Do auditors have forgotten that cash was king?

With the famous scandal around WIRECARD, it is like with crises (in general), they are wake-up calls and they push to more virtuous management. Auditors seem to keep falling into similar traps. We can only be surprised by such an absence of basic controls on liquidities available on bank accounts. It looks like the audit treatments and tolerances can vary from customer to customer and from auditor to auditor. Who should question quality of audit processes and accuracy of controls?

Falling in the trap

The auditors seem to fall always in similar traps. The Wirecard payment firm default is the best proof of the risk of inappropriate audit. The company admitted recently the EUR 1,9 bln of cash “probably never existed”, then it collapsed. It seems that auditors have failed for three years in a row to request crucial pieces of information from a bank based in Singapore. The auditors have relied their review on documents and screenshots coming from third party trustee or from the company itself. Doesn’t it ring a bell? It reminds us the Enron, or closer to us, Parmalat in 2003 (i.e. A 3,9bln EUR held offshore and forged). There are other interesting examples of failures. Does it show a deterioration of audit quality that is unacceptable? Does it come from an exceptional situation and fraudsters well organized? Difficult to claim.

However, we should make sure there is no deterioration of external audit quality, in general.

Is WIRECARD the tree that hides the forest?

Is WIRECARD as we use to say in French the tree which is hiding the forest? They sometimes find an agreement on a big fine although the damages can be much bigger. In the ENRON case, it went up to the bankruptcy of the audit firm (one of the big fives). Therefore, it is not the first time an audit firm (even a large one) had displayed an unacceptable lack of curiosity about how and where a MNC has parked its liquidities. In another case, JPMorgan also mixed up client money and own funds for billion of USD, audited by a large audit firm. First thing: all have been hit at a moment or another. The fines (when applied) aren’t in proportion to the damages, in my view. The construction group Carillion was also glued in a similar case and in Belgium, Lernout & Hauspie was one of the major scandals ever with Moneytron. Therefore, the last omission and failure to check on where a customer stored money, is important given the size of the company, the country, the DAX index participation, and amount involved. Even if it was a collusive fraud, it is the duty of auditors (and they do) to control directly from the bank the amounts on the accounts and not to rely on third party and client confirmations. It is one of the major principles young auditors learn.

Fast closing and fees cutting do not help improving quality

The fact customers pay less and less and want faster closing, do not contribute to increased audit quality. However, the base principles must be kept protected. Excess cash on bank accounts is maybe the most important one. As for rating agencies, the auditors (and CRA’s) are paid by customers (by issuers), rather than by a third party, more independent, like a supervisor. You can be tempted to reduce costs and indirectly to impact accounts review quality. The cheaper, the lighter the audit review, I guess. They also run audits because they expect lucrative side businesses like advisory, tax or other services. The business model is a bit truncated by the cheap audit subsidized by expensive advisory (to compensate). It is always at the expense of audit quality. Again, we cannot generalize the situation. However, it is a real risk. There are potential conflicts of interest that regulations try to mitigate. The split between both may help in better pricing audit services and in delivering better controls. But we cannot be certain. No one expects to be the “unlucky one” and to be caught out. You never want to bite the hands of those who feed you. But, we are all paying or will pay for those who were caught with the hands in the honey pot.

Hall of shame

Have you noticed that Wirecard has not even manage to make its first interest payment on its EUR 500m bond issue? The investors called them a “NCAA” (i.e. “No Coupon At All”) and the hall of shame of the capital markets. Nevertheless, it is important for people from the street to understand it has nothing to do with the pandemic. This is a fraud going on for a long time. It remains a rare phenomenon. WIrecard was rated by Moody’s at Baa3, lowest level of investment grade, before the collapse. It proves again that an opinion from a rating agency is not a verified fact. Wirecard story looks like Steinhoof in 2017 in RSA, which was convinced of “accounting irregularities”. 

What should we propose, therefore?

Instead of criticizing, I would prefer to search for solutions to prevent such a disaster again. I keep thinking there are at least three recommendations to be made: (1). The turnover of external auditors should be increased. Why not every three years? (2). A double audit like in France could help reducing the risks and finally (3). As for rating agencies, we can legitimately raise the question: “who audit the auditors?” We need to control them given their key role.

I am sure we can find many other provisions and rules to guarantee better audits and stronger audit firms. In my opinion, the pricing of audit has been deteriorated over years and it may impact quality. Audit business should not be subsidized by other advisory or tax practices. The separation could help better pricing the audits to get more quality and stronger controls. There is no miracle recipe. However, we can certainly take measure to reinforce audits and prevent such accounting and fraud catastrophes. The Supervisors and watchdogs are also responsible in such cases of absence of due diligence. It is funny to notice that the FT was the one that pushed them with their journalist investigations. I also consider that we must have more independent directors with competencies and expertise to do their job. The famous glorious German industrial and tech model has been severely hit last years and some conglomerates shrunk (e.g. Bayer, VW, Thyssen Gruppe, Siemens, …). Auditors will claim that even most robust audit procedures may not uncover. It is fair to also say that deregulations and new digital business models are fertile grounds for scams. We do not know whether the audit firm will face similar issue as Arthur Andersen with ENRON. However, it will significantly impact its worldwide businesses at least.

Fran?ois Masquelier - SimplyTREASURY