Our Protectors, Encouraging Malfeasance

Every time I try to do a little investigative work I'm sidetracked by new and more interesting facts. In this case, the new and interesting information that I came across is about the Public Company Accounting Oversight Board (PCAOB). It appears that the PCAOB is the organization or agency that was set up after the Enron and WorldCom fiasco to ensure that someone was watching the accounting and auditing firms. Don't forget that Arthur Andersen (AA) was thrown under the bus as an attempt to assuage an outraged public after Enron.

As part of the Sarbane-Oxley legislation PCAOB was created in 2003 to, "...oversee the auditors of public companies in order to protect the interests of investors..." Now remember, the PCAOB is a private, non-profit organization that requests a bulk of their funding from the SEC. Yeah...I know, the SEC is that other agency that also "...protects investors..." When I take a look at the folks who run this organization I am hopeful that the usual suspects aren't in charge. Ahh, lo and behold, the chairman of the board is none other than a former partner of Ernst & Young LLP (EY), one of the largest accounting and auditing firms in the world. I am irked at the fact that the agency set up to protect me from auditing malfeasance has as their leader a former partner of EY.

Well, maybe these folks are really trying to changes things. So the first thing I do is go to the section on enforcement. I know this has got to be the juiciest section of the website. After all, look at all the drama that has gone on in the last 2 years. As I look down the list of disciplinary proceedings that have taken place since the PCAOB was created I see only one company, Deloitte & Touche LLP, that I recognize out of the 22 cases listed. That doesn't make sense at all.

I decided to take a look at the Deloitte & Touche LLP (D&T) case since I suspect that the other firms were easy prey for the PCAOB. The case against D&T was in regards to the accounting irregularities that were associated with Ligand Pharmaceuticals (LGND). Ligand was forced to restate their financial reports for 2002, 2003 and 2004. In the summary against D&T, it was claimed that D&T knew of the irregularities and failed to comply with PCAOB auditing standards.

The penalty for the offense that D&T committed was a fine of one million dollars ($1,000,000) for not recognizing "...approximately $59 million less in revenue" or a reduction of 52% in revenue for the year 2003. Notice there was no statement of inflating revenue or falsifying the documents. Instead it was simply a matter of recognizing or not recognizing $59 million dollars. Considering that the amount in question is more than half the revenue generated for the year, I think this was more than just a lack of recognition.

Now that you have the quick and dirty of the situation let's craft a little perspective around the enforcement piece. The PCAOB fined D&T $1 million for (not) recognizing $59 million on the balance sheet of LGND. This represents 1.7% of the amount that was "falsified." However, as a result of the restatement of earnings, the market capitalization of LGND fell from $2.6 billion in April of 2004 to $649 million in March of 2005. This equals a loss in market capitalization of $1.9 billion.

The punchline to all of this is that if you add the "falsified" amount to the loss of market capitalization in LGND stock then investors lost a total of $2 billion. This makes the $1 million fine to D&T equal to 0.0005% (5/10,000th) of the amount that was lost by investors. In many respects, this kind of penalty encourages the auditing firms to continue to do what they've been doing all along.

Although I am not surprised by my findings I'm still disgusted at the amount of time and money that is wasted on an agency that draws down $157 million a year to not have any impact on the process of increasing the quality of auditing and the firms that conduct such activities. I find it hard to believe that the PCAOB could only find 22 instances where enforcement action was necessary in the years since its creation. If the wording of the disciplinary action against D&T was about "not recognizing" then the last two years was irrefutable evidence of other auditing firms not recognize problems in companies like Bear Stearns, Fannie Mae, Lehman, etc. Touc.

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