7/31/2019 Anderson on Audit and Regulation - ICSA Chartered
Secretary (Jun 2012)
1/118 w w w . c h a r t e r e d s e c r e t a r y . n e t
Taking the rapaverted when regulators persuaded the big
banks, who were LTCMs clients, to buy out
the hedge fund and avoid a cascading failure
in the broader market. The urgency to regulate
the derivatives market seemingly abated, the
trillion-dollar trade in over-the-counter (OTC)
derivatives resumed in earnest, ramping up
systemic risk in the process.
Example 2: From the late 1990s to the early
2000s, dozens of public companies in Canada
and the US suffered consequential market losseswhen poor
accounting practices, unethical
judgement, and in some cases, fraud, were
revealed. Job and pension losses for ordinary
people were deep and painful. The financial
audit function rightly came under scrutiny for
its (sometimes conflicted) role in providing audit
and advisory service to the buyers (generally
management teams) of its services. Post
mortem reviews led to codified audit committee
independence, reforms to auditor appointment
and tighter financial controls and a rich new
compliance business for audit firms. Legislative
and regulatory responses were aimed not
at constraining the scope of business but at
enhancing the oversight of internal controls and
financial reporting.
The greatest danger in the first example is to
peoples wealth and the stability of the capitalist
system. It addresses systemic risk, rather than
individual company behaviour. In contrast to the
second example, this was a failure of regulatory
decision-makers to produce appropriate
regulation to channel human nature. This was
not an audit failure.
Taken together, these examples highlight the
relevance of setting appropriate parameters for
business not too loose to allow the excesses
of human nature to wreak havoc and not too
onerous to kill innovation. They also highlightthe importance of
truly understanding where
blame can realistically be apportioned. Of
course, effective, fair capitalism requires both
robust regulation and good external auditors.
At the core, however, we need business leaders
on boards and in management who apply
sound judgement to make good business
decisions across the organisation as a whole.
how better to define, monitor and enforce a
safer scope of business activity.
Canada and the United States provide
examples to illustrate the relative influence
of regulators and independent auditors overcorporations. Its
useful to differentiate between
the kind of troubles that can be mitigated
by tighter regulation, and those which could
be remedied by better audit-based insights.
Consider the following examples and ask which
would have made the vital difference: better
regulation or better auditing?
Example 1: the financial markets were
brought to the brink when Long Term Capital
Management (LTCM), a well regarded hedge
fund, failed on derivatives bets gone bad.
Its derivatives business, entirely opaque to
the market and regulators, was touted as
an example of the best of unfettered capital
markets. A market meltdown was narrowly
T
he European Commission thinks it can
help markets and governments avoid
nasty surprises by singling out public
company auditors for special attention.
Shouldnt auditors have known and hencealerted clients to the
precariousness of their
positions in advance of the financial crisis?
In singling out auditors for scrutiny, the
European Commission has only found a
convenient scapegoat, rather than a solution.
The greater challenge in preventing another
financial mess lies with the regulators and the
regulations (or lack thereof) themselves. While
auditors do have privileged access to financial
accounts, processes and reporting, the problem
is less about what was done and more about
what was allowed to be done that is to say,
the scope of permissible business activity.
A more productive focus would be a self-
reflective one for regulators, understanding
David Anderson MBA PhD ICD.D is the
President of the Anderson Governance
Group based in Toronto. He can be
reached at [email protected]
and +1 (416) 815 1212.
David Anderson is President of the Anderson Governance Group
with David Anderson
The European Commission has only
found a convenient scapegoat.
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