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”.
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