In the sordid world of high finance

Between 2007 and 2009, the utterly unforeseen crash of several of the world’s biggest commercial banks almost wrecked the global economy, which is still recovering from it. Terrified governments immediately gave the banks trillions of public dollars invented from thin air, but were never seriously criticised for the bailout or for abandoning their own neo-liberal ideology. All the banks involved had been taking wild risks, but their accounts had always been approved by the world’s biggest accounting firms — KPMG, PwC, EY, and Deloitte. The Big Four control 99 per cent of the audit market, which totals $100 billion annually, but auditing is a secondary activity for them; the consultancy business alone is worth $250 billion a year.

How it all began

Two outstandingly clear and authoritative books show the central role of global accountancy firms in the crash. Richard Brooks, a former tax inspector and now an investigative journalist, has spent several years exposing financial scandals in his work for the news magazine Private Eye . Brooks starts in ancient Mesopotamia, where the need to list stocks of grain and livestock by cutting symbols into wet clay with a cut reed may well have germinated the written word. Much later — in 1202 — Leonardo Fibonacci revolutionised European commerce by adopting the Hindu-Arabic number system and thereby creating a new economic cosmology.

The next great development was Luca de Pacioli’s 1494 five-volume Summa Arithmetica , which has three volumes respectively on bookkeeping, trade, and money and exchange; the book’s coverage of double-entry bookkeeping — every transaction is recorded as a credit in one account with an equal debit in another — meant that double-entry became a pan-European practice in the next two centuries.

This technique was ideal for the ruling dynasties of the Italian city-states as they extended their influence across Europe — and into the Vatican. Professor Ian D Gow, of the University of Melbourne, and Stuart Kells, a writer and authority on antiquarian books, start with a short history of the Florence-centred Medici Bank, and augment the contemporary narrative with telling historical examples.

Brooks shows how the British South Sea Bubble, which burst in 1720, and enormous fraud in the privately-driven expansion of the British railways, confirmed the importance of accurate accounting, but thereby put accountancy in a crucial position. Crucially, the practitioners’ self-proclaimed integrity was accepted at face value.

At Big Four level, the results have been disastrous. As private industry expanded in the 19th century, the accountants increasingly became consultants too, gaining immense power over businesses. Among the worst results of the resulting mutual dependence was the 2007-09 crash, which exposed what both books identify as avarice and internal neglect. Gow and Kells specify the criminality within the accountants Arthur Andersen, and Brooks heads a chapter ‘Trust Me, I’m a Consultant’.

Most of the Big Four’s accounting had relied on the hubristic assumption that as long as nobody called in a debt then debts could be sold on; notional money — and astronomical profits — could be conjured up indefinitely, with loans counting as assets irrespective of their soundness. One labourer earning $14,000 a year was given a house-loan of $724,000.

Regulators, many of whom are former high-level figures in the financial sector, have long moved unquestioned through the revolving door between business and government, and impose very limited fines even for serious audit failures. The Big Four — whose mergers and takeovers Brooks shows with lucid diagrams — seem to ensure their own safety with donations to election campaigns; in the US alone these, lawfully, totalled billions of dollars even before the Supreme Court’s respective rulings in Citizens United and McCutcheon. Regulatory law is often — as all the authors show — hopelessly inadequate.

Gow and Kells also examine the internal culture of accountancy corporates. Their chapter ‘Porn Star’ describes a testosterone-charged and conformist atmosphere in which blowing the whistle is hugely risky; in many jurisdictions, whistleblowing is itself a criminal offence. Both books cover the case of former PwC employees Antoine Deltour and Raphaël Halet, to whom a Luxembourg court gave suspended sentences despite PwC and prosecution demands for tough punishments; the convictions, however, stood. Yet whistles are still blown, usually by middle-ranking employees, notably women.

Inevitably, consultancy has spread into tax avoidance, with leaders claiming that accounting firms need not consider the soundness or the substance of a business. Tax avoidance is often lawful, but prosecution for breaches is hard and cleaning up is harder. The Big Four are often the only ones big enough to do that; furthermore, their own internal structure – more complex than those of many state bureaucracies – is devolved to national and local entities, so that serious systemic problems are treated as minor local difficulties.

Accounting shenanigans

This often serves to conceal the sector’s need for the state; as Private Eye reports, the recent collapse of the British firm Carillion — which worked solely on large-scale state-funded projects under the Private Finance Initiative (the UK form of PPP) — shows that Carillion’s auditors KPMG and the internal auditor Deloitte face potential recovery litigation. PwC, for its part, earned £14 million from Carillion consultancy and is now earning even more by helping the Official Receiver liquidate the company. The vast overstatement of Carillion’s finances has a Medici parallel; Pacioli himself advises auditors to record an asset worth 20 as being worth 24.

Both books make several recommendations, starting with a complete separation of auditing and consultancy. Gow and Kells argue, furthermore, that accountancy faces challenges from within; for example, if a computer can read a firm’s entire record of transactions, then firms may well use regulation-compliant audit software before long.

That, however, is not itself a solution. If the Florentine republic, that interregnum in the Medici period, was the locus of the political Enlightenment, the Medici consolidated financial methods which are central to another major feature of modernity, namely capitalism. Yet those in the former category must always face one question which, it seems, those in the latter must permanently suppress: Quis custodiet ipsos custodes?

MEET THE AUTHORS

Richard Brooks is an investigative journalist for Private Eye. Ian D Gow is director of the Melbourne Centre for Corporate Governance and Regulation at the University of Melbourne.

Stuart Kells was formerly Assistant Auditor-General of the state of Victoria, and a director at KPMG .

Arvind Sivaramakrishnan is t he reviewer teaches at IIT Madras

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