Barron's: Toothless Watchdogs? Auditing the Audit Firms

[steven johnson]

Buyer beware. Tomorrow's Barron's suggests that in the murky world of audit firms, their reports are not a guarantee of no fraud.

MONDAY, MAY 11, 2009

Toothless Watchdogs? Auditing the Audit Firms
By A.C. THOMPSON and JAKE BERNSTEIN

Investors beware: Financial audits can go only so far in detecting fraud.

THE BIG FOUR ACCOUNTING FIRMS ARE USED to embarrassing headlines about their purported misdeeds. After all, the past decade has seen one business catastrophe after another at companies audited by the major firms. Witness the scandals at Tyco, WorldCom and Xerox.

These days of Ponzimania have put the glare on two smaller auditing firms. BDO Seidman, the seventh-largest U.S. auditor in terms of net revenue, has been linked to disgraced financier J. Ezra Merkin and so, indirectly, to the ubiquitous Bernard Madoff. McGladrey & Pullen, the fifth-largest in the field, is under fire for its connection to a $3 billion Ponzi scheme purportedly masterminded by Minnesota entrepreneur Thomas J. Petters.

BDO Seidman and McGladrey & Pullen stand accused of signing off on the books of fraud-ridden businesses. The firms stand by their work.
In investor lawsuits filed in recent months, BDO Seidman and McGladrey & Pullen stand accused of shoddy audits and signing off on the books of fraud-ridden businesses and investment funds. The cases, together with a string of earlier ones involving the two firms, raise unsettling questions about the level of confidence investors can put in financial audits.

The two audit firms say they stand by their work, and there is, in fact, some murkiness about auditors' responsibilities for detecting fraud. The firms are supposed to "obtain reasonable assurance about whether the financial statements are free from material misstatement, including misstatements caused by fraud," according to the Public Company Accounting Oversight Board, the federal entity that supervises auditors of public companies. The gray area centers on what is reasonable, an issue that often plays out in the courts because accounting firms can be one of the only solvent players left when a company goes down.

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