Had there been a sound mechanism for keeping an eye on account books on the corporate sector of US, its financial crisis could have been averted
The issue regarding the role of external financial auditors in managing good governance of the corporate sector by maintaining high standard of auditing, has assumed importance again, especially during recent years due to a number of audit scandals and failures of serious magnitude at the international level.
The whole process of auditing is highly demanding, as it requires careful scrutiny of the financial statements, according to the audit codes and procedures with full mental alertness and integrity. If the auditing standards and procedures are followed meticulously with alertness and integrity, the auditors’ role has overriding impact on not only establishing a sound framework of good corporate governance but also has deep implications for overall performance of the economy.
The issue of audit quality, transparency and ethics has drawn again a fresh consideration regarding the rotation of audit firms after a specified period of engagement and not the audit partner, though among a very limited circle of legislators in developed countries, academicians and the auditors’ administering institutions, in view of the recent international financial crisis.
It is believed that had there been a sound mechanism for keeping an eye on the account books in the corporate sector of US, its most serious financial crisis could have been averted.
The same conviction may be noticed in the speech delivered by Jan. F Qvigstad, Deputy Governor, Central Bank of Norway in a seminar arranged by Peace Research Institute of Oslo (PRI). He was of the view that international financial crisis “has revealed weaknesses in the financial system” which lacked financial sector regulations to be observed by the accounting firms.
On analysing the factors responsible for the recent global financial crisis, it may be concluded that besides a few other factors, non-observance of auditing standards and ethics was basically responsible for the worldwide meltdown which is considered next to the Great Depression of Thirties. Tracing down the causes of the international financial crisis, some considered the collapse of Lehman Brothers in US, as a major factor exacerbating this world wide phenomenon as result of maneuvering of its accounts books by its management to create misleading financial position of the firm in collusion with their auditors which led to their collapse.
The Lehman Brothers were a global financial service firm, which was engaged in multifarious financial businesses such as investment banking, investment management, equity and fixed income sales, including its primary business of dealing with US Treasury security market. It was the fourth largest investment bank in the US with 25,000 employees worldwide prior to its bankruptcy in 2008. The report revealed that Lehman Brothers was practicing shuffling of bad assets by loaning to other firms in exchange for short term, at quarter ending.
It was also further stated in the report that Lehman, which was unhealthy for a while, cooked its audit books in collusion with its audit firm for window dressing. By such means the auditors shed $ 39 billion at the end quarter of 2007 from its balance sheet, $ 49 billion in the first quarter of 2008 and $50 billion in the second quarter of 2008, to make it look impressive to the stakeholders, credit rating agencies and regulators.
On the leakage of these facts, it ignited exodus of its clients on a massive scale resulting drastic losses to it in stock market and devaluation of its assets. It caused colossal financial losses to Lehman Brothers, marking the largest bankruptcy in the US history which shook the country’s financial system to the core.
Its “collapse was a seminal event that greatly intensified the 2008 crisis. It is widely viewed as watershed moment in the global financial crisis contributing to the erosion of close to $ 10 trillion in market capitalisation from global equity markets in October 2008, the biggest monthly decline on record at the time”. The factor behind the failure of Lehman Brother was the accountancy fraud by its auditors which shook many sectors of a number of countries ultimately infecting severe recession in US and subsequently spreading it in a sizeable number of countries of the world.
This most serious occurrence shaking the world makes us highly conscious to look afresh whether the stringent regulatory framework adopted by the US framed under commonly called Sarbanes-Oxley Act and followed by many developed countries, could avert audit fraud of such a high magnitude leading to corporate debacle.
This experience draws attention to the adoption of the principle of rotation of audit firms in the code of corporate governance of countries. The issue seems to have greater significance in case of developing countries where the audit procedures, its rules and institutional arrangements are not as sound as in developed countries.
The objective is to ensure the interest of the corporate sector and of the shareholders of the listed companies against any corporate debacle either on account of any financial scandal or accounting failure. There is no doubt that the major factor responsible for worldwide financial meltdown originated on account of most spectacular and shocking balance sheet manipulations by the auditors of the Lehman Brothers.
The International Chamber of Commerce (ICC), which is against the principle of compulsory audit firm rotation, conceded that it had been adopted or was under consideration by a number of national governments. In a recent important move, the European Commission, while considering a radical structure of the audit industry expressed their plan to introduce mandatory rotation and caps on advisory services. Their Commissioner, Michel Barnier in his policy statement stated that “the demise of big five firm Anderson, following the 2002 Enron scandal, demonstrated that the risk of a large auditor collapsing was not academic”. He suggested that “with audit firms, as with other sectors, the status quo is not an option, the status quo will not be an option for the European Commission”.
This article was originally published at: The News
The opinions expressed in this article are the author's own and do not necessarily reflect the viewpoint or stance of SDPI.