Auditing Companies’ Ethics

In the wake of the corporate collapses that began with Enron,
the finger was pointed keenly at auditors, who were demonised to such an extent
that lawmakers in Europe and America were kept so busy drafting new accounting
rules and regulations that any real in-depth analysis of the causes of those
corporate disasters didn’t happen until long after new rules were already in
place. But the rules did not prevent Madoff’s giant Ponzi scheme — at this
stage, it isn’t clear whether any of the audit firms should have known about the
scheme when they performed, for example, due diligence work for clients and
funds that lent him the money. And upon reflection of PricewaterhouseCooper’s
statement that its audits of Satyam were conducted ‘in accordance with
applicable auditing standards and were supported by appropriate audit
evidence’, it becomes apparent that the rules did not stop senior financial
executives from producing fictitious numbers.

Authorities aren’t making those same mistakes this time
round. So far, regulatory muscles haven’t been flexed in terms of drafting reams
of new rules, but questions are being asked again about whether auditors could
have done more to mitigate the current corporate collapses in this financial
crisis.

Although the profession says there are lessons to be learnt
from this current crisis, for now it doesn’t support the creation of any new
rules. ‘It’s wrong to say this is all about unethical behaviour by companies. We
would be very nervous about new standards,’ says Steve Maslin, Grant Thornton’s
head of external professional affairs. ‘What comes out of the analysis of this
financial crisis isn’t that we need new standards but that they are better
policed.’ Nina Barakzai, an ethics expert who sits on IFAC’s ethics standards
board, supports this view : ‘We don’t need to change any regulations until we
know why we are changing them and how that will impact on other things . . . It
becomes more important to stick with principles now in the current climate.’ To
ensure better policing of the existing rules, Maslin suggests companies could do
more to regularly check the composition of the executive and non-executive
boards to see if they are ‘fit for purpose’.

One issue that keeps resurfacing is the role of auditors in
assessing business ethics, and whether it is possible to accurately measure a
company’s ethics. The profession has always been supportive of increased
disclosure and narrative reporting, breaking ground with the development of the
operating and financial review (OFR), or the Business Review. Narrative
disclosure has increased significantly over the past decade and continues to
rise, but assurance of this for the most part is not widespread, and anyway its
currently unclear as to whether any existing assurance in this sphere did
anything to prevent the present financial crisis.

The question remains, is it possible to assess and measure
the business ethics of people and are auditors the best placed to do it ? There
are issues of conflict to seriously consider. Accountants may have the most
appropriate skills but aren’t often independent enough to do this kind of
reporting. You won’t get the equivalent of audit report on financial statements
by way of an audit opinion on business ethics.

Like many in the profession, Maslin is concerned that we
ended up forcing companies to report on so many different items that already
weighty financial reports have become even longer. Accountants nonetheless have
a role to play in fostering ethical behaviour in business.

‘In terms of measuring business ethics, we are really in our
nappies,’ says Leo Martin, Director and co-founder of Good Corporation, which
has developed a standard to measure companies’ business ethics. Martin points to
the Siemens corruption scandal, currently in the courts, as an example of how
difficult it would be to catch such unethical behaviour in an audit : Siemens
agreed to pay a record $ 1.34 bn (£ 970 m) in fines in December 2008 after being
investigated for serious bribery involving top executives and management board
members. The inquiry revealed questionable payments of roughly $ 1.9 bn between
2002 and 2006, leading to investigations in Germany and the US.

‘Most auditors would never catch that behaviour because it
didn’t appear in the accounts. That requires a different kind of auditing and
whistle-blowing,’ Martin adds. Auditors are already working closely with
anti-corruption and fraud organisations like Transparency International to
develop controls to combat corporate corruption, and research what role they can
play in detecting corruption.

Laurence Cockcroft, former Chairman of Transparency
International, says management attitudes have changed considerably since the mid
1990s in a positive way and there’s greater awareness now. We are in a new era,
but there’s a long way to go,’ he says.

What is certain is that any assurance or auditing of business
ethics must remain unquestionably independent, and more importantly be perceived
to be independent too. Credibility is vital in the current market.

The AIU – Audit Inspection Unit, part of the Professional Oversight Board, found the top seven audit firms’ methods of conducting audit to be generally acceptable, but the report also pinpointed a number of problem areas, expressing concerns over independence and ethical behaviour at several of the firms it reviewed. Accountants are keenly aware of the need to highlight their credibility and that objectivity is where auditors have to avoid compromising. There is general agreement the problem lies in the fact that there are vast questions of judgment involved. Normally these are discussed and mutually resolved; however, behind-the-scenes debate between auditors and boards isn’t appreciated as much as it should be.

Firms must work to allay any concerns the regulators and investors have and heed their suggestions to help restore credibility in the financial systems. No one knows what will happen next in terms of the global economy but economists and business experts predict worse is still to come, which means that the profession will need to illustrate its robustness.

Excerpted from article by Michelle Perry in Accountancy [ICAEW – UK] February 2009.