Asymmetrical Information

I dunno, but if I were the CEO of the company, I might think of firing KPMG. After all, aren't they being paid as
certified auditors? Whether the CFO is an accountant or not seems immaterial. If he's gone and hired a firm full of CPAs to audit his company's books, then there would only stand to reason that he might have some expectations of professional standards of them, standards that the auditors --for the fees they were paid, remember--should be willing to put on paper. Seems to me that the the company has been extorted--under pain of missing a filing deadline--into firing one of its officers whose only offense is to request in writing some assurance that his employer actually got what it had paid for.

HA! As I suspected the whole time, all the talk about corporate oversight and protecting the individual investor 12 months ago is nothing more than a full employment act for lawyers. Reason enough to get completely out of the markets, and go blow it on your self or your spouse or your grandkids, or something equally ridiculous.

(WORM is "write-once-read-many" - apparently at the cost of $450 per hour per reading. This could be a new revenue stream...)

Getting CEO's to sign off on accounts seemed a bit pointless from the start. A lot of the skullduggery going on in the accounts may be going on behind the CEO's back and, as Mindles pointed out, the CEO hires the accountants to tell him/her everything is ok, not the other way around.

This law was a red herring from the start, designed to distract people from noticing that real reform just was not occuring.

But then, that's what happens when you put a former accounting industry lobbyist in charge of the SEC.

It appears that the CFO is caught in a Catch 22 vise. And yes, the law is being abused to help attorneys "earn" more money. We should probably not kill all the lawyers, but it is mandatory that their power be checked and balanced.

The major problem, as you noted, is a clearly defined standards. I read somewhere that corporate accountants often keep two sets of books, one that pleases regulators and another that actually makes sense. If this is true, it seems clear that the problem is not lack of regulation, but clarity and content of regulation. Informative post!!

So the trial lawyers are going to ride to the rescue and save us from the current accounting integrity crisis? Great. They, in large part, were the ones who created the current mess.

In the early 1980s and before, it was generally accepted that an auditor's role was to look over the shoulder of the CFO and determine that the corporate financial statements were more or less correct. That is, it was understood that the auditor was not there to discover fraud nor to second guess management's business judgment. The assumption was that management was basically honest and that an auditor's tests should be designed to catch inadvertent errors, identify inappropriate applications of accounting theory, and curb "aggressive" accounting procedures that, while technically permissible, might tend to make a company look more robust than it was. Having fulfilled this limited role, the auditor was protected from liability should it later prove that a fraud had occurred or that management had mislead the auditor.

By the late 1980s, things had changed. Auditors were being held liable for things they "should have known", for not conducting tests to identify fraud (even though the terms of their engagement specifically stated they would not conduct such tests), and for relying too heavily on management's rosy projections about future business performance. Auditors were even being held liable when they had identified a potential problem, brought the problem to management's attention, and resigned rather than issue a favorable opinion without management having corrected the problem.

If you were an auditor, what would you do? You are no longer protected by doing your job properly. Instead, it appears that protection lies in making sure clients are in technical compliance with the accounting rules (whether or not the application of those rules leads to a reasonable result). It's far more difficult for an attorney to pin responsibility on the auditor if it can be shown that everything done was in accordance with the technical rules.

Auditors always provided two basic services. The helped clients understand the application of very technical and complex rules and they made sure the end result were financial statements that "fairly represented" the condition of the company. Historically, auditors had always placed most of their emphasis on the second of the two roles. As they became more subject to liability, they shifted their emphasis to the first role. In effect, they became the financial equivalent of tax accountants. Their role became one of helping clients understand how to make the company look its best while still following all the rules. (Recall, Enron's accounting for its "special purpose entities" met all the technical rules.)

Forgive me if I don't believe giving the trial lawyers more power will improve things.

Expecting government regulators to give you clarity is like expecting George W. Bush to draft the Declaration of Independence.

It matters not. Soon there'll be another form to fix the current reforms, which some will scream is overweaning and others will scream is a giveaway to the e-vill corporate overlords. That's life in a democracy.

It looks to me like clear disclosure requirements and lists of no-nos are regulations too. So the issue becomes who is going to enforce these particular regulations.

Well, the SEC isn't, partly for political reasons, but mostly because it just doesn't have the resources.

So when an investor feels damaged because disclosure requirements weren't met, or a firm broke a clear standard (assuming such standards can be written) how is he supposed to obtain redress other than by going to court?

I'm sure there will soon be a parade of abusive lawsuit stories, and I know some myself. But the fact is there needs to be an enforcement mechanism. The one we have is mostly private - lawyers - rather than public - the SEC. That should delight lots of folks here. And if it doesn't, then what do you propose?

Slightly off-topic (or not), an external audit by P-W some years ago stated that there were deficiencies in my department. When I asked the auditor to spell them out, he refused because "You'd fix them and make my next year's report harder to do".

Sounds like the market for disposible CFOs just got more expensive. These guys are going to be hired for a year and then take a hike after signing off on one or two annual statements. Meanwhile there is going to be some deputy CFO who is the real power behind the throne, but he doesn't have to sign the books.

First a disclosure. I am a CPA working for a large accounting firm. I currently work in computer security but was a financial audit staff member prior to that.

First, neither the CEO nor the CFO hire the auditors to perform their annual audit. The auditors are hired by a committee of the board of directors, generally, the audit committee which includes only outside directors (non-employees). The auditor is hired to provide an idependent opinion on the fairness of the financial statements to the board of directors and financial statement users.

Second, the financial statements are the responsibility of the management of the company (CEO and CFO) who should have sufficient knowledge and experience to prepare financial statements.

Third, while the CFO make seek the advice of the auditors for a specific transaction, the auditor should only discuss the issues of the transaction and the options afforded to the Company. It is up to the CFO to make an informed decision based on all adivce received. If the auditor is responsible for making accouting decisions, the the auditor immediately impairs its indepence and cannot provide the opinion that it was hired to provide in point one.

Granted, the CFO cannot do the entire job him/herself, and consequently must hire accountants on his/her staff who are competent in providing advice, making recommendations, etc.

Please note that this is all what Tinbergen would have called "displacement activity"; the desperate need for people who have invested a lot of themselves in efficient markets theory to maintain their belief in the face of countervailing evidence. Since nobody wants to face up to the possibility that stock market manias and panics happen (as that would bring the whole system into question), a model of the crash needs to be created under which it was all the fault of a Few Bad Apples whose wrongdoing undermined a Fundamentally Sound System. This model also holds out, for the time being, the attractive prospect that once we have Firm Regulation to Set The Ground Rules, the market will recover. It was a crock in the 1930s and it's a crock now.

On the other hand, I tend to view it as a pretty harmless activity; all that's happening is that socially, we're spending much more than the optimum level on producing fraud prevention. Unlikely to have material long term consequences ...

wow dsquared.. that's just awesome...

hahahaha

as for bringing the "whole system into question" bullshit.. you seem to lack an ability to accept the evidence from the physical sciences that ou can get runaway actions with basic, stable rules (multiple attractors lead to euqilibriums that can rapidly change or oscillate, but this says nothing about the validity of fluid mechanics or basic physics)

as for saying that overproducing fraud prevention will likely have no effect... you've obviously never heard of compound interest either... the flaws in your reasoning are massive, but it comes down to the fact that you love the state and that it can't be wrong when it screws with the big bad corporations... and remember, people must be kept unfree to decide what they want, or else they might make their lves better, and no real socialist can accept that!

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