Auditors' white-hat image gets spattered: agencies probe accountants' role in company failures.

Auditors' white-hat image gets spattered 

Agencies probe accountants' role in company failures

No longer seen as wearing the white hats in protecting shareholder interests, auditors at independent accounting firms today seem under fire almost as much as Los Angeles Police Chief Daryl F. Gates.

Currently aiming at auditors for lapses of independence and other issues are: California State Board of Accountancy, such federal agencies as the Office of Thrift Supervision and the Securities and Exchange Commission as well as attorneys specializing in strike suits for shareholders and insurance policy holders.

Blame increasingly is being heaped on auditors for failing to blow their whistles in various insolvency cases. A particularly bruising one for the profession involved the failed Lincoln Savings & Loan Association, American Continental Corp. and their notorious one-time boss, the indicted Charles Keating Jr.

More recent is the case of First Executive Corp., its subsidiary, Executive Life Insurance Co., and their boss, Fred Carr, reputedly Michael Milken's best customer before the Drexel Burnham Lambert junk bond chief went to prison. California's insurance commissioner put Executive Life under regulatory control because of the company's "hazardous" financial condition, presumably resulting from the insurer's massive portfolio of soured junk bonds.

* The California State Board of Accountancy now is investigating the audits by Deloitte & Touche for 1989 and by Price Waterhouse for 1990 of First Executive/Executive Life, revealed Carol Sigmann. The state board's executive officer indicated the investigations involve why First Executive's annual reports audited by the two firms did not clearly disclose an enormous potential tax liability of more than half a billion dollars.

After California Insurance Commissioner John Garamendi had Executive Life placed in conservatorship April 11, the Internal Revenue Service on April 19 slapped a lien on all of the company's property. The IRS claimed Executive Life owed a towering $643.39 million in back taxes, interest and penalties for the three years of 1981-83.

Sigmann said her agency is funding its investigations of Deloitte & Touche and Price Waterhouse, both Big Six accounting firms, with $1.5 million paid April 25 by Ernst & Young, another Big Six firm, to settle a board accusation. That related to the "unqualified opinion" of the 1987 annual report of Lincoln Savings/American Continental.

The companies' subsequent failures didled American Continental investors out of tens of millions of dollars. U.S. taxpayers are expected to be socked with bills aggregating more than $2 billion to support the insolvent Lincoln's government-insured savings accounts.

The state board accused an L.A. partner of Ernst & Young of agreeing to improper recognition of about $62 million in profits on real estate transactions. Without that, according to the accusation, Lincoln/American Continental would have reported a pretax loss approximating $36 million.

That just could have alerted regulators to the shaky financial condition of Lincoln/American Continental then and thereby reduced losses subsequently suffered by investors and taxpayers.

* SEC Chairman Richard C. Breeden told a House committee May 2 his agency is conducting an investigation looking at "all aspects" of accountants, including their presumed "independence." Actually, said Mary M. McCue, director of public affairs at the agency, the SEC formed a task force a year ago to look into auditing matters, and that work is continuing.

She indicated that was triggered after the SEC in fiscal '89 reported what the agency considered two instances of improper audits. One was by a partner of KPMG Peat Marwick, McCue said, the other by a partner of Coopers & Lybrand, both Big Six firms.

* The Office of Thrift Supervision, which regulates the savings and loan industry (not accounting firms), recently hit San Francisco Federal Savings & Loan Association with an $80,000 fine. That was because of a loan made to a San Francisco partner of KPMG Peat Marwick, the auditor of the S&L and its parent, SFFed Corp.

The OTS, of course, is not empowered to discipline accounting firms, but it clearly considered the S&L's loan to its auditor improper, particularly after the Lincoln and other S&L debacles.

KPMG Peat Marwick, for its part, believes the transaction was proper and in line with regulations and American Society of Certified Public Accountants policy, averred John Higgins, a spokesman for the firm. "We continue to believe the firm is totally independent in this matter."

While allowing he could appreciate the focus OTS now is placing on auditors' independence, Higgins contended it wasn't fair for the agency to rewrite the rules in hindsight.

Other issues that have been raising questions about auditors' independence lately: contingency fees, "revolving doors" and fees derived from consulting jobs performed for audit clients.

* Contingency fees are not an issue in California because they are banned by the state. They previously were banned also by ASCPA, but the Federal Trade Commission ruled it illegal for the professional society to set policy regarding fees.

Thus, in certain other states accounting firms are permitted to perform audits on a contingency basis -- subject to the client's being able to raise capital from investors who look at the audited financial statements.

However, said Avedick B. (Dick) Poladian, this issue has to do with the evaluation process of the accounting firm in determining whether to accept a client. That is, suggested the L.A. managing partner of Arthur Andersen & Co., an accounting firm should not accept a client if getting paid is dependent on the corporation's success in raising capital.

* Revolving doors are analogous to retired Pentagon admirals and generals going to work for defense contractors that were awarded contracts or were supervised by those same officers -- a practice Congress has tried to curb. It has been fairly common for years for clients to hire their auditors' partners and managers.

The accounting profession has very stern rules about revolving doors, asserted Richard (Dick) Stewart, L.A. managing partner of Grant Thornton, a national accounting firm. If a firm member gets a job offer from a client, Stewart said, the member must disclose that promptly at the firm.

"If he doesn't tell, he's broken every rule in the book," Stewart stressed.

If a CPA is out on an audit and approached by a client with an offer of employment, the CPA should reject the offer immediately or be removed, chimed in Arthur Andersen's Poladian. However, he allowed, professional judgment is involved as to whether to accept the offer, for it is a "free market."

* Poladian asserted management consulting is entirely separate from auditing and tax practice -- they are "two separate units" at Arthur Andersen. Moreover, he continued, the audit committee -- comprised of outside directors on a corporation's board -- closely questions the auditors about any potential conflict of interest in performing both types of services for a client.

"The line is very clear," said Grant Thornton's Stewart. He contended it's appropriate for a CPA firm, which performs the audit, to offer "advisory management" services by providing management with choices. But it is inappropriate for the firm to start "acting as management" for the client, he said, for the firm then would be auditing itself.

Both Stewart and Poladian suggested a Chinese wall exists in most major CPA firms between their audit/tax practice and consulting practice to avoid a potential conflict of interest.

It may be remembered that investment banking/brokerage firms also claimed such arrangements existed between their two types of business. Nonetheless, brokers peeked over the Chinese wall to get and make illegal use "inside information" garnered from the investment banking part of the firm.

When this was mentioned to Stewart, he concluded: "The foundations of our profession are strong. Our independence can't be breeched if we want to stay in business."