Memorandum from Professor Prem Sikka,
University of Essex
This submission argues (see below) that the
auditing industry has failed to deliver meaningful audits at banks.
Conventional audit model is broken and cannot be repaired. Auditors
cannot be independent of the companies they audit. Auditing is
also a highly profitable business, but auditors enjoy too many
liability shields and lack pressures to deliver good audits. Audit
failures are manufactured within accounting firms but regulators
pay little attention to the organisational culture that produces
the failures. Research shows that a large part of audit work continues
to be falsified but the Financial Reporting Council (FRC) has
done nothing to check this.
Accounting firms may shelter behind claims of
ethics and integrity, but they are involved in money laundering,
tax avoidance/evasion and bribery, corruption and violation of
laws and rules.
Such an industry lacks the necessary social credibility to perform
public interest functions.
Banks, as limited liability companies, are created
the state and it has the ultimate moral and legal responsibility
for their accountability and good conduct. Banks should be audited
on a real-time basis directly by the regulators. Thus regulators
will have timely information about any impending crisis.
Worthless Audit Reports
An early estimate suggested that despite a raft
of accounting standards, banks had around US$5,000 billion of
assets and liabilities off balance sheet (Financial Times,
3 June 2008) though this figure is being constantly revised. Some
banks have shown assets, especially subprime mortgages, at highly
inflated values and derivatives have long been a powerful tool
for inflating company profits by hiding losses and hence the risks
of company operations. The chief executive of a leading financial
advisory business argued that a "big part of the problem
is that accounting rules have allowed banks to inflate the value
of their assets. Accounting has become a new exercise in creative
fiction, with the result that banks are carrying a lot of "sludge"
assets clogging up the balance sheet" (Reuters,
30 October 2008).
Table 1 shows that distressed financial enterprises,
whether in the UK, or elsewhere, received unqualified audit opinions
on their financial statements published immediately prior to the
public declaration of financial difficulties. These opinions were
provided by one of the Big Four accounting firmsPricewaterhouseCoopers
(PwC), Deloitte & Touche (D&T), Ernst & Young (E&Y)
and KPMG. These firms claim to have a combined global income of
over US$96 billion. They also claim to apply the same standards
across their global operations.
| Company|| Country
|| Year End|| Auditor
||Date of Audit Report||Audit Opinion
||Fees Audit||(millions) Non-Audit
| Abbey National||UK
||31 December 2007||D&T||4 March 2008
|Alliance & Leicester||UK
||31 December 2007||D&T
||19 February 2008||Unqualified
|Barclays ||UK||31 December 2007
||PwC||7 March 2008||Unqualified
|Bear Stearns||USA||30 November 2007
||D&T||28 January 2008
|Bradford & Bingley||UK
||31 December 2007||KPMG||12 February 2008
|Carlyle Capital Corporation||Guernsey
||31 December 2007||PwC||27 February 2008
|Citigroup||USA||31 December 2007
||KPMG||22 February 2008
|Dexia||France/Belgium||31 December 2007
||PwC and Mazars & Guérard||28 March 2008
|Fannie Mae||USA||31 December 2007
||D&T||26 February 2008
|Fortis||Holland||31 December 2007
||KPMG and PwC||6 March 2008
|Freddie Mac||USA||31 December 2007
||PwC||27 February 2008||*Unqualified
|Glitnir||Iceland||31 December 2007
||PwC||31 January 2008||Unqualified
|HBOS||UK||31 December 2007
||KPMG||26 February 2008
|Hypo Real Estate||Germany
||31 December 2007||KPMG||25 March 2008
|Indymac||USA||31 December 2007
||E&Y||28 February 2008
|ING||Holland||31 December 2007
||E&Y||17 March 2008
||31 December 2007||KPMG||30 January 2008
|Landsbanki||Iceland||31 December 2007
||PwC||28 January 2008||Unqualified
|Lehman Brothers||USA||30 November 2007
||E&Y ||28 January 2008
|Lloyds TSB||UK||31 December 2007
||PwC||21 February 2008||Unqualified
|Northern Rock||UK||31 December 2006
||PwC||27 February 2007||Unqualified
|Royal Bank of Scotland||UK
||31 December 2007||D&T||27 February 2008
|TCF Financial Corp||USA
||31 December 2007||KPMG||14 February 2008
||31 December 2007||KPMG||27 February 2008
|UBS||Switzerland||31 December 2007
||E&Y||6 March 2008
|US Bancorp||USA||31 December 2007
||E&Y||20 February 2008
|Wachovia||USA||31 December 2007
||KPMG||25 February 2008
|Washington Mutual||USA||31 December 2007
||D&T||28 February 2008
1. Data as per financial statements and statutory filings
shown on the respective company's website.
2. "Audit fee" also includes "audit related
3. * Denotes that audit report draws attention to some
matters already contained in the notes to financial statements.
Admittedly, the list in Table 1 is incomplete, but it is
useful for highlighting a number of issues. Adverse "key
financial ratios" are considered to be an indicator of going
concern problems. Major institutions had leverage ratios
in the range of 11:1 to 83:1. Excessive leverage is just one sign
of impending financial problems. For example, a report by the
US Securities and Exchange Commission (SEC) noted that Bear Stearns
"was highly leveraged, with a gross leverage ratio of approximately
33 to 1 prior to its collapse".
One expert informed the US House of Representatives Committee
on Oversight and Government Reform that Lehman Brothers, the fourth
largest investment bank, "had a leverage of more than 30
to 1. With this leverage, a mere 3.3% drop in the value of assets
wipes out the entire value of equity and makes the company insolvent".
Yet auditors did not note the consequences of such high ratios.
The UK auditing standards state that the "auditor's
procedures necessarily involve a consideration of the entity's
ability to continue in operational existence for the foreseeable
future. In turn that necessitates consideration of both the current
and the possible future circumstances of the business and the
environment in which it operates".
Auditing standards also require auditors to "perform audit
procedures designed to obtain sufficient appropriate audit evidence
that all events up to the date of the auditor's report that may
require adjustment of, or disclosure in, the financial statements
have been identified".
How the auditors constructed audits to satisfy themselves that
banks were a going concern is open to conjecture, but the financial
difficulties of many became publicly evident soon after receiving
unqualified audit reports.
The 2006 financial statements of Northern Rock carried an
unqualified audit opinion. On 25 July 2007, the bank's interim
accounts for six months to 30 June 2007 received a positive report
from its reporting accountants. Within days, the bank was under
siege and nationalised in early September 2007.
Lehman Brothers received an unqualified audit opinion on its annual
accounts on 28 January 2008, followed by a clean bill of health
on its quarterly accounts on 10 July 2008. By early August it
was experiencing severe financial problems and filed for bankruptcy
on 14 September 2008. Bear Stearns, America's fifth largest investment
bank, received an unqualified audit opinion on 28 January 2008.
On 10 March its financial problems hit the headlines and on 14
March, with state support, it was sold to JP Morgan Chase. Carlyle
Capital Corporation received an unqualified audit opinion on 27
February 2008. On 9 March, the company was known to be discussing
its precarious financial position with its lenders. On 12 March,
the company was placed into liquidation. Thornburg Mortgage, America's
second-largest independent mortgage provider received an unqualified
audit opinion on 27 February 2008. On 7 March, the company received
a letter, dated 4 March 2008, from its independent auditor, KPMG
LLP, stating that their audit report, dated 27 February 2008,
on the company's consolidated financial statements as of 31 December
2007, and 2006, and for the two-year period ended 31 December
2007, which is included in the company's Annual Report on Form
10-K for 2007, should no longer be relied upon.
New Century Financial Corporation, America's second largest
subprime mortgage lender, announced its financial problems in
February 2007. It was delisted in March 2007. On 24 May 2007,
it announced that its 2005 financial statement should not be relied
upon and an insolvency examiner was appointed. Yet auditors remained
oblivious to any sectoral problems. After the collapse of Northern
Rock, auditors should have become aware that banks were facing
acute financial problems, but they continued to issue unqualified
Auditing firms are commercial enterprises and cannot afford
to alienate their paymasters. The basic auditing model requires
one set of business entrepreneurs (auditing firms) to regulate
another (company directors). Neither party owes a "duty of
care" to any individual shareholder, creditor, employee,
bank depositor or borrower. Their success is measured by profits
rather than anything they might do for society, regulators or
There has been no state sponsored investigation into the
current banking and auditing failures. The Bank of Credit and
Commerce International (BCCI) was considered to be one of the
biggest banking frauds of the twentieth century. In 1992, a US
Senate report stated
that "BCCI's British auditors, Abu Dhabi owners, and British
regulators, had now become BCCI's partners, not in crime, but
in cover up" (p 276). Yet this did not persuade any UK government
department to investigate the episode. Eventually, in 2006, some
15 years after the events, without considering any of the findings
of the US Senate, a disciplinary panel of the UK accountancy profession
fined Price Watehrouse (now part of PricewaterhouseCoopers) £150,000.
At that time the firm had UK income of around £2 billion.
Did the UK learn anything from past failures?
Table 1 also shows that auditors received considerable income
from their audit clients, which may be significant for regional
offices managing the audit. The fee dependency and related advancement
of career creates conflict of interests. The insolvency examiner
of New Century Financial Corporation, America's second largest
subprime mortgage lender, stated that "KPMG bears responsibility,
at a minimum, for suggesting accounting changes in the second
and third quarters of 2006 that were inconsistent with GAAP and
for failing to detect the material understatements... The KPMG
team acquiesced in New Century's departures from prescribed accounting
methodologies and often resisted or ignored valid recommendations
from specialists within KPMG. At times, the engagement team acted
more as advocates for New Century, even when practices were questioned
by KPMG specialists who had greater knowledge of relevant accounting
guidelines and industry practice. When one KPMG specialist persisted
in objecting to a particular accounting practice on the eve of
the Company's 2005 Form 10-K filingan objection that was
well founded and later led to a change in the Company's practicethe
lead KPMG engagement partner told him in an email: "I am
very disappointed we are still discussing this. As far as I am
concerned we are done. The client thinks we are done. All we are
going to do is piss everybody off".
Table 1 shows that in most cases, auditors provided non-auditing
services and this inevitably raises the age-old question about
auditor independence. The issues were again flagged by the US
Senate Committee's report on the collapse of Enron
and revisited by the UK House of Commons Treasury Committee report
on Northern Rock. The Committee stated that "there appears
to be a particular conflict of interest between the statutory
role of the auditor, and the other work it may undertake for a
financial institution" (p. 115). The immediate response from
the Auditing Practices Board (APB), UK's auditing standard setter,
was that "After Enron we consulted on this question of auditor
conflicts of interest and there was no appetite for a blanket
ban on non-audit services" (Accountancy Age, 7 February 2008).
The APB is dominated by the auditing industry and is no position
to set independent or effective auditing standards.
The public encounters auditors in many other walks of life
eg passport checks at airports, HMRC inspectors, health and safety
officers, etc. In none of these cases the auditee selects, appoints
or remunerates the auditors. Yet that is a common practice in
the case of company audits.
Traditionalists have often claimed that external audit adds
credibility to financial statements. Such claims may be based
upon the view that auditors have "inside" knowledge
and are thus able to curb management enthusiasm and impart superior
information. The difficulty with such a hypothesis is that the
current financial crisis shows that markets and significant others
were not comforted by unqualified audit opinions. Evidently, markets
and significant others attached little value to audit reports.
Perhaps, they know that auditors are too close to their clients
and thus largely discounted their opinions.
The issuing of audit reports is subject to organizational
and regulatory politics. Auditors may be reluctant to qualify
bank accounts for fear of losing a substantial client, creating
panic or jeopardising their liability position. During previous
banking failures US legislators argued that auditor silence "caused
substantial injury to innocent depositors and customers".
The Financial Services and Markets Act 2000 formalises exchange
of information between auditors and regulators. It requires auditors
to inform the regulators if during the course of their audit they
become aware of anything that materially affects the regulator's
functions of consumer protection and maintenance of market confidence.
Within this context, auditors are obliged to inform regulators
of their intention to issue a qualified audit report. Whether
auditors did so or were dissuaded from issuing qualified opinions
is not known. The politics of audit opinion beg questions about
the value of an audit.
The organisational culture is a key ingredient in the manufacture
of audits. Some glimpses of firm culture have been noted. For
example, DTI inspectors noted that auditors at the business empire
of late Robert Maxwell "consistently agreed accounting treatments
of transactions that served the interest of RM (Robert Maxwell)
and not those of the trustees or the beneficiaries of the pension
scheme, provided it could be justified by an interpretation of
the letter of the relevant standards or regulations".
The audit firm's strategy was summed up by a senior partner who
told staff that "The first requirement is to continue to
be at the beck and call of RM [Robert Maxwell], his sons and staff,
appear when wanted and provide whatever is required".
also shows that a large number of audit staff either use irregular
practices or falsify audit work, ie claim that audit work is done
when in fact it has not been done. I have submitted research to
the FRC, but it has not informed any of its utterances.
In a market economy, pressures are exerted upon producers
to improve the quality of their goods and services. The comparative
pressures on auditors are weak. In the UK, auditors can trade
as limited liability companies and limited liability partnerships.
In addition, following the 1990 House of Lords' Caparo
is now part of the Companies Act, auditors generally owe a "duty
of care" to the company only and not to any individual shareholder,
creditor or other stakeholder. A HM Treasury paper
acknowledges that individual stakeholders cannot successfully
sue auditors even when they can show that "the auditors had
been negligent". Auditors also enjoy the benefit of the principle
of "contributory negligence". This principle was applied
in the litigation after the collapse of Barings. In this case,
the liquidator KPMG sued auditors initially for £1 billion,
subsequently revised to £200 million. The court ruled that
Deloitte & Touche was negligent in its audit work. However,
auditors only had to pay £1.5 million because the bank, its
directors and poor internal controls contributed to the frauds
and collapse of the bank. The case emphasised that despite admitting
negligence auditors face little liability.
Liability concessions to auditing firms have continued unabated.
In the words of Joseph Stiglitz, former senior Vice-President
of the World Bank, "there are plenty of carrots encouraging
accounting firms to look the other way... there had been one big
stick discouraging them. If things went awry, they could be sued...
In 1995, (US) Congress.. provided substantial [liability] protection
for the auditors. But we may have gone too far: insulated from
suits, the accountants are now willing to take more "gambles".
Despite Enron and WorldCom, the Companies Act 2006 gave the US
style "proportionate liability" to UK auditors. The
dilution of liability has reduced incentives to produce good audits.
For over a century auditors have utilised methods of an industrial
age in which tangible things could be examined, counted and measured
and their values could be checked from invoices and vouchers.
Such a world has been eclipsed by complex financial instruments
(eg derivatives) whose value depends on uncertain future events
and can be anything from zero to several million dollars/pounds.
Derivatives were central to the collapse of Barings, Enron and
Parmalat. The US government's 1998 bailout of Long Term Capital
Management (LTCM) showed that even the Nobel Prize winners in
economics had difficulties in valuing derivatives. It is doubtful
that auditor knowledge surpasses that of Nobel Prize winners.
They seem to go along with the "mark-to-model" accounting
practices of banks.
Auditors may argue that the financial crisis unfolded suddenly
and they were thus ill-prepared to make judgments about the likely
financial distress. The difficulty with such an argument is that
finance capitalism and expansion of credit has been in ascendancy
and played a leading role in the banking crises in Latin America,
South-East Asia, Sweden, Norway and Japan. The US experienced
a Savings and Loan crisis in the early 1990s. Fannie Mae has a
history of accounting and auditing problems. In 1991, the Bank
of Credit and Commerce International was closed. The mid-1990s,
collapse of Barings attracted considerable international attention.
Previous episodes have highlighted issues about earnings management,
income shifting, excessive leverage, complex financial instruments
and failures of conventional auditing technologies. Auditors have
paid little attention to changes in capitalism and emerging issues.
Professional accounting education prioritises technical and rote
learning and neglects reflections upon the social aspects of accounting
In an ideal world accounting firms would compete to advance
standards and quality of work, but they are involved in a race-to-the-bottom.
They are unfit to deliver worthwhile audits.
In the year 2000, Consob, the Italian Competition Authority
fined Arthur Andersen, Coopers & Lybrand [now part of PricewaterhouseCoopers],
Deloitte & Touche, KPMG, Price Waterhouse [now part of PricewaterhouseCoopers],
Reconta Ernst & Young, the then Big-Six accounting firms,
for operating a cartel.
The firms had agreement to restrict competition and carved out
the auditing market. In November 2005, France introduced legislation
restricting the ability of auditing firms to sell non-auditing
services to audit clients. It imposed a ban on offering an audit
if the client has received other services from the audit firm
in the previous two years. The Big Four firms and Grant Thornton
formed an alliance to contest the law (Accountancy Age, 20 September
2007). Previously, Ernst & Young and PricewaterhouseCoopers
combined forces to pressurise the UK government to secure liability
concessions in the shape of limited liability partnerships. As
the UK government eventually capitulated an Ernst & Young
senior partner boasted, "It was the work that Ernst &
Young and Price Waterhouse undertook with the Jersey government
| that concentrated the mind of UK ministers on the structure
of professional partnerships. The idea that two of the biggest
accountancy firms plus, conceivably, legal, architectural and
engineering and other partnerships, might take flight and register
offshore looked like a real threat. I have no doubt whatsoever
that ourselves and Price Waterhouse drove it onto the government's
agenda because of the Jersey
idea" (Accountancy Age, 29 March 2001).
Following a US Senate investigation into the sale of tax
avoidance/evasion schemes, KPMG admitted "criminal wrongdoing"
and paid a fine of $456 million. The Senate report
stated that "KPMG tax professionals were directed to contact
existing clients about the product, including KPMG's own audit
clients | By engaging in this marketing tactic, KPMG not only
took advantage of its auditor-client relationship, but also created
a conflict of interest in those cases where it successfully sold
a tax product to an audit client." (pages 4, 9, 15-16)
A UK Tax Tribunal found that KPMG cold-called on clients
to sell a scheme that would boost corporate earnings by avoiding
sales tax (or Value Added Tax (VAT)). The scheme involving use
of offshore tax havens and complex corporate structures was declared
unlawful by the Tribunal and subsequently the European Court of
Justice described it as "unacceptable" (The Observer,
27 March 2005).
The role of Deloitte & Touche in crafting tax avoidance
schemes for Enron is under scrutiny.
A US Senate report
stated that "PricewaterhouseCoopers sold generic tax products
to multiple clients, despite evidence that some.. were potentially
abusive or illegal". The same Senate report also concluded
that Ernst & Young (E&Y) sold "abusive or illegal
tax shelters". The US Justice Department charged "four
current and former partners of Big-Four accounting firm Ernst
& Young ("E&Y") with tax fraud conspiracy and
related crimes arising out of tax shelters promoted by E&Y"
(US Justice Department press release, 30 May 2007).
Ernst & Young marketed a scheme to enable retailers to
boost earnings by avoiding VAT and levying a credit handling fee
on credit card sales. The scheme was declared unlawful by a Tax
Tribunal and a UK Treasury spokesperson described it as "one
of the most blatantly abusive avoidance scams of recent years"
(The Guardian, 19 July 2005).
In August 2007, the US Justice Department
announced that "IBM Corporation and PricewaterhouseCoopers
have both agreed to pay the United States more than $5.2 million
to settle allegations that the companies solicited and provided
improper payments and other things of value on technology contracts
with government agencies... PWC will pay $2,316,662".
In July 2005, the US Department of Justice announced that
PricewaterhouseCoopers paid the government $41.9 million to "resolve
allegations that it defrauded numerous federal government agencies
over a 13-year period.
In January 2006, the US government announced that Ernst &
Young and KPMG settled lawsuits "concerning false claims
allegedly submitted to various agencies of the United States in
connection with travel reimbursement. ...E&Y has agreed to
pay $4,471,980 and KPMG has agreed to pay $2,770,000" (Department
of Justice press release, 3 January 2006).
The involvement of major accountancy firms in bribery and
fraud is highlighted by the New York District Attorney Robert
to the US Senate Subcommittee on Permanent Investigations on 16
July 2001 (also see New York Times, 4 May 1995).
In a money laundering case,
a UK High Court judgement stated that "Mr Jackson and Mr
Griffin are professional men. They obviously knew they were laundering
money.... It must have been obvious to them that their clients
could not afford their activities to see the light of the day.
Secrecy is the badge of fraud. They must have realised at least
that their clients might be involved in a fraud on the plaintiffs".
Jackson & Co. were introduced to the High Holborn branch of
Lloyds Bank Plc. in March 1983 by a Mr Humphrey, a partner in
the well known firm of Thornton Baker [now part of Grant Thornton].
They probably took over an established arrangement. Thenceforth
they provided the payee companies| In each case Mr Jackson and
Mr Griffin were the directors and the authorised signatories on
the company's account at Lloyds Bank. In the case of the first
few companies Mr Humphrey was also a director and authorised signatory".
To this day, no action has been taken against the firm or its
In January 1999, following a $2.5 million fine on PricewaterhouseCoopers
for violating audit independence rules, primarily relating to
ownership of securities in client companies, (SEC press release,
14 January 1999), the US Securities and Exchange Commission (SEC)
commissioned a study into the firm's compliance practices. The
that "a substantial number of PwC professionals, particularly
partners, had violations of the independence rules, and that many
had multiple violations". The study said that over 8,000
violations of the rules, in a one month period, were found and
the firm agreed to revise its compliance procedures. In 2002,
PricewaterhouseCoopers were fined $5 million for violating auditor
independence rules and entering "into impermissible contingent
fee arrangements with 14 public audit clients..." (SEC press
release, 17 July 2002).
Following previous US regulatory actions, in 1995, Ernst
& Young gave undertakings to comply with the auditor independence
rules. The SEC learnt that for the period 1994 to 2000, contrary
to the rules on auditor independence, Ernst & Young (EY) entered
into a business relationship with software giant PeopleSoft, one
of its audit clients. This time the SEC prosecuted.
Ernst & Young were fined $1.7 million, banned for six months
from securing new audit clients and also put on probation for
the next two years. Ernst & Young were again censured in March
2007 for violation of auditor independence rules and fined $1.7
million. In 2003, a [former] Ernst & Young partner was arrested
on criminal charges for allegedly altering and destroying audit
working papers and obstructing investigations relating to NextCard
(SEC press release, 25 September 2003). He became the first case
to be tried under the Sarbanes-Oxley Act 2002. He admitted that
"he knowingly altered, destroyed and falsified records with
the intent to impede and obstruct an investigation by the Securities
and Exchange Commission (SEC)... by not informing the SEC of these
alterations and deletions that he knowingly concealed and covered
up an original version of the documents with the intent to impede,
obstruct, and influence an investigation of the SEC (US Department
of Justice press release, 27 January 2005). The Ernst & Young
partner was sentenced to a year in federal prison, a fine of $5,000
and two years of supervised release. In August 2008, the firm
was again fined $2.9 million for further violations of auditor
KPMG was admonished by the US authorities for violating auditor
independence rules by holding investments in a client company
(SEC press release, 14 January 2002).
In 2005, Deloitte & Touche were fined $50 million to
settle charges stemming from its audit of Adelphia Communications
Corporation. The SEC stated that "Deloitte engaged in improper
professional conduct and caused Adelphia's violations of the recordkeeping
provisions of the securities laws because it failed to detect
a massive fraud... Deloitte failed to design an audit appropriately
tailored to address audit risk areas that Deloitte had explicitly
identified" (SEC press release, 26 April 2005). After settlement
with the SEC, Deloitte issued a press statement stating that "the
client and certain of its senior executives and others deliberately
misled Deloitte & Touche". The SEC objected to this characterisation
and forced the firm to revise its press release which ommitted
the above sentence. In 2007, a Deloitte partner responsible for
the Adelphia audit was banned for life from conducting audits.
In September 2005, Japanese regulators arrested four partners
of ChuoAoyama PricewaterhouseCoopers for allegedly helping executives
at Kenebo, an audit client, to falsify company accounts. (Financial
Times, 14 September 2005). Subsequently, the regulator stated
that "ChuoAoyama PricewaterhouseCoopers admitted the facts
charged in the Kanebo accounting fraud scandal" and that
the four "willfully certified Kanebo's falsified annual reports
for the five periods, ending March 1999, March 2000, March 2001,
March 2002 and March 2003, as not containing such falsities".
The firm's licence to conduct company audits was suspended for
a two month period covering July-August 2006. Subsequently, despite
a name change, a number of major clients deserted and in August
2007 the firm was disbanded.
The above malaise affects small and medium size firms too.
Consider the case of Versailles Group, whose founder was convicted
of fraud. A 2004 report of a disciplinary committee of the profession
noted that "In 1996, Mr Clough [company's finance director]
arranged for publication of the Versailles accounts, and their
circulation to shareholders, before [emphasised in the original]
the audit was completed. The published accounts contained a false
audit certificate. When this was discovered, Nunn Hayward signed
an audit certificate on unchanged accounts after little further
work, and these were re-circulated to shareholders. In the face
of this obvious dishonesty, Nunn Hayward acquiesced in a circular
to shareholders describing what had happened as "an oversight".
The reality was that Versailles was too important a client for
Nunn Hayward to risk losing: when resignation as auditors was
mentioned by Nunn Hayward's solicitors, Mr Dales [partner in-charge
of audit] responded that this was "a big fee account"
and his firm did not want to resign...". The report goes
on to add that one member of the audit team, raised concerns which
included "a lack of access to Versailles's accounting records;
Versailles's reluctance to produce fundamental accounting information;
its complex accounting system and the amount of control which
Mr Cushnie [company chairman] was able to exert over it; and the
lack of information about Traders in the British Virgin Islands.
She wrote two memoranda, the first to Mr Ian Nunn, the senior
partner, and Mr Dales, and the second to all the Nunn Hayward
partners, detailing her concerns. These were ignored, and she
was shortly moved off the audit. | Nunn Hayward and Mr Dales...
signed false "comfort letters" required by the banks
which had lent money to Versailles. ...There is evidence that
several comfort letters were simply faxed to Nunn Hayward by Versailles's
accountant with the request: "...please type the enclosed
letters on your letter head... and fax them across to Fred [Clough]
asap and post hard copy to him direct.".
The above is a small snippet of evidence that suggests that
major accounting firms are unfit to act as public watchdogs.
The present auditing model is broken and cannot be repaired.
Audits of banks are supposedly conducted to protect depositors
and borrowers, and possibly act as eyes and ears of regulators.
Yet auditors do not owe a "duty of care" to these stakeholders.
Auditors are not appointed by any of these constituencies either.
Present auditors are not independent of the companies they audit.
They lack pressures to deliver good audits.
The flaws persuaded the previous Conservative administration
to create the Audit Commission, an independent statutory body,
for appointment and remuneration of auditors for public bodies.
The auditors are generally prohibited from selling consultancy
services to audit clients. It is also recognised that the private
sector auditors, with their fee dependency on clients, are not
in a position to conduct effective audits. For these reasons,
the draft legislation that created the US Securities and Exchange
Commission (SEC) in the 1930s proposed that the Commission should
be the auditor for public companies.
However, under the weight of corporate lobbying the proposal was
The present current financial crisis is an opportunity to
build alternative institutional arrangements for auditing. Banks
and financial enterprises should be audited directly by the Bank
of England (BoE), the Financial Services Authority (FSA), or other
designated statutory authorities. They should have specialist
teams of auditors. Such auditors will act as eyes and ears of
regulators and also help to build an institutional memory of past
problems and emerging issues. Currently auditors hide behind claims
of "duty of confidentiality" to clients. Such complications
will be eliminated by reforms suggested here.
Audits should be conducted on a real-time basis. Ex-post
audits are of little use at banks, especially as banks engage
in real time transfers of money. Auditors need to be continuously
present at banks to monitor significant transactions and enforce
capital adequacy, solvency and other regulations.
Auditors of banks should owe a "duty of care" to
all stakeholders, including savers and borrowers.
The Treasury Select Committee should periodically consider
effectiveness of the arrangements for bank audits.
The NAO should examine the effectiveness and efficiency of
The auditors shall act exclusively as auditors and that means
that they would not act as consultants and advisers to banks or
For some evidence see-Sikka, P (2008). Enterprise Culture and
Accountancy Firms: New Masters of the Universe. Accounting,
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