Friday, February 24, 2012

Regulator Warns Auditors

In the continuing saga that is the prevalence of fraud by Chinese companies in the North American stock markets, Canadian regulators found that independent auditors are doing "disappointing" work. This is scary for investors, as the work of the independent auditors is a key component of the investor's ability to trust a company's financial statements.

The regulator reviewed 24 audits, and found that further work had to be performed on no less than two-thirds of the audits for which the full paperwork could be obtained! Many investors may scoff at this, believing that the shoddy work was probably performed by small, one-person operations, but this was not the case: "...they include the major national audit firms as well as a number of smaller firms..."

In a couple of scary notes, "the regulator said it found cases where management controlled the gathering of external confirmations – instead of the auditors themselves contacting the banks or third-party creditors." No wonder these RTO frauds had to be identified by short-sellers...the auditors aren't doing their jobs!

Perhaps foreshadowing potential headlines that may emerge in the future, regulators "said the further reviews will look at companies based in Russia, India, Brazil and other locations" whereas this one was focused on Chinese-based firms.

There is an inherent conflict of interest involved in such audits. It is the companies that pay the auditors, and therefore many auditors will be willing to do whatever it takes to keep a company's business. Perhaps if enough high-profile scandals occur some day in the future, this model will be changed to one with fewer perverse incentives.

1 comment:

Raja said...

that's a good point. Look at what PwC as auditor did in case of Satyam in India.
While the US investors got some compensation for this whole saga. Indian investors were left to lick their own wounds.