Much has been said over the past few months about the responsibility of regulators in the current global financial crisis. I’ve written about it myself back in September suggesting that they are yet to acknowledge their role and their own failings.

Three months on, it still seems that the regulators are either in denial, or suffering from a debilitating shock of their own past incompetence, as we are still not seeing much positive change from them. Even with the current obvious trend for greater regulation promoted on the government level, there is no clear evidence of regulators stepping up their game.

What do I mean by that, I hear you say? Well, there are two aspects to this. The first one is about acknowledging regulators’ failure to prevent the financial crisis – and in this, I am going to specifically focus on auditors in this post. The second aspect is about regulators changing their attitudes immediately, not at some point in the future. That would be the subject of another post.  

Role of auditors: I was deeply disappointed to see an article in the November Accountancy magazine called “the Blame Game” arguing that auditors are not really responsible for the meltdown of the financial system.

This magazine is the official publication of ICAEW, the Institute of Chartered Accountants of England and Wales, and its opinions carry some weight in the British accountants’ profession. The article goes on to admit that there has been some criticism of “dodgy auditing” and a general failure to accept responsibility – quoting Emile Woolf, Accountancy’s columnist, which was also quoted in the article:

Auditors have contributed to the crisis by accepting directors’ “mark-to-market” valuation of trading assets, when some basic questions would have shown them that those directors (i) hadn’t the remotest clue what was in the mortgage / loan packages they had acquired; (ii) were utterly bemused by the nature of the complex derivatives on which their asset valuation rested; and (iii) knew that there was no market to “mark” to.

Auditors and their outstanding job? So far, so good, sounds very fair. However. It then goes on to quote various parters of big audit firms that “the suggestion that auditors are to blame for failing to prevent market meltdown has been branded a “cheap shot” by the profession” and that auditors have done an “outstanding job”. Apparently auditors simply give a view on “whether the numbers are right and should not comment on the risks of a particular business model”.

It is the last bit that incensed me. Now, I worked as an external auditor in my past life. And at least yearly, we did control and risk assessments on the companies we audited in my days – not that long ago, only just over 10 years back. Our objective was to make sure we understood the business processes in advance of the big year end audit, documented all internal controls, and tested and checked compliance.

For instance, auditing a mortgage company, we would review its portfolio of products, understand its client base, review how risk premiums were calculated and applied, speak to mortgage underwriters and look at their paperwork in detail. We look at their rates charged and compared them to competitors’. Our audit seniors would then write up a document about business processes – it all tied into assessing whether the business is a going concern and how well it operated internally.

If this is not commenting on risks of a business model, what is? Has this been scrapped all of a sudden in the heady days of the last economic upturn? I find this hard to believe. More likely, it is a symptom of senior people doing a little play on words and trying to “redefine the definition” of auditors’ remit in order to wriggle out of admitting responsibility when it suits them.  

Warning signs: OK, I am not really suggesting auditors themselves caused the financial meltdown – and I don’t think anyone is either. But they failed to spot the warning signs, and failed to report these on time. Just like those directors, they were “utterly bemused” by the complexities of the financial structures, and chose to stay so. In this, they were surely in breach of their responsibility to the shareholders to get to the bottom of things and report on risks they found. So I personally cannot support the view of “outstanding job” having been done, but what do I know!!!

Legal cases: The article concludes with looking at the possibility of auditors being sued for negligence, reminds readers that the primary responsibility lies with banks’ directors; that other regulators were also responsible; and that there are many complex legal questions to overcome before auditors can be really held liable, none of which has apparently really been tested in court.

And the conclusion? You’ll like this. “In the absence of any major lawsuits .. for the moment at least, auditors are not really being blamed”. So, rest assured, Mr and Mrs Accountant Auditor, the magazine has given you a stamp of reassurance to calm your worries.

A profession full of contradictions: Honestly, it’s just not really good enough. Talking about skirting round the issue and covering up the real questions with appropriaty comforting quotes from senior audit partners noted down on a good day. If the question whether and to whom an auditor owes a duty of care is still a grey area, why do we bother with audits in the first place? And if some claim that auditors should not comment on risks of business models, why is it that many accountancy practices are currently choosing to rebrand their audit branches as “business assurance”? None of this stacks up. It sounds like people are desperately trying to defend the indefensible.

Surely now it’s time to grow up and be honest about the real issues before it’s too late!

Copyright 2008 by CuriouslyInspired

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