Select Committee on Treasury Appendices to the Minutes of Evidence


Further memorandum submitted by Professor Prem Sikka

  I have recently become aware that the published "Minutes of Evidence", dated 16 April 2002, contain remarks by Mrs Fearnley, Mr Brandt and Professor Beattie on the oral and written evidence that I previously submitted to the Committee.[17] When commenting upon the work of fellow academics, it is customary to provide a copy of the commentary and invite a reply. However, for the reasons best known to Messrs Fearnley, Brandt and Beattie, the usual courtesies have not been extended to me. One can only speculate about their motives since they have close links with accountancy trade associations and accountancy firms. Nevertheless, I am happy to respond to their observations and put matters on the public record.

My Evidence is Old

  In a world where God is considered to be dead, no evidence or argument is sacred. However, due to the prevailing social conventions some evidence is ascribed a certain kind of hardness. In this context, the reports prepared by the government are ascribed a certain kind of hardness and given some credibility.

  I cited DTI inspectors' reports to show that poverty of auditing practices and concerns about auditor independence are not new. The impairment of auditor independence due to the provision of consultancy services and the longevity of auditor appointment has been highlighted in some DTI reports. Yet the DTI has done nothing about such concerns. It routinely refers the matters to accountancy trade associations who have been only too glad to sweep the matters under their dust-laden carpets.

  It has been difficult to cite more recent DTI reports. Major frauds at Maxwell, Guinness, Blue Arrow and others resulted in legal action by government agencies and were documented in the DTI inspectors' reports. In the light of evidence, the possibilities of accounting and auditing reforms could be discussed. However, the government policies seem to have shifted. Though legal action was taken against some of the individuals involved in the Polly Peck, Resort Hotels, Levitt and the BCCI frauds, it was not accompanied by the appointment of DTI inspectors. The DTI took nearly 10 years to publish its report on the Maxwell frauds. A report on the irregularities at Queens Moat Houses was commissioned in 1993 but has not yet been published. In 1995, I also published a study (Sikka, P, and Willmott, H, "The Power of `Independence': Defending and Extending the Jurisdiction of Accounting in the UK", Accounting, Organizations and Society, Vol 20, No 6, pages 547-581) which showed that many of the major DTI inspectors' reports have been suppressed without any public statement or announcement to Parliament. It is as though the DTI is shielding the anti-social practices of major accountancy firms from critical public scrutiny. This relationship is highly collusive and should be thoroughly investigated.


  The framework of auditing has certainly changed, but from that it does not follow that it is necessarily stronger.

  Auditors are regulated by accountancy trade associations who have no independence from the auditing industry. Irregularities at Polly Peck, Levitt, Resort hotels, Allied Carpets, Wickes, Wiggins and others have all come to light after the formal appointment of accountancy bodies as regulators. On a number of occasions, the Financial Reporting Review Panel (FRRP) has found that the audited accounts, carrying an unqualified audit opinion, were "defective". The Panel forced the companies to revise their accounts. Yet the auditing regulators have rarely disciplined the auditors issuing misleading audit reports.

  The present auditing regulators have never published a list of firms that they have visited and found wanting. In many cases, the former audit managers and partners became the finance directors and CEOs and were audited by their one-time juniors. The accountancy bodies remained silent. The same bodies did nothing as auditors acted as consultants and remained in office for years. They failed to devise any independent measure of audit quality and did not require accountancy firms to publish any meaningful information about their affairs, clientele, conflicts of interests or anything else. They are aware of research which shows that a substantial part of audit work may be falsified, but have done nothing.

  Despite acting as regulators, the accountancy bodies do not owe a "duty of care" to individuals affected by their activities. They have routinely sided with the auditing industry. For example, they have opposed proposals that would require auditors to owe a "duty of care" to the individuals placing reliance upon published audited accounts. Even in the aftermath of the BCCI scandal, in its evidence to Lord Justice Bingham, the Institute of Chartered Accountants in England and Wales (ICAEW), opposed the need for a statutory "duty" upon auditors to report irregularities to financial sector regulators. During the Committee stages of the Companies Act 1989, the same organisation opposed (speaking through Tim Smith MP and Jeremy Hanley MP) proposals for companies to have independent and elected audit committees. At the same time, they also opposed any need for companies to publish the fees paid to their auditors for non-audit work. Reforms have always been imposed in the teeth of opposition from the accountancy bodies.

  Even on the disciplinary front, the present regulators are inadequate. In January 2002, the auditors of Polly Peck were fined £75,000, some 10 years after the event. Most of the blame was placed on an auditor who had died in the intervening years. The same strategy was used for the Maxwell auditors. The public is still waiting for any action against the BCCI auditors.

  Accounting standard setters can continue to provide tough accounting standards, but time and time again the auditors have colluded with companies to ignore them, or have simply been bought out. The anti-social practices of major auditing firms are a problem. Until they are effectively regulated and controlled, there is little prospect of taming companies and their executives.

  In any system of regulation, there is a concern that the regulators will be "captured" by those to be regulated. In the auditing industry, that has been the starting point. Self-regulation has failed. The present auditing regulators have no sense of public responsibility and they cannot be independent of the auditing industry, which finances them. There is an urgent need to provide independent and robust regulation for the auditing industry.


  Money laundering is a major concern. But the accountancy bodies and their sponsors have done little to check the anti-social practices.

  The IMF and the OECD estimate that around $1.6 trillion is laundered each year. Most of the money comes from tax evasion, illicit trading, narcotics, bribery, smuggling, murder, slavery, pornography, robberies and prostitution. The illicit cash is turned into cybercash and transactions through shell companies and bank accounts. Accountants and lawyers, whose main concern is to secure private fees, front many of these. Their reward is around 20 per cent of the money laundered. No one can launder large amounts of monies without the direct or indirect involvement of accountants. Accountants report less than 1 per cent of the suspicious transactions reported to the National Criminal Intelligence Service (NCIS).


Total Disclosures
Disclosures by Accountants
Disclosures by Solicitors

Source: Annual Reports of the National Criminal Intelligence Service.

  Each year the NCIS complains that accountants do not report money laundering and suspicious transactions to it. In response, the DTI Ministers wring their hands and the accountancy trade associations make pious statements. The "Proceeds of Crime Bill" proposed to make it a criminal offence for accountants not to report any suspicions or dubious transactions to the National Criminal Intelligence Service (NCIS), as well as the Inland Revenue. In response, the ICAEW claims that the "government plans to crack down on money laundering could be very damaging economically and pose a serious threat to the role of the accountant" (, 6 June 2001).

  Evidence relating to the involvement of accountancy firms in money laundering is not hard to find. I have published an extensive study of one case in which Lord Justice Millett (AGIP (Africa) Limited v Jackson & Others (1990) 1 Ch 265 and 275) pointed the finger at accountants and accountancy firms. In this case, 27 separate companies, incorporated in London by a major accountancy firm, were used to launder money, making it difficult to trace the source and destination of the proceeds. The paper trail went from Tunisia, London, the Isle of Man and Jersey to France and beyond. Most of the companies never traded but millions passed through their bank accounts. Accountancy firms collected fees for forming, operating and liquidating the shell companies. Depite the very clear and strong court judgment, there was no independent investigation or inquiry. The ICAEW and the UK government did the usual whitewash.

  The study, "The Accountants' Laundromat" is attached. It was published by the Association for Accountancy and Business Affairs (AABA). As its director, I waive all copyrights and would invite the Treasury Committee to place it on the public record.[18]

  To maintain their growth in profits, some major firms have little hesitation in bribing officials to ensure that their "private" interests triumph over the wider social interests. The Manhattan district attorney told the US Senate Permanent Subcommittee on Investigations that major accountancy firms are laundering money, bribing officials and facilitating tax evasion. In one episode, "In 1996, the US regulators concluded a case involving the bribery of bank officers in US and foreign banks in connection with sales of emerging markets debt, transactions that earned millions for the corrupt bankers and their co-conspirators. In this case, a private debt trader in Westchester County, New York, formerly a vice-president of a major US bank, set up shell companies in Antigua with the help of one of the "big-five" accounting firms. Employees of the accounting firm served as nominee managers and directors. The payments arranged by the accounting firm on behalf of the crooked debt trader included bribes paid to a New York banker in the name of a British Virgin Islands company, into a Swiss bank account; bribes to two bankers in Florida in the name of another British Virgin Islands corporation and bribes to a banker in Amsterdam into a numbered Swiss account".

  The shell company in the above case went under the name of Merlin Overseas Limited. There was no actual physical business in Antigua, named Merlin. It consisted of little more than a fax machine in a Caribbean office of Price Waterhouse (New York Daily News, 10 January 1999). "This accounting company was complicit", said Robert Morgenthau, the Manhattan district attorney. "They facilitated hiding of bribes that were paid to bank officers, and they provided the officers and directors for those phoney companies." Morgenthau prosecuted the rogue at the centre of the scheme but could not put his hands on Price Waterhouse. The district attorney's office asked Price Waterhouse in Manhattan for help in reaching the people behind Merlin, but the help was not forthcoming. They were told that the Price Waterhouse in Antigua is not the same legal creature as the one in New York.

  Consider another case prosecuted by the Manhattan district attorney. "In 1996, the US Department of Justice came into possession of a tape containing computerised records of a defunct Caymans bank, Guardian Bank and Trust Company. The bank was started by John Mathewson, a businessman from Illinois. Years after opening a numbered Swiss bank account whilst vacationing in the Caymans, he was persuaded by a Caymans banker to start his own bank. According to Mathewson, his application for a bank licence asked for little more than his name, address and previous bank history. The bank was set up and used to launder money for its depositors, 95 per cent of whom were US residents. Fake invoices to enable US citizens and corporations to disguise deposits were used. The government of Cayman sought to block the release of banking information and refused to help the FBI to decode computer records. The official Cayman liquidators of the bank (two partners in another major worldwide accounting firm) brought a suit in the US District Court in New Jersey seeking the return of the computer tape to the Caymans. In their brief, the liquidators argued that disclosure of the contents of the records to, among others, the US Internal Revenue Service would "Have a significant negative impact on the integrity, confidentiality, and stability of the financial services industry of the Cayman Islands. The confidence of the offshore financial community in the privacy afforded to legitimate account holders of Cayman Islands offshore banks is at the heart of the Territory's financial services industry and economy, as a whole. Thus, not only would the bank be irreparably injured by the government's retention of the tape, but the international bank and Eurocurrency industries of the Cayman Islands (and indeed, the economy of the Territory), could suffer irreparable injury as well". After decoding the tape without the help of the Caymans government, the US authorities discovered that the Guardian Bank's US depositors had $300 million offshore, hidden from tax authorities, litigants and creditors. In view of his help to the US authorities, Matthewson was given a five year suspended prison sentence and said, "I have no excuse for what I did in aiding US citizens to evade taxes, and the fact that every other bank in the Caymans was doing it is no excuse".


  Messrs Fearnley, Brandt and Beattie refer to the "systematic empirical research and casual empiricism". They do not say what "systematic" means. Even their own research is based upon access to a handful of selected firms. Yet from that they make generalisations not only in their original submission, but also in their subsequent commentary. Their access was partly conditioned by their closeness to accountancy firms and accountancy trade associations. The truth is that all research is partial because of our social positioning, choice of theories, research methods or access to the subject matter. By default, Fearnley et al, also seem to be suggesting that unless something fits their conception of "systematic" research, it cannot count. Such a world-view privileges obscure academic practices and has disenfranchised the voices of so many people suffering from audit failures and other anti-social practices. Are the concerns of BCCI depositors, Maxwell pensioners, WorldCom employees, Xerox investors and others not to be heard because they do not meet some obscure conception of "systematic"?

  Accountancy firms remain some of the most secretive organisations in the UK. For many years, I have argued that as they enjoy a state guaranteed market of external auditing, they should be required to publish meaningful information about their affairs. This would include matters such as audit tenders, copies of audit contracts, relationships with company directors, composition of audit teams, time spent on audits, conflicts of interests, weaknesses in internal controls, incentives to audit partners, and much more. The Treasury Committee would be aware that audit partners at Enron, Waste Management and WorldCom were incentivised to sell consultancy to audit clients. Their financial reward system encouraged them to use audit as a stall for selling other services. I also believe that auditors' working papers should be freely available to representatives of audit stakeholders (eg directly elected audit committees) and all named domestic and international regulators. Sunshine is the best antiseptic to institutionalised corrosive practices. In the absence of the above information, one can only refer to whatever falls into the public domain. The available evidence shows that lowballing and opinion shopping are common. This is empirical evidence in the sense that it is of this world and relates to the world that people experience. It represents social practices of major organisations. If accountancy firms were to open their files I would be very pleased to conduct a critical scrutiny of their practices.


  Messrs Fearnley and Beattie seem to advocate "rotation of audit partners" rather than the audit firm. This has been totally ineffective. How likely is it that partner B upon taking over the audit from partner A will blow the whistle on audit failures and enable injured stakeholders to seek redress?

  In almost every headline scandal, after a number of years, the firms changed audit partners (such changes also occur because partners leave, retire or die) but this does not bring a fresh pair of eyes, ears or concerns. Rotation of audit firms, say every five years, has a potential to curb the collusive relationships between companies and auditors. This policy can also bring fresher perspectives.

  The whole idea behind the French legislation is to encourage rotation of auditors. In practice, firms tend to be replaced after their term in office has expired.

  Recent events (Enron, WorldCom, Xerox and others) have further highlighted the need to effectively control and regulate major accountancy firms.

  I commend my original proposals to the Committee. I am also willing to provide any further evidence should the Committee so require.

8 July 2002

17   HC758-III, Ev 73. Back

18   Not printed. Back

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