A PERVERSE ACCOUNTING & AUDIT SYSTEM IN CORPORATE AMERICA.

So now, after the Enron surprise, and Qwest, and Microstrategy, and Xerox, it is Worldcom, who suddenly "discovers" that their accounting is flawed, ends up "restating" their earnings, this time for $ 3.8 billion.

As a career internal auditor for over 30 years, I am not at all surprised. That is what results when you deal with a perverse system.

This perverse system in place in corporate America which produces these results will continue to produce them, until the system is effectively understood, dealt with and changed.

I'll try to describe this "perverse" system in lay terms:

Step 1: The investment community, financial institutions, Wall Street analysts, Government, etc., require corporations to have their books reviewed by an independent accountant or accounting firm to ensure compliance with generally accepted accounting standards, in order to feel safe about their investments and the way results are reported.

Step 2: Accounting firms provide their prestige by signing, many times, "clean" audit reports a) based on "not-very-competent" audit field work performed by recent graduates without much experience or knowledge (read: hiring less experienced staff is cheaper) and b) affected by the accounting firm's own profitability goals, which to be accomplished require avoiding rocking the boat too hard by making public any substantive findings or recommendations. Their profitability demands they keep the ongoing business and have their contracts extended over the years generating more professional fees.

Step 3: The independence and work integrity of those accounting firms is further compromised by their providing "additional consulting services" to the very same companies they audit, in a clear case of conflict of interest that has been ignored for many years. After all, internal financial executives (CFOs, Controllers) have a say -a critical one, sometimes- when choosing and keeping or firing the external audit team, so issuing reports critical of their work is dangerous to the accounting firm's permanence on the job, thus the incentive is to look the other way, for self-preservation, the first law of life.

Step 4: Corporations also hire internal audit teams, to obtain additional and "independent" evaluations of internal controls and procedures, which happens to be my specialty. Usually the internal audit function is made to report to a CFO or Controller, which seriously impairs its independence, because you end up evaluating financial controls under the responsibility of your own boss, who, by the way, can fire you if your evaluation of areas under his responsibility shows him/her in a poor light.

Step 5: Every now and then, when something bad about a corporation is made public, or when there is public knowledge about wrongdoings, improper postings, etc., companies dismantle the old and hire a new internal and/or external audit team, whose options are:

a) to continue with the previous scheme, looking the other way when faced with improprieties or serious issues to avoid an internal war and preserve your own job and income, or

b) work with integrity, calling something that walks like a duck, and quacks like a duck, "a duck", risking being fired as consequence.

I should know it: I have been a career auditor for many years, and have paid dearly for my uncompromising and non-negotiable attachment to integrity. I have been dismissed from several Fortune 500 companies, for which I performed as Internal Audit Manager or Corporate Audit Director, due to issuing reports that were critical in areas such as manipulation of P&L reserves and depreciations, or improper income reporting, or finding postings that for one reason or another were far from reflecting the truth, or other issues affecting results, to accomplish "business goals" (read: collect executive bonuses for accomplishing certain pre-established figures).

Some of those companies (yes, they are public, and, yes, some of their stock is widely held by unsuspecting investors) are still covering up my findings and replacing audit teams, with the dubious objective of "protecting stock value" (read: avoiding loss of value of executives' stock options).

If experience is to be taken into consideration, my 30 years in the audit profession have shown me that intentional distortion (up or down) of financial and operational reporting figures, as well as corruption and acting for convenience instead of integrity, is a common occurrence, which is widespread and rampant in corporate America. The presence of partially-qualified audit teams and the loss of independence resulting from those external audit firms having "other business interests" have rendered the audit function ineffective. Furthermore, having the internal audit function reporting to corporate financial executives instead of reporting to the stockholders or, at the very least, to the board of directors, renders it incapable to effectively produce uncompromised and independent results.

Until the real issues, some of which are briefly described here, are dealt with, the investment community will keep being surprised by Enrons, Quests, Xeroxs, Worldcoms and others to come in the future. I wonder who will be next? Perhaps the next scandal with be related to one of my ex employers? I certainly won't invest in their stock, but the regular investor does not know what I know about them.

John Berlin
auditdirector@hotmail.com