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S. Balakrishnan

Among the pillars of market economies are auditors and credit rating agencies.

Auditors came under the magnifying glass after the collapse of Enron, the US energy giant, which was so surprising and abrupt that it was suspected there was something fishy in its books, certified by one of the world’s (then) biggest accounting firms - Arthur Andersen no less.

The courts found AA guilty of improper professional conduct and despite a reversal in the Supreme Court, it was the end of the firm. Still, it is difficult to believe that as versatile and knowledgeable as AA did not know the accounting shenanigans of Enron or its extreme financial vulnerability.

The systemic damage caused by Enron pales in size and significance compared with the havoc caused by the sub-prime mortgage crisis.

A major part of the blame for this should be laid at the door of the other major supposedly ‘independent’ institutions – credit rating agencies.

Their award of investment grade to debt paper synthesised out of dubious mortgage pools was responsible for the bubble in CDOs and credit derivatives and became the undoing of many hoary names in commercial and investment banking and insurance.

The two – auditors and credit rating agencies – have much in common. They are supposed to protect not their clients (corporates and banks which auditors audit and raters rate), but shareholders and investors – entirely different, remote groups.

Naturally, the former want to paint the best possible financial picture of themselves. But, it is corporate boards and managements which pay for the work. It is difficult to imagine a clearer case of conflict of interest.

Over the years, an incestuous relationship between the scanned and the scanner has developed and grown.

Accounting firms and rating agencies have discovered a wide range of areas where they could help their clients – management consulting, IT, financial advice and structuring, investment banking – the list is endless.

(Some assignments are a real test – one of the Big Five took on an environment impact assessment in a southern state without any expertise whatsoever. Its report was a word-for-word reproduction of a Government document on the same matter)!

Credit rating agencies too have diversified considerably from their original charter and remit. The fees for consulting and advisory services are extraordinarily lucrative, with the result rating is the least of their income streams as are the audit fees of large accounting firms.

While audit companies are not listed on stock exchanges, rating agencies are. So the name of the game becomes ‘maximising shareholder value’ - and not serving investors’ interests as should be their sole objective.

The current systemic breakdown is an opportunity to remind these institutions of their original purpose and who they represent and really work for – something they seem to have completely forgotten in their pursuit of lucre.

It looks as though that will need restructuring and funding of their services in new ways, so that ethics, integrity and commitment to investors are not easily given the go by as they are now.

More Stories on : Credit Rating | Financial Scan

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