What's behind the accounting scandals at some big corporations? I received this analysis from an experienced Certified Public Account in Charlotte who didn't want his name used. I thought you might find it as interesting as I did.

The CPA wrote:

During the last 15 years I have worked for several of the (former) Big 6 accounting firms. Recent scandals make it clear that something is wrong in the way audits are performed and funded.

I have found the people who work for these firms to be of the highest caliber and generally very ethical. I think the problem is a set of relationships that undermines the auditor's independence.

Accountants make much of being "independent," as opposed to lawyers, who are "advocates." Perry Mason defends his clients no matter what. A CPA (auditor) is supposed to have a higher calling -- to represent the public interest (the "P" in CPA), no matter what the wishes of the client.

The fact that most of the professional jobs in an accounting firm office hinge on keeping the client happy reduces the independence auditors claim is necessary to perform the audit.

Other relationships also affect this independence. These large accounting firms plot and plan to place their key former employees in top posts at client firms. At one major company the vice-chairman and CFO, the chief accounting officer, the chief internal auditor and a host of other key employees are "alumni" of the CPA firm currently auditing them.

Does that familiarity makes it more or less likely that when a tough accounting issue comes up, the CPA firm will see things the client's way? More or less likely that the client will propose a change in auditors?

Many CPA firms donate to the charities favored by the client firm's management. They cajole their employees to contribute and politically support candidates that "client" management said to support, from Congress down to the school board level.

Large multi-national CPA firms have so-called "rotation" policies that allow audit partners to be rotated from one client to another. At a firm I worked for the rotation occurred every seven years. The problem is that the rotation was all smoke and mirrors. It satisfied SEC requirements but did little to alter the close relationship.

There are two kinds of audit clients. One is the large multi-national corporation that is "too big to lose." These are the Enrons, Global Crossings and WorldComs that the big accounting firms rely on to pay their bills and partner draws. The relationship with them is protected at all costs.

The rest fall into the general audit pool. These smaller clients are routinely subjected to strict interpretations of accounting principles and standards.

Large audit clients also use consultants from the big accounting firms. These consultants generate huge billings for non-audit work. This work is said to be separated by a "Chinese wall," with the auditor on one side and the consultant on the other. Yet the money goes into the same pair of pants, so the audit partners benefit from the consultants' work.

Another issue is the method in which SEC audit engagements are performed. Auditors place "reliance" on internal controls to avoid detailed testing of transactions. They place "reliance" on the client's internal auditors to do much of the heavy lifting in an audit. The net effect is that a lot of what the actual large multi-national auditor does is little more than window dressing and signing the audit opinion.

Several issues need to be considered as rules governing the accounting profession are revisited:

* Should the Securities and Exchange Commission allow CPAs to be paid by the client for audit services, or should there be an independent payment process that removes the client relationship from the mix? The link between the money paid by auditors and their desire to "keep the client happy" is a weakness in the current system.

* Should the SEC allow an accounting firm's CPAs or senior managers to leave the firm and go to work for the client company?

* Should the SEC require rotation of the audit firm as opposed to rotation of the audit partner? Rotating the firm would preclude the institutional affinity that builds up between client and auditor.

* Should the SEC allow CPAs to audit public companies while their firm does lucrative consulting work for the same companies?

* Should the SEC allow CPAs to participate in the pet projects of executives at firms they're auditing?

* Should CEOs be allowed to hit up accounting firm management for their favorite charities and expect them to deliver as part of the auditor-client relationship?

These conflicts should be part of the public debate. The current proposals in Congress and by the accounting profession are woefully inadequate. The public should expect more from both.

Ed

Williams