Markkula Center of Applied Ethics

An Open Letter to the "Big 4" Audit Firms

By William K. Black

Here's some free advice from a lawyer who sued auditors for a living: You folks are making it too easy. My regulatory colleagues and I collected hundreds of millions of dollars in damages from you for the taxpayers during from the S&L debacle. You obviously learned no useful lessons from that experience. Don't tempt me to leave academia and take up my former calling.

Your latest move has been to try to prevent John Biggs, the highly regarded head of one of the largest pension funds in the world from being named to run the newly created accounting oversight body. Your concern is that he will be too vigorous a supervisor. But nothing could be better for the accounting profession than the appointment of a vigorous supervisor known for his toughness and integrity.

Your failure to vigorously police yourselves is what got you into your current predicament. You had the greatest deal any accountants in the world ever had - you got to regulate yourself in the richest nation in history in a financial system that mandated that every publicly traded company hire an external auditor. You have now aided so many CEOs in looting "their" firms that you have succeeded in getting yourself expelled from this financial Eden.

I won't preach at you about the public interest and what the "P" in "CPA" is supposed to stand for. I'll limit my advice to your naked self-interest. You may have noticed a missing chair at the table in your club. Arthur Andersen (AA), perhaps the proudest of the one-time "Big 8" is no more.

I know you blame the Justice Department for AA's demise. If only AA had not been prosecuted so successfully perhaps it would still be in business giving clean opinions to the top control frauds (frauds by controlling persons).

Here's what you need to hear: AA committed suicide; the Justice Department did not kill it. AA killed itself by ignoring all the advice its own for-hire consultants would have given their clients on how to manage a company.

AA was one of three of the then-Big 8 firms that paid many scores of millions of dollars of damages as a result of the S&L debacle. It did extraordinarily bad things on behalf of Charles Keating's Lincoln Savings in both its roles as a consultant and auditor. (As consultant, it prepared, years after the fact, documents that were stuffed into Lincoln's loan files so they would look like contemporaneous underwriting. The purpose was to deceive the federal examiners and disguise the fraud.) We got hundreds of millions in damages from AA and its peers arising from the debacle.

The way that AA and its peers reacted to the S&L debacle was suicidal. Virtually all of the energy went into trying to avoid being sued - not by curing the deficiencies that led to the suits, but through "tort reform" designed to make it far harder and less attractive to sue audit firms. There was zero recognition that clean opinions from Big 8 firms for well over 100 control frauds - even though they were deeply insolvent and engaged in massive accounting irregularities - might indicate that the system was broken.

Instead of reforming, the top audit firms made things worse. The pressures on audit partners to bring in high-fee clients and push consulting services have intensified.

You could have prevented many of the current financial scandals and the resultant trashing of the world financial markets. Indeed, all the scams that have come to light at this time, just like all the S&L scams, were easy calls as a matter of accounting. Every accountant, internal and external, who worked on the Enron partnerships, the broadband swaps and the capitalizing of expenses at WorldCom, for example, knew that the sole purpose of the transactions was financial alchemy. Of course, you can't admit that publicly because you would be admitting that you should be liable for billions of dollars of damages.

So what should you do now? Here's the proverbial bottom line: Weak regulation hurts not simply investors but the most reputable members of your profession. So let's hear from that wing of the profession. How many of you support Mr. Biggs?

William K. Black
Assistant Professor, LBJ School of Public Affairs
University of Texas at Austin
Visiting Scholar, Markkula Center for Applied Ethics
Santa Clara University

Contact Information:
O: 408/551-6025

I was litigation director of the Federal Home Loan Bank Board and Senior Deputy Chief Counsel for Enforcement and Litigation of its successor agency, the Office of Thrift Supervision, during the S&L debacle. I teach courses in microeconomics, advanced topics in public financial management and regulation, and white-collar crime. My J.D. is from the University of Michigan (1976) and my Ph.D. in Criminology is from the University of California at Irvine (1998). My areas of specialization include white-collar crime, financial regulation and corporate governance.

For more ethical perspectives on the news, click here.

New Materials

Center News