Nothing

Introduction While it is generally acknowledged that the key to the recent spate of corporate collapses lies in the lack of effective corporate governance, there are a number of other factors that need to be considered in understanding this phenomenon. These include the new age of materialism that developed during the 1990s and the consequent corporate and investor greed, which contributed to the spiral that led to the demise of corporations such as Enron, WorldCom, HIH, One.Tel and the global accounting firm Arthur Andersen. Compounding these developments in the corporate environment was the behaviour of the traditional gatekeepers, including accountants in particular, who betrayed the public trust. The accounting profession is now paying the price, with increased government regulation and a credibility crisis that will take many years to resolve. A fairytale Looking back to 1999, it was inconceivable at the time that probably the world’s most respected accounting firm was predicting its demise; the stuff of fairytales– which leads us to the well-known ‘fairytale’ of Alice in Wonderland: As observed by Leung and Cooper (2003), the tea party of corporate greed has been exposed with a vengeance in recent times, with the CEOs and directors (the March Hare and the Mad Hatter) having their fill, the regulators (the Dormouse) caught sleeping, and the accountants and auditors (Alice) joining the fray at the surreal event. The party seems to come around every decade or so, until the bubble seems to expand another size in absurdity and cost to the community, before it finally implodes once again. Whatever the reasons, this time an increasingly angry public have seen their superannuation and pension savings savagely mauled, and respect for corporate managers, regulators and the accounting profession has arguably sunk to an all-time low (Leung & Cooper 2003). Management and stewardship issues: The new age of materialism could also help explain why, in recent years, Australian CEOs have been awarding themselves unprecedented – and to many, unbelievable – pay rises, and have become much more ruthless in their attitudes to customers and employees. Corporate boards often justify astronomical salary and bonus payments by the need to compete on the international market and to reward CEOs for the positive impact they can have on the share price. This heightened materialism also provides a context for the arguably declining ethical standards among company directors, accountants and auditors. David Knott, the former chairman of corporate regulator the Australian Securities and Investment Commission (ASIC), has strongly criticised the outbreak of management greed, the failure of boards to put a brake on excessive and structurally unsound remuneration practices, the focus on short-term pay-offs, and the behaviour of analysts – and at least some auditors – in foregoing their ethics in return for record-level fees and commissions. At the same time, others have lamented that the regulators were caught sleeping. The collapse of a system of open corporate accountability was due to the rise of a clique of shareholder-entrepreneurs who instigated accounting manipulation. It is shown that social capital (namely, the capital contributed by workers) demanded accurate financial information, with the support of cooperative governance. But systematic wealth transfers in favour of cliques of promoters, directors and institutions narrowed the social base of share ownership, increasing the power of the cliques and reducing proper accountability. This cyclical effect can be seen also in agency compensation, a mechanism to minimise agency costs by aligning individual agents’ interests with those of the organisation. But as such a mechanism becomes the tool for wealth transfers, and prey to power and materialism, agency compensation can become the rationale for creative accounting and ultimately the demise of corporations. Also, accounting and auditing rules develop according to the accountability demanded by collective capital, which is in turn the subject of manipulations by managerial agents, resulting in a failure to produce transparent information. Individual financial status and capital maintenance reputation were secured through accounting manipulations and dividend announcements and little reliance was placed on the publication or auditing of financial statements. It successfully provided a portrait of how an open corporate accountability system collapsed, with features of shareholder-entrepreneurs, accounting manipulation and the failure of a reliable audit function. Example of Enron’ collapse: The implosion in 2002 of Arthur Andersen (one of the then ‘Big Five’ global accounting firms) following the collapse of Enron was arguably the defining moment when public trust was lost in the accounting profession and when the gatekeeping role was clearly breached. Enron is a classic case of corporate collapse caused by the failure of the board, a series of accounting frauds, lack of independence and objectivity by the auditor, and poor corporate ethics. The Powers Report is known as an authoritative investigation of what went wrong. In summary, the issues uncovered by the Powers investigation included substantial and unapproved employee bonuses paid to managers and executives; partnerships (Special Purpose Entities, or SPEs) established to accomplish favourable financial results without bona fide economic objectives, and which did not conform to accounting rules. The Powers Report also found failures of the Enron board of directors in their fiduciary duties, high-risk accounting practices, inappropriate conflicts of interest, extensive undisclosed off-the-books activities, and excessive compensation. It was also noted that there was a lack of independence by the board and the auditors. Déjà vu Poor management, inadequate controls, competition, acquisitions, financing, poor corporate culture and similar issues have continued to be common factors in corporate collapses. However, in looking back at the collapses of the ‘60s, ‘70s and ‘80s in Australia, it is also apparent that the regulation of corporate groups was, and arguably remains, ineffective. On each occasion, regulation has been increased and accounting standards improved, and yet, as noted by Clarke and Dean (2001), there has not been any observable slowing of the manner in which corporate groups feature in corporate crises. In fact, the use of complex corporate structures continues to be a recurrent feature in corporate failures, and the unraveling of the financial impact of the failure of corporate group structures remains bewilderingly complex. For example, in the case of HIH Insurance, the liquidator announced that it would be two years before the first general dividend payment and up to 10 years before the final payment. An additional factor in the recent collapses was sheer greed. In a system fed by stock options, boardroom perks, and consulting and underwriting fees, enough was never enough. The seeds of the present crisis, particularly in the United States, were sown in the technology stock boom of the early 1990s, with the now bankrupt e-commerce companies then hailed as the way of the future. At the same time, the telecommunications revolution, in a new world of unregulated competition, required billions in investment for fibre optic cables, satellites and microwave towers. Where were the gatekeepers' Accountants, auditors, investment banks and law firms, whose independence and integrity had been traditionally relied upon, joined the rush – under threat of being left behind – to access the riches from the new dot.com revolution. In the new age of materialism, the belief in the revolution was so pervasive that the gatekeepers became servants to the new players, rather than remain as the independent guardians. The traditional breaks in the system those whose mandate it was to act as a gatekeeper were tempted by misguided compensation policies within their firms to forfeit their autonomy and independence. Further to the review above of the famous Enron collapse, which is synonymous with the loss of credibility by the accounting profession, an analysis of three of Australia’s biggest corporate collapses, namely HIH Insurance, Harris Scarfe and One.Tel, provides an inside view into how accountants and auditors, together with other professionals such as lawyers, failed in their gatekeeper role. HIH Insurance In March 2001, HIH was known as a price-cutter and more willing underwriter than its competitors in the insurance industry, and excessive discounting was one of the contributing factors to the failure of the company. In relation to the efficacy of the audits, Owen commented that: ‘… in my view, Andersen’s approach in the audit of 1999 and 2000 was insufficiently rigorous to engender in users confidence as to the reliability of HIH’s financial statements. This detracted from the users’ ability to appreciate fully HIH’s true financial position’. Finally, there were also problems with the prima facie independence of the audit committee of the board, whose membership was mainly made up of accountants. The chairman and another member of the committee were both former partners of Arthur Andersen, the auditors of HIH, the finance director was a former Arthur Andersen partner, and another two members of the audit committee had business relationships with the company. Harris Scarfe The retailer Harris Scarfe had operated for 150 years before it was placed into voluntary administration by the directors on 2 April 2001, after discovering irregularities dating back six years. In their report to creditors, the administrators highlighted that the systematic overstatement of profit had been funded by increased debt, both to the bank and the creditors. After investigations by ASIC, ASIC alleged the chief financial officer had altered Harris Scarfe’s accounts to inflate the company’s profits and had created a false picture that Harris Scarfe was in good financial health, permitting it to trade when it was virtually insolvent. Additionally, the Audit committee and its internal members met only once a year. One.Tel One.Tel was placed in administration and subsequently into liquidation in May 2001 with estimated debts of $600 million. According to an ASIC spokeswoman, the potential breaches included possible insolvent trading; possible insider trading and market disclosure issues. The liquidator’s inquiry into One.Tel was told how multimillion-dollar bonuses paid to the founders were effectively hidden from public scrutiny by questionable accounting practices. A change in accounting policy treated the bonuses as deferred expenditure and for set-up costs associated with One.Tel’s businesses across Europe and Australia. This treatment, along with other questionable accounting adjustments, had the effect of converting a loss into a profit. The fairytale comes true At the beginning of this paper, the Mad Hatter’s tea party included Alice the accountant and auditor, who wanted to join in. Well, the accounting profession did join the party of corporate greed and is now paying the price: it is no longer a fairytale. An analysis of the corporate failures in the past provides ample evidence of individual accountants – and, by association, the profession itself – abandoning the traditional gatekeeper role and joining the fray. Attempts to restore credibility in financial reporting and auditing IFAC found that the credibility of reporting is both a national issue in each country and an international issue, with action required at both levels. Some of the specific recommendations of particular relevance to the profession include reduction of incentives to misstate accounts which should require the proper expensing of costs and clear disclosure of the terms of share options; greater attention to auditor independence and corporate governance processes; the raising of auditor effectiveness, primarily through greater attention to audit quality control processes; and the strengthening of auditing and reporting practices and regulation. Of particular importance to the accounting profession are the recommendations in respect of financial reporting and audit reform. Some of the CLERP 9 recommendations have already been implemented. These include broadening membership of the AASB, increasing Australian involvement in the development of international accounting standards, and developing professional accounting body guidelines for seeking independent advice. In respect of audit reform, the recommendations include developing higher standards for the independence of auditors, amending the Corporations Act to require an annual audit statement by auditors to disclose all details of their non-audit services, and the imposition of restrictions on retired auditors becoming directors of former client companies. Conclusion The above analysis of corporate collapses and the role of accountants and auditors is not a particularly happy one. The profession has lost much of its credibility, public trust has been badly shaken, and the profession has learned the hard way that it should not take its position in society for granted. As the capital market evolved alongside the rapid growth of technology and globalisation, there was an unhealthy shift in attitudes in the corporate world, one that has also existed in earlier times in the development of modern corporations (Leung & Cooper 2003). It is important to understand this phenomenon if any proposed reforms are to be effective in the future. For the sake of the trusting public, let us hope the period of corporate greed so evident in recent years is forever past history. But then, history does have a habit of repeating itself.