Collapsing markets have shown once more that the multi-national firms paid millions of dollars to audit public companies’ financial statements have been asleep on the job.
Already, shareholders have watched in horror as once large, respected companies, with large, respected auditors, have happily signed off on balance sheets which bore little resemblance to the underlying facts. ABC Learning Centers, Centro, Allco, MFS, City Pacific and Babcock and Brown produced misleading financial statements over a period of years. On the basis of these statements, investors and banks provided large sums of money for these bold riders to carefully build their houses of cards, only to see them blow away at the first puff of a credit crisis.
Some of the auditing missteps, such as the infamous arithmetic error committed by City Pacific in its 2007 full and half-year accounts (and completely missed by auditor KPMG), can be attributed to utter incompetence. However, as occurred at Enron, in many instances, auditors signing off on reports received more significant fees from their client for non-audit work. In its last year before sliding into bankruptcy, Enron paid its auditors, Arthur Andersen, US$25 million for audit work, and US$27 million for other services.
However, despite the clear warnings posed by Enron (and the subsequent Sarbanes-Oxley legislation which in part, included rules regarding auditor independence), many Australian companies continue to pay their auditors considerable sums for other services.
Some of the more extreme examples include:
- Hedge fund manager, HFA (whose share price slumped from $2.41 to $0.13) paid auditor KPMG $2.5 million for non-audit services and only $392,621 for audit services since 2006;
- Both Oxiana and Zinifex (who earlier this year merged to form Oz Minerals) were audited by KPMG. On Monday, Oz Minerals entered into a month-long suspension, citing debt concerns. Citigroup believes that Oz Minerals will have a net debt position of $500 million by the end of the year. In its most recent audited results, the company reported a strong net cash position. In the past two years, Zinifex paid KPMG $3.9 million for non-audit work (largely due diligence advice) compared with $1.3 million for audit services;
- Challenger Financial, part-owned by James Packer, paid its auditor Ernst & Young more than $12.2 million since 2006. During that time, the struggling financial services company paid audit fees of $3.5 million. Challenger shares have fallen from $6.35 to $1.23 this year;
- The now defunct MFS paid its auditor, KPMG, $483,000 for audit services in 2007 compared with $771,000 for non-audit services;
- Struggling property group Mirvac, managed to spend more than $9.8 million on non-audit services to PwC, and only $3.99 million on audit services;
- Allco, which is currently in administration, paid its auditor, KPMG, $2.96 for non-audit services in 2007 (compared with $3.1 million for audit services).
- Consumer finance group Flexigroup, whose scrip has fallen by almost 90 percent this year, paid auditor PwC $4.3 million for non-audit fees but only $1.2 million for audit work over the past three years. Flexigroup shares have fallen 93 percent from their April 2007 high; and
- Logistics company, Toll Holdings, paid $17.33 million to auditor KPMG since 2006. Audit fees during that time were $8.7 million. KPMG also happened to be the independent remuneration consultant which advised Toll regarding its controversial $8.85 million options payout to CEO Paul Little in June 2007. KPMG continues to audit Toll.
While it is difficult to draw specific conclusions between high non-audit fees and poor performance, the willingness of companies to pay significant non-audit fees throws a question (whether reasonable or not) over the validity of their financial statements. Perhaps coincidentally, some of the poorest performed companies in recent years also happened to pay the highest relative levels of non-audit fees.
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