Black Friday, Black Accounting, White Christmas

Pic credit – Huffington Post

[Black Friday]  Black Friday–so named due to crowded stores, crowded roadways and bad shopping behavior–is today in the United States.  It gets bad out there, as described in this Huffington post article, “9 Reasons To Stay Home On Black Friday (And Forget The Damn HDTV).”

Why do so many shoppers love Black Friday?  They think they are being served by stores offering unbelievable deals, incredulous sales and stocked shelves.

But are they being served? Stores have an inclination to raise prices because of increased quantity demanded (remember your lessons from Econ 101?).  They offer an occasional bargain against as stark environment.  Shoppers rush in to fight against each other to grab an over-hyped bargain.  There is no excuse for bad shopping behavior, but in truth the retail industry promotes it.

A popular shopping day for many decades, the Christmas shopping period now has expanded over to Black Friday eve, Black Friday week, pre-Black Friday week, and even Black November.

The shopping day was originally named Black Friday by Philadelphia police in the 1960s because it was such a horrible time of year to be serving the public. But the retail industry doesn’t care, it really is there to serve itself.  It’s all about money.  And money always brings out the black in business.

There are many parallels between Black Friday and Black Accounting.

Auditing firms arose in the United States in the early 1900s. The country was expanding and so was business.  Against the context of unregulated financial markets, audit firms sold their services–an independent opinion –as value added.  The investing public trusted these opinions and directed their capital to companies offering assurance about the reliability of the corporate financial statements.

The name of the game was independence, and audit firms were mostly independent.

But conditions changed when the federal government mandated that publicly traded companies had to purchase an audit opinion for their financial statements.  The government did this in an attempt to serve the public as a means to trust financial statements. In reality, if honest audit opinions were for sale then shopping investors would rush to the stores to purchase them.

How did the large audit firms respond?  Not by serving the investing public.  Big audit was there to promote sky high prices, reduced costs (difficulty in suing audit firms for negligence), and barriers to entry (state licensure).  And of course, audit firms always promote their services as independent when they are anything but independent.

This year, large audit firms are so completely in control of their line of business that they have defeated regulatory efforts to instill a minimum degree of independence.  What are these efforts?  Forced auditor rotation and a prohibition against consulting services.  In reality, there can be no auditor independence when the audit firm is a business partner of the audited company.  That is why this season we are afflicted with Black Accounting.

Against this bleak reality, I continue to hope for a White Christmas.  I want to bury the blackness.  As an investor, I hunger for honest financial statements, or at least financial statements with an honest audit opinion.

Dare I check my hung stocking on Christmas Eve?

Debit and credit – – David Albrecht

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SEC Commissioner Luis A. Aguilar on Auditor Quality and Rotation

Sarah N. Lynch is a young business reporter for Reuters.  She has previously published such good work that I’ve started looking for her by-line.  Her story on Friday, June 29, 2012 alerts us to an important auditing issue.

Lynch’s story is “SEC official backs shareholders on auditor independence.”  In this story, she reports on a speech by SEC Commissioner Louis A Aguilar (Democrat) to the NAPPA 2012 Legal Education Conference in Philadelphia, PA, on June 27, 2012.

Aguilar’s speech is noteworthy for two reasons.  First, it was one of two speeches last week by SEC Commissioners in which it was emphasized that audit quality is deteriorating and investor confidence in securities markets is waning.  Second, Commissioner Aguilar disagrees with SEC staffers who have blocked shareholder proposals to rotate auditors at their company or to promote other forms of improving auditor quality.

Really?  Companies have received at least two dozen shareholder proposals to vote on auditor rotation and increased auditor disclosure, and the SEC’s Division of Corporation Finance let companies block them from shareholder vote?  Aguilar’s comments on this are highlighted below.

It is apparent that pressure is being directed at the PCAOB from the lofty heights of the Commissioners of the SEC.

Aguilar’s speech is important.  To promote your reading of relevant portions, I’m publishing them in this blog post.

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Alleged Ernst & Young Judge Bribing and Cover Up

Jonathan Russell, city diary editor for London’s Telegraph Group, has an interesting story on today’s Telegraph website. It is titled, “Ernst & Young ‘Covered Up Judge Bribe Case.’”

My write-up is based on Russell’s story, and his story is supposedly based on court documents.  I have no personal knowledge of anything other than Russell’s story.  I am not alleging anything, only summarizing what has been reported.

Russell writes,

Mr [Cathal] Lyons was a partner with E&Y’s Russian practice when the alleged wrongdoing came to light. It was originally investigated by James Mandel, E&Y’s general counsel in Moscow. In a witness statement supplied in support of Mr Lyons’s case, Mr Mandel said he suspected the payment may have been corrupt and wrote a report to that effect.

“I had the suspicion that this payment was not a proper payment for legal fees, but was an illegal payment possibly made to facilitate a positive outcome of a tax case,” he claimed in his witness statement.

He suspected that the €120,000 payment via a Russian law firm was made to influence a 390m rouble (£8.4m) court case brought by Russian tax authorities investigating a tax avoidance scheme E&Y was using to pay its Russian partners. E&Y was later cleared of liability in the case.

Russell continues,

Mr Lyons claims that after he reported his concerns about the case to E&Y’s global head office, his medical insurance was withdrawn and he was dismissed.

In his writ he says the dismissal flowed from “personal animosity against him rising from a discussion in late 2010 between the claimant and Maz Krupski [E&Y’s director of global tax and statutory] regarding alleged corruption by the practice.”

Mr. Lyons is suing for 20 years continuance of medical support, stemming from serious injuries sustained in a 2005 automobile accident.  The medical support payments are valued at $6,000,000.

I will make an effort to retrieve relevant British court documents.

In an interesting coincidence, Jonathan Middup, partner at Ernst & Young (UK) Fraud Investigation & Dispute Services, has a piece in Friday’s growthbusiness.co.uk titled, “The UK Bribery Act One Year On.”  In this article, Middup “… looks back on the first year of the UK Bribery Act to see if the British perception of corrupt practice has changed.”

Debit and credit – – David Albrecht

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Moody’s Downgrades Spanish Banks

I’ve been writing about the Spanish bank crisis (“Spanish Non Sequitur” and “Followup to the Spanish Non Sequitur“) because it is related to mainstream financial reporting and auditing.  How so?

The Spanish government recently hired all of the Big 4 (still don’t know from which countries) to tidy up the financial statements from many banks in the industry.  I’ve written about how this is a novel strategy to cleaning up faulty financial statements.

In addition, this is related to the push for global accounting standards.  If IFRS doesn’t work well in a mid-size European country, then how can it work as the primary tool for regulating banks world wide?

Nathalie Tadena, of the Wall Street Journal, wrote yesterday on “Moody’s Cuts Ratings on 28 Spanish Banks.”  Moody’s has downgraded bank ratings to one notch above junk.  Ouch.  In part, this is because of Spain’s sovereign debt crisis, and in part this is because “banks … have been hollowed out by a five-year property slump that has left them exposed to hundreds of billions of dollars in loans to builders and developers.”

The U.S. has experience in dealing with bank difficulties caused by economy shaking issues in real estate. The 1980s Savings & Loan Crisis and 2008 Subprime Financial Securities Crisis come to mind.  Both American crises showed that banks easily succumb to temptation in hiding losses from investors, and that auditors are loathe to alert investors to going concern difficulties.

Spain, welcome to the club.  It is dealing with its bank crisis by hiring Big 4 audit firms to clean up the financial statements of larger banks in its banking industry.  Undiscussed, though, is why Spain is hiring the same audit firms which previously had been a party to issuing unflagged misleading financial statements.

I’m glued to the newswire looking for the next development in this story.

Debit and credit – – David Albrecht

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EY Not Penalized in UK for Lehman Audit

The auditor disciplinary arm of the Financial Reporting Council (FRC) of the UK has concluded its investigation and on June 22, 2012 announced that Ernst & Young (EY) is not to be penalized for its audit of the November 30, 2007, financial statements of Lehman Brothers Holdings Inc (LBHI).

Executive Counsel considers that there is no realistic prospect that a Tribunal would make an adverse finding against Ernst & Young LLP in the UK or Members within that firm. The investigation will therefore be closed and no further action taken.

Coupled with an earlier announcement from the Securities and Exchange Commission (SEC) of the US that no legal proceedings are likely to be initiated against EY or its employees, this marks the end of one the darkest chapters in recent accounting and auditing history.

Although EY will not be penalized for failing to alert investors to LBHI’s sophisticated scheme to manipulate its financial statements, it has embarrassed itself and shamed all of us in the accounting and auditing industry.

EY has showed itself to be no better than Arthur Andersen.  Ernst & Young, shame on you. 

The FRC is the regulator and standard-setter in the UK responsible for corporate governance and financial reporting as well as the audit, accounting and actuarial professions.  It is not a governmental unit, but a private organization.  It operates in the public interest.

The FRC operates in a manner similar to the Financial Accounting Standards Board (FASB) and Public Company Accounting Oversight Board (PCAOB) of the US.

A unit of the FRC, Accountancy and Actuarial Discipline Board (“AADB”), has investigated Ernst & Young over the LBHI matter.  This is its summary of the investigation:

1. On 10th June 2010 the Accountancy and Actuarial Discipline Board (“AADB”) considered the matter of Lehman Brothers (“Lehmans”) and decided, pursuant to paragraph 5(8) of the AADB Accountancy Scheme (“the Scheme”), that the matter should be investigated by the AADB.
2. Lehman Brothers Holdings Inc. (“LBHI”) sought Chapter 11 protection in the United States of America on 15^thSeptember 2008. The US Bankruptcy Court nominated an Examiner, Anton R. Valukas, who published his report into Lehmans’ collapse on 11^th March 2010. The report made criticisms of Lehmans’ auditor, Ernst & Young, for failing to question and challenge improper or inadequate disclosures in Lehmans’ financial statements. The Examiner’s criticisms specifically related to the use by Lehmans of transactions known as Repo 105 and Repo 108 transactions. The report did not specify whether the criticisms related to the primary auditor of LBHI, which was Ernst & Young in New York, or Ernst & Young generally.
3. Repo 105s and Repo 108s were used by Lehmans to raise short term funds and, by virtue of compliance with US Financial Accounting Standard 140 (“FAS140”) which requires certain transactions to be treated as sales instead of financing transactions, enabled Lehmans to reduce its balance sheet and leverage ratios. The Examiner found that whilst the use of Repo 105/ 108 transactions may not have been inherently improper its sole function as employed by Lehmans was balance sheet manipulation.
4. The scope of the AADB investigation was as follows:“The conduct of Members and a Member Firm in relation to: (a) the preparation and audits of the financial statements of Lehman Brothers Holdings Inc.and UK operations including Lehman Brothers International (Europe) for the year ended 30^th November 2007;and (b) the use and accounting treatment of transactions known as “Repo 105s” and “Repo 108s” by Lehman Brothers Holdings Inc. and UK operations including Lehman Brothers International (Europe).”

5. The focus of the investigation was the audit by Ernst & Young LLP in the UK (“EYUK”) of Lehman Brothers International (Europe) (“LBIE”) and of Repo 105 and Repo 108 transactions which were conducted through LBIE.  EYUK audited the trial balance of LBIE prepared under US GAAP for consolidation into LBHI’s consolidated financial statements. The audit of LBIE’s trial balance formed the basis of a ‘Specific Scope Conclusion’ to Ernst & Young in New York.
6. In the course of the investigation, the investigation team obtained and reviewed EYUK’s audit files; hard copy documentation; information from EYUK staff members’ laptops and emails, and information from other regulators. The team also interviewed EYUK audit team staff and former members of staff of Lehmans.

Debit and credit – – David Albrecht

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Freed Maxick Captures AAM Awards

The Association for Accounting Marketing (AAM) has released a public announcement, “Thirty-eight Awards Distributed to Honor Top Marketing Firms.”  Although 20 firms received recognition, Freed Maxick, CPAs, PC, led the way with seven awards.  Congratulations.

Membership in AAM is too pricey for most accounting professors, and I am no exception.  Never-the-less, I do my best to follow it because marketing is such a key activity for any accounting or financial services firm.  The surest way to partner is to create, nurture and grow a sizable client list.  In addition, nine members of AAM made the Accounting Today Top 100 Most Influential People in Accounting for 2011.

WithumSmith + Brown, PC received an award for its blogs.  This is well deserved in my opinion.  It also received the award for small budget multimedia, presumably for its flash dance video.

Is it time for a category to be created for integrated social media campaigns?  How about for Tweeter of the Year?

Awards were issued in 11 categories:  branding, collateral, marketing campaigns, advertising, website, multimedia, internal programs, events, surveys, business development/lead generation and maverick marketing.  “This was the 18^th year that the annual awards were presented. Recipients were announced at the 2012 AAM Summit in partnership with the AICPA Practitioners Symposium and TECH+ Conference, held in Las Vegas, NV on June 11, 2012.”

Debit and credit – – David Albrecht

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Power of the Press in Accounting

Following journalists and bloggers has become part of my daily routine.  I pay attention to what is written and to its impact.  In accounting, there tends not to be too much impact, because regulators, corporate executives and audit firm managers seem impervious to what other people say.  They always do what they darn well want to.

Dena Aubin, David Ingram and Sarah N. Lynch, however, have been able to see the power of their pens.

Dena Aubin is a journalist for Reuters who writes on auditing.  David Ingram is a Reuters journalist who writes on lobbying and business.  Sarah N. Lynch is a financial regulatory reporter.  In various combinations, they have partnered on an interesting series of articles:

• “Ernst & Young tightropes between audit, advocacy” by Dena Aubin, David Ingram and Sarah Lynch, [Washington–March 8, 2012].
• “Big 4 auditors spend more than ever on U.S. lobbying” by David Ingram and Dena Aubin, [March 13, 2012].
• “Ernst, clients, cut lobbying ties-records” by David Ingram and Dena Aubin, [Washington/New York–May 4, 2012]

In today’s post I’ll write about the first and third of their series.

In  “Ernst & Young tightropes between audit, advocacy,” Aubin and Ingram write about Washington Council Ernst & Young (WCEY) and reactions to their activities.  Aubin and Ingram report that WCEY (a unit of Ernst and Young) provides lobbying services valued at $12 million per year.  WCEY does enough business that I had become aware of its existence.  Some of its clients also engage Ernst & Young to audit their financial statements.

And that’s the rub.  It is a violation of both common sense and professional ethics that I find shocking.

Aubin and Ingram reported that Senators Carl Levin and Jack Reed were now expressing concern.  Aubin and Ingram were unable to receive public comment from the SEC and PCAOB on the issue.

On March 8, I was skeptical that anything would happen to dissuade Ernst & Young from this practice.

On Friday, May 4, I received a pleasant surprise.  In “Ernst, clients, cut auditing ties-records.”  Ingram and Aubin report that an examination of reports filed under the Lobbying Disclosure Act revealed that some of Ernst’s audit clients were no longer lobbying clients.  None of the companies, nor Ernst & Young, would comment on the relationship changes.

However, the cause and effect seems obvious.   The first story apparently showed enough light on the Ernst & Young lobbying activity that it changed what it was doing.

Congratulations Dena and Dave!

Also included in the article are comments from the SEC:

The chief accountant for the U.S. Securities and Exchange Commission, James Kroeker, speaking at a financial reporting conference at Baruch College in New York on Thursday, said SEC rules state an auditor should not act in an advocacy role for a company it audits and lobbying would be inconsistent with that.

Kroeker did not mention any audit firms by name.

He said: “If you think about lobbying in the traditional sense, you would say, ‘wouldn’t somebody that’s lobbying be placing themselves in a position to be an advocate?'”

Asked whether the SEC was looking into E&Y’s lobbying activities, an official in the agency’s enforcement division declined to comment because its investigations are not public.

“We are aware of it and we are cognizant of what the rules are,” said Howard Scheck, chief accountant of the SEC’s division of enforcement, on the sidelines of Thursday’s conference.

“If there’s a violation that we find, we’ll certainly do something about that,” he said, without referring to E&Y.

I’m impressed with these journalists, Aubin, Ingram and Lynch.  Their articles have shown original fact finding, effective organization, and a steady flow from start to finish.  I’m adding them to the list of business journalists whom I follow.

Debit and credit – – David Albrecht

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CPA Firm Branding and McGladrey LLP

McGladrey and Pullen, LLP, has completed its rebranding, officially changing its name to McGladrey, LLP.  mcgladreypullen.com now redirects to mcgladrey.com.

Branding (and rebranding) is an important element in a CPA firm’s strategic efforts.  It is the management of identity, reputation and image.

All large CPA firms constantly work their brand.  Occasionally, a firm’s strategy calls for a change in public identity, hence the need for rebranding.

I think McGladrey’s rebranding is intended to communicate to the public that it views itself as one of the big boys.  Although it is not a Big 4, it never-the-less is big.

McGladrey’s name change and rebranding efforts parallel that of the other largest CPA firms.  Deloitte & Touche has become Deloitte.  Ernst & Young is becoming Ernst.  PriceWaterhouseCoopers has become PWC.  BDO Seidman has become BDO.  Plante & Moran has become Plante Moran.  Baird Kurtz & Dobson has become BKD.

Sometimes branding activities commence with a merger, such as between Larson Allen with Clifton Gunderson to become CliftonLarsonAllen.  Notice the similarity with PriceWaterhouseCoopers?  How soon do you think it will be before CliftonLarsonAllen becomes either Clifton, or Larson (don’t think it will become CLA). And when is Grant Thornton going to do something?

This trend toward shorter CPA firm names is taking place because of these branding considerations.

1. Size, or bigness.  Being viewed as large (or larger or largest) has always been important to CPA firms, as size has been viewed as a proxy for quality.  [Can it be that “Mine is bigger than yours,” is more apt in the audit industry than the locker room?]  Doesn’t big business needs Big Audit?  Eight specific accounting firms benefited from the emergence of the Big 8 brand. There are huge benefits to being one of the Big 8,7,6,5,4.  It is not coincidental that the gap between any of the Big 4 and the others widens every year.
2. Oneness.  A single name creates an image of consistency throughout the firm.  It is implied that the same service and quality of service is provided anywhere in the country, or the world.  It is all the same.  This is one reason why the largest firms are battling the PCAOB proposal to disclose the engagement lead partner’s name as part of the audit opinion.
3. Brand name awareness.  One has made it big if the world instantly recognizes him, her, or it by a single name–Lebron, Bird, Oprah, Madonna, Cher, Kleenex.  It may be a self-fullfilling prophecy to shorten your name.  McGladrey bespeaks a desire for increased brand awareness.  It represents a step to a bigger stage.
4. Corporate.  When it was McGladrey & Pullen, there was still a tie to an individual’s name.  McGladrey sounds more  corporate and monolithic.  In addition, the firm is now preeminent.  The firm is more important than any partner.  Individual partners are now employees.

For branding efforts to be successful, a firm or company has to become its brand.  McGladrey & Pullen will have to change if it truly wants to become McGladrey.

What do you think?  Please leave a comment below.

Debit and credit – – David Albrecht

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