Prem Sikka: It couldn't happen here? Don't bank on it

The next WorldCom, Xerox or Enron scandal could strike closer to home

Government ministers and the accountancy establishment are busy telling people that the WorldCom crisis couldn't happen here. The reality is that they cannot offer us any such comfort. What has befallen WorldCom, Xerox, Global Crossing and Enron could easily affect companies in this country, and to say otherwise shows a poor understanding of the causes of the scandals. In fact, in this country we are ill-prepared to cope with the fraud and greed that infects so much of business today.

At the heart of the WorldCom disaster, which left the company with a $4bn hole in its finances, was the decision by its directors to fraudulently show ordinary expenses as investments in their accounts. They did so in pursuit of higher financial rewards: in other words, greed. Any determined entrepreneur could do the same anywhere in the world. And the auditors would pretend not to notice anything.

Today the emphasis in business is on profit at all costs. Directors' salaries, bonuses, perks and share options are linked to published profits rather than to any quality of production, innovation, research and development, customer satisfaction, staff training, or service to the local community. This enterprise culture of ours has not been accompanied by moral constraints on senior managers. How many involved in Polly Peck and Enron considered the consequences of their careful plans? Did WorldCom's founder, Bernie Ebbers, or its chief financial officer, Scott Sullivan, ever ponder them? Instead, corporate culture drove them to consider any deal to be acceptable as long as it generated private gains.

Bending the rules to steal a march on competitors is a sign of business acumen. Inevitably, this encourages firms – and auditors – to massage, cook and roast the accounts. That highly trained, supposedly respectable members of a profession such as accountancy should behave in so disreputable a manner says much about the deeply ingrained capitalist enterprise culture of the West. But the problem in Britain goes deeper than that. We lack a suitable institutional structure that is vital for strict regulation of business. And today wealthy corporations finance political parties and offer consultancies to past and potential ministers – the very people whom we should be able to rely on to regulate the market.

In America, the picture is very different. This weekend President Bush condemned corporate greed in the aftermath of the WorldCom scandal, even though he risked depressing stock prices in the short term. And the US Securities and Exchange Commission (SEC) mounted and secured a criminal conviction against Enron's auditors, Arthur Andersen, within five months of the scandal breaking. Here in Britain, we have nothing like the SEC. We lack the appropriate investigations, prosecutions and enforcement mechanisms. The nearest thing to the SEC is the Financial Services Authority (FSA), whose remit primarily relates to the financial sector. The rest of the commercial sector does not have an independent overseer.

Our system for prosecuting miscreants is fragmented and not always effective. The Serious Fraud Office (SFO), the Crown Prosecution Service, the Inland Revenue, Customs & Excise and others are too poorly resourced and organised to mount major prosecutions, as we saw in the Maxwell, Levitt and Guinness frauds.

Instead the Department of Trade and Industry (DTI) acts as the promoter, defender, judge, jury and prosecutor of big business. Often the temptation is to hush things up. The DTI failed to appoint inspectors to investigate the frauds at Levitt, Polly Peck and Resort Hotels. In 1991, the fraud-infested Bank of Credit and Commerce International (BCCI) was closed with the loss of 14,000 jobs. Over a million bank depositors lost deposits totalling $1.85bn. It was the biggest banking fraud of the 20th century. The US Senate conducted public hearings and produced a report within 18 months of its closure. At the very least, the report stimulated debate. Here, by contrast, there has been no thorough independent investigation of the frauds or of the roles of accountants and auditors.

What we rely on to ensure good corporate governance is auditors. With 250,000 qualified accountants, Britain has more accountants than the rest of the EU put together. Company auditors have more rights than the police. They have access to all company records, files and documents. They have a statutory right of information and explanation from any officer or employee of the company.

Yet this unparalleled investment in economic surveillance has not delivered better corporate governance, company accounts, audits and freedom from frauds or scandals. It is hard to think of any instance when auditors blew the whistle on any major scandal – and there have been plenty of them.

Consider why this might be. The very practice of auditing is flawed. It expects one set of entrepreneurs (the accountancy firms) to invigilate and regulate another set (company directors). Profits, market share and the number of clients measure the success and failure of both.

Auditing also provides accountancy businesses with an entrée to firms to which they can then sell consultancy services, at high fees. The auditors are regulated by professional accountancy bodies that have no independence from the auditing industry. Major firms are not required to publish any details about the quality of audits. Research shows that a large part of audit work is falsified; the work is never done. Rather than a solution, accountancy firms are the source of major problems. They are often implicated in headline scandals. Yet no major accountancy firm has ever been prosecuted by the DTI for failures and incompetence. Instead they are rewarded with lucrative government contracts.

The Conservatives rewarded them with privatisation contracts. The same firms are the driving force behind this government's privatisation projects. They have handled nearly 400 public-private partnership (PPP) schemes and private finance initiative (PFI) projects with a value of £55bn. The same accountancy firms are working on both sides of the street, raking in fees from the Government and the companies making money from the privatisation projects. These companies are estimated to make more than £2bn from government consultancy projects.

Threats of lawsuits and tough enforcement can challenge the practices of accountancy firms. But auditing firms do not owe a "duty of care" to any shareholder, creditor, employee, pension scheme member or stakeholder. In opposition, New Labour promised to introduce legislation. But the post-1997, business-friendly New Labour reneged. It introduced the limited liability partnership legislation, making it harder for injured parties to get compensation from accountancy firms. The architect of this policy was Stuart Bell MP, who until 1997 was Labour's trade and industry spokesman. He later became a consultant to Ernst & Young.

In opposition, New Labour promised to dismantle self-regulation and appoint a single statute-based regulator for accountancy matters. Then in his incarnation as Trade and Industry Secretary, Peter Mandelson decided against it. The UK now has 23 regulators dealing with accountancy. After his DTI exit, Mandelson earned speaking fees from Ernst & Young.

Rather than prosecuting negligent auditing firms, the DTI passes that buck to the professional accountancy bodies who do their usual whitewash. Most of the blame for the Maxwell audit failures was placed on an auditor who died in the intervening 10 years. In January, after 10 more years of navel-gazing, Polly Peck's auditors were fined £75,000. Again, most of the blame was placed on an auditor who had died since the scandal broke.

The prospects for major reform are minimal. In the absence of institutional and legal changes, companies, their advisers and auditors have few economic incentives to check their anti-social practices.

Prem Sikka is professor of accounting at the University of Essex. Tomorrow his book 'Dirty Business: the Unchecked Power of Major Accountancy Firms' will be published by the Association for Accountancy and Business Affairs.