Auditors: A wake-up call to sleepy policemen

Auditors are thought to be the policemen of finance – detectors of dodgy accounting and fraud in company accounts. But they've found themselves under scrutiny after the scandals at WorldCom and Enron. Profits were outrageously inflated, and their auditor, Andersen, didn't complain.

The UK has also had its fair share of accounting scandals, if on a smaller scale than in the US. Examples include SSL International, the maker of Durex condoms, which is subject to an investigation by the Serious Fraud Office after it overstated profits by £19m. The SFO has also charged directors with fraudulent trading at recruitment firm Corporate Services Group and collapsed trade finance company Versailles Group, following the re-adjustment of their accounts. On Friday, Trade Secretary Patricia Hewitt said she would propose shaking up the appointment of auditors to put them on their mettle.

So why are the financial policemen so sleepy? One big factor is that executive directors often appoint the auditors and decide their fees. The Government announced last week that this practice may soon be outlawed.

"It's a bit like burglars being able to appoint the policemen and decide their pay and bonuses," says Raj Bairoliya, managing director of the independent firm Forensic Accounting. "It's hardly surprising if we get a tame policeman."

Mr Bairoliya does not believe auditors intentionally ignore malpractice, but that there are pressures on them that make finding fraud difficult. For a start, companies can complain if life gets too difficult. "Fraudulent management are quite effective at getting the audit firms to remove good auditors and retain the ones who will see things their way," he says. "They simply have to complain that Bloggs does not fit in or doesn't understand the business and, nine times out of 10, Bloggs will be replaced because the client must be kept happy.

"Isn't it strange that most auditors go through their entire career without ever discovering a fraud?"

But even if the Government decides that auditors will no longer answer to management but to independent directors, they will still have to rely on the information that the managers provide.

"Most of the time, auditors are relying a lot on the credibility of figures," says Mark Tantam, a partner in fraud man-agement services at Deloitte & Touche, which is taking over the UK arm of Andersen. "If you have got a dishonest management team, unless something is obviously wrong about the figures, there's only so much [an auditor] can do."

Auditors will also have to shift their mindset from serving their clients to a more sceptical role. "They are not saying 'what could be wrong here?'; they usually say, 'what is right?'," says David Lee, chairman of forensic accountants Lee & Allan, who investigated the financial mess created by the late tycoon Robert Maxwell.

But proposed reforms in the UK have not always been welcomed. In 1998, the Auditing Practices Board proposed making audits tougher. "There were a number of solutions, such as increasing the scope of auditing to make it more forensic or intrusive," says Jon Grant, an executive director at the APB. "The response from companies, shareholders and regulators was a close to unanimous 'no'."

He adds: "I don't think UK audits are failing in the context of what they are asked to do. Auditing is a pretty successful technique when management are honest and aren't under enormous pressure to perform and produce ever-increasing profits." And he says that a thorough forensic investigation could mean audit costs are increased by a factor of 10, which might not be in shareholders' interests.

Peter Wyman, president of the Institute of Chartered Accountants in England and Wales (ICAEW), says auditors are now keener to uncover fraud to avoid the shame heaped on Andersen. "If you find a major problem, and therefore save face, you are a hero. I think the pressure is in the right direction."

Chris Dickson, the executive counsel of the disciplinary arm of the ICAEW, says the current rules can detect most frauds. "It is actually difficult for company executives to get away with fraud, provided auditors approach their work with a proper degree of scepticism and follow appropriate auditing standards and guidelines."

So the beleaguered auditing profession has a mandate: get more cynical or shareholders certainly will do.