Accounting scandals end in farce

By Michael Coote

Friday 22nd November 2002

High farce has played itself out in the US securities markets. Securities & Exchange Commission chairman Harvey Pitt was forced to resign over the appointment of William Webster as chairman of the Public Company Accounting Oversight Board. The board is the US government's response to accounting scandals like Enron. In theory, the board will ensure that US accountants play it straight with auditing.

It seems Mr Webster was head of the director's audit committee of a company called US Technologies, an internet incubator that has packed up. Allegations of accounting fraud have surfaced and its auditor, before being fired, was BDO Seidman, the sixth largest accounting firm in the US.

The auditor warned of "material weakness in the company's internal controls" before it got the boot. It claims that Mr Webster knew of the warning. Mr Webster, formerly a government lawyer, federal judge and boss of the CIA and FBI, mentioned to Mr Pitt he had worked on auditing oversight at US Technologies.

In an oversight of his own, Mr Pitt neglected to pass on this nugget on to the SEC, which voted by a narrow majority to appoint Mr Webster.

When the story broke, Mr Pitt, a former corporate lobbyist who was criticised for being a poacher turned gamekeeper in taking the SEC job in the first place, resigned. Mr Webster then sent his resignation to Mr Pitt, presumably on the assumption the latter now had the spare time to read it.

In his letter, Mr Webster managed to implicate Alan Greenspan, chairman of the US Federal Reserve, and Paul O'Neill, secretary of the Treasury, in vetting his appointment.

A debilitating political conflict is likely to flow from the scandal as investigations unfold. Conspiracy theorists might even think it was deliberate.

The Pitt-Webster fiasco represents the first direct hit on the Bush administration's handling of the financial markets since Enron collapsed. Previously the scandals could be blamed on the Clinton bubble. But both Messrs Pitt and Webster were effectively Bush appointees. In particular, Mr Webster did not apply for the board chairmanship invited to do so, he was chosen over 450 applicants.

The buck stops on the president's desk. Mr Pitt was an inert choice to begin with, being widely criticised for having done virtually nothing over Enron, and Mr Webster was an accident waiting to happen.

President Bush has messed up at a time when confidence in his administration is direly needed. And the opportunity has recurred to examine his disposal of Harken Energy shares some years ago, which critics allege involved insider trading, a charge the president denies.

It cannot be encouraging that the SEC lost its boss under a cloud and that the accounting standards board has been discredited before it even got started. Nor that critical SEC decision-making could be so botched.

The US markets are drifting rudderlessly. It probably serves the ideological interests of the Republicans and their corporate backers to knock out a couple of interventionist bodies perceived to be obstructive to freewheeling capitalism, but for investors who wish to avoid fraud it is back to square one. Accounting reform will probably lose momentum now the oversight board has been made to look so ridiculous.

There is, however, a private-sector solution to accounting standards that could do away with government intervention in auditing. In an article, "Guarding against corporate scandal," David Gross of Slate.com describes a proposal put forward by New York University accounting professor Joshua Ronen. In March, Professor Ronen argued in the New York Times that public companies should have to take out mandatory accounting insurance.

The chronic problem with auditing is that the client pays the auditor. Conflict of interest for the auditor results, especially if its firm has other lucrative arrangements in place with the client such as consulting.

Under Professor Ronen's plan, listed firms would be obliged to pay an insurance company a premium. The insurance company in turn would hire the auditor. As insurance companies are risk-averse and dislike paying out on big claims, it is a fair bet the auditor would take a firm line on keeping company books clean.

Dodgy companies would find themselves priced out of the accounting insurance market and shut down as a consequence. Shonky auditors would soon be reported through the insurance industry grapevine and never work in the industry again.

Professor Ronen's theory is a neat, market-based, self-regulating solution that merits serious debate in this country. One obvious objection would be to ask who audits the insurers, but that problem does not seem insurmountable.

The antics of the Pitt-Webster affair should not distract accountants, investors and regulators from pushing on with audit reform. One of the ways in which the New Zealand sharemarket can be internationally distinctive, and attract more foreign capital, is to establish an auditing regime that is second to none.

If this result could be achieved by attacking auditor conflict of interest at its root, then we would be much enhanced in value as an investment destination. Accounting insurance should be a hot topic here right now.

Comments from our readers

No comments yet