In the Netherlands it's the AFM. It has been very critical of the quality of the audits it has sampled for several years now. However, Dutch courts have placed the onus of proof in establishing that the auditing system at the big-4 is defective in the hands of the supervisor. That's hard to establish via samples.
External accounting has a basic function in society. But when the auditee foots the bill and is also the one to provide information on his / her own (possibly faulty) procedures it's not hard to imagine things going wrong.
Currently the AFM demands higher standards and asks for more budget for oversight in order to be able to look at more cases. Guess who pays for that oversight - the companies already paying an arm and a leg for the audit.
The impression from the title is different than what the article actually says--EY missed red flags that resulted in passing the audit when it should have failed, and later scrutiny is what caused the companies to implode.
I'm not sure where you got the impression that problems such as $300 million in fabricated sales, or $5 billion in undisclosed debt which were missed in audits is an issue with external scrutiny.
My post is specifically pointing out that the wording makes it sound like EY audited the companies and their findings are what caused the companies to implode, which is what the parent comment seemed to assume, but the article actually says that it was the fact that EY did not find problems during their audits, which were later found, causing companies to implode.
> I'm not sure where you got the impression that problems such as $300 million in fabricated sales, or $5 billion in undisclosed debt which were missed in audits is an issue with external scrutiny.
You don't think these might have caused problems for the company in the absence of external scrutiny?
The story is more interesting, especially in the case of Wirecard.
The FT started questioning Wirecard's accounts years ago, and Wirecard and the German financial services regulator, BaFin responded by... launching legal attacks on the FT, accusing the paper of colluding with short sellers.
The FT kept finding and printing more and more evidence, EY kept giving Wirecard audit cover, and BaFin kept up an aggressive defence... of Wirecard.
Then finally €1.9bn was found to be missing. The various "evidence" provided to EY to "prove" the money was real shouldn't have fooled anyone who had even the most basic grasp of professional auditing. When the shares were in freefall, BaFin finally admitted that perhaps there was a problem.
Then EY's CEO sent a letter to clients in which he said “Many people believe that the fraud at Wirecard should have been detected earlier and we fully understand that. Even though we were successful in uncovering the fraud, we regret that it was not uncovered sooner.”
The part in italics is simply a lie. EY did not uncover the fraud. The FT did. And in fact what finally killed Wirecard was an independent audit by another Big 4 member - KPMG - which was supposed to vindicate Wirecard, but actually found "irregularities" which Wirecard couldn't explain.
So - what to conclude? It's hard to avoid a cynical interpretation - that auditing at this level is basically PR with spreadsheets, intended to reassure investors that everything is fine, and not a serious effort to reveal financial irregularities.
It's not just EY. KPMG, Deloitte, and PWC have all had issues of their own. The underlying problem is that these companies are hired by their clients to provide a clean bill of health, and if they're too thorough they're not hired again. So the incentives are - let's say - heavily aligned against too much stringency.
The FT Wirecard story is well worth a read. The FT is (expensively) paywalled, but some of the reporting is free.
The other dimension is cost, auditing a business to the point that you could conceivably uncover any fraud is prohibitively expensive, auditors, for better or worse are highly trained and specialized professionals and the hours that they work cost their clients substantially. If you really want a system that prevents all fraud, rather than most, then you’re going to have to accept much higher costs, which given its relative rarity is possibly not worth paying for.
Ah, that's funny, because the way I read the headline, I assumed it was saying that they imploded because of lax auditing by E&Y, which should have caught their problems before they snowballed into too-large-to ignore implosion drivers.
It might've just been me misinterpreting, but I thought the parent comment meant that EY would become the "Big One" after auditing the other companies and causing them to implode
Ah, hahaha I thought that was just a general comment about any of the others being potentially hole-ridden enough that an audit would destroy everyone but the one doing the auditing.
The Indian government is also unusually (as far as my impressions take me) dedicated to supporting domestic Indian firms in direct competition with international firms. (It's not clear to me from the article you shared that's what happened, though, just airing a possibility.)
Probably it should be the "big None" but the people best positioned to do something about it are inherently conflicted.
Three of the Big Four are head-quartered in London†, and so the most likely avenue to better regulate them would begin in Westminster. But Westminster has for many years been in the hands of Tories, who have successfully hoodwinked the British people into believing that somehow all the awful things Tories keep doing would be fixed if only they had more Tories in charge of everything. The Tories pay the Big Four piles of tax payer money, including to "fix" problems caused by other members of the Big Four. For some reason the proposed answer often seems to be "Pay Big Four firms more money" perhaps they could pay a Big Four firm to find out why that is?
† All of the Big Four are organised as Groups, so that a relatively small company - in three cases based in London - handles the global brand, while independent businesses in dozens of countries share that brand, intellectual property and so on. Legally it is possible to pretend these aren't the same firm, although it sure is convenient how easily senior employees move between one of the independent businesses and the others as they wish...
The establishment of corporate personhood has been a major threat to our society. It doesn't make sense that some abstract entity can have more legal rights than people. If someone commits a crime, they go to jail and so they cannot continue to harm society. On the other hand, if a corporation commits a crime, they get a fine and keep doing what they were doing. There should be a point beyond which people need to go to jail or the corporation shares need to be seized by the government.
There needs to be an incentive for shareholders to dump shares of unethical companies. The government should provide that incentive.
Accounting firms and their partnership structure confuses me. Seems very archaic relative to corporate structures. Makes it hard to figure out who’s calling the shots.
When I go to the Canadian E&Y website, it says:
> EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.
> KPMG International changed its legal structure from a Swiss Verein to a co-operative under Swiss law in 2003[25] and to a limited company in 2020.[4]
Are they basically franchises? Is there some uber-partner at the global hq collecting massive commissions?
Well it's mostly because partnerships are extremely flexible flow-through structures.
If it were a corporate structure, there is corporate tax, so you have more of an incentive to spend as much as you can as opposed to tight spending and paying people as little as you can so you get as much profits as you can (partnership flows directly to the individuals, so there is no form of double taxation).
Also with a partnership you just rewrite your agreement which you keep 100% internally and do whatever you want. Corporate structure has a lot more overhead, you have requirements that should be met and so forth.
There are good reasons.. most of them the same old bs taking advantage of the system in one way or another.
They're partnerships because they're usually legally required to be partnerships as a matter of liability concerns. (Most countries now allow professional firms to be professional LPs, LLPs, or PCs, limiting the financial liability of partners for the debts of other partners but not those resulting from their own malpractice.)
This is how I understood it was well. Big four partnership structure is optimized to comply with the legal requirements for auditors. That is why e.g. accenture (which has no auditing arm) can be publicly traded but the rest cannot.
They are global collectives of individual country-level partnerships (though in some countries they are allowed to be corporate entities rather than partnership entities).
Each country-level partnership is its own independent firm, and can generally choose to re-affiliate with another multinational "firm" as it desires. This actually happens quite frequently.
Generally, the member firms cross-bill each other at discounted rates. They make up for it through increased volume of work and/or more lucrative work.
You'll see similar models in law firms. IMHO it's driven by two key elements in the business: An apprenticeship-like, up-or-out model for developing talent and a vested owner-operator class at the "partner" level.
These firms effectively operate as a collective for the benefit of the partner class. New partners must invest capital, ongoing partners get returns, and older partners retire with a terminal payout. Some partners may take on expanded leadership roles and get higher annual payouts.
The overarching legal structure is a sort of "modularization" to limit the liability of lawsuits and enable flexible operation. There is a usually a global partnership council that dictates universal operating norms and practices.
Again, fundamentally, it operates as a collective and international units support each other for collective benefit.
I would be really interested to see this model applied to software. I am unaware of any firm that has done it this way so far — which is odd, because it really does seem tailor-made to suit our sort of work, no?
i think the reason consultancies (legal firms, accounting firms, etc) do it, and not traditional software companies, is because the worker hours translate directly into billable hours. Partners are incentivized to bring in more business, which the associates (and the partner him/herself) can bill against. I think partners are usually expected to bring in a certain amount of business to justify their profit share.
In a traditional software company, like a SaaS business, I don't know how it would translate. A developer fixing bugs might be important for the business, but ultimately is hard to translate to the bottom line. It's not like hiring a high level executive will have a guaranteed ROI in the same way.
Sounds like the distinction is between project work and owning one or more products. A Wipro could function like this. No reason a Microsoft couldn’t, but they just don’t.
Deloitte make a huge point of hiring apprentices - taking on dozens (maybe nearly ~100) of them on every year. Seems the general goal of everyone there is to make partner one day.
In software co's, profit sharing is split between equity vs commission, where equity for hard-to-attribute & motivate stuff and commission for easy-to-attribute-and-motivate stuff. Doing profit sharing incentives for devs risks getting weird quickly.
-- It's hard to measure contributions of a dev in a team of 5-10 (how much was them, another dev, the PM, the designer?) while pretty clear for say a sales + sales eng pair.
-- Likewise, there's a danger of confusing incentivizes of having a dev make commission-based decisions, esp. when counter to what a PM needs to incentivize. in a sense, part of the PM's job is to prevent sales/marketing/management from confusing the rest of the org!
For product orgs, some companies do incentives and promotions based on profit/loss measurables ("1% datacenter power savings => $10M/yr savings => ..."), I think team-based w/ some sort of hierarchy. Alternatively, Cisco weird spin-in system worked well... for those liked by the involved leads.
When _not_ a product org and a more direct line to $, like a sales eng supporting sales, or a dev supporting a quant, easier to go commission/profit-sharing based..
I always wondered why law firms used partnership structures, but this seems like the core reason (most other reasons could would still work within a limited liability corporate structure).
I know opportunity costs are a thing but a lawfirm seems like the one of the worst possible targets for a lawsuit even without attorney-client priveledge complicating matters. Barring smoking gun damning evidence (which they would be skilled at knowing how to avoid both in terms of not doing it and not getting caught).
I would have guessed it as more a result of billable hour basis means it is practically "pure per person labor" dependent even with structures of management, less experienced lawyers and paralegals to effectively transmute the less experienced working hours into more experienced hours by them reviewing and signing off on the work of underlings.
Without the head partner you have 400 billable hours of junior lawyer and paralegal work. With one you effectively have 410 hours of partner legal work and they have staked their reputation and used their expertise on it to verify it. If the partner spent those 10 hours day drinking and signing off without reading it turns out to be 400 hours of soverign citizen tier pseudolegal nonsense arguments is their head essentially.
> I know opportunity costs are a thing but a lawfirm seems like the one of the worst possible targets for a lawsuit even without attorney-client priveledge complicating matters.
If you're suing someone else's lawyer, yah. But if you're suing your own lawyer... that privilege is client's privilege, and they can waive it if they want to sue their attorney (AFAIK).
In the U.S., law firms are very often structured as "limited liability partnerships," a.k.a. LLPs. In most versions of LLPs, each individual lawyer is responsible for her own malpractice and that of the people she supervises, but not of the malpractice of others. [0]
there is a concept in RICO law called 'piercing the corporate veil,' where lawsuits against a company can 'pierce through' layers of holding company structures, to exactly prevent people from creating shell companies to limit liability.
In practice, however, it is another line of defense, because you have to argue in court for each layer to peel back.
Can you elaborate on the "new partners must invest capital" part? I've heard of this, notably in the TV show Suits where when the lead character got promoted to partner, he was asked to contribute a lump sum of cash. Sounded nuts to me that a promotion meant you basically got a chance to pay (I know it's actually invest) money.
Every firm has its own specific way of doing it, but the short version is that non-partner workers at a firm are normal employees with a normal salary, benefits, etc. But they do not own any equity/stake/shares in the firm.
Once you are promoted to partner, you are no longer an employee of the firm and in some cases you no longer earn a salary. Instead when you are promoted to partner, you are allowed to "buy in" by purchasing a certain number of shares of the company. Once you own those shares you are then part-owner of the firm (rather than an employee) and enjoy profit-sharing.
Relative is in HR at a big4, this is basically correct. Some ballpark numbers.
A "first year" partner may have to pay ~$150,000 into the partnership, on perhaps a $300,000ish a year in profit sharing. Usually this is just a reduction in the profit sharing (or perhaps a multi year loan, i forget). Its not uncommon to earn less as a first year partner than your last year as Managing Director.
You are not longer an employee, but part owner. You move onto a totally separate HR system (Benefits, etc.).
Relative works with mostly senior partners, multiple of them are making $1 million+ a year. That's not common, but as you move up the ranks of partnership, that's not a crazy salary. They work a lot, are all divorced, don't seem to even have time to enjoy the $$ etc. Listening to the details, I'm not super jealous.
It may be different in other firms but at least for the big 4 firm in familiar with sr managers can be promoted to either partner or managing director, and mds usually take home more that first year because of the buy in, usually in the form of an interest free loan.
you have to buy a partnership. The firm usually makes you an interest free loan to buy the partnership. Some people bought into arther anderson right before enron blew them up.
The partnership is often the most valuable single asset a partner owns. It prevents them from jumping ship and taking clients. And it acts to hopefully prevent a partner from taking risks that could destroy the firm. Even senior people who might become partners in the near future will not want to put that partnership at risk.
When you retire, they'll buy your partnership out - often paid out over a few years.
That doesn't feel much different from the (common, highly tax-favored) early exercise of stock options in a startup.
If you're becoming a part-owner, of course it makes sense you have to buy shares, my only confusion is how they determine the relationship between the value of those shares and what you have to pay for them.
They know how many shares in the partnership they have, and the profits they earned and have no other shareholders, the remaining profit gets divided up among the partners.
Do they ever clean house of one of the national divisions? Or wouldn't do that (too directly) because that could be construed as being too involved in the local operations?
>Are they basically franchises? Is there some uber-partner at the global hq collecting massive commissions?
Yes and no. In practice, each "country firm" (such as the PwC US firm) operate as individual companies with their own leadership team that, while they don't have the typical CxO titles, they have the same roles. Tim Ryan is basically the CEO of PwC US, for example, and PwC UK is a different company with a different CEO.
Internationally there is also an umbrella organization that helps coordinate really high level stuff like branding (since all the country organizations share the same branding), internal IT strategy (such as getting everyone to use the same productivity tools to make it easier for cross-firm collaboration), etc.
The individual companies reap benefits from this coordination because of the singular, strengthened brand, culture, methodology etc. So in that way it sort of is like a franchise. But that international organization doesn't have much to do with the day-to-day in-country operations or decisions about specific audits/projects. That would be the responsibility of the local partners/leadership team.
Nah, the reality is that it's very easy to figure out who's accountable for any specific project. While it may not be clear who is in charge of a firm as a whole, that is not the case at the project level. Every project/audit must be signed off on by a partner, and that partner is the responsible party for any and all firm activity that happens on that project/audit.
The water gets muddied because that partner may not actually be involved in the project very much, and in controversial situations they may try to blame someone else (such as a lower level firm employee who was involved) for any mistakes, but at the end of the day the partner who signed their name to the contract is the person held accountable.
Is this a similar type of standard Professional Engineers are held to? I'm sure they don't, e.g. design every member of a bridge and do the stress calculations by themselves, but when it comes time to certify the design, the PE (and the PE alone, if I understand the way it works correctly, regardless of how many people worked on the drafts) is the one upon whom the entirety of the blame lies should the bridge collapse.
AFAIK, yes. Other people on the project/audit can be held responsible too if they contributed negligently, but the partner who oversaw the project is ultimately accountable for the work. That partner is also who the PCAOB/SEC would fine and/or suspend their accounting certification.
This is correct, the firm will usually have internal fines for partners with inspection failures / comments. There is significant individual liability for an audit partner.
They also provide project management services and run PMO in multi vendor scenario. At least according to my personal experience they field in rookie armed with powerpoint and excel templates and zero brain. Perhaps they Re asked not to use brains.
There is no need to say what kind of mess they end of creating.
Just spitballing, but public companies could pay a small tax in lieu of paying an auditing firm, and the auditing could be done by government-employed accountants who are beholden to the public interest. Of course this would never happen because it would destroy the politically-powerful auditing firms.
We already do this. The expensive auditors exist to wrangle the complex organization of multinationals into a digestible form so that they can be pushed through the compliance processes of the government employed accountants more efficiently.
The auditors are doing by far the bulk of the work, with the government essentially just signing off on it. This has directly lead to scandals such as Enron and possibly Wirecard.
Yes. I don't know what you're expecting under a "small tax" burden. Did you want that tax burden to be 10x? Besides companies are still going to want to buy their own accounting services to avoid the hassle and cost of resubmission, or penalty (if you're going with an early-punitive measure).
If your goal is to increase the power of the accountancy industrial complex I suppose your strategy is a good one.
Interesting, but I would personally like to leave the government out of this (let's not introduce deeper/political conflicts of interests).
What about just standardizing the fees charged for audits and doing a fixed rotation (rotate e.g. once every 4 years) of assignments of auditing companies to clients (companies being audited)?
This way on one hand the conflict of interest by paying megabucks to auditing firms (to get a positive audit outcome) would vanish (as the fees would be fixed), on the other hand a auditing companies would lose the tendency to try to stick to a particular client (by providing positive audit outcome).
Or we could disentangle government from regulator. The market needs rules and enforcement, maybe the government could pay a private regulator to some of that.
The government can at least ideally be replaced/restructured popularly when it gets its hands dirty with conflicts of interest. The redress for private corruption is much less powerful. I don't understand why it's so often taken as a truism that somehow introducing privatization or profit motive will improve a given problem; I would have hoped by now the numerous flaws in that approach would be apparent.
> public companies could pay a small tax in lieu of paying an auditing firm, and the auditing could be done by government-employed accountants who are beholden to the public interest
Oh man, I am starting an accounting firm if this gets traction.
Not only will the government-employed auditors get paid, but companies wanting to avoid embarrassing findings will pay for pre-audits. Then, when the right administration comes in, the government audits will be outsourced.
Ideally shareholders or investors would. It’s the same reason why the home buyer pays for the home inspection; it’s a conflict of interest for the selling party to pay for their inspection.
I can't read the article (paywall), but in general - you can't. E&Y (and the other audit firms) have very real conflict rules that prevent audit customers from using advisory services and vice versa.
In fact, we went down the road in building out an offer that would have worked with one of the firms and we abandoned it because it was so painful to just determine if they had a conflict and then we would lose the customer if they did.
There has been an issue with auditing. Internally in an audit firm the focus has moved in the last 5-8 years almost entirely to compliance.
It is MUCH MUCH more important that you document everything per the insane number of checklists with sometimes wildly overboard list of requirements than actually look (or have time) to find errors. Actually finding a problem, actual accuracy of audits is no longer emphasized.
As a result, staff go into drudge mode on all sides, some of the work is boilerplate wasted effort, so folks on all sides can get into a lets get through this mentality rather than a lets look into this mentality.
This is in part because one stick here, a review process / PCAOB inspection process is HIGHLY focused on the documentation / checklist part of things. No credit is given for actually finding problems at clients, but LOTS of demerits if everything is not in exact documentation format it needs to be.
Seriously, the PCAOB calls things "audit failures" when something like the work around an item wasn't properly documented in their view EVEN THOUGH the actual numbers were accurate. So auditor signed off on right number, and that is a "failure"
That's a change from past, if numbers were wrong and they had been signed off on, THAT was an "audit failure".
But now, as long as you have followed the steps and checked the boxes, then even IF you miss something, that's OK, because it's "reasonable" not absolute assurance and there is a note that a "well performed" audit may still miss things. Well performed has been interpreted to mean huge amounts of documentation.
This matters legally too - the payouts on these failures may be surprisingly small.
So doing gobs of paperwork is of great importance, and there is little reward left in terms of actually finding problems both by PCAOB and because that can ruffle feathers at client that hired you. So every incentive is for massive amounts of somewhat thoughtless documentation and less substance.
Solutions.
- Name audit partner on report - the fact this isn't done is ridiculous.
- The auditors could be hired by the people who use the audit if possible.
- Get rid of a LOT of boilerplate, it kills staff motivation - folks just go intro drudge / checkbox mode.
- Then add some randomized forensic level rather than checkbox level work, with deep deep checks that staff might enjoy doing and feel like they were really looking for stuff rather than just "papering" the audit.
- Focus on RESULTS. Did auditors sign off on numbers that were right or wrong. That should be entire focus of auditing. Reward folks who find errors. Literally, have a pool of funds for auditors who find the biggest misstatements.
- Include list of auditor proposed adjusting entries to client financials in audit report. Again, focus on the actual results / quality of client / auditor work.
As someone who works closely with Big 4 auditors at a public company, I completely agree. However, typically a firm does not audit and consult the same company at the same time to my knowledge.
This is a regulatory oversight problem, pure and simple, and it has existed forever. The incentive structure is far too conflicted for self policing. See also: ratings agencies.
WRT the 2006 financial crisis, there were about 10-20 regulatory agencies that had the power/responsibility to maintain stability. Each of them failed, but none were held to account; they each just made some excuses, and demanded more power and money.
Every time there's a crisis, the relevant regulator is exonerated of any responsibility, so their incentives are even weaker than those of the executives getting bailed out.
I agree. In addition regulators have zero incentives to serve the interests of the regular people. They do, however, have a huge incentive to block the market for the new competition (aka regulatory capture) and then comfortably rest and vest in a major corporation after quitting their government job with full benefits.
I agree that it's an incentive problem, and that it is directly analogous to what happened with the ratings agencies, but I don't think regulation will help much.
Auditing worked when the shareholders were paying for it, because they were interested in getting 'tough' reports, and they were holding the auditors to account. As soon as you make it mandatory, and the companies are paying for it, the audit becomes de rigueur; more of a formality than a search for truth. I don't think regulators are part of the solution here.
I think that having 'crowdfunded' audits by shareholders would work much better, but it probably won't happen while audits are required for all public companies. You'd have to put the onus of auditing back on the shareholders, and expect that some results will go un-audited.
Regulations would help if they were truly enforced and, in the case of fraud, criminal charges were pursued. White collar prosecutions are so rare, there is no longer any real deterrent.
I am not sure how regulation will really solve a problem of incentives. I know that locking up corporate executives is very popular, but I don't think it works. You just end up with a bunch of audits that are technically correct, but fail to detect big problems.
I recently read "The Smartest Guys in the Room", and I'm not sure how you regulate that kind of problem out of existence; I don't think Sarbanes–Oxley really fixed it, but I am not sure regulations really can. Look at Theranos and Nikola; these should have been found out earlier, but their deceptions were not covered by auditors.
Of course there will still be fraud, but enforcement of regulations provides powerful disincentives to cheat. Right now it's wild west, and when systemic risk shows up, the Fed bails everyone out without consequence.
I don't think regulations can get rid of systemic risk, but maybe that's because of how I see systemic risk issues. Most of those huge market corrections seem to be due to massive mistakes made simultaneously by a lot of people. The 2006 crisis is a great example, where investors thought real estate markets in different states were independent of each other, which turned out to be incorrect.
The real estate bubble and the financial crisis in 2008 that followed was due to oversight failure, pure and simple. Rather than address that failure, the government bailed out everyone.
The regulators were relying on the same assumption (of uncorrelated real estate markets state-by-state) by the credit ratings agencies.
The investors, ratings agencies, and regulators all believed in the same incorrect assumption. If that assumption had been correct, the crisis would never have happened.
Auditors do not look for fraud. Plain and simple. It has NEVER been their job. I have at least a dozen auditors/accountants as close friends. Talk to any auditor and that’s the first thing they will tell you. If they happen upon fraud they need to tell the authorities immediately but otherwise don’t expect auditors to be the ones who are also fraud detectors.
So why exactly does anyone want that, if not as a subgoal of spotting fraud? (I mean, if the first link in the chain is "because that's what's necessary and sufficient to comply with the law" then why was the law written that way?)
I would presume that the (not unreasonable) assumption is that "verification that a company's books are drawn up according to prevailing requirements." makes it harder to hide fraud.
Well I did just talk to the auditor of my company (100m ebitda, not massive but not small), last week about their questions regarding fraud and it seems you're entirely wrong...
Color me confused, but where I work we are subject to two auditing companies and they don't necessarily ask the same questions but they do review what the other does.
So is that a normal process or is that only where industry regulation requires it?
In Australia, Uber became too on the nose for even EY. And perennial tax entrepreneurs Macquarie Bank won't let their staff use Uber because they are uncomfortable with the tax treatment (I think they think the receipts aren't legit but this I am guessing).
At PayPal it’s crazy how incestuous their relationships with consultants are. The Assistant Treasurer is married to the partner at Deloitte who they give out their finance consulting work and she just so happened to increase the number of consultants there by 3-4x. Saw similar stuff at other departments. The people who were from or affiliated with a consulting firm would route work to those firms to cover for them. All the consultants I ever worked with were pretty useless anyways, just always felt like we were training some recent college grad.
There's a lot of caver-emptor required : many companies have notes on their accounts from auditors saying things like "we can't see the accounts in Italy" for years before the staggering frauds are discovered. Investors generally don't care at all, and only start squealing when the firm charges £100m to their results.
If investors treated accounts & audits seriously then it would be different. But they don't - and so many, if not most big companies have significant standing "irregularities".
My experience of EY as a customer has been bad. Created a digital solution in the security sector and EY wouldn't be damned to use it themselves. Also there internal billing between entities is expensive and strange
128 comments
[ 2.7 ms ] story [ 266 ms ] threadWill it soon be the 'Big Three'?
External accounting has a basic function in society. But when the auditee foots the bill and is also the one to provide information on his / her own (possibly faulty) procedures it's not hard to imagine things going wrong.
Currently the AFM demands higher standards and asks for more budget for oversight in order to be able to look at more cases. Guess who pays for that oversight - the companies already paying an arm and a leg for the audit.
Not a surprise. If they start to scrutinize accountants' practices, then they'll be expected to place the same scrutiny on lawyers' practices.
Really? If scrutiny is what caused the companies to implode, it seems like there's a strong argument to be made that the problem was the scrutiny.
You want to find problems that are problems whether you find them or not, not problems that are only problems because you called them "problems".
My post is specifically pointing out that the wording makes it sound like EY audited the companies and their findings are what caused the companies to implode, which is what the parent comment seemed to assume, but the article actually says that it was the fact that EY did not find problems during their audits, which were later found, causing companies to implode.
You don't think these might have caused problems for the company in the absence of external scrutiny?
The FT started questioning Wirecard's accounts years ago, and Wirecard and the German financial services regulator, BaFin responded by... launching legal attacks on the FT, accusing the paper of colluding with short sellers.
The FT kept finding and printing more and more evidence, EY kept giving Wirecard audit cover, and BaFin kept up an aggressive defence... of Wirecard.
Then finally €1.9bn was found to be missing. The various "evidence" provided to EY to "prove" the money was real shouldn't have fooled anyone who had even the most basic grasp of professional auditing. When the shares were in freefall, BaFin finally admitted that perhaps there was a problem.
Then EY's CEO sent a letter to clients in which he said “Many people believe that the fraud at Wirecard should have been detected earlier and we fully understand that. Even though we were successful in uncovering the fraud, we regret that it was not uncovered sooner.”
The part in italics is simply a lie. EY did not uncover the fraud. The FT did. And in fact what finally killed Wirecard was an independent audit by another Big 4 member - KPMG - which was supposed to vindicate Wirecard, but actually found "irregularities" which Wirecard couldn't explain.
So - what to conclude? It's hard to avoid a cynical interpretation - that auditing at this level is basically PR with spreadsheets, intended to reassure investors that everything is fine, and not a serious effort to reveal financial irregularities.
It's not just EY. KPMG, Deloitte, and PWC have all had issues of their own. The underlying problem is that these companies are hired by their clients to provide a clean bill of health, and if they're too thorough they're not hired again. So the incentives are - let's say - heavily aligned against too much stringency.
The FT Wirecard story is well worth a read. The FT is (expensively) paywalled, but some of the reporting is free.
https://www.ft.com/content/284fb1ad-ddc0-45df-a075-0709b3686...
(Not quite sure that idiom works in US English so maybe only for some markets ;-)
https://www.thehindubusinessline.com/info-tech/satyam-scam-s...
Three of the Big Four are head-quartered in London†, and so the most likely avenue to better regulate them would begin in Westminster. But Westminster has for many years been in the hands of Tories, who have successfully hoodwinked the British people into believing that somehow all the awful things Tories keep doing would be fixed if only they had more Tories in charge of everything. The Tories pay the Big Four piles of tax payer money, including to "fix" problems caused by other members of the Big Four. For some reason the proposed answer often seems to be "Pay Big Four firms more money" perhaps they could pay a Big Four firm to find out why that is?
† All of the Big Four are organised as Groups, so that a relatively small company - in three cases based in London - handles the global brand, while independent businesses in dozens of countries share that brand, intellectual property and so on. Legally it is possible to pretend these aren't the same firm, although it sure is convenient how easily senior employees move between one of the independent businesses and the others as they wish...
There needs to be an incentive for shareholders to dump shares of unethical companies. The government should provide that incentive.
When I go to the Canadian E&Y website, it says:
> EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.
PwC refers me to a separate website for their structure: https://www.pwc.com/gx/en/about/corporate-governance/network...
KPMG has been mixing it up, per wikipedia:
> KPMG International changed its legal structure from a Swiss Verein to a co-operative under Swiss law in 2003[25] and to a limited company in 2020.[4]
Are they basically franchises? Is there some uber-partner at the global hq collecting massive commissions?
If it were a corporate structure, there is corporate tax, so you have more of an incentive to spend as much as you can as opposed to tight spending and paying people as little as you can so you get as much profits as you can (partnership flows directly to the individuals, so there is no form of double taxation).
Also with a partnership you just rewrite your agreement which you keep 100% internally and do whatever you want. Corporate structure has a lot more overhead, you have requirements that should be met and so forth.
There are good reasons.. most of them the same old bs taking advantage of the system in one way or another.
Each country-level partnership is its own independent firm, and can generally choose to re-affiliate with another multinational "firm" as it desires. This actually happens quite frequently.
Generally, the member firms cross-bill each other at discounted rates. They make up for it through increased volume of work and/or more lucrative work.
These firms effectively operate as a collective for the benefit of the partner class. New partners must invest capital, ongoing partners get returns, and older partners retire with a terminal payout. Some partners may take on expanded leadership roles and get higher annual payouts.
The overarching legal structure is a sort of "modularization" to limit the liability of lawsuits and enable flexible operation. There is a usually a global partnership council that dictates universal operating norms and practices.
Again, fundamentally, it operates as a collective and international units support each other for collective benefit.
Or maybe I am missing something.
In a traditional software company, like a SaaS business, I don't know how it would translate. A developer fixing bugs might be important for the business, but ultimately is hard to translate to the bottom line. It's not like hiring a high level executive will have a guaranteed ROI in the same way.
-- It's hard to measure contributions of a dev in a team of 5-10 (how much was them, another dev, the PM, the designer?) while pretty clear for say a sales + sales eng pair.
-- Likewise, there's a danger of confusing incentivizes of having a dev make commission-based decisions, esp. when counter to what a PM needs to incentivize. in a sense, part of the PM's job is to prevent sales/marketing/management from confusing the rest of the org!
For product orgs, some companies do incentives and promotions based on profit/loss measurables ("1% datacenter power savings => $10M/yr savings => ..."), I think team-based w/ some sort of hierarchy. Alternatively, Cisco weird spin-in system worked well... for those liked by the involved leads.
When _not_ a product org and a more direct line to $, like a sales eng supporting sales, or a dev supporting a quant, easier to go commission/profit-sharing based..
I always wondered why law firms used partnership structures, but this seems like the core reason (most other reasons could would still work within a limited liability corporate structure).
I would have guessed it as more a result of billable hour basis means it is practically "pure per person labor" dependent even with structures of management, less experienced lawyers and paralegals to effectively transmute the less experienced working hours into more experienced hours by them reviewing and signing off on the work of underlings.
Without the head partner you have 400 billable hours of junior lawyer and paralegal work. With one you effectively have 410 hours of partner legal work and they have staked their reputation and used their expertise on it to verify it. If the partner spent those 10 hours day drinking and signing off without reading it turns out to be 400 hours of soverign citizen tier pseudolegal nonsense arguments is their head essentially.
If you're suing someone else's lawyer, yah. But if you're suing your own lawyer... that privilege is client's privilege, and they can waive it if they want to sue their attorney (AFAIK).
Here they act a lot like limited companies but are tax-transparent.
[0] https://en.wikipedia.org/wiki/Limited_liability_partnership
In practice, however, it is another line of defense, because you have to argue in court for each layer to peel back.
[0] https://en.wikipedia.org/wiki/Limited_liability_partnership
Once you are promoted to partner, you are no longer an employee of the firm and in some cases you no longer earn a salary. Instead when you are promoted to partner, you are allowed to "buy in" by purchasing a certain number of shares of the company. Once you own those shares you are then part-owner of the firm (rather than an employee) and enjoy profit-sharing.
A "first year" partner may have to pay ~$150,000 into the partnership, on perhaps a $300,000ish a year in profit sharing. Usually this is just a reduction in the profit sharing (or perhaps a multi year loan, i forget). Its not uncommon to earn less as a first year partner than your last year as Managing Director. You are not longer an employee, but part owner. You move onto a totally separate HR system (Benefits, etc.).
Relative works with mostly senior partners, multiple of them are making $1 million+ a year. That's not common, but as you move up the ranks of partnership, that's not a crazy salary. They work a lot, are all divorced, don't seem to even have time to enjoy the $$ etc. Listening to the details, I'm not super jealous.
The partnership is often the most valuable single asset a partner owns. It prevents them from jumping ship and taking clients. And it acts to hopefully prevent a partner from taking risks that could destroy the firm. Even senior people who might become partners in the near future will not want to put that partnership at risk.
When you retire, they'll buy your partnership out - often paid out over a few years.
If you're becoming a part-owner, of course it makes sense you have to buy shares, my only confusion is how they determine the relationship between the value of those shares and what you have to pay for them.
The firm could just give it to you, but the value of the interest would then be taxable income to you that you would need to pay taxes on in cash.
As others note, buying in also makes you literally and figuratively “invested” in a way that is thought to promote better behavior.
Do they ever clean house of one of the national divisions? Or wouldn't do that (too directly) because that could be construed as being too involved in the local operations?
Yes and no. In practice, each "country firm" (such as the PwC US firm) operate as individual companies with their own leadership team that, while they don't have the typical CxO titles, they have the same roles. Tim Ryan is basically the CEO of PwC US, for example, and PwC UK is a different company with a different CEO.
Internationally there is also an umbrella organization that helps coordinate really high level stuff like branding (since all the country organizations share the same branding), internal IT strategy (such as getting everyone to use the same productivity tools to make it easier for cross-firm collaboration), etc.
The individual companies reap benefits from this coordination because of the singular, strengthened brand, culture, methodology etc. So in that way it sort of is like a franchise. But that international organization doesn't have much to do with the day-to-day in-country operations or decisions about specific audits/projects. That would be the responsibility of the local partners/leadership team.
Making it very hard to hold someone, well, accountable.
Almost as if not an accident.
The water gets muddied because that partner may not actually be involved in the project very much, and in controversial situations they may try to blame someone else (such as a lower level firm employee who was involved) for any mistakes, but at the end of the day the partner who signed their name to the contract is the person held accountable.
There is no need to say what kind of mess they end of creating.
Like a big pool or something everyone contributes to and then they get randomly assigned someone or something?
If your goal is to increase the power of the accountancy industrial complex I suppose your strategy is a good one.
What about just standardizing the fees charged for audits and doing a fixed rotation (rotate e.g. once every 4 years) of assignments of auditing companies to clients (companies being audited)?
This way on one hand the conflict of interest by paying megabucks to auditing firms (to get a positive audit outcome) would vanish (as the fees would be fixed), on the other hand a auditing companies would lose the tendency to try to stick to a particular client (by providing positive audit outcome).
Oh man, I am starting an accounting firm if this gets traction.
Not only will the government-employed auditors get paid, but companies wanting to avoid embarrassing findings will pay for pre-audits. Then, when the right administration comes in, the government audits will be outsourced.
In fact, we went down the road in building out an offer that would have worked with one of the firms and we abandoned it because it was so painful to just determine if they had a conflict and then we would lose the customer if they did.
It is MUCH MUCH more important that you document everything per the insane number of checklists with sometimes wildly overboard list of requirements than actually look (or have time) to find errors. Actually finding a problem, actual accuracy of audits is no longer emphasized.
As a result, staff go into drudge mode on all sides, some of the work is boilerplate wasted effort, so folks on all sides can get into a lets get through this mentality rather than a lets look into this mentality.
This is in part because one stick here, a review process / PCAOB inspection process is HIGHLY focused on the documentation / checklist part of things. No credit is given for actually finding problems at clients, but LOTS of demerits if everything is not in exact documentation format it needs to be.
Seriously, the PCAOB calls things "audit failures" when something like the work around an item wasn't properly documented in their view EVEN THOUGH the actual numbers were accurate. So auditor signed off on right number, and that is a "failure"
That's a change from past, if numbers were wrong and they had been signed off on, THAT was an "audit failure".
But now, as long as you have followed the steps and checked the boxes, then even IF you miss something, that's OK, because it's "reasonable" not absolute assurance and there is a note that a "well performed" audit may still miss things. Well performed has been interpreted to mean huge amounts of documentation.
This matters legally too - the payouts on these failures may be surprisingly small.
So doing gobs of paperwork is of great importance, and there is little reward left in terms of actually finding problems both by PCAOB and because that can ruffle feathers at client that hired you. So every incentive is for massive amounts of somewhat thoughtless documentation and less substance.
Solutions.
- Name audit partner on report - the fact this isn't done is ridiculous.
- The auditors could be hired by the people who use the audit if possible.
- Get rid of a LOT of boilerplate, it kills staff motivation - folks just go intro drudge / checkbox mode.
- Then add some randomized forensic level rather than checkbox level work, with deep deep checks that staff might enjoy doing and feel like they were really looking for stuff rather than just "papering" the audit.
- Focus on RESULTS. Did auditors sign off on numbers that were right or wrong. That should be entire focus of auditing. Reward folks who find errors. Literally, have a pool of funds for auditors who find the biggest misstatements.
- Include list of auditor proposed adjusting entries to client financials in audit report. Again, focus on the actual results / quality of client / auditor work.
One can dream :)
https://www.nytimes.com/2014/08/22/business/regulators-strug...
Fraud and Ponzi schemes will persist until regulators get real.
WRT the 2006 financial crisis, there were about 10-20 regulatory agencies that had the power/responsibility to maintain stability. Each of them failed, but none were held to account; they each just made some excuses, and demanded more power and money.
Every time there's a crisis, the relevant regulator is exonerated of any responsibility, so their incentives are even weaker than those of the executives getting bailed out.
Auditing worked when the shareholders were paying for it, because they were interested in getting 'tough' reports, and they were holding the auditors to account. As soon as you make it mandatory, and the companies are paying for it, the audit becomes de rigueur; more of a formality than a search for truth. I don't think regulators are part of the solution here.
I think that having 'crowdfunded' audits by shareholders would work much better, but it probably won't happen while audits are required for all public companies. You'd have to put the onus of auditing back on the shareholders, and expect that some results will go un-audited.
I recently read "The Smartest Guys in the Room", and I'm not sure how you regulate that kind of problem out of existence; I don't think Sarbanes–Oxley really fixed it, but I am not sure regulations really can. Look at Theranos and Nikola; these should have been found out earlier, but their deceptions were not covered by auditors.
It wasn't magic.
The investors, ratings agencies, and regulators all believed in the same incorrect assumption. If that assumption had been correct, the crisis would never have happened.
Fraud is among the most-egregious forms of bookkeeping errors.
So is that a normal process or is that only where industry regulation requires it?
If investors treated accounts & audits seriously then it would be different. But they don't - and so many, if not most big companies have significant standing "irregularities".