I’ve been in a lively exchange with Francine McKenna (Re: The Auditors) – she of the stiletto heels and equally sharp tongue – especially about her tart message last week to Senate banking committee chairman Christopher Dodd (D-Conn.):
“Demand PwC be fired as AIG’s auditors, and get rid of Fannie Mae and Freddie Mac auditors (Deloitte and PWC, respectively). Have the PCAOB audit them directly.”
Take Francine’s position (elaborated here) for discussion, without necessarily agreeing, that the Big Four should be stripped of their engagements for the large financial institutions subject to government rescue or take-over. At the heart of the concern: with all the Big Four carrying death-penalty litigation into the current mess, and all being targets of new mega-claims, there are no available private alternatives.
Her interesting view is that with Fannie and Freddie taken over – and with the government’s controlling interest in AIG and about to invest in nine of the country’s largest banks — its interests and those of taxpayers are best looked after by a government-run audit function as well.
Expand the PCAOB’s current remit, she says, or create a new form of inspector general.
Despite a skeptical first reaction, this may be the plausible path to the re-engineering of the model of private assurance — which I’ve been arguing (for example, here) is inevitable with a litigation-driven collapse of the Big Four themselves.
Here’s why:
First, Francine sees no problem in building a federal audit agency. Currently the PCAOB has 500 staff. To build a remotely credible capability, it would have to grow by orders of magnitude, at all experience levels and in world-wide locations. But personnel will be available: The wave of bank failures, bail-outs and mergers is drastically reducing the population of surviving institutions, so the net loss of clients among the Big Four is about to put small armies of bean-counters on the streets.
While it is depressing to think of the creation of yet another vast bureaucracy, the civil service manpower needed through the years of the trillion-dollar bailout reduces opposition to a quibble. It does require noting, however, that the hiring will be of those unable to migrate their stature and compensation in the private sector – namely, the superannuated and the second-rate – not exactly a recipe for staying ahead of a sector of mind-bending complexity.
It bears asking, also, how the concepts of independence and avoidance of conflicts could be squared with the appearance of one agency auditing another. But since the intellectually sound argument for “independence in fact” gave way decades ago with the rationalized acceptability of “client pays,” it would be an easy step to condone a cross-Washington audit function.
As for the questionable value in the market place of an report both by and for the government, the current one-page “pass-fail” audit report is already a no-value anachronism (see here), useful only for statutory compliance but of no useful purpose to investors. So it could as well be done by a collection of civil servants, with the diminished level of attention and respect it would deserve.
Government assumption of audit responsibility opens this tempting door:
Even under state ownership, the huge and complex financial institutions will have undiminished future needs for sophisticated and specialized assurance – in such areas as financial product design and evaluation, process execution and operational soundness – which the Big Four should be both able and enthusiastic to design and deliver.
Freed from delivery of low-value but litigation-laden audits, they should in reason be evolving their services — only under contractual terms unburdened by the threat of investor claims.
To be sure, for the sake of transparency and accountability of public funds, the banks themselves might well choose to offer to the outside world the reports they would obtain from the Big Four (or the niche providers who would no doubt arise by spin-off or new growth) – but this would be under strict limitations of warranty and liability.
Tasting both the potential stream of new revenue and the liability relief offered under such a model could be heady for the Big Four, who might well see the potential to extend the model across the entire spectrum of public companies.
In practice, they could tender to a new audit agency the keys to their now-outmoded franchise – thereby finally unshackling themselves from its unsustainable burden. By evolving into sources of real user value, they would escape the looming fate of catastrophic collapse.
Senator Dodd has not given Francine the courtesy of a response – which seems a little ungracious, for a politician savvy enough about the new media to run his own blog and subscribe to an instant message platform.
Especially when she has lit the fuse on an issue ripe for political leadership. By taking up this opportunity, under Dodd’s sponsorship, the large firms could be enabled to survive — to re-design their assurance products, to re-discover relationships with their clients, and to restore their purpose.
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