Trust The Numbers?

Investments are based on numbers. But can we trust the numbers?

Ten years ago the investment world was rocked by the Enron scandal, when one of the largest companies in America turned out to be based on an elaborate accounting fraud. A few months later the failure of Worldcom and Adelphia raised serious questions as to whether any accounting could be trusted.

Congress’s response was the Sarbanes-Oxley Act of 2002. The Act did many things, but one thing it did not do was mandate auditor rotation. That is, it allowed companies who’ve used the same auditing firm for decades to continue on with that firm. Originally, that was the plan. At Enron, their accountants at Arthur Anderson had gotten so cozy with management that they were unwilling to blow the whistle on the energy giant. The Justice Department goofed by filing criminal charges against the auditing firm. Clients around the country quite naturally got nervous and cancelled their contracts, thereby destroying the firm.

Now we’re left with an oligopoly where three auditing firms control over 95% percent of the market for large corporations. So some folks are suggesting that firms be forced to change auditors every seven years. Fresh eyes every few years, they claim, would strengthen auditor independence, improve the content and scope of the audit, and improve the accounting standards used.

But it’s a mistake to think that regulation can accomplish what competition can’t. It’s likely that enforced turnover will only strengthen the hands of the managers running a company. There’s already plenty of leeway for unscrupulous bosses to dip into the till. Having a newbie every few years just makes it less likely anyone will find where the bodies are buried.

Douglas R. Tengdin, CFA
Chief Investment Officer
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