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Auditors claim to be watchdogs, not bloodhoundsAccountants are under fire after the Worldcom scandal, and it could easily happen hereNIALL BRADY

THE auditor is a watchdog and not a bloodhound. This has always been the profession's lastline of defence when it is caught off guard, and is being trotted out once again following last

week's revelations of an alleged $3.8bn (

3.85bn) fraud at US telecommunications companyWorldCom.

When a corrupt management is hell-bent on inflating profits and deceiving shareholders,accountants argue that rule books and auditors' questions are unlikely to get in their way.

The Institute of Chartered Accountants in Ireland was quick off the mark as the WorldComsaga unfolded.

"We must recognise that no rules will work if the individuals charged with observing them arenot committed to the principles that underlie them, " said chief executive Brian Walsh. "Itappears from reports that [WorldCom] suffered from a gross failure of management and

specifically a gross failure to prevent fraud." But with confidence in financial reporting intatters after Enron and WorldCom, accountants will have to come up with something better.If they cannot be relied on to blow the whistle on such serious lapses in corporategovernance, why bother with auditors at all?

"Companies commit fraud but unless we can rely on external auditors to ensure thataccounts are trustworthy, all trust goes out the window, " said Ann Fitzgerald, secretarygeneral of the Irish Association of Investment Managers. She is also a member the IrishAuditing and Accounting Supervisory Authority (IAASA) which is being set up by thegovernment to police the profession after serious lapses in the audits of financial institutionsemerged during the Dirt inquiry.

Few commentators are buying the notion, widely promoted last week by the professionalaccountancy bodies, that Enron and WorldCom are purely American scandals that could nothappen here. According to Walsh, the fatal flaw in US accounting is not that there are toofew rules but that there are too many. This prescriptive approach forces companies to followthe rule book even when they believe that the result distorts their true financial position.

Because we follow the looser UK regime, which is based on general principles rather thandetailed rules, Irish companies have greater flexibility and some, such as Independent News& Media and IFG Group, have used this freedom to depart from generally acceptedaccounting principles (GAAP) when they believe that alternative treatments show a truerpicture of their finances.

But the argument that Irish and UK accounting standards are in some way superior cut littleice with Niamh Brennan, an accounting professor at UCD and a member of the review groupthat advised the government to set up IAASA. She pointed to the example of troubled drugscompany Elan, whose Irish accounts were no better than its US GAAP numbers at revealingthe extent to which earnings may have been overstated.

"Of course it could happen here and it may already be happening for all we know, " Brennansaid. "It's naive and simplistic to suggest otherwise. Why is the Tnaiste establishing theIAASA if there is not considerable evidence of failings in Irish auditing?" She also believesthat auditors and accountants cannot shoulder all of the blame for failing to pick up oncreative accounting. "Equity analysts also have a lot of questions to answer, " she said.

"They are sophisticated users of financial statements and I can't understand why they don'tspot these things. There seems to be a complicit nod-and-a-wink culture among a largegroup of people that allows this to continue." But analysts, just like investors, should be

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entitled to take audited financial statements at face value, said Rory Gillen, head of privateclients at Merrion Stockbrokers. "We have to put our hands up too we could have dugdeeper, " he said. "But we're entitled to rely on audited accounts as a true and fairrepresentation of financial condition and cash flow." He likened WorldCom's sleight of hand,where $3.8bn of expenditure that should have been written off against earnings wasincorrectly capitalised as an asset on the balance sheet, to a two-man poker game. Whileone card player gains at the other's expense, the total pot of money on the table neverchanges.

"In the same way companies are shuffling between the profit and loss account and balancesheet but no money is being made." he said.

"What should have been going through WorldCom's profit and loss account went to itsbalance sheet instead, falsely increasing profit while creating a balance sheet asset that wasworth nothing." Gillen believes part of the solution to today's auditing crisis lies in tackling theconflicts of interest within the big accounting firms, which make the bulk of their money fromcross-selling consultancy services to their audit clients.

Pressure from US regulators has already led to Ernst & Young and KPMG spinning off theirconsulting arms, while PricewaterhouseCoopers has rebranded its consulting unit underthe much derided moniker Monday in preparation for a stock market flotation later thisyear. But Gillen said these measures do not go far enough; accounting firms would still befree to provide lucrative tax advice to their audit clients.

"The scandals are now so big they cannot be ignored and the problem won't be solved by asimple piece of legislation, " he said. "You can get rid of the conflicts of interest that haveaffected the independence of auditors but ultimately you have to recognise that accountingis not an exact science. In a bear market like we have now, when the tide goes out, yousoon discover who's got no clothes on." And with accounting practices under the microscope

as never before, we had better brace ourselves for the spectacle of more scantilycladfinance directors in the weeks to come.June 30, 2002

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