Accounting: How Firm a Foundation?

The recent news that the vast majority of the 2,698 partners of PricewaterhouseCoopers had violated rules that prevent their investment in companies whose audits the firm certifies had me eagerly devouring the details. There is nothing a business ethics professor likes more than a good scandal, rich with righteous public outrage.

My own inquiries this week have made me both more and less sympathetic to PricewaterhouseCoopers. First, it is important to note that all the information we now have comes from a report the firm itself commissioned, albeit as part of a lawsuit resolution. PWC is coping with an increasingly complex environment for public auditing, as are the other four of the “Big 5” accounting firms. Their clients are merging and divesting more frequently and more rapidly than ever before. The companies that each large accounting firm represents change daily. This puts a burden on the individual employee or partner to track, almost daily, the firm’s client list, to see if there are any conflicts of interest. Clients come and go daily. At the same time, the Big 5 firms are involved in a consolidation process themselves (the Big 8 are now the Big 5). PWC is the product of a 1998 merger of Price Waterhouse and Coopers & Lybrand. When they merged, the partners of both firms suddenly had roughly twice as many companies they could not invest in.

The investigation released last week estimates that about half the violations reported, some 4,000 of 8,000, were the result of delays by partners in checking the new list of clients and divesting investments where the combined firm was the auditor. If the report is accurate, should we excuse PWC for its “nominal” violations and await the next scandal for use in my MBA course?

Several aspects of the story make me uneasy and may be cause for significant public concern. The report suggests that there was a pattern of neglect in the predecessor firms prior to the creation of PWC in 1998. And even the fact that more than 4,000 violations appear to have occurred in the wake of the merger suggests a significant breakdown of internal process and controls. While the task is complex, information technology certainly allows major accounting firms to maintain an up-to-date list of all clients on its intranet Web site and to constantly compare this to another database of all partners’ personal investments. In the wake of this disclosure, the adoption of such a system is a no-brainer.

So also is instilling a culture of compliance that understands that the rules and conflicts of interest are serious concerns.

Of even greater public concern are two arguments I heard from a few accountants this week. One argument is that these rules are petty and that the primary concern is whether any audits were actually compromised. Indeed, a letter last week from the PWC chairman and its CEO to the firm’s employees stated that the investigation’s findings were “embarrassing to our firm and to all of us as partners” but “these infractions of independence rules, however unacceptable, did not in any way impair the professional objectivity and integrity of our audits.” While this may be true, the public’s confidence in the integrity of financial statements and the financial markets is not undergirded by the good will and earnest assurances of PWC.

I also have heard the argument that the size of a Big 5 accounting firm makes it unnecessary to restrict the investments of all partners just because one remote office does an audit. This might work in consulting, but public auditing is a very different industry. Auditors represent not just the client but also the public. The Big 5 firms must avoid even an appearance that their judgment in an audit is compromised.

PWC and its competitors merged because they believe that there are economies in having larger firms. Then let them accept that there also are costs and among them are the broader restrictions on the personal investments of their partners. The conflict of interest rules, as written, serve a critical function and must be preserved.