The Government has just released its policy on auditor independence. However, tax lawyer Mark Leibler* says there are other problems.
In the US we have recently witnessed the collapses of Enron and WorldCom. In Australia we have had HIH, One.Tel and Harris Scarfe. While there has been a tendency to blame the auditors, these disasters have not been caused by auditing practices. Bad management is inevitably a root cause. But misleading accounts serve to exacerbate the destruction, with investors buying and selling on the stock exchange unaware of what the accounts are failing to disclose. Something is seriously wrong when the financial statements of apparently healthy but, in reality, doomed companies have largely complied with the demands of accounting standards. I am on the public record for emphasising the dual legal requirements for audited accounts to comply with accounting standards and to also present a true and fair view. I have also criticised auditors, directors and the ASIC for ignoring these legal requirements. My view may be regarded by some accountants, with fixed views, as an extreme one. But I'm prepared to stand by it, if it ultimately improves the lot of the investor and shareholder.
The Corporations Act 2001 requires that financial reports of Australian public companies to both comply with accounting standards and give "a true and fair view" of the financial position and performance of the company. If there is a conflict between the two requirements, then the true and fair view must be reflected through further information incorporated in the notes to the accounts. The explanatory memorandum which accompanied the 1998 amendments to the Corporations Law, inserting a reference, for the first time, to "the financial position and performance of the company", stated that this approach was viewed as being consistent with "information that is relevant to the assessment of performance, financial position and financing and investing". I am absolutely convinced that a move to market value and economically realistic accounting, through a "mark to market" approach, is necessary to give such a true and fair view. Some say that this would bring in too much subjectivity and too much judgement and ought therefore to be categorically rejected. But this is patently ridiculous.
Is it seriously suggested that just because judgments may differ we have no option but to revert to a system of financial reporting that provides a largely irrelevant historical record of a company's financial dealings? I am well aware that there is no agreement or authoritative court judgments on what true and fair view means. I am also well aware that the requirement is to give a true and fair view – not the true and fair view, so that there may be a range of acceptable views in any given case. But just because we cannot find a one size fits all definition doesn't mean that we are entitled to render the concept totally devoid of content and therefore useless. Whether or not mark to market accounting is adopted, it is beyond argument that in many cases compliance with accounting standards can and does produce grotesque and misleading accounts that in no way comply with the true and fair view requirement. It's clear from recent evidence that, in practice, those who audit our companies either don't understand, or, more alarmingly, choose to ignore their legally mandated obligations to do just that.
The ability to sidestep such crucial legislative requirements is made possible by the fact that the ASIC either cannot, or will not, enforce the law. The ASIC believes it would be a very heavy burden to require every board of directors to separately enquire whether any set of accounts which complies with accounting standards also reflects a true and fair view. Yet the assumption of this burden is a legal requirement. In failing to enforce the law, is the ASIC seriously suggesting that it is never possible to demonstrate that directors did not take all reasonable steps to comply with the true and fair view requirement? Australia is not alone, and certainly not the worst offender, with what I call legally mandated accounting distortions. Until recently in the US heavy reliance has been placed on accounting standards, there having been no requirement to provide a true and fair view. Using as an example aircraft market prices pre – and post – September 11, 2001, Walter Schuetze, the former chief accountant of the Securities and Exchange Commission, highlighted the problems with the US approach in his testimony to a Senate committee earlier this year.
Pre – September 11, the major airlines, to the extent that they own aircraft instead of leasing them, had, on their balance sheets, aircraft at the cost of acquiring them. Post – September 11, the market prices of each aircraft fell about 50 per cent – say from $100 million to $50 million. Yet, under the US rules, those airlines continue to report each aircraft on their balance sheets at $100 million. Under mark to market accounting, he claims, each aircraft would be reported on the balance sheets at its real value of $50 million. It is no wonder, given recent events, that the law in the US has recently changed to require CEOs and CFOs to certify, in effect, their belief that the company's accounts are true and fair. The real challenge for all of us now is to persuade directors, auditors and the ASIC to better understand what the law requires and to encourage the ASIC to take appropriate steps to enforce it. The current debate highlights just how poorly served the investing public is by auditors. In other markets, we have focus groups to ensure that the customer's needs are targeted and satisfied. In the securities market the investor is the customer. But, in this market, unlike any other, the customer continues to be patronised by the arcane world of auditing practices, and doubly so because of the ASIC's failure to police accounts according to legislative requirements.
Auditor independence is a core concern in Australia today. But independence is only valuable to the extent that it enhances accountability in financial reporting. Accountability, in turn, is only worth pursuing if it is directed at a meaningful outcome. If the true and fair view requirement is ignored, then reforms designed to enhance independence and accountability will not achieve the desired outcome. The system we have here in Australia is pretty good. The key to avoiding further sudden and unexpected corporate collapses does not lie in radically overhauling the law. Tougher enforcement of existing law is what is required.
Mark Leibler is a senior partner, Arnold Bloch Leibler, Lawyer. This is an edited version of his speech to the Australian-Israeli Chamber for Commerce in Adelaide on August 26.
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