Firms That Imploded Have Something in Common: Ernst and Young Audited Them
wsj.com
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When I go to the Canadian E&Y website, it says:
> EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.
PwC refers me to a separate website for their structure: https://www.pwc.com/gx/en/about/corporate-governance/network...
KPMG has been mixing it up, per wikipedia:
> KPMG International changed its legal structure from a Swiss Verein to a co-operative under Swiss law in 2003[25] and to a limited company in 2020.[4]
Are they basically franchises? Is there some uber-partner at the global hq collecting massive commissions?
If it were a corporate structure, there is corporate tax, so you have more of an incentive to spend as much as you can as opposed to tight spending and paying people as little as you can so you get as much profits as you can (partnership flows directly to the individuals, so there is no form of double taxation).
Also with a partnership you just rewrite your agreement which you keep 100% internally and do whatever you want. Corporate structure has a lot more overhead, you have requirements that should be met and so forth.
There are good reasons.. most of them the same old bs taking advantage of the system in one way or another.
Each country-level partnership is its own independent firm, and can generally choose to re-affiliate with another multinational "firm" as it desires. This actually happens quite frequently.
Generally, the member firms cross-bill each other at discounted rates. They make up for it through increased volume of work and/or more lucrative work.
These firms effectively operate as a collective for the benefit of the partner class. New partners must invest capital, ongoing partners get returns, and older partners retire with a terminal payout. Some partners may take on expanded leadership roles and get higher annual payouts.
The overarching legal structure is a sort of "modularization" to limit the liability of lawsuits and enable flexible operation. There is a usually a global partnership council that dictates universal operating norms and practices.
Again, fundamentally, it operates as a collective and international units support each other for collective benefit.
Or maybe I am missing something.
In a traditional software company, like a SaaS business, I don't know how it would translate. A developer fixing bugs might be important for the business, but ultimately is hard to translate to the bottom line. It's not like hiring a high level executive will have a guaranteed ROI in the same way.
-- It's hard to measure contributions of a dev in a team of 5-10 (how much was them, another dev, the PM, the designer?) while pretty clear for say a sales + sales eng pair.
-- Likewise, there's a danger of confusing incentivizes of having a dev make commission-based decisions, esp. when counter to what a PM needs to incentivize. in a sense, part of the PM's job is to prevent sales/marketing/management from confusing the rest of the org!
For product orgs, some companies do incentives and promotions based on profit/loss measurables ("1% datacenter power savings => $10M/yr savings => ..."), I think team-based w/ some sort of hierarchy. Alternatively, Cisco weird spin-in system worked well... for those liked by the involved leads.
When _not_ a product org and a more direct line to $, like a sales eng supporting sales, or a dev supporting a quant, easier to go commission/profit-sharing based..
I always wondered why law firms used partnership structures, but this seems like the core reason (most other reasons could would still work within a limited liability corporate structure).
I would have guessed it as more a result of billable hour basis means it is practically "pure per person labor" dependent even with structures of management, less experienced lawyers and paralegals to effectively transmute the less experienced working hours into more experienced hours by them reviewing and signing off on the work of underlings.
Without the head partner you have 400 billable hours of junior lawyer and paralegal work. With one you effectively have 410 hours of partner legal work and they have staked their reputation and used their expertise on it to verify it. If the partner spent those 10 hours day drinking and signing off without reading it turns out to be 400 hours of soverign citizen tier pseudolegal nonsense arguments is their head essentially.
If you're suing someone else's lawyer, yah. But if you're suing your own lawyer... that privilege is client's privilege, and they can waive it if they want to sue their attorney (AFAIK).
Here they act a lot like limited companies but are tax-transparent.
[0] https://en.wikipedia.org/wiki/Limited_liability_partnership
In practice, however, it is another line of defense, because you have to argue in court for each layer to peel back.
[0] https://en.wikipedia.org/wiki/Limited_liability_partnership
Once you are promoted to partner, you are no longer an employee of the firm and in some cases you no longer earn a salary. Instead when you are promoted to partner, you are allowed to "buy in" by purchasing a certain number of shares of the company. Once you own those shares you are then part-owner of the firm (rather than an employee) and enjoy profit-sharing.
A "first year" partner may have to pay ~$150,000 into the partnership, on perhaps a $300,000ish a year in profit sharing. Usually this is just a reduction in the profit sharing (or perhaps a multi year loan, i forget). Its not uncommon to earn less as a first year partner than your last year as Managing Director. You are not longer an employee, but part owner. You move onto a totally separate HR system (Benefits, etc.).
Relative works with mostly senior partners, multiple of them are making $1 million+ a year. That's not common, but as you move up the ranks of partnership, that's not a crazy salary. They work a lot, are all divorced, don't seem to even have time to enjoy the $$ etc. Listening to the details, I'm not super jealous.
The partnership is often the most valuable single asset a partner owns. It prevents them from jumping ship and taking clients. And it acts to hopefully prevent a partner from taking risks that could destroy the firm. Even senior people who might become partners in the near future will not want to put that partnership at risk.
When you retire, they'll buy your partnership out - often paid out over a few years.
If you're becoming a part-owner, of course it makes sense you have to buy shares, my only confusion is how they determine the relationship between the value of those shares and what you have to pay for them.
The firm could just give it to you, but the value of the interest would then be taxable income to you that you would need to pay taxes on in cash.
As others note, buying in also makes you literally and figuratively “invested” in a way that is thought to promote better behavior.
Do they ever clean house of one of the national divisions? Or wouldn't do that (too directly) because that could be construed as being too involved in the local operations?
Yes and no. In practice, each "country firm" (such as the PwC US firm) operate as individual companies with their own leadership team that, while they don't have the typical CxO titles, they have the same roles. Tim Ryan is basically the CEO of PwC US, for example, and PwC UK is a different company with a different CEO.
Internationally there is also an umbrella organization that helps coordinate really high level stuff like branding (since all the country organizations share the same branding), internal IT strategy (such as getting everyone to use the same productivity tools to make it easier for cross-firm collaboration), etc.
The individual companies reap benefits from this coordination because of the singular, strengthened brand, culture, methodology etc. So in that way it sort of is like a franchise. But that international organization doesn't have much to do with the day-to-day in-country operations or decisions about specific audits/projects. That would be the responsibility of the local partners/leadership team.
Making it very hard to hold someone, well, accountable.
Almost as if not an accident.
The water gets muddied because that partner may not actually be involved in the project very much, and in controversial situations they may try to blame someone else (such as a lower level firm employee who was involved) for any mistakes, but at the end of the day the partner who signed their name to the contract is the person held accountable.
There is no need to say what kind of mess they end of creating.
https://www.nytimes.com/2014/08/22/business/regulators-strug...
Fraud and Ponzi schemes will persist until regulators get real.
WRT the 2006 financial crisis, there were about 10-20 regulatory agencies that had the power/responsibility to maintain stability. Each of them failed, but none were held to account; they each just made some excuses, and demanded more power and money.
Every time there's a crisis, the relevant regulator is exonerated of any responsibility, so their incentives are even weaker than those of the executives getting bailed out.
Auditing worked when the shareholders were paying for it, because they were interested in getting 'tough' reports, and they were holding the auditors to account. As soon as you make it mandatory, and the companies are paying for it, the audit becomes de rigueur; more of a formality than a search for truth. I don't think regulators are part of the solution here.
I think that having 'crowdfunded' audits by shareholders would work much better, but it probably won't happen while audits are required for all public companies. You'd have to put the onus of auditing back on the shareholders, and expect that some results will go un-audited.
I recently read "The Smartest Guys in the Room", and I'm not sure how you regulate that kind of problem out of existence; I don't think Sarbanes–Oxley really fixed it, but I am not sure regulations really can. Look at Theranos and Nikola; these should have been found out earlier, but their deceptions were not covered by auditors.
It wasn't magic.
The investors, ratings agencies, and regulators all believed in the same incorrect assumption. If that assumption had been correct, the crisis would never have happened.
Fraud is among the most-egregious forms of bookkeeping errors.
Will it soon be the 'Big Three'?
External accounting has a basic function in society. But when the auditee foots the bill and is also the one to provide information on his / her own (possibly faulty) procedures it's not hard to imagine things going wrong.
Currently the AFM demands higher standards and asks for more budget for oversight in order to be able to look at more cases. Guess who pays for that oversight - the companies already paying an arm and a leg for the audit.
Not a surprise. If they start to scrutinize accountants' practices, then they'll be expected to place the same scrutiny on lawyers' practices.
Really? If scrutiny is what caused the companies to implode, it seems like there's a strong argument to be made that the problem was the scrutiny.
You want to find problems that are problems whether you find them or not, not problems that are only problems because you called them "problems".
My post is specifically pointing out that the wording makes it sound like EY audited the companies and their findings are what caused the companies to implode, which is what the parent comment seemed to assume, but the article actually says that it was the fact that EY did not find problems during their audits, which were later found, causing companies to implode.
You don't think these might have caused problems for the company in the absence of external scrutiny?
The FT started questioning Wirecard's accounts years ago, and Wirecard and the German financial services regulator, BaFin responded by... launching legal attacks on the FT, accusing the paper of colluding with short sellers.
The FT kept finding and printing more and more evidence, EY kept giving Wirecard audit cover, and BaFin kept up an aggressive defence... of Wirecard.
Then finally €1.9bn was found to be missing. The various "evidence" provided to EY to "prove" the money was real shouldn't have fooled anyone who had even the most basic grasp of professional auditing. When the shares were in freefall, BaFin finally admitted that perhaps there was a problem.
Then EY's CEO sent a letter to clients in which he said “Many people believe that the fraud at Wirecard should have been detected earlier and we fully understand that. Even though we were successful in uncovering the fraud, we regret that it was not uncovered sooner.”
The part in italics is simply a lie. EY did not uncover the fraud. The FT did. And in fact what finally killed Wirecard was an independent audit by another Big 4 member - KPMG - which was supposed to vindicate Wirecard, but actually found "irregularities" which Wirecard couldn't explain.
So - what to conclude? It's hard to avoid a cynical interpretation - that auditing at this level is basically PR with spreadsheets, intended to reassure investors that everything is fine, and not a serious effort to reveal financial irregularities.
It's not just EY. KPMG, Deloitte, and PWC have all had issues of their own. The underlying problem is that these companies are hired by their clients to provide a clean bill of health, and if they're too thorough they're not hired again. So the incentives are - let's say - heavily aligned against too much stringency.
The FT Wirecard story is well worth a read. The FT is (expensively) paywalled, but some of the reporting is free.
https://www.ft.com/content/284fb1ad-ddc0-45df-a075-0709b3686...
(Not quite sure that idiom works in US English so maybe only for some markets ;-)
https://www.thehindubusinessline.com/info-tech/satyam-scam-s...
Three of the Big Four are head-quartered in London†, and so the most likely avenue to better regulate them would begin in Westminster. But Westminster has for many years been in the hands of Tories, who have successfully hoodwinked the British people into believing that somehow all the awful things Tories keep doing would be fixed if only they had more Tories in charge of everything. The Tories pay the Big Four piles of tax payer money, including to "fix" problems caused by other members of the Big Four. For some reason the proposed answer often seems to be "Pay Big Four firms more money" perhaps they could pay a Big Four firm to find out why that is?
† All of the Big Four are organised as Groups, so that a relatively small company - in three cases based in London - handles the global brand, while independent businesses in dozens of countries share that brand, intellectual property and so on. Legally it is possible to pretend these aren't the same firm, although it sure is convenient how easily senior employees move between one of the independent businesses and the others as they wish...
There needs to be an incentive for shareholders to dump shares of unethical companies. The government should provide that incentive.
So is that a normal process or is that only where industry regulation requires it?
Like a big pool or something everyone contributes to and then they get randomly assigned someone or something?
If your goal is to increase the power of the accountancy industrial complex I suppose your strategy is a good one.
What about just standardizing the fees charged for audits and doing a fixed rotation (rotate e.g. once every 4 years) of assignments of auditing companies to clients (companies being audited)?
This way on one hand the conflict of interest by paying megabucks to auditing firms (to get a positive audit outcome) would vanish (as the fees would be fixed), on the other hand a auditing companies would lose the tendency to try to stick to a particular client (by providing positive audit outcome).
Oh man, I am starting an accounting firm if this gets traction.
Not only will the government-employed auditors get paid, but companies wanting to avoid embarrassing findings will pay for pre-audits. Then, when the right administration comes in, the government audits will be outsourced.
In fact, we went down the road in building out an offer that would have worked with one of the firms and we abandoned it because it was so painful to just determine if they had a conflict and then we would lose the customer if they did.
If investors treated accounts & audits seriously then it would be different. But they don't - and so many, if not most big companies have significant standing "irregularities".
It is MUCH MUCH more important that you document everything per the insane number of checklists with sometimes wildly overboard list of requirements than actually look (or have time) to find errors. Actually finding a problem, actual accuracy of audits is no longer emphasized.
As a result, staff go into drudge mode on all sides, some of the work is boilerplate wasted effort, so folks on all sides can get into a lets get through this mentality rather than a lets look into this mentality.
This is in part because one stick here, a review process / PCAOB inspection process is HIGHLY focused on the documentation / checklist part of things. No credit is given for actually finding problems at clients, but LOTS of demerits if everything is not in exact documentation format it needs to be.
Seriously, the PCAOB calls things "audit failures" when something like the work around an item wasn't properly documented in their view EVEN THOUGH the actual numbers were accurate. So auditor signed off on right number, and that is a "failure"
That's a change from past, if numbers were wrong and they had been signed off on, THAT was an "audit failure".
But now, as long as you have followed the steps and checked the boxes, then even IF you miss something, that's OK, because it's "reasonable" not absolute assurance and there is a note that a "well performed" audit may still miss things. Well performed has been interpreted to mean huge amounts of documentation.
This matters legally too - the payouts on these failures may be surprisingly small.
So doing gobs of paperwork is of great importance, and there is little reward left in terms of actually finding problems both by PCAOB and because that can ruffle feathers at client that hired you. So every incentive is for massive amounts of somewhat thoughtless documentation and less substance.
Solutions.
- Name audit partner on report - the fact this isn't done is ridiculous.
- The auditors could be hired by the people who use the audit if possible.
- Get rid of a LOT of boilerplate, it kills staff motivation - folks just go intro drudge / checkbox mode.
- Then add some randomized forensic level rather than checkbox level work, with deep deep checks that staff might enjoy doing and feel like they were really looking for stuff rather than just "papering" the audit.
- Focus on RESULTS. Did auditors sign off on numbers that were right or wrong. That should be entire focus of auditing. Reward folks who find errors. Literally, have a pool of funds for auditors who find the biggest misstatements.
- Include list of auditor proposed adjusting entries to client financials in audit report. Again, focus on the actual results / quality of client / auditor work.
One can dream :)