CREDIBILITY & INDEPENDENCE.
First of all, thank you for inviting me and give me the privilege to talk about my favorite
subject: Governance.When I issued my report in November 2001, two weeks before we
learned about the Enron scandal, I never thought that the subject would become such a hot
topic.
At a recent conference on corporate governance in New York, organised by the Conference
Board, a consistant message was that investors are not coming back into the stock market
until they see concrete evidence that Corporate America isn`t running a cynical scheme to
defraud the ordinary shareholder.
We may agree or disagree with that statement, it may apply in your country or you may think
that this is a problem in the United States and it really will not happen the same way in your
country. You may be right. But, can you take the risk that you are wrong and let your
financial markets and your shareholders stay away from your corporations? Can you afford
to be silent and not react? I don`t think so. Not today!
More so,, shareholders in the United States and Canada express very clearly at their
annual meetings that they are not satisfied with the behavior of the boards that are appointed
to represent them. . In a recent survey, the Inverstor Responsability
Research Center, based in Washington, found that in 2002, as a
whole, 802 shareholders proposals were presented at annual meetings. In the first two
months of 2003, 800, and, 653 of these were on governance. Shareholders don`t trust the
boards in their oversight of management and don`t trust the new laws and regulations to
protect them ( Don`t forget that this is after Sarbanes Oxley was in
force!)
What can we do to restore the faith of investors? More aggressive prosecution of
wrongdoers? More changes in corporate governance practices? Increased focus on
personnaland corporate ethics ? Increased pressure on boards and auditors to be
independant?Higher quality of audit committeees?Public interest criteria imposed on other
participants (lawyers, analysts )?
I just want to stress that, although the conference is about the auditing profession, other
participants are also as much involved in restoring the credibility of the financial reporting and
the trust of the financial markets : management, boards, analysts, regulators, the media,,,,
That is not to say that we should not react strongly and constructively but to underline the
fact that auditors are one part of the model and that we expect others to take their
responsabilities and react accordingly.
Now,coming back to our profession!. It is very clear that we were on the front line of the
attack. Why is that? Clearly because we were the most vulnerable: our profession had
already begun to lose its credibility long before Enron..Our lack of independence of
perceived lack of independence was a heated discussion issue in the boardrooms in North
America. How could that happens? We had rules to regulate our independence and I
am sure that every auditor thought that he or she was acting with ethics
It is clear that both shareholders and boards were very much convinced that auditors were
working for management whatever the engagement process was and in doing so , not
fulfilling their most important role : overseeing management on behalf of the shareholders.
This is the first and foremost perception or.... fact that needs to be changed.
Auditors are partners of boardmembers to oversee management and to be accountable
to shareholders on the credibility of the financial information given to them.
How do we do that?
First of all, we will need to educate our boards. In North America, we now require that audit
committee members be financially literate. This has to be a given and I would submit to you
that all boardmembers should be financially literate if we want to assume our accountability to
shareholders. But I am going further than that.Boardmembers need to understand and
appeciate the added value that auditors are bringing to the table. Paul Volcker said that
`` auditors are trustee of trust and tranparency in the marketplace`` We are bringing an
independent perspective on management decision.This is why it is crucial to restore the
trust relationship between the auditors and the board.
The first step is the rebuild the relationship between the audit committee and the auditors.
1)Every year or even every quarter, auditors are signing a letter to certify their independence:
according to the rules, this client does not represent more than so many % of their total reve
nues, that they don`t perform other work than audit or audit related work. So what!
If a client , even if the fees are below the threshold required to be independant is respected,
is very important for the auditor` s status within the firm not only on a global basis but
also within his or her own community , the perception is that this auditor will lean towards
management view to keep the engagament.
2)I have seen a situation lately, where the auditors caved in to management`s pressure to
adopt one specific accounting treatment. Because of the increased scrutiny of the SEC ,
eighteen months after they changed their mind and ask for a restatement.It is clear that, in the
audit committee`smind, they perceived management as their client and at the end , did not
care about the fair and complete disclosure to the shareholders. Now the new client is
the SEC.
3)The audit committtee or the board are not expert in accounting and auditing and will never
be. What we are bringing to the table is our business judgement. What we need from the
auditors is an indendent assesment of the choice of accounting principles as well as the
assumptions underlying the application of these accounting principles. When ask, the auditors
answer is generally ``it is reasonnable``. Reasonnable might mean different things to
different people. Are we more conservative ? Are we more aggressive? Is it a fair
representation of the business transaction? We need to have an open discussion with
auditors,probably without management being present, so that we have the real insependent
assesment , to be able, in turn, to reassure our shareholders that the financial information
they receive is a fair, complete representation of the financial representation of the financial
situation of the corporation.
4)As well, there are issues about auditing per se. We are all working with the assumption
that, as the EU Commission said last week`` one brand name also implies an equally high
level of audit quality throughout the world`` In fact, country partnerships and, I would add,
some lead
partner ( the Enron case) enjoys strong autonomy and the quality of audit may be different
from one audit to the other. I don`t remember audit firms being very transparant about that,
and, speaking for myself, I was completely taken aback when I learned that the lead partner,
in the Enron audit, refused to follow the advice of their technical expert. Even as one member
of the profession, I could not imagine that could happen!And we, as professionals experts,
we expect the business world to trust our work, to find credible our opinion on the financials
statements.
It is very clear that the relationship between audit committees and auditors must change right
now. As it is now required in the US, the engagement of auditots should not be done by
management but by the audit committee on behalf of the shareholders. It is the firts step.,
to restore the independence or the perception on independence of auditors and thus our
credibility.
An issue that I would like to raise without necessarely having an answer to it, is the non audit
work done by smaller firm for smaller clients. Most of my business life, I was CEO and
shareholder of a medium size company and our auditors were doing much more than the
audit. In fact auditing per se was a very small part of our partnership. They were my adviser
in acquisitions, negociations with the government, internal controls etc.... Big companies do
have the resources to get, internally, competent people to help the corporation to grow, be
competitive and accountable to their shareholders. That does not always apply to smaller
corporations .We should not forget that governance is not an end in itself bur a way to add
value to the corporation and its shareholders. On one hand, we have to be accountable to
the shareholders and insure that our reporting is fair and complete. On the other hand,
is it good business to deprive management of these smaller
corporations of the advice of
competent consultants who know the business better than any other consultants, even if
the perception is that they will lack independence?I would submit to you, given my
experience as a CEO of a small companiy, that our regulators will have to think
carefully before imposing the same requirements to these companies, if they want to help
fortering entrepreuship in their countries.
The last element that I would like to discuss before concluding is the role of management.
In my country, management is responsible for the financial statements. The auditors will
audit them, the audit committee will review them, but the the first line responsability will
always rest with management. A great number of these preparers are members of our
profession. What about their credibility and their integrity? Can they perform their work
with an independent mind? Quite often, they are working under a lot of pressure, pressure
from the CEO to use the accounting pronciples or assumptions that will produce the
best results, pressure from the market to achieve their targets, pressure from their own
renumeration system. They are at the very beginning of the chain. They need to act with as
much ethics and integrity than any other player if we want our financial reporting to be
credible. Can they be really independent as we define independent with rules and regulations?
Given my comments up to now, it is easy to predict waht are is my conclusion.
1) First of all, shareholders don`t think that more rules will protect them better.
2) Independence is not about rules. We can have as many rules as we want, if auditors
are not prepare to act as partners of the governing body to oversee management, are not
prepare to challenge management, are not prepare to discuss openly with the governing
body about accouting and auditing but also about their concerns, the risks involved in
the business, the audit committtee will never be confident in their assessment of
management`s decision.
The fisrt step to rebuild credibility has to be in the boardroom. We can add more rules.
Independence is a state of mind and will never be regulated..