAS and ICAI annual report on Audit Regulation). The focus on mechanical compliance with auditing standards (which are not independently formulated) pays little attention to the organisational culture that facilitates conflict of interests, possible falsification of audit work and the institutionalisation of audit failures.

  The public has a right to know the identity of producers of goods/services who produce goods/services of unacceptable quality. But the accountancy bodies do not act in the public interest. When the ICAEW was asked for the names of the firms whose work has failed to meet its standards, it replied:

    "It is not our practice to provide lists of firms visited other than to the Audit Registration Committee" (letters dated 1 December 1992 and 5 February 1993).

  The public bears the cost of regulation but is not given information about the poor standards of auditing.

  In principle, accountancy bodies could support calls for changes to the legal and institutional structures so that the auditing firms are persuaded to revise organisational structures and values that construct an audit. However, their position is compromised by the pursuit of narrow economic interests. Despite acting as statutory regulators, they routinely side with the producers/sellers of audits (Cousins et al., 1998; Mitchell et al., 1998) and consider themselves to be primarily "responsible for protecting and promoting the interests of (their) members" (Certified Accountant, September 1991, p 12). In pursuit of such policies, they have a history of opposing any association of audits with detection and reporting of fraud (Sikka et al., 1998). Even in the aftermath of the closure of the Bank of Credit and Commerce International (BCCI), the auditing industry opposed the imposition of any "duty" to report financial irregularities in financial businesses (eg banks, insurance and financial services companies) to the regulators (Bingham, 1992). The accountancy bodies have often sided with corporate elites to oppose change. For example, they have opposed obligations for companies to publish the profit and loss account, balance sheet, market value of assets, group accounts, movements on reserves, audit reports, corporate turnover, payments to auditors for non-audit work and the need for companies to have independent audit committees, just to mention a few (Puxty et al., 1994). The position adopted by the accountancy bodies sees the social problems from the perspective of the auditing industry and its patrons, and rarely from the perspective of the wider public that might be affected by their policies. Overall, the regulatory activities do no focus upon the organisational practices and values that give rise to audit failures.


  Auditing functions as a technology that facilitates harms to many stakeholders. Audit failures are highlighted by unexpected corporate collapses and scandals rather than by accountancy firms or their regulators. As long as a company survives, the audit failures continue to be glossed over. In times of recessions and economic downturn, the frauds and fiddles can no longer be covered and audit failures come to light. Audit failures have played a part in the loss of jobs, homes, savings, taxes, pensions and investments. Audit failures are crafted by the culture and organisational practices institutionalised within accountancy firms. However, they are rarely subjected to any critical scrutiny by the state or the regulators.

  Audits are performed by "private" commercial organisations. In common with other capitalist organisations, the requirement to increase fees and profits shapes their organisational practices and culture. The evidence cited in this paper shows that in pursuit of profits, accountancy firms standardise audits and exploit labour, expecting staff to work excessive hours for no/little pay. Some staff respond to such pressures by resorting to irregular auditing practices, unauthorised short-cuts and falsification of audit work. Despite the proliferation of auditing standards on planning, controlling, recording and review of audits (Auditing Practices Committee, 1980), the audit working papers are not necessarily reviewed by another partner/manager. Firms routinely destroy notes and files that might assist investigators (Department of Trade and Industry, 1995, p 324-325). Despite laws strengthening the position of resigning auditors, accountancy firms seem to be keen to walk away quietly. To advance their economic interests, audit firms seem to enter into private deals with company directors, assuring them that they will obstruct inquiries and not easily provide meaningful information to stakeholders. Some accountancy firms have also devised organisational structures that thwart co-operation with the regulators. They are headquartered in offshore financial centres that are known for their secrecy and lack of co-operation with international investigators and regulators (Mitchell et al., 2002). Such structures and practices are the result of carefully nurtured organisational policies and values, put in place after careful discussions amongst partners and with legal advisers. The organisational practices seek to advance the short-term economic interest of auditing firms and provide the context for understanding audit failures.

  In an environment that links performance to profits, bonuses, salaries and promotion accountancy firms (and their partners) are not keen to offend corporate sensitivities, as a reputation for being troublesome may not be conducive to securing auditing and lucrative consultancy business. Audit failures "reveal shortcomings in both vigilance and diligence" and "a failure to achieve an appropriate degree of objectivity and scepticism" (Joint Disciplinary Scheme, 1999). Rather than focusing attention upon the role of organisational cultures and practices in facilitating audit failures, the tendency of the auditing industry and its regulators is to deflect attention. The typical strategy has been to individualise audit failures (Sikka, 2001), blame company directors, corporate governance practices, lax accounting standards and the expectations of significant others (Sikka et al., 1998). This way, the organisational practices and values responsible for audit failures remain shielded from scrutiny and audit failures remain institutionalised.

  Some questions about organisational practices could be raised by the availability of meaningful information. However, accountancy firms are some of the most secretive organisations in the world. Little is known about their financial[41] and organisational[42] affairs. Information about auditor relationships with companies, conflict of interests, details of the audit team, audit contract, audit effort, profitability and contents of auditor files is remarkably scarce. In principle, the imposition of stringent liability and "due care" laws could persuade accountancy firms to reflect upon the consequences of their organisational practices. However, the legal environment is weak and the UK auditors do not owe a "duty of care" to individual shareholder, creditor or other stakeholder. Due to inequalities in wealth distribution and cuts in legal-aid, many injured stakeholders do not have the necessary financial, legal and political resources to challenge the firms and facilitate a public scrutiny of their organisational practices. The regulators could generate pressure for changes in cultures dominating accountancy firms, but they have a close and cosy relationship with auditing firms. The auditing industry is regulated by the accountancy trade associations who are also responsible for promoting and defending the industry. To be effective regulators also need economic pressures, but they do not owe a "duty of care" to anyone relying upon their monitoring, licensing and disciplining activities.

  Problems of auditing are the result of the business ideologies. Yet no auditing regulator is examining the shift in capitalist economies. The 1980s and the 1990s are characterised as marking a major shift (in the Western world) from industrial capitalism to finance capitalism where money itself has become a commodity. Due to technological developments, money can easily roam the world. There is no longer any relationship between money, credit and the productive economy. Rather than directly investing in the production of goods and services, corporations make money by placing clever bets (gambling or hedging) on interest rate movements, exchange rates, security prices, commodities and land speculation. Under such circumstances, traditional ex-post audits are of limited use. Not surprisingly, many of the major scandals and audit failures have occurred in the financial sector (BCCI, Savings and Loan, Levitt, Barlow Clowes, Wallace Smith, Barings, Yamaichi). Yet this malaise is no longer restricted to just the financial sector. Companies in all sectors are pursuing get-rich quick schemes, Enron, primarily an energy company had been heavily engaged in financial engineering. Major companies (Enron, BT, NTL, Vodaphone NewsCorp) are funding their growth by debt rather than equity. Enron was one of the world's largest traders in derivatives. The value of corporate debt (unlike bank loans) is not fixed. This debt-fuelled economy requires new reflections on accounting, auditing and regulation. Are ex-post audits of any use? Should banks have real-time audits? Such questions cannot be considered by accountancy trade associations or the Accounting Standards Board (ASB) since they are concerned with micro issues and do not always consider the macro developments.

  The socio-economic changes call for reflections on new economic developments and alternative modes of audits. Faced with the changing social context, auditors have sought refuge in traditional "duty of confidentiality" to client. This prioritising of "private" interest over the "public" interest has injured numerous bank depositors, pension scheme members and other stakeholders. Clearly new institutional and legal practices are called for. These could include the performance of audits by the staff of the regulators. Taxation authorities (eg Inland Revenue, Customs and Excise) are already empowered to conduct independent audits of specific aspects of business. Could their jurisdiction not be extended? The employees of the regulators (eg the Financial Services Agency) could conduct audits. Unlike the BCCI auditors, they would not easily be able to hide behind the veil of "confidentiality" and refuse to co-operate with regulators. Neither will they be able to act as consultants to the audit clients and acquire a vested business interest. Auditors frequently claim that the public does not understand the functions and purposes of an audit. Therefore, it can't have too many objections, if the representatives of the public takeover the external audit function.

  As the auditing industry has "ditched any pretence of their being public spirited" (Hanlon, 1994, p 150), its interests should be secondary to those concerned with the protection of stakeholders. Subject to suitable safeguards, it does not matter who conducts audit or forces corporations to be accountable. The development of alternative policies can enrich public debates. It could be argued that external audit be made non-mandatory and replaced with new public policies. One could require all companies and their directors to have compulsory insurance (say some multiple of gross assets) so that adequate protection is available to stakeholders against fraud The second policy would require the introduction of legislation that specifies (or authorises a regulatory body to specify) the kind of information which companies must publish. Failure to publish the required information and maintain adequate insurance cover would be a criminal offence and would make directors personally liable for company's debts. As insurance premiums would be dependent upon some estimation of risk, insurance companies could ask accountancy firms to make appropriate investigations and report. In such circumstances, the insurance companies and the auditing firms would have to negotiate the terms on which corporate risks are to be assessed. It is also likely that many auditing firms would have to accept fraud detection/reporting as an objective of each assignment, possibly in return for a negotiated ceiling on liability. Under such scenarios, the audit function (as we now understand it) would in practice be taken over by the insurance industry, but the public would have considerable protection from frauds. Do the governments have the desire to think new policies?

  If the current policies are to be pursued then, ideally, company directors should have no say in the appointment and remuneration of auditors. Audits of major companies should be carried out by a government department. Government should empower the National Audit Office, Inland Revenue and Customs and Excise to perform company audits. This might not only produce independent audits but also increase the tax revenues, as auditors would be less willing to go along with doubtful practices. Whose visit is likely to worry company directors more? The visit from Inland Revenue or a visit from the local accountancy firm? However, we do not live in an ideal world. Governments are unlikely to have the backbone to support such proposals. Accountancy firms and their patrons would mobilise their economic and political resources to oppose anything that tightly curbs their ability to mould financial statements.

  Therefore, one is looking for the ninth best solutions. The solutions have to be appropriate for dealing with a powerful industry that routinely fails and harms innocent people. If audits are to be conducted by the private sector then a large number of reforms are needed. Some are mentioned below:

    —  Instead of 23 separate regulators, a single statute-based independent regulator, namely a Companies Commission, should regulate accountancy business. It should take over all the licensing and monitoring powers currently exercised by the accountancy trade associations.

    —  The members of the Commission must sever all connections with their employers so that unlike their part-time counterparts in the current ASB and APB, they can speak openly on all issues without fear of sanctions by their paymasters. To minimise the chances of "capture", members should serve for a maximum of five years. Accounting and auditing issues are essentially about wealth distribution, accountability, risk management, social justice and fairness. Therefore, the membership should reflect a wide constituency. Accountants, as technical experts, should be available in an advisory capacity. Structures and processes should not be dominated by the cloak of technical interests. The assumed technical experts should not be able to formulate social policies under the guise of "techniques" to mystify others.

    —  The Commission should meet in the open and pursue a "full sunshine" policy. Agenda papers and minutes should be accessible to any member of the public on the payment of modest fees. The composition and terms of reference of all working parties should be announced and the results of votes publicly available.

    —  Public hearings should be an integral part of the accounting/auditing standard setting process. It should be an offence for two or more members of the regulatory body to meet in private and fix the contents of proposed regulations. Indeed, at the beginning of each meeting, members should clearly state that they have not violated this requirement.

    —  Unlike the present position, the regulator should owe a "duty of care" to the parties affected by its decisions.

    —  Complaints against the Commission should be investigated by an independent Ombudsman with periodic scrutiny from the Parliamentary Trade and Industry Select Committee.

    —  The Companies Commission should each year review the changes in the economy and consider the resulting changes needed in accounting and auditing.

    —  The Companies Commission should consider ways of expanding supply of auditors. For example, by authorising new organisations (eg Inland Revenue, National Audit Office) to conduct company audits.

    —  The Companies Commission should have its staff to investigate incidences of audit failures and publish speedy reports.

    —  The Companies Commission should have a statutory right of access to all auditor working papers. It shall have powers to investigate the overall standards and organisational practices of firms implicated in audit failures.

    —  The Companies Commission should have the right to pass copies of auditor working papers to recognised international regulators. Thus accountancy firms should not be able to obstruct (as in the case of Enron, BCCI, Barings, International Signal Corporation Group) international inquiries.

    —  The Commission shall have the powers to fine and prosecute firms. It shall also secure undertakings from the firms eg to improve their quality control and organisational practices.

    —  To ensure that the public is protected, the Commission shall list the names of the firms whose standards have been found to be inadequate during any monitoring visit.

    —  Auditors and stakeholders should be able to see a judicial review of the recommendations of the Commission.

    —  Companies should have directly elected (eg by shareholders and employees) non-executive full-time directors. They should not be able to hold numerous directorships simultaneously. The non-executive directors should seek suitable auditors and make appropriate recommendation to stakeholders. Stakeholders should be able to field alternative candidates for the office of the auditor.

    —  Company auditors shall be elected by a simple vote of individual shareholders, employees and bank depositors, where appropriate. Directors shall not be able to subvert this decision by casting proxy votes.

    —  Auditors should act exclusively as auditors. The state guaranteed mark of external auditing was not given to accountants to enable them to use it as a stall for selling other services. Auditors should not be allowed to sell consultancy services to any audit client. Neither the audit firm nor any of its associates shall be a party of any part of the financial statements being audited. In reality, Auditors have become personnel departments and extensions of finance departments of the companies they audit. In Germany auditors are prohibited from selling consultancy services to audit clients. In the UK, the Audit Commission appoints local authority auditors. They are generally prohibited from selling consultancy services to the local authorities that they audit. In the corporate sector, auditing firms devise tax avoidance schemes, off-balance sheet financing schemes, dream up creative accounting ideas, corporate strategy, write-up books, advise on mergers, acquisitions and factory closures. All this makes them as dependent as any other door to door salesman. It compromises their independence. The auditors are expected to act as referees and umpires, but their reliance on directors and their financial involvement with the companies give them little incentive to report unsavoury practices. They cannot be independent of the directors and have acquiesced to numerous novel accounting practices. As the accountancy trade associations frequently claim, "the auditors not only needs to be, but must also be seen to be independent".

    —  At every AGM there should be a declaration that the directors have not used auditors or any of their associates for any non-auditing services.

    —  No auditor shall remain in office for a period exceeding five/seven years. In France, auditors are changed every seven years and it works fairly well. The longevity of the auditor's term in office played a part in auditor silence at Maxwell, Levitt, Polly Peck, Grays Building Society and many other places. A fresh broom and eyes are highly desirable.

    —  Where the company's auditors have been changed during the year then a report shall be filed with the Registrar of Companies stating the matters discussed by the directors with the proposed auditors. If any of the company's accounting policy changes coincide with the replacement of auditors then they shall be explained and the auditors should state whether they have agreed to such changes. "Opinion shopping" is a widespread phenomena in the UK. Directors approach auditing firms and ask whether they approve of particular accounting policies, frequently designed to show company performance in the best possible light. Directors have economic incentives to go "opinion shopping, as their salary, pensions, perks and bonuses are increasingly linked with accounting measures rather than market shares, innovations, quality of production as happens in Japan and Germany. The legal fiction is that auditors are hired and fired by shareholders. The practical reality is that auditors are hired and fired by directors and they can be in close collusion even to the extent to devising tax, transfer pricing and other accounting dodges. For all practical purposes, directors are the "clients" of auditors. Auditors depend upon directors for their continuation in office and in the face of competition from other firms, they are all too willing to push accounting interpretations to the limit. Public disclosure is a vital means of alerting the public.

    —  Auditors duties should be clarified by statute. The Companies Acts spell out the directors' duties in considerable detail. Similar detail is absent for auditor responsibilities. The auditing industry is quite happy for it prefers vague arrangements which enable it to shield its fee earning opportunities. The professional bodies claim that auditors are not responsible for detecting and reporting fraud (after BCCI the financial sector auditors have a "duty" to report irregularities to the regulators) or for commenting on business efficiency, effectiveness and financial soundness etc. Yet such audit objectives are common place in the public sector. Auditors of all PLCs should be required to report any material fraud or irregularity which they come across during their normal audit, to the appropriate regulators.

    —  Auditor working papers should be available for inspection by designated representatives of stakeholders (eg a directly elected audit committee).

    —  No member of the audit team can obtain paid employment with an audit client for a period of five years since the last audit visit.

    —  Auditors shall owe a "duty of care" to the individuals who are shareholders, creditors, pensions scheme members and employees at the date of the audit report This means that auditors are not liable to an indeterminate number of people.

    —  The incoming auditor should have statutory right of access to the files and working papers of the outgoing auditors. This will enable them to make a better and informed assessment of the desirability of the client and also appreciate the validity, or otherwise, of the statements issued by the resigning auditor.

    —  Anyone authorised to conduct the audit of a public limited company should be required to publish meaningful information their affairs. They should be required to file copies of the audit contract, audit tender, report on companies internal controls, composition of the audit team, relationship with company directors, assurance given/received from directors, conflicts of interests, details of meetings held with the audit committee, and so on.

  If we are to transform the existing practices, then a first step must be to create a framework which allows various voices, so far stifled, to be heard. The opening up of structures can advance competing discourses and values, something that is essential if real and emancipatory change is to take place. A strengthened regulatory, legal and accountability environment would give auditors incentives to reflect upon their narrow pursuit of economic interests.

  Perhaps the above suggestions are too provocative. They are sure to be opposed by the auditing industry which has a long history of opposing change (Puxty et al., 1994, Bingham, 1992). Yet can the auditing industry be constantly permitted to hold the public to ransom and to dissociate itself from the consequences of its own failures.


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26   "Risk" is a fairly loose term. In everyday language "risks" tend to be associated with hazards, dangers, threats or harms. Back

27   In the early 1990s, Enron outsourced its internal audit function to Arthur Andersen. Back

28   The US Department of Justice (press release, 14 March 2002 has formally charged Arthur Andersen with criminal conduct). Back

29   The term "culture" is subject to considerable debate. Things in themselves rarely have any meaning. It is the participants who give meaning to practices and situations. In the context of this paper, "culture" is understood as the production and exchange of meanings within an accountancy firm. It is constantly produced and exchanged in personal and social interaction. Meanings also regulate and organise the conduct of daily life (Hall, 1997). Back

30   The accounting numbers forming the basis of mathematic models are themselves the product of the politics of the time. Back

31   Ironically, they are also threatening the survival of Enron's auditors, Arthur Andersen. Back

32   The omissions and oversights were enough to persuade one commentator to conclude that "what in a working-class occupation would be seen as blatantly corrupt, in a middle-class one is seen as a badge of pride" (Jenkins, 1999). Back

33   According to government ministers, "unless the auditor uses a statement for some improper purpose-for instance, he is malicious in the legal sense-no person who is criticised will be able to sue him successfully for libel" (Hansard, House of Lords Debates, 5 April 1976, col 1488). Back

34   Curiously, Peter Aigner was simultaneously appointed a DTI inspector to investigate auditor failures whilst the conduct of his own audits was under investigation. The DTI did not publish the final report. Back

35   Such claims are easy to make, as auditing firms are some of the most secretive organisations. Nevertheless, on occasions authoritative investigators have associated audit failures with the sale of consultancy services to audit clients (US Senate, 1992; Department of Trade and Industry, 1976, 1979). Back

36   The Banking Act of 1987 required regular meetings between bank management, auditors and the Bank of England to discuss matters of mutual interest. The auditors' traditional duty of confidentiality to client companies was relaxed to allow them to report matters to regulators provided they acted in "good faith". Back

37   It may be argued that auditors did no wish to qualify the accounts of a bank, for the fear to causing a run. However, in 1999 PricewaterhouseCoopers issued a qualified report on the 1997-98 accounts of the Meghraj Bank, a major Asian bank with branches in the UK (Financial Times, 19 May 1999, p 23). Back

38   Price Waterhouse (UK) partners did agree to be interviewed by Subcommittee staff in PW's London office. The offer was declined due to concerns that the interviews would be of little use in the absence of subpoenaed documents (US Senate, 1992, p 258). Back

39 (accessed on 10 April 2002). Back

40   Most of the major lawsuits are usually by one accountancy firm (in its capacity as a receiver or liquidator) against another (Cousins et al., 1998). Back

41   Despite campaigning to secure the right to trade as limited liability companies, most audit firms shunned this possibility because "firms have always stood out against revealing any financial information except their annual fee income" (Accountancy, April 1994, p 26) and that "the obligation on (auditing firms trading as) companies to publish their accounts is perceived as a considerable drawback" (The Accountant, September 1991, p 2). Back

42   Little is known about the organisational structure of major accountancy firms. The US Senate's hearings on the closure of the Bank of Credit and Commerce International (BCCI) showed that Price Waterhouse(UK) is owned by Price Waterhouse Worldwide, based in Bermuda (United States, Senate Committee on Foreign Relations, 1992). Back

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