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Is audit facing an ethical crisis? By Rob Lewis

29th Jun 2007
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Accountants have always struggled with ethical problems. In 1711 the directors of the South Sea Company took on a proportion of the national debt in return for a trading monopoly. Those keeping the books knew the promise to vitalise the national economy was built on nothing but hot air and hysteria, but they kept quiet. As history shows, it didn't end well.

Last year a letter appeared in an industry magazine from a whistle-blowing accountant which illustrates that those in the profession are still facing the same old problems.

“No one can really discuss ethics until he has been asked to do something that is unethical,” the reader wrote. “I never met anyone who didn’t believe that he or she had high morals before an ethical issue forced a certain decision.” The reader was an accountant in industry, with a young family, who had witnessed unethical behaviour at work and resigned because of it. He was out of work for 18 months. “Was it worth it?” he asked. “That is a personal question I don’t have the answer to. But please, God, don’t offer me this choice again.”

To find the worst incident to spoil the profession's carefully groomed reputation, one only has to look back five years to the Enron scandal. In fact, in a study released by Careers in Audit (CIA) last month, 48% of all British auditors said they knew senior colleagues who had deliberately sidelined ethical objections for commercial gain.

“In terms of what an audit is and what an auditor can provide, I’d say that Enron was the lowest point the industry’s ever had,” said Max Williamson, CEO at CIA. “We were interested to see, five years on from Sarbanes Oxley, how things had changed. Clearly, they haven’t changed enough. There’s been a lot of work to restore public confidence, but this figure is very worrying. It surprised me.”

However shocking these numbers are, Williamson is careful not to paint too bleak a picture. He believes things are improving, and he’s at pains to point out that all the other surveys CIA have suggest that auditors have become much more ethically aware in recent years. But if another accounting scandal does break, it will be too little, too late.

Williamson believes that the profession’s staff shortage is doing nothing to help the situation, considering the extra burden placed on accountants by much of the post-Enron legislation. “Europe is about 50,000 auditors short at the moment,” he claims. “So introducing regulations is all well and good, but if you don’t have the staff to implement those regulations then they’re not much use. There has to be ongoing compliance, and if there aren’t enough guys to do that there’s no point.”

The lack of choice at the top end of the audit market may be another catalyst for ethical crisis. “I think it’s a really unhealthy market,” Williamson explains. “You couldn’t get rid of another one of those firms. You couldn’t take action against KPMG, for example, if they were embroiled in an accounting scandal. They’re too important economically. It’s not a good situation for the industry to be in.”

Trouble at the top
America best illustrates how audit monopoly can give the larger firms something akin to legal immunity. Following Arthur Andersen surrendering its licenses to practice for the infamous document-shredding Enron debacle in 2002, the federal government has proven reluctant to prosecute the remaining major firms – and the Big Four know this. Documents released last week relating to KPMG’s illegal tax shelters dispute show how the firms’ lawyers told the US Department of Justice that criminal charges would be a ‘nuclear bomb’, sending the firm into a ‘death spiral’ which would leave 1,000 companies without an auditor.
Faced with the dire economic consequences of the Big Four becoming the Big Three overnight, top officials interceded, and the charges were dropped. “Does the notion of corporate criminal liability mean anything for the Big Four?” Deputy Attorney General James Comey wondered.

Worryingly, in the UK, the Big Four has an even bigger market share than in the States. In March, the US Association Of Corporate Counsel (ACC) claimed that a European Enron was just around the corner. It may not have been idle talk. What’s worse, Williamson argues Britain’s accounting dynamics mean the Big Four would be treated with an even softer touch than in the US if criminal conduct ever came to light.

“It would throw up a whole load of issues,” he says, “and one of them would be the UK’s principles-led approach. It’s because of that we’ve been able to sidestep Sarbanes Oxley, and that’s made the LSE phenomenally popular over the last few years. If that were to go, and we were to be forced into UK SOX, that would cause problems for a lot of businesses, as well as making the City a less attractive destination for all those foreign companies who are deciding to list.”

Richard Sexton, head of assurance at PricewaterhouseCoopers said the CIA survey was "inconsistent with our own internal quality, procedures and ethical reviews." Present in PwC was "an enormous number of safeguards to give our partners the appropriate support they need to deal with whatever pressure they come under in an ethical way."

As well they might, because the Big Four hardly face the sort of market dynamics that encourages ethical behaviour. Do businesses have any choice but to brace themselves for the impact of further scandal? Well, if you haven’t implemented a practical ethics policy in your firm, now would be a good time.

When that lonesome whistle blows
An ethical business atmosphere (should you not already work in one) isn’t exactly something you can achieve with a PowerPoint presentation. Ultimately, it comes down to whether staff feel they can make an ethical choice. The underlying irony is that in order to minimise whistle-blowing, whistle-blowing has to be actively encouraged.
CIMA, like many accounting bodies, runs an ethics help-line. Once it’s been determined that unethical activity may be occurring, callers can ring a second line that advises on what you can do about it. This has been outsourced to the Institute of Business Ethics (IBE).

“We’re called the whistle-blowing charity,” says IBE deputy director Anna Myers. Although their effect may not be immediate, she argues simple things such as briefings, staff discussions and proper training can do much to reduce the likelihood of unethical behaviour. So the introduction of a separate ethics paper for ACCA students and the inclusion of an ethical component to the ICAEW exams are both welcome developments – if they’re not too late.
Despite the dark murmurings of the ACC earlier in the year, Myers offers a couple of reasons as to why Britain might escape a major scandal. For one, the whistle-blowing culture is entirely different, favouring confidentiality over anonymity. “Anonymity has never been an approach we’ve promoted,” she says.

Anonymity means it’s hard to reassure the worried party, severely handicaps feedback, and raises concerns about the authenticity of the problem. In recent years, it’s been the whistle-blowing model for several US companies – most notably Enron.

Furthermore, it’s worth noting that what little non-anonymous whistle-blowing did take place at Enron was internal. Sherron Watkins, one of Time magazine’s 2002 people of the year, expressed her concerns in an internal memo. “Watkins blew the whistle in a soundproof room,” as Charles Gancke of the American Freedom Centre put it.
In contrast, while protection for external whistle-blowers was only enshrined in US law with the advent of Sarbanes Oxley, it’s been on British statue books for years. The Public Interest Disclosure Act came into effect in 1999, and its early arrival may in itself prove enough to keep audit’s big names on the straight and narrow.

Outside the Big Four
The Big Four may steal headlines and furrow brows, but what about the rest of the pack? It wasn’t the conduct of the smaller firms that triggered the reform and regulation of the last five years. The truth may be that they’ve continued to walk the same ethical tightrope they’ve always done.

Giles Murphy is national head of assurance and business services at mid-tier firm Smith Williamson. When Andersen left the market, did the shadow it cast over the profession extend outside the limelight of the FTSE 350?
“I think we’re at the edge of the lake,” explains Murphy, “and there’s a bit of a ripple from where that stone was dropped. It’s raised awareness, and the rules have been clarified, but I don’t think we are ethically any better than we were ten years ago. Ultimately what governs most people’s approach is that they’re proud of their professional reputation.”

Eric Kench, Chairman of the Practice Society, argues that whatever’s going on at the top end of the market, it’s the auditors in very small firms who have always been the most vulnerable to unethical pressures. The clients of bigger firms are also generally chartered accountants themselves, and are bound by the same ethical rules, at least supposedly. In the smaller firm, Kench argues, the auditor is probably the accountant too, and many of the decisions are made by him alone. By the same logic, sole practitioners are the most exposed of all.
While the Big Four have the budget with which to run helplines, hire ethics officers, and implement dedicated pro-ethical policy, no such support network exists for the auditor in a small practice.

“If you were a junior partner in a small firm,” Kench says, “quite frankly I’m not sure where you’d go. The ICAEW has an ethical helpline, but I bet if you rang them up and said ‘I believe my senior partner is acting unethically, what should I do?’ they’d advise you to resign. Great lot of help that is.”

So perhaps we shouldn’t focus all our ire and anxiety onto the Big Four. After all, however big or small the numbers you’re dealing with might be, ethical choices are ultimately a matter for the single individual - as the directors of the South Seas Company found out, when they were visted by Charles Snell, who many consider to be the first modern auditor.


Replies (4)

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By jon_griffey
29th Jun 2007 17:03

Ethics and small firms
I disagree with Eric Kench's assertion that small firms and sole practitioners are more vulnerable to ethical pressures. As a partner in a small firm of auditors myself I am free to make my own decisions and stand up to clients, even telling them to go elsewhere. By definition the fee will always be small in absolute terms In a larger firm, there are the internal pressures to meet billing targets, recovery rates etc, which you simply do not have in a small firm. In a large firm, when you have a really large fee like for example Enron, is the audit partner really going to stand up to them over some issue and be the one that lost the fee?

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By St Ninian
02nd Jul 2007 10:16

another small firm view
My guess is that most small general practitioners with an audit practice would say that they have always been concerned with ethics and are probably more free to express their ethical views to a client - sometimes quite forcefully - than perhaps is an audit partner in a large firm 'in control' of a large public interest audit case. This has, over the years certainly been the case for me and for my firm. Whatever it is that we do for the client, whether it be tax, accountancy or audit, or other work, both specialist and routine, it is our independence which both underlies everything and is valued by the client. Like Jon Griffey, I disagree with Mr Kench's assertion, and smaller audit practitioners should perhaps be concerned that such remarks could, if left unchallenged, lead to a misunderstanding of the role of the smaller auditor in the life of the smaller business and of the independent relationship to the smaller business owner/manager.

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By J Lessels
29th Jun 2007 11:48

Really a bigger problem for small firms?
It's all very well saying ethical dilemmas are greater for smaller firms and sole practitioners and maybe they are from a theoretical point of view, but only big firms find themselves in a position to create major catastrophes. Enron was a disater not just becasue people did dishonest things but because they did dishonest things with billions of dollars and were then able to hurt a very large number of people financially. The same applies with other financial fiascos like Equitable Life. Small firms just don't get into these sort of numbers.

That said, I think the ethical issues affecting large firms of accountants only reflect the general ethical shortfall in Western society as a whole.

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Dennis Howlett
By dahowlett
29th Jun 2007 16:25

No compass
Rob - you've missed a real opportunity to attack this issue at source: the absolute failure of the country's most senior trade association, ICAEW, to grab this thorny problem and solve it once and for all by developing a separate, examinable paper on this topic. Instead, ethics has been blended to other papers. That should be fun to watch.

That qualification could be supported by calling to account the senior leaders of the Big Four when they fall short - as they do with boring regularity. It doesn't happen. And no - I'm not B4 bashing but they're the ones making th headlines. How for example does PwC think it's going to get away withdrawing 10 years of Yukos audit certificates?

Anything else as action will continue to see the profession perceived as redundant and untrustworthy. That's not what 99% of CAs signed up for. They deserve better.

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