Auditors as whistleblowers
Some years ago the Business Times in an editorial raised a conflict of interest issue pertaining to audit firms offering other services to the corporate sector.
Such services included consultancies and head-hunting for top positions. The question raised was what happens when an individual head-hunted by an audit company for a client is found to be dipping his or her fingers in the company kitty (diddling the accounts)? Will the audit firm ring the alarm bells and alert the management; ‘protect’ the fraudster’ or report the matter resulting in the errant officer being sacked but persuade the management to continue the audit service despite a error in judgment visà-vis the selection of the officer concerned?
Auditors play a vital role but in past two decades have come under the microscope after some global collapses – Enron (and the Arthur Anderson fiasco), Lehman Brothers, etc –connected to shady accounting practices.
The 10 worst corporate accounting scandals of all time, as reported widely over the years, were the Houston-based Waste Management scandal (1998 – US$1.7 billion in fake earnings), Enron scandal (2001- hid huge from shareholders who eventually lost $74 billion), WorldCom scandal (2002 - inflated assets by as much as $11 billion); Tyco Scandal (2002 – top management stole $150 million): HealthSouth scandal (2003 – earnings’ numbers were allegedly inflated by $1.4 billion), Freddie Mac (2003 - $5 billion in earnings were mis-stated); American International Group (AIG) scandal (2005- alleged accounting fraud up to $3.9 billion), Lehman Brothers scandal (2008-hid over $50 billion in loans disguised as sales), Bernie Madoff scandal (2008-tricked investors out of $64.8 billion in largest Ponzi scheme in history), and the Satyam scandal (2009 -falsely boosted revenue by $1.5 billion).
These conflicts of interest and global accountancy scandals vis-à-vis the role of auditors are being repeated today in the light of some encouraging, recent remarks by Securities and Exchange Commission (SEC) Chairman Thilak Karunaratne who says the SEC wants auditors to act as whistleblowers in firms they audit.
“We are exploring the possibility of placing a legal duty on audit firms carrying out audits of listed companies to report any irregularities or improper conduct they find in the financial statements of the company to SEC. This type of responsibility imposed on auditors will assist the regulator to be more vigilant and take preemptive action to protect the interest of investors,” Mr. Karunaratne was quoted as saying at a recent programme for corporate directors jointly organised by the Institute of Chartered Accountants (CA Sri Lanka) and the SEC.The Business Times commends the SEC chief on the proposed new initiative but hopes that such steps are also accompanied by stiff penalties not restricted only to fines similar to the compounding provisions relating to insider trading where errant directors got away earlier by paying a fine.
Sri Lankan corporate laws are tough (on paper) but hardly enforced and often controlled by the ‘influence of politics” which creeps in and finally takes over. That has happened in the past with big fish escaping the net, an issue that the regulator is facing currently in bringing to book insider traders and fraudsters in the stock market.
The decision of the SEC to issue directions to auditors to blow the whistle under a new legal framework is an answer to the prayers of many independent and small shareholders of many listed companies who have complained about auditors conniving with companies. Shareholders, investors and good governance activists complained to CA Sri Lanka many years ago over ‘professional’ misconduct of some of its high profile members. Internal ethic committee probes were held but the results still remain a secret. Ironically some of these members are the very persons who have drafted good governance codes for directors and continue to serve on panels espousing ethics and good governance for corporate directors!
Whistleblowing is a new paradigm in Sri Lankan culture and yet to take root given the weakness of protective legislation. This is despite a few listed companies implementing whistle-blowing provisions some years back in corporate governance structures. One company stated in its annual report some years back that its “whistleblowing” policy enables individuals to report “any concerns on matters affecting the group or their employment, without fear of recrimination, and reduces the risk of things going wrong or of malpractice taking place and remaining unreported”.
The weakness in such policies, however ‘friendly’ they seem to employees to report a fraud or irregularities, stems from the absence of built-in safeguards (through external protection- maybe Labour Department or external, state agency) against victimisation. The Witness Protection Act, passed by the Sri Lankan parliament last year, is a good example of protecting witnesses. As proposed by some think-tanks for many years now, Sri Lanka needs to develop Whistleblowing Protection Act that could even apply to state companies.
The few companies that have whistleblowing policies have seen little success, either because there are no irregular happenings (hard to believe in today’s context) or employees are reluctant to report such cases fearing victimisation which has happened in the past.
In 2009, a lower-ranked worker at the National Blood Bank was the whistleblower in a scandal at that institute which got wide play in the media but he was subsequently ‘threatened’ by the authorities.
In the case of listed companies, there are many occasions where auditors sit alongside directors at annual general meetings and endorse accounts despite shareholders raising many questions on the finances which go unanswered. In today’s AGM culture, persistently, questioning shareholders are considered an irritant by directors.
The need to ‘audit the auditors’ is a standing joke over the years owing to the lack of confidence of shareholders in auditors providing a ‘credible’ clean bill of health to a company’s accounts. Auditors are re-appointed irrespective of objections at AGMs, the conduct of which is another issue that requires more in-depth discussion (in another editorial) along with the ‘credibility’ of independent directors.
While commending the SEC on the proposal to hold auditors accountable for irregularities in companies, another suggested step is for the regulator to encourage whistleblowing by employees (and even shareholders) with suitable policy guidelines.