Fixing Financials

Auditing holds a special place in my heart, probably because that is what Mrs. Businesspundit does and is (believe it or not) really interested in. She has devoured several books about Enron and Arthur Anderson, and even read a textbook on improving audits – for fun! Anyway, I try to follow audit news and I think this article on auditor independence has some of the best ideas I have heard yet.

While the Sarbanes-Oxley Act set up a broad-gauge attack on auditor-independence abuse, some off-the-wall tactics might be needed to keep audits honest, academics say.

One way to assure objective accounting is to encourage insurers to underwrite coverage for financial-statement risks, according to one professor. Another proposes melding the income statement and the corporate tax return into a single form to help erase auditor conflicts of interests.

Those ideas emerged at an "Auditor Independence Forum" focused on diagnosing and offering potential cures for what might often be a too-close-for-comfort relationship between auditors and their clients.

By blocking excessive management influence over auditors, financial-statement insurance could be a boon to auditor independence, says Joshua Ronen, an accounting professor at New York University's Stern School of Business, which sponsored the event.

Ronen's notion is to have insurers work with auditors to set coverage and premiums based on the results of the audit. Insurance policies covering the legal liabilities associated with financial-statement fraud would be issued only if auditors can publish clean opinions. If the auditor issues a qualified opinion, the insurer won't issue coverage unless the company renegotiates new policy terms. Basic policy terms would be released publicly in the auditor's statement.

If a covered company incurs losses because of financial statement fraud, the insurer would be on the hook for damages related to shareholder suits.

The biggest problem with American accounting is cultural. We tend to be more concerned with complying to the letter of the law rather than with the spirit of the law. That may be due to the legalistic thinking patterns that have become so ingrained in us. Something has to change, and the best way to incite change is to modify the incentives so that someone other than the auditor wants a good audit. The insurance idea is definitely a step in the right direction.