Re:Balance -- Jim Peterson

Dixon Illinois: Fifty Three Million Dollars Go Missing -- So Who Let the Horses Out?

 

    Trust – but verify.

            -- Ronald Reagan 

The revelation of a $ 53 million embezzlement by the treasurer and comptroller of the city of Dixon Illinois – home of the 40^th American president – once again brings this to the fore:

“Why are the accountants still so bewildered that there should be an ‘expectations gap’?”

According to her criminal indictment released on May 1, Rita Crundwell went undetected since 1990 in accumulating all the appurtenances of a life of rural luxury – not only the typical clothing and jewelry, but trucks and trailers, Liberty Coach motor home and Ford Thunderbird convertible -- all supporting her sideline prominence in the boots-and-bling world of quarterhorse breeders (here).

Extractions of that magnitude, from the coffers of a city with an annual budget of only $ 8 to $ 9 million, might have required her full-time devotion to shoveling the cash with both hands. But the self-efficient Ms. Crundwell did not scruple to observe four full weeks of paid vacation each year, and was evidently only caught out when she extended her absence to an additional twelve weeks.

Separation of employees’ duties? Back-up authority that someone else should glance at the city’s checkbook? Allowing her family members to pick up the city’s mail while she was on her holidays? Could the demands of minding the city’s affairs be so simple, naive and blasé, even in the exurban Midwest?

As for the expected queries (here and here) – what about the gatekeepers at the corral?

A large regional accounting firm is reported to have done compilation services for the city since 2006, having done audits in prior years.[1] But the distinction has so far not been explored.

Which, borrowing a metaphor from Ms. Crundwell’s expensive equestrian hobby, is to beat a sad and very dead horse. Because, as the professionals are in the process of learning to their sorrow, simple proximity and association are enough to attract whole worlds of grief.

The International Auditing and Assurance Standards Board – source of auditing standards on a global basis – on March 16 issued a new version of guidance on the performance of compilations:

"Since a compilation engagement is not an assurance engagement, a compilation engagement does not require the practitioner to verify the accuracy or completeness of the information provided by management for the compilation, or otherwise to gather evidence to express an audit opinion or a review conclusion on the preparation of the financial information."

The IAASB also speaks to the intended use of compiled financial statements, however, posing the question whether: 

"External parties other than the intended users of the compiled financial information are likely to associate the practitioner with the financial information, and there is a risk that the level of the practitioner’s involvement with the information may be misunderstood …"

What the IAASB does not offer – understandably, considering the many settings in which full-blown audits are not worth the cost or effort involved – is aide to either the profession or the user community on a necessary risk-based inquiry:

“Just because a service can be done, does it make any sense and should it be done?”

The accounting profession, mistakenly relying on disclosure of the limits on what a compilation report does or does not say, has traditionally looked on that work as low risk – which it mostly is. But consider the environment, and the typical level and quality of competence, governance and integrity in municipal government. What level of confidence should with safety be routinely reposed in those entrusted with management of a small city’s financial resources?

A typical compilation report – while offering no opinion – does recite that the accountant has performed with appropriate skill, ethics and the exercise of appropriate professional judgment. But that is all it takes to get burned.

I have tried to get across, both to my students in Risk Management and to my friends and clients in the profession, that for one caught holding an empty gasoline can, while standing next to a suspicious conflagration, it is not easy to avoid suspicion of arson. The explanation goes down hard, that the container was an innocent impulse purchase at the local hardware store.

As both an exercise for law and business students, and a message in the real world: there is no harm in not wearing a seatbelt, most of the time – or in not locking the barn door. Except for the rare time when it isn’t okay – and then it really matters. A long record of “being lucky” or a history of “getting by” counts for nothing when a bad event exposes the devastation wrought by casual habits.

How accountable the good townsfolk of Dixon will hold their city fathers for the quality of their stewardship – and whatever the exit cost may ultimately be, for a blinkered exercise in the assessment of risk and exposure to Crundwell’s plundering – it is once more made crystal clear that the accounting profession continues to market services that are under-comprehended and over-sold.

 

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[1] My requests to the firm’s media contact for an opportunity to converse have not been answered.

France's Post-Election Week -- A Case of Blue Flu

I had not intended so soon to re-visit the French presidential elections – except that on May 8, a French national holiday and two days after its people voted to oust President Nicholas Sarkosy and deliver to François Holland his first elective office, we were to take the Eurostar train through the Channel tunnel from Paris to London.

To show their gratitude for the election of the country’s second post-war Socialist leader, whose campaign promises had included an expanded public sector, higher wages and a return to shorter hours and youthful retirement, the nation’s customs agents staged work slowdowns at the airports and the rail stations, including Gare du Nord.

We had moved smoothly through the station’s sometime bottlenecks of ticket retrieval, check-in and French and British passport controls – only to stand stalled and helpless for a full hour, along with a back-up of mostly British tourists, while a bloated crew of blue-uniformed gens douanes herded luggage like tortoises through the metal detectors. 

There being no reason other than passenger harassment for the unnecessary and glacially-paced opening of bags, re-screening of gift packages and second-level scrutiny of tickets and passports – the agents only returned to usual speed once their delaying tactics had forced a symbolic twenty-minute delay in the train’s departure, leaving the train staff and the entire passenger group sweating and frustrated.

Early in my expatriate years, my French secretary had explained the country’s characteristic labor bargain – which is that the general population will tolerate modest disruption with patience and sympathy, so long as the greves are limited in length, properly scheduled to begin and end on time, and understood not to force any real change in the state-dependent culture.  

To generate that amount of ill-will, then – reminiscent of the Air France pilots’ strike on the eve of the 1998 World Cup – seemed gratuitous, counter-productive and futile.

Especially as the breadth of Hollande’s popular appeal was manifest not just in his 52% - 48% victory margin, but from the visual contrasts in the election-night television coverage. No translation was needed for an Anglophone – the screens showed Sarko’s supporters to be mostly elderly and entirely lily-white, correct and upright in their neck scarves and stiff upper lips – while the demonstrative Hollande crowds comprised the young, the African and the impatient.

To pay off that support, Hollande – derided as “Flamby” for the squishy, pudding-like insubstantiality beneath his anodyne leftist rhetoric – has the potential to work considerable disorder both to the country’s sovereign debt  rating and to German-led plans to restore the European Union’s economies through austerity.  

But with parliamentary elections approaching in early June, and Sarkosy’s ex-Gaullist party confronting the choice of relegation to the legislative wilderness or a devil’s bargain with Marine LePen’s record-setting far-right achievements in the first electoral round, it may be predicted that Hollande will postpone through the spring the payoff of his accumulated Socialist due bills.

That would mean that the sacred season of France’s summer holidays will be here before he has a chance to act on his promises of a confiscatory 75% tax rate, return of the 35-hour work week and other budgetary impossibilities. 

Which in turn would put an optimist’s spin on the wisdom of American cowboy humorist Will Rogers, that “no man’s purse is safe while the legislature is in session.”

Meanwhile Hollande’s promise to bring home the French troops presently stationed in harm’s way in Afghanistan would have one benefit: they could be re-deployed to luggage-screening duty at the gares, putting some substance behind Eurostar’s attempts to run its trains on time.   

 

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Dewey Survive? If Not, Do We Learn?

The death spiral has tightened for the Dewey LeBoeuf law firm. The cascade of partner defections and other bad news since its erosion began in January has accelerated day-by-day. Official lay-off warnings have been announced, and the end was foretold over the weekend with the casual insouciance and indignity of a Twitter message.

Briefly among the top-20 US-based firms, with nearly 1300 lawyers, the terminally-ill Dewey has shown again the instability of a business model based on the recruitment of over-priced superstars into its bloated 2007 post-merger structure, and the inability to handle the demands of big-ticket partner guarantees, issued without internal transparency and conflicted with declining levels of recession-era business.

Anyone surprised? Not with any memory, decade-by-decade, of Finley Kumble (RIP 1987), Mudge Rose (1995) or Altheimer & Gray (2003).

Put more plainly, the drug-like attraction of a hot lawyer’s addictive book of business leaves behind the nastiness of overdose and withdrawal when the revenues prove just as hot by rushing out the door.

The global market for legal services will digest Dewey’s disintegration without a hiccup of regret. The notion can be dismissed as fancy, that a law firm should be “too big to fail,” or that clients will be deprived even momentarily of immediate and costly attention.

Not so, the parallel issue of continued access to global scale audit services, if a Big Four accounting firm reaches the same crisis point.

The fragility of the Big Four has been a matter of on-going concern in these precincts, because of their calculable financial inability to withstand the existential shock of a worst-case performance failure (here), and the complete absence of viable strategies for their survival (here). The collapse of the Dewey firm makes it of pressing interest that nobody is asking this question: 

Can a large professional services partnership be saved by reorganization, a “living will” or some other contingent failure-preventive? 

In Dewey’s context, commentators would find the question foolish, as the firm's collapse displays yet again that high-cost lawyers can be as fickle and unready to be loyal colleagues as they are to be competent strategists and managers.

It is risible to suggest that a collection of leading counselors to clients in the global economies could be reorganized with stability in bankruptcy, when a firm’s lawyers flee like cockroaches under the harsh light of financial distress. It is no less impossible to conceive that the personnel of a Big Four firm, similarly pressured, could be persuaded to suspend their self-interest and hang around to be caught up in a culture of failure as the last rats on a sinking ship.

It is fair to observe, on one hand, that the large accounting networks are less dependent on the individual egos of their leaders, or that their mega-engagements would be as mobile as a lawyer’s prima donna attitude. But, on the other, it is also the case that those networks are larger in headcount and global locations and complexity by several orders of magnitude than the BigLaw firms, making even less feasible the possibility of resuscitation of a patient in intensive care. 

Yet the accounting regulators continue to avoid the reality and to advance the impossible – legacy of the loopy idea advanced in 2008 by Paul Volcker as part of Bush-era Treasury Secretary Paulson’s Advisory Committee on the Auditing Profession, that accounting firm leadership replacement or a pre-packed failure-management strategy would have the least chance of credibility or success.

Examples:

• Last fall’s “reform” proposals of EU markets commissioner Michel Barnier purported to recognize the “systemic risk if one of the Big Four… collapses” -- without a credible suggestion how to accomplish the oxymoron of an “orderly failure” (here).

• In the spring of 2011 the House of Lords in London tossed out the idea of “living wills,” drawing on the thoroughly inapplicable model of the troubled financial institutions (here).

• And the marathon attention given by the PCAOB to possibly mandated auditor rotation included hundreds of comment letters and three full days of hearings (here), without a shred of attention to the survivability issue.

To believe that the fate befalling Dewey simply “can’t happen” to the much larger, therefore more clumsy and inflexible accounting firms, reflects some mix of denial, hubris and naïveté.

But it will be the consequence of the disintegration of the global audit franchise, as with the rubble that was once Dewey LeBoeuf, that -- as put by the poet Percy Shelley -- “nothing besides remains.”

 

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