The high cost of unaccountable accounting; it's time to put the "independent" back in "independent audit."

The High Cost of Unaccountable Accounting

"You need an operation," says the doctor in the old Henny Youngman joke. "But doctor," says the patient, "I don't want an operation." "OK, then," says the doctor, "for the same price, I'll touch up your x-rays."

It's an old joke, yes, but for too many of the nation's accountants it's something else. It's a living.

There they were, the accountants from the prestigious Big Eight firm of Arthur Young and Company giving "unqualified" audits - that's professional jargon for EVERYTHING'S OK OVER HERE - to Charles Keating's Lincoln Savings and Loan. This was at the same time regional federal regulators had concluded that Lincoln was a "ticking time bomb." Soon after, the bomb exploded, bankrupting thousands of investors who - at least partly on the strength of the Arthur Young audits - had been lured into uninsured junk bonds. And leaving millions of taxpayers with a $2.5 billion bill to pay for the federally insured deposits that were lost. The only thing "unqualified" about Lincoln was the extent of the damage.

Was Arthur Young's role in the Lincoln fiasco simply a matter of making auditing mistakes? Well, according to Richard Breeden, chairman of the Securities and Exchange Commission (SEC), when the SEC began investigating these audits, Arthur Young wouldn't respond voluntarily to requests for information. Breeden says that even after issuing a subpoena, the SEC was given documents made partially unintelligible by Arthur Young stampings and was told by the firm that copyright considerations restricted their availability to investigators.

Shortly after the second favorable audit, Jack Atchison, the Arthur Young executive in charge of the Lincoln account, left for a job with Lincoln's parent company. The new job came with a much higher salary - just under $1 million a year.

The Atchison episode tells you everthing you need to know about the accounting profession's shortcomings. There are lots of ways to cook the books, and accountants are too willing to make use of them because if they do they can be on the receiving end of a very grateful client. And because if they don't, they might blow the account. Your client probably doesn't want an operation, but you want your client - so you touch up his x-rays.

As the Lincoln case shows on a gargantuan scale, this accounting mentality isn't some little vocational quirk - it's a menace to us all. Many accountants seem to have forgotten that. According to The Wall Street Journal, Janice Vincent, regional director for the company that Arthur Young was later folded into, defended the Lincoln audits by stating that accounting firms aren't auditing to determine the safety and soundness of the firm, but only to see if they've complied with generally accepted accounting principles. Well, if those generally accepted principles are worthless, what good is that?

Bert Ely, a financial consultant, got it right when he told The New York Times, "Accountants and auditors are not supposed to be advocates for their clients. You hire lawyers for that."

Unaccountable accounting is popping up everywhere these days. Recently Labor Department Inspector General James Hyland and his deputy Raymond Maria wrote that "major business failures following unqualified audit opinions have generated unprecedented public concern that the accounting profession is not protecting investors and creditors through the discovery and reporting of fraud and irregular activities." These Labor officials are worried that the lack of accounting rigor applied to private pension plan funds could produce an S&L-like disaster. According to the Labor inspector general's latest findings, "Reports prepared by independent public accountants are of questionable value in monitoring benefit plan compliance."

Cut the cord

Another bizarre and widely publicized business flame-out with its share of screwy accounting was ZZZZ Best, the carpet and furniture cleaning enterprise hatched by a wily Los Angeles teenager named Barry Minkow. Minkow's publicly traded company was based on multiple fraudulent loans, and its collapse vaporized millions from large firms and small-time investors alike. In packaging his stock offering, Minkow got plenty of help from his look-the-other-way accountants, Ernst & Whinney, a firm that later merged with Arthur Young. As Joe Domanick puts it in Faking It in America, his book on the Minkow scam, "A public offering of the size of ZZZZ Best's was undoubtedly one of the biggest jobs the relatively tiny Reseda branch of Ernst & Whinney was likely to see. . . .Ernst & Whinney was under tremendous self-imposed pressure to make the offering work. The competition in stock underwriting, like that in big-time law and accounting, was fierce, and Barry was the golden goose nobody wanted to kill."

The accountants have golden-goosed us too many times. How can we get them back to the business of telling the truth about business? The key is to break the current unhealthy ties that bind: Have the accounting firm chosen by somebody else besides the company getting the check-up, somebody completely unconnected to it. (The Washington Monthly has been urging this reform for a long time - see "Accountants: Those Wonderful People Who Gave You Maurice Stans," Thomas Redburn, February 1975.) That "somebody else" should be the SEC, which would approve all pairings of auditor to audited (the accountants would still be paid by the firm examined). Gone forever would be any worries about "blowing the account." And these assignments should be for a limited duration - for three years, say. This keeps the relationship sufficiently arms-length and has the added benefit that people work better and harder when they know that soon enough, somebody with no special love for them is going to check the results. The best way to get rid of Henny Youngman's doctor is to get a second opinion.

Scott Shuger is an editor of The Washington Monthly. Ned Martel is an intern at the Monthly.