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Just who does a company auditor really serve?

‘The thrust of reform should be on making auditors see that their client is the investor and not the company executive.’

British lawmakers are pushing for a full-blown antitrust probe into the country’s four big accountancy firms following the demise of UK construction group Carillion.

The current domination of KPMG, PwC, EY and Deloitte isn’t working for shareholders. But creating more competition among the bean counters won’t be enough on its own. The fundamental problem is who the client is. The thrust of reform should be on making auditors see that their client is the investor and not the company executive.

Carillion’s accounts weren’t completely useless. Recent annual reports contained red flags of the company’s deteriorating financial health that were apparent to the smart money. Some long funds cut their holdings and hedge funds took large short positions, as my colleague Chris Bryant points out.

If the evidence was there to those who looked hard, it’s odd that the company was given a clean bill of health from accountancy firm KPMG months before it went bust. The impression is that auditors are on the side of the company rather than the shareholder. (KPMG says it believes it conducted its audit appropriately.)

Would more competition have made a difference? Companies may have only one accountant available if the few competing firms are already working for a rival. A lack of choice in any market usually leads to lower quality.

One response would be to force the Big Four to shed clients to mid-tier firms, creating a Big Five or Big Six. The risk is this greater competition just leads to a race to the bottom on fees with no improvement in quality. Other remedies are needed first.

Source:Bloomberg

The combination of audit and more lucrative consultancy work has long been chided – with good reason. Consultancy creates a client-pleasing culture. That’s at odds with the auditor’s role in challenging the assumptions behind company statements.

Opponents of a separation say combining the two services helps attract talent. This is a weak argument. Further lowering the current cap on consultancy fees, or completely separating audit and consultancy, is hard to argue with.

The accountancy firm should clearly serve the non-executive directors on the company’s audit committee which, in turn, is charged with looking out for shareholders. The risk is that the auditor’s main point of contact is the executive in the form of the chief financial officer.

Shareholders already have a vote on the appointment of the auditor. But annual reports could provide more useful disclosure on the frequency and depth of the last year’s contact between the firm and the audit committee, and between the latter and shareholders.

Now consider the nature of the job itself. Companies present the accounts, auditors check them. Out pops a financial statement that gives the false impression of extreme precision. Numbers that are the based on assumptions might be better presented as a range, accompanied by a critique of the judgments applied by the company.

Creating more big audit firms may create upward pressure on quality. But so long as they aren’t incentivised to have shareholders front of mind, it won’t be a long wait for the next Carillion.

© 2018 Bloomberg

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Exactly the same problem exists in the legal profession.

Their first duty is to serve the interests of “justice”. Not those of crooked clients.

Almost any profession that makes lots of money and “self-regulates” has this problem.

Themselves obviously.

Same as for everyone else.

Who in their right mind thought otherwise?

Answer: bleeding heart socialists and those with their hands forever out (very prevalent in darkest Africa).

Methinks, KPMG (the most conflicted auditor is SA history) only mainly served Investec in the Kebblegate saga…
They claim they, during the ‘’Kebblegate’’ saga did not, see not, hear not and picked up anything irregular, untoward of fraudulent during their audits, for many moons, at Investec, JCI, Tsec, Socgen (BNZ and Scrip lending Transactions etc), Western Areas, and of course the big victim and latest client, Randgold.
The KPMG Services report, dated May 8, 2006 found:
‘’No evidence indicating that JCI LTD and its subsidiaries, particularly CMMS, owned any Randgold Resources shares’’ and that ‘’further investigations did not show it either’’
Oh really? These stories were covered extensively by the mainstream media but the ”powers that be” , so far kept this biggest fraud case in our financial history, UN-prosecuted!

Why would an auditor who is able to spot misrepresentations, work as an auditor when he could make ten times the money working as a hedge-fund manager or a short-seller? The audit profession is the scapegoat for investors who are too lazy to do their own due-diligence. The opinion of the auditor is only part of the information available to the investor. The share-price is the summary of all of the information available to participants. This is why dedicated investors are technical annalists.

You’re contradicting yourself totally Sensei. If the share price is the summary of all the available information, then you can never win except with insider information. In my experience, very few investors (and no chartist/technical analyst/dart thrower) ever analyses all the available info, and you just have to analyse more than the average investor and have more common sense if you want to generate alpha.

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