Lindsay Maxted: It's an Ill Wind…

There are lessons to be learnt from the accounting scandals of 2002

By Leon Gettler

The accounting profession had an annus horribilis last year, but KPMG chief executive Lindsay Maxsted believes the crisis opened up opportunities for his firm.

Not that everyone necessarily concurs. Still, the word "crisis" as defined in the Concise Oxford Dictionary, can mean "turning point". And this is what is now facing the profession.

"Half the partners look at it in a half-full way and half of them look at it as half-empty," Maxsted says. "Some partners cope well with that and some don't. It's really about changing the whole mindset. It does create a lot of opportunities as well as threats around the traditional fee base."

The accounting world was rocked in 2002 when Andersen imploded globally in a series of accounting scandals and corporate collapses that cost investors billions of dollars, wiped out thousands of jobs and destroyed retirement savings. Andersen, once a pillar of trust, collapsed because it put more value on lucrative fees than on honest bookkeeping.

The significance of last year's events cannot be underestimated. Andersen and other audit firms were supposed to be custodians of public trust. Auditors know the rules. If an accounting firm puts its name on a financial statement, it tells the public that the company is playing by the rules. If an audit firm signs off on accounts, it says that the figures conform to those standards. All of which is why shockwaves from the accounting scandals are still being felt. Regulators, investors and analysts are wondering whether the financial statements being put out by companies are fictitious.

Far from being respected figures, accountants are now being mocked for their association with financial scandals. A recent Morgan poll on professional ethics found that accountants were marginally more respected than talkback announcers and television journalists. People trusted their dentists more. Similarly, a BBC poll found that bean counters had a slightly better reputation than car dealers and government ministers, but not as good as road sweepers, social workers and plumbers.

Andersen was not the only accounting firm that came under fire for using audit as a shopfront for more lucrative services such as consulting. The US Securities and Exchange Commission, for instance, charged Ernst & Young for compromising the independence of its audits of PeopleSoft by entering a business venture with the company. Deloitte & Touche was asked how much it knew when it audited the accounts of US cable company Adelphia Communications, whose founder John Rigas was led away in handcuffs. PricewaterhouseCoopers has been embroiled in the Allied Irish Bank scandal in New York and has reached a $US55 million settlement for a class-action lawsuit alleging it defrauded investors in the software maker Microstrategy by approving financial reports that turned out to be wrong.

And KPMG itself came under fire in the United States for a conflict of interest for investing more than $US100 million in the AIM mutual fund, one of its audit clients. KPMG has also come under scrutiny for its role as the auditor of Xerox, which was fined for overstating figures.

The crisis of reputation has thrown up new management challenges for KPMG Australia. Maxsted insists that the firm has always had rigorous probity checking procedures. That said, he has bolstered these by setting up a two-person team to make sure nothing slips through the cracks.

"We've had to up the ante on our conflict-checking procedures to make sure we don't get into a position where we are advising someone and two weeks later we say we shouldn't be here. Before we take on a new client, there are all sorts of checks in terms of the probity around that client. Then there are checks around the probity of that client in terms of what sort of work we have done before, what conflicts of interest."

Maxsted disagrees with the assertions of Sir David Tweedie, chairman of the London-based International Accounting Standards Board, that the "mandarins" in accounting firms, the guardians of professional standards, were pushed aside by the "samurai" intent on capturing jobs with big fees.

"Did it go too far in terms of the services that were being offered? 'Yes and no', is the answer to that," Maxsted says. "It was always seen as a response to what the business community was asking for. A lot of that stuff is cyclical and it's what is seen as appropriate at the time. And I've never seen an auditor deliberately compromise to make sure they sold some other service."

He agrees that in a market as small as Australia, the potential for these sorts of conflicts has become more pronounced, with the Big Five accounting giants now down to four. But he does not see this as a reason for relaxing the rules here. At the same time, having one less competitor can bring in new business.

Another potential positive, he says, is that companies are looking closely at how their books are audited. That means there is more chance of picking up extra work as organisations structure their affairs to reduce the risk of conflict.

Gone are the days when accounting firms would low-ball audit in order to get their foot in the door and sell more lucrative services. At the same time, the focus on financial reporting means that more value-added extras, such as tax and risk management, can be put on to an audit. "Audit-assurance has come of age," Maxsted says. "Through all this discussion over the last 12 months, we as suppliers and the business community as customers have reassessed just how valuable an audit is."

One of the biggest management challenges ahead for Maxsted is the prospect of Australian accounting firms incorporating and moving away from a pure partnership model. Negotiating a model that balances the collegiate nature of partnerships and the rewards of incorporation will be tricky.

"A company model has a lot going for it as it makes it quite clear what the structure is; who is accountable to whom. At the same time, it is also clear that one reason KPMG is so great is the proprietorial nature of partnerships. In bad times, people tend to stick together better than a group of executives in a corporation."

It's an Ill Wind... was published in the April 2003 edition of Management Today. For details of Management Today back orders please click here.