Audit the auditors; Rule changes will make the profession serve investors better

August 18, 2013 4:52 pm

Audit the auditors

Rule changes will make the profession serve investors better

There has been plenty of blame to go around for the financial crisis and the scandals it exposed. Until recently, some of it stuck to auditors who had signed off on company accounts that were quickly exposed as wishful thinking or worse. But efforts to improve the value of audits to investors have produced mixed results in the face of resistance from the profession.The US is now considering a proposal to make auditors pass more detailed judgment on companies. The Public Company Accounting Oversight Board – the auditors’ watchdog – wants audits to include more than just the pass-fail assessment that has been the practice since the 1940s. Under the proposal, auditors would have to highlight any business area that they found required significant scrutiny before they could stamp their approval on a company’s account. In the words of one PCAOB member, the goal is “telling investors what kept the auditor up at night”.

The Securities and Exchange Commission, which has the final say, should adopt the PCAOB’s proposal. This would match similar rules passed by the UK’s Financial Reporting Council. The case for having auditors report on the questions raised during audits – not merely the final conclusion – is unanswerable. Pass-fail cannot distinguish accounts that pass with flying colours and those that barely scrape by. Investors deserve better – and investors are auditors’ true constituency even if managers are their employers.

That is why preventing too cosy a relationship between companies and their auditors is vital. But this year on both sides of the Atlantic the audit profession successfully pushed back attempts to force big companies to rotate between auditors over time. In the US, mandatory rotation was overwhelmingly voted down by the House of Representatives. In the UK, the Financial Reporting Council stepped back from an earlier plan for mandatory rotations, opting instead to require audit contracts to be retendered every five years. But if auditors and clients have become too close, a retender will clearly not solve the problem if the company is free to renew the incumbent’s contract at will.

For the UK, the FRC could yet be corrected by an update of EU rules, which are not yet finalised but may well include mandatory rotation. Even more importantly, auditors should reconcile themselves to richer reporting and to rotation. Both will bring auditors more competition – but also greater rewards to those who stand out among competitors.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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