The SEC will take ESG seriously

Combined with a Final Rule Change in November, the announcement of Allison Herren Lee as Acting Chair of the SEC is excellent news from an ESG (Environmental, Social, Governance) and Sustainability reporting perspective. Rest assured, the new US administration’s acceptance of the science of Climate Change and stated understanding that there are already major impacts on the environment, are going to result in a major shake-up in corporate reporting.

For too many years the SEC has paid lip service to the need for ESG reporting.

No rule change will be needed

This means, finally, there will be real movement in requiring companies to provide ESG reporting. Way back in 2009, I wrote to the SEC in support of the Social Investment Forum (SIF) vision of what mandatory Environmental, Social and Governance (ESG) disclosure should look like. I pointed out there than the existing Reg S-K already mandated reporting on ESG in the MD&A.

Companies listed on the US markets are required to file various forms with the SEC, with the most notable being the Form 10-K, the annual filing that includes both financial information, and significant additional information included in the "Management Discussion and Analysis" (MD&A) section. The content of the Form 10-K is controlled by Regulation S-K, and there is some specific wording that applies to ESG and Sustainability reporting. However, it does not explicitly state ESG or Sustainability. 

I argued then, and still believe, that the "known trends" and "uncertainties" requirement was enough.

There is already the requirement under §229.303 for companies to "Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations."

I believe that Climate Change and the wide range of potential negative impacts, raises to the standard of a "known trend", or at a minimum, based on the overwhelming amount of scientific research undertaken to date, an "uncertainty". Equally, Social and Governance issues have a significant impact on liquidity and operations, and therefore should rise to the level of "known trends" or "uncertainties".

The SEC has acted on the "known trend" or "uncertainty" clause before, when Y2K reporting was mandated. At that time the SEC also took the bold step of stating that boilerplate reporting would not be acceptable, and that filers had to provide detailed discussion of their plans, including potential impact on customers, and the cost to address. “No net impact” was not an acceptable response. The SEC's actions in relation to Y2K could form the basis for similar action in relation to Climate Change and ESG reporting.

Allison Herren Lee's appointment as Acting Chair of the agency will bring about a sea change in ESG reporting.

“During my time as Commissioner, I have focused on climate and sustainability, and those issues will continue to be a priority for me,”

Read those words again “those issues will continue to be a priority”. Finally, we will have some real reporting on ESG and sustainability in annual filings, and hopefully not the boilerplate. Investors and the public should begin to see what companies really think are the risks (and opportunities), and will need to say exactly what they plan to do to address the potential impact of Climate Change.

The Rules have changed

In November 2020, a Final Rule from the SEC strengthened the reporting requirement. In their Final Rule, they discuss the change from "will" have a material impact, to "reasonably likely" to have a material impact. 

"Item 303(a)(3)(ii) currently requires a registrant to describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material impact (favorable or unfavorable) on net sales or revenues or income from continuing operations".

The Commission's final Rule says:

"We are adopting Item 303(b)(2)(ii) with these amendments substantially as proposed, but with slight modifications to clarify that the “reasonably likely” threshold applies throughout Item 303. Furthermore, our amendments to Item 303(a) state that, as part of MD&A’s objectives, whether a matter is “reasonably likely” to have a material impact on future operations is based on “management’s assessment.”

I could contend that it will be the very brave, or very disconnected, company executive who, in "management's assessment", determines that Climate Change cannot be considered "reasonably likely" to have an impact on "continuing operations".

Preparing for the change

So with this change and increased reporting, what should reporting companies be doing?

First, consider a complete review of your CRS reporting. CSR has too frequently been seen as something owned by or shared with Marketing and Communications. The greater the ‘power’ in Marketing for the production of CRS reporting, the greater the risk that what you are reporting does not fully map to the reality of your operations or strategic expectations.

There is a risk of shareholder, regulator or customer sanction if your CSR reporting is not in sync with your internal strategic plans and the assumptions used to create those plans and, more importantly, with what you have been reporting in SEC other regulated filings. If there is a disconnect, then there is a risk to reputation and a risk that a regulator (or the markets) will respond punitively to a belief that the company has been ‘hiding’ information, or spinning and ‘greenwashing’.

CRS and Sustainability have just jumped to the top, or near the top, of the Internal Audit risk universe. What controls are in place over the production of the CSR report? What processes are in place to validate the information that is reported? Does management override play a part in the production of such reporting?

Instead of repeating myself, I’ll just point you to my post on the subject from all the way back in 2015; Why CSR is an important part of your risk universe.

Pick a Standard

There are several ‘competing’ CSR and Sustainability reporting standards. Do your research. Each has its strength, but so far we do not know which one will be the ‘one true standard’ the way COSO became the presumptive standard for internal control following SOX.

My own betting would be on either (or both) the SASB and the GRI standards. Both are comprehensive and established. SASB is modelled on the need for rules-based reporting and standards used in corporate financial reporting, and the very name pays homage to the FASB. The GRI standard, however, is global and has been around for close to 20 years. There may be some flaws, but it is a comprehensive standard for wider ESG reporting.

Plan ahead

Expect ESG reporting to expand, and expect scrutiny of reported information to increase. Mismatches between current and historical CSR and Sustainability reporting and corporate communications will come to light, so be prepared if you are concerned that there may have been mismatches.

With Climate Change on the agenda (finally) and with a new SEC Chair nominated (with clear views on ESG) there can be little doubt that ESG and Sustainability reporting will no longer be something for the marketing people; it is now center stage for regulatory reporting.

So, Prediction Time

Watching what is happening, seeing the general revulsion at Trump’s incitement of insurrection and the actual storming of the Capitol, I think it is possible to make some extrapolations.

First, the highlights. The 2024 Presidential Campaign will be fought by four political parties; the Democrats, the Republicans, the American Patriots Party, and the Libertarians. The split of the vote will be something not far from 55%, 25%, 10%, and 10%. President Harris will be re-elected in an Electoral College landslide that will eclipse Joe Biden's, and Trump's before him.

Now a little of the thinking behind this.

1. The Republican Party is dead as we know it. It can no longer hold the wide range of constituents, and the Trumpists will split to become a new party, the American Patriots Party. The rump Republican Party will be made up of long-term fiscal and social conservatives, especially the Constitutionalists. They will continue to control strong constituencies in the South and in some rural states. Religious conservatives will have a difficult time deciding where they will land, and many will stay with the Party that is conservative without being crazy. There are conservative Christians who have actually read the bible (well, the New Testament anyway) and cannot or will not be able to continue to support Trump and his anti-Christian behaviours.
2. The American Patriots Party will come into being in the first six months of 2021, and will be the Trumpist Party in all but name. Basically, this will be the White Supremacist party, and the home for QAnon and other conspiracy theorists. The party will never command a significant share of the vote. It will win a few seats in the mid-terms, but will find itself starved for money and influence in a congress that will still be distancing itself from Trump and his ilk. Their platforms will be and remain secessionist and anti “Deep State” and with Donald Trump Jr as the head of the party, they will perpetuate a “stab in the back” myth, knowing full well that they are stealing that from the early Nazi Party. There will be splinter groups even from this, as we should expect an Amerikan Eugène Terre'Blanche, with a similar end.
3. The Libertarian Party will be a big winner from the end of the Republican Party as we know it. The moderately educated and modestly affluent conservative but anti-government Republicans will look for a new home. Seeing their previous hope (small government, high tax-cut Republican congressmen and senators) become more ‘mainstream’ conservative and fiscally responsible, even voting for higher taxes to fund the deficit and military (but nothing else), they will look for a new home. They will be as disgusted by the American “Patriots” as most of Amerika, and so will find solace in the arms of the Libertarian Party.
4. This leaves us with the Democratic Party. As the party in power they will have a natural advantage, and simply introducing some calm will work to their advantage. Under Democrats the pandemic will be defeated and the nation will mourn. There will be, of course, plenty of Democrats who will ensure that the message is clear: under Trump, this was allowed to happen with no consideration for people, while under the Democrats the pandemic was brought to heel, and the nation healed. The economy will bounce back under a Democratic administration, and while the deficit will continue to climb, Treasury and Fed policies will ensure low-interest rates and plenty of stimulus to keep the markets afloat (and ensure that are no places better than the markets to invest for a return).

Yesterday (8 January 2020) in the Reagan National Airport, Senator Lindsey Graham was yelled at and called a Traitor. While personally, I believe he is a traitor, the people yelling at him were the very Trumpists he has encouraged through his slavish support for their prophet, Donald Trump. Graham was an ‘old fashioned’ Republican and will attempt to survive in the Republican Party, and that will be difficult. Look for him to announce that this will be his last term. He will be rejected by the Patriots Party, and his only hope is that the file used to blackmail his has not fallen into the hands of Don Jr. If that happens, then he may be retiring sooner than the end of his term.

Mitt Romney will probably emerge as the real leader of the traditional Republican Party. This will leave little room for the rejectionists. They will (probably) be deprived of plumb committee seats, and will find themselves in the back rows. As the only Republican to vote against Trump in the first impeachment, he is the only traditional Republican with the moral standing to front and leads the party. McConnell is yesterday’s fish, and wrapped in newspaper will be thrown onto the trash. Graham, as mentioned, has no hope of regaining any position of authority. His apparent but not disclosed health issues from a few months ago may precipitate an early retirement. He will not be missed. There are other traditional Republicans, but few have been able to demonstrate an adequate level of independence from Trump.

The likes of Ted Cruz and Josh Hawley were already positioning themselves to take over the Trumpist mantle, and they will have no home other than the Patriots Party. They will find themselves in the same fight that they are in now, against each other but more importantly against Don Jr and the rest of the clan. With their political experience and ability to raise donor money, they will have a decided advantage over Don Jr, and they will use that advantage. Can they actually push the Trumps out of the Trumpist party? That remains to be seen, but it is their only constituency and their only hope.

The undereducated white male is a shrinking demographic. In addition, simple shame will shrink the ranks of those who will be putting Patriot Party flags on their front lawns. Finally, the funding required to run a major political party does not come from the poor or the collection plate, it comes from mega (not MAGA) donors who expect a return for their investment. There is little chance of anyone getting a meaningful return from this crowd.

President Harris will of course win in 2024, and by a landslide bigger than her predecessor Joe Biden, as she cries out to carry on his legacy to build a greater, freer, safer and more egalitarian nation; a more “perfect union”,mmmmqmf2q2den will be remembered as the President who brought America Back from the darkness of the Trump years. But at 78, the pressures of the presidency will eventually take their toll. He will not, for one reason or another, run in 2024. Will Harris already be President by then? That is a 50-50 bet that I won’t take. But she will be Madam President in January 2025.

6/1 and the End of Trump (and all who sail with him)

There is so much to write, and it is difficult to find a place to start. But I guess I can start with the end:

Trump signs and flags are going to disappear across Amerika today. Arrests will accelerate over the coming weeks. The Republican Party will now splinter and effectively will die as a political party of meaningful standing. Trump truly burned as much of it to the ground as he could. The question remaining is how much damage can he do between now and when he is removed, on the 20^th or before?

Georgia and the impact

It is probably right to start here. Both Senate seats in Georgia have been won by the Democrats, and with that, control of the Senate. Not a blank chequebook, but the ability to ensure that bills actually reach the floor and Senators are required to actually register their vote, so that their positions can actually be recorded, instead of the 2-year act of cowardice that has seen almost no bills reach the floor of the Senate.

Most importantly, Biden will now be able to nominate who he wants in his cabinet and on the bench. He will need to use this power quickly. The first proof is his announcement that Marrick Garland will be his pick for Attorney General, a pick that would have been either impossible or very difficult to get through a Senate with Republican control.

At a guess, news of the loss of Georgia probably contributed to the violence, as the Trumpist Cult could then clearly see that they have lost all; the House, the Senate and the White House. Their rage was stirred up by Trump. The knowledge that they would not even have part of the government to ‘protect them’ may well have added to their sense of betrayal. Of course, Trump (and Giuliani and others) claiming that there was massive voter fraud in the Georgia runoff could not have helped. But the news probably added to the frustration of the Trumpist Cultists.

Trump’s “Stolen Election” rally, and his cowardice

Trump held his rally in front of the White House, and Don Jr and Giuliani spoke before the main act, Trump himself. We watched Trump for the first hour, until the channels switched to the Capitol. Giuliani called for “trail by combat” to a bunch of wannabe revolutionaries. Don Jr incited, and Ivanka called the mob “American Patriots”.

Before the mob actually breached the Capitol, Charlie Savage of the Washington Post posted this in the comments next to the live streaming from the Senate floor:

 

Charlie Savage Washington Correspondent If any of the Capitol Police or staffers get hurt or worse because of the protesters outside the Capitol, Trump is going to face accusations that he incited a riot. At the end of his speech, Trump told his supporters on the Mall that Republicans have been too nice, like a boxer with his hands tied behind his back, and now needed to “fight much harder” against “bad people.” He told them to walk to the Capitol and “demand” that Congress “confront this egregious assault on our democracy” (that is, his loss to Biden), and kept exhorting them that “you have to show strength and you have to be strong” and “you will never take back our country with weakness.” (His defense will be that amid all that militancy, he also used the adverb “peacefully” once.) 2:13 PM ET

 

Yet after saying “We will march to Congress” he got into his motorcade to ride 200 meters back to the White House. Coward.

Storming the Capitol

The Trump “Save America March” broke up and marched to Congress, just as he told them to.

And when they arrived, the barriers were pushed aside, and protesters reached the bottom of the steps of the Capitol. There are questions about who opened the barriers. Regardless, crowds gathered at the bottom of the eastern steps to the Capitol, and crowds gathered at the western side and began to scale the scaffolding that has been put up for the inauguration. There was an inadequate police presence, of Capitol Police and DC Police, and there was no National Guard available. With everyone knowing that there was a high chance of unrest, where were they?

I understand that it might not have been wise to surround the Capitol with a wall of National Guard or police, as the optics of that would be terrible. I can hear it now “they needed the Army to protect them as they stole the election”. So from a public perception perspective, it makes plenty of sense to keep all the security services and military well out of sight. But they should have been on-call, waiting lined up and ready to roll if needed. This will go down as a major failure to prepare, or at worst a calculated attempt to allow rioters to gain entry and overturn the election (or attempt to).

Soon they were at the doors, and windows were broken and protesters climbing in. Soon enough, mobs running through the building. One person was shot trying to break into the Senate chamber. That person since died. I’ll not use her name. While she is an Air Force veteran, she has soiled the flag that she saluted, and has shit upon the Constitution that she swore to protect, from all enemies, foreign and domestic (herself being one of those enemies).

One of the most disturbing pictures, and it is difficult to narrow it down to just one, is the protester/rioter walking through the Statuary Hall carrying the Confederate flag. That is not “Stop the Steal”, that is “Overthrow the Republic”, and that is at Trump’s feet.

Eventually, the Guard and the Police arrived, and order was restored. People were forced to exit the building and leave the grounds. We now read that 50+ people were arrested. That number is a joke. Thousands violated the Capitol, and they are all on camera and video. And the really stupid one videoed themselves and took selfies as they committed riot and attempted to overthrow the government. There will be some short trials and long sentences.

Counting the vote resumed

Even after the Capitol has been stormed by Trumpist rioters, still, some Trumpist Senators continued to object. Remember these names. They are traitors to the nation and the Constitution. They have put a man above the Constitution. They have attempted to install a king. The “Breaking News” Alert from the New York Times summed it up perfectly:

 

Those voting against the results of the American election were: Senators Josh Hawley of Missouri, Ted Cruz of Texas, Tommy Tuberville of Alabama, Cindy Hyde-Smith of Mississippi, Senator Roger Marshall of Kansas and John Kennedy of Louisiana.

 

“Those voting against the results of the American election”.

At about 3:30am Washington time (or thereabouts) Mike Pence read the prepared remarks that included the count of Electors for Biden/Harris and for Trump/Pence. He then declared Biden to be the President-Elect who will be sworn in on the 20^th of January. It was over. Even Trump was forced to issue, through an advisor because his Twitter and Facebook and Instagram accounts have been locked for 12 – 24 hours, that there will be a peaceful transfer of power.

Orderly transfer

Of course, there hasn’t been a peaceful transfer of power. There has been a campaign of rejection of the results culminating in an attempted coup by the mob, stirred up by Trump and his followers. The transfer of power does not happen only on the 20^th, but is a process that starts, or should have started, in November after the election results are clear. A transition team from both the sitting administration and the incoming administration work together to ensure that there is continuity of government. To ensure that new appointees can start the new administration fully briefed on the current situation in the government agencies, the status of programs, and so that staff can get to know each other and who they will be working with. Policies can be discussed so that the incoming administration has an idea of the effort in front of them. National Security continuity is required, and incoming administration officials must know the security threats that the country faces, so that there can be no gap and no period of potential weakness that an enemy can exploit.

Failure to do this is not the peaceful transfer of power.

Trump has not signalled that there will be a orderly transfer of power, he has issued a surrender statement indicating that he recognises (or enough of his direct advisors and supporters recognise) that he will be replaced, that he did lose, and that his insurrection failed. He is now negotiating a peaceful and jail-free departure from the White House on the 20^th.

Make no mistake, Trump is being prised out of the White House with the threat of being physically dragged out. He tried, and failed, and will now depart in such a way as to try one last smear against Biden. But he also has almost no loyalists left.

His insurrection failed. But he will claim that he didn’t actually want that to happen; those well-meaning patriots got out of hand. Good people; the best people, just very enthusiastic people. He will continue to say that the election was stolen, until he is finally sued in civil court by a few states demanding damages. There certainly will be some people in the crowd who will join any suits against Trump for fraud, saying they believed the President when he lied to them, and did what the President wanted and told them to do. It will be an interesting set of lawsuits.

The rest of (Trump’s) Amerika

By now, the morning after, I fully expect that across Amerika Republicans and Trump supporters who are not crazy will be taking down their Trump banners. Trump 2020 bumper stickers will be scraped off. While they will remain conservative, and may still believe in a “deep state”, they also are Amerikans, and they know that inciting you followers to storm the Capitol and walk through the Statuary Hall with the Confederate flag is going beyond the acceptable.

In Wisconsin and Pennsylvania, and quite possibly in Texas, the Trump flags and signs will come down. In the Klan-South it may take a little longer, but in the VFWs (Veterans of Foreign Wars – equivalent to the RSAs in the Commonwealth) the Trump banners will come down. What happened was a direct assault on the Constitution, and that was something they all swore to defend.

Hopefully, the preachers will back-off as fast as they can. They know their constituencies better than anyone. They did not condemn Trump before, because they had good alms paying congregations who wanted to hear how Trump was stopping abortion and making Amerika strong, stopping Communists and keeping the, um, non-Amerikans (read: Blacks, Asians and Hispanics) from displacing good God-fearing Christian Amerikans.

There will be little overt repudiation, because the internal psychological backflips needed will not be possible. But Trump and Trumpism is done, other than for a fringe that will be there no matter what happens. They will no longer, however, be a political force.

 

AI and External Audit: Not until the Business Model Changes

I’ve just read an article on AI and Audit, asking when (or if) Artificial Intelligence will take over the Auditing of companies financial statements. (“Distinguishing Hype from Reality about the Future of Automated Audits” By Gregory P. Shields, CPA, CA  http://thinktwenty20.com/images/Issues/Winter_2020.pdf)

While the article provides a fine survey of the technical issues and impediments, it misses one key element; AI is a threat to the Auditing and consulting firms' business model. Until they can determine how they incorporate this without erosion of fees and profit, there will be limited uptake.

It is an interesting article, if you are into this kind of thing, and considers three scenarios.

 

Arguably, predictions fall into three overall categories:   1. AI will soon displace human auditors. Clairvoyants in this category might be referred to as chicken littles, predicting the auditing sky will soon fall on human auditors. 2. AI will complement the work of human auditors, but never entirely displace them. These clairvoyants might be referred to as eternal optimists, looking at the future of human auditors through rose-coloured glasses. 3. AI will ultimately displace human auditors. These clairvoyants may be the realists. But, what does “ultimately” mean and what are the implications for decisions that have to be made now? (Gregory is a member of the board of directors of the University of Waterloo Centre for Information Integrity and Information Systems Assurance (UWCISA). He is also a member of CPA Canada’s Audit Data Analytics Committee. Before his retirement, he was CPA Canada Director, Auditing and Assurance Standards. His recent projects include developing non-authoritative auditing guidance on data analytics, cryptocurrencies, and accounting estimates.)

The conclusion is not surprising; that AI still has a long way to go, that regulators will take convincing, and that there remain too many cognitive processes that cannot yet be replicated by AI. These are the “value-added” that the human accounting specialist brings to the audit.

But what is missing from the article is the change required in the economics of audit to allow AI to play a meaningful role in disintermediating the human auditor.

The Accounting profession and Auditing firms exist in and rely on an economic model that will delay the introduction of full AI support for the audit. Auditing firms are highly profitable ‘consulting’ companies with a market niche that they will exploit and protect from competitors, and AI is, even if used as an ‘internal’ tool, a competitor.

Almost all major accounting firms are partnerships. While this is mostly a structural and governance mythology, they are bodies of self-feeding units that rely on a “Borg” like assimilation into a greater single entity which looks out for the collective interests. Let’s break that down. Auditing firms are like ant hives, all working together, but ready to cull the non-performing elements, and perfectly happy to jettison worker ants to protect the hive.

Each Partner owns a number of shares in the company, and those shares pay a dividend to the partners. The more shares, the greater the percentage of profits. Junior Partners “buy” a starter set of shares, and as they progress in profitability and seniority, they are allocated more shares. There are no external shareholders, and therefore no wider investor community to answer to. Certainly they talk stakeholders, but what they means are those that can impact their business model for the better or worse.

Each Partner has a team (or shares a team with other partners for efficiency) and ‘sells’ those resources to clients on specific engagements. Basically, people-hours for an agreed person-hour rate, frequently merged into a single overall rate or price for the job. At the core is that simple economics of the cost of inputs and the income generated by those inputs. Technology helps those inputs (people hours) be more productive and increases the potential price of that input on an hourly basis – because fundamentally, hours are the product.

Just as a metal stamping business many (does) use percentage utilisation of metal stamping machines as a measure of productivity, the accounting firms carefully monitor individual human utilisation rates as the core to determining productivity and potential profitability. People-hours utilised (billable) is the core of the Auditing (and associated consulting services) profession's productivity and profitability.

All other functions within the Auditing and consulting firms are paid for by the numbers of hours of human time that are sold and can be seen by the client as being delivered. The cost of delivering those hours if high. Premises, technology, HR services, and ongoing training of staff are significant costs. But there is another cost; the cost of ensuring that the profession continues to exert control over companies and their financial supply chains. After all, without a ‘clean’ audit, most companies cannot access capital at economic rates.

As an aside, brothels work in much the same way; the fundamental product is people-time, and the more time your product can spend ‘billing’ the more profitable the enterprise. Just like the brothels, if the young ones are not producing enough revenue, the young ones and the madams suffer.

A non-profitable partner or business unit within an Audit and consulting firm will be culled, and quickly. This means that a major element of the Senior Manager through Partner ranks, and especially anyone aspiring to Partner rank, is the selling of new business and the protection of and ideally expansion of fees with existing clients.

Unlike the brothels, Auditing and consulting firms have the additional costs of sustaining an industry body whose purpose is to ensure that they retain their dominance in the financial supply chain. (although I guess one could equate this to the cost of bribes to police and local officials?)

Audit firms carry the additional costs of lobbying at the international, national and state level, and through ‘ownership’ (capture is probably a better word) of the process for standards-setting. And standards that will threaten their business model will be managed. The International Accounting Standards Board (as one example) would find itself significantly less effective without the ongoing support from the major Auditing and accounting firms. The accountants and auditors provide much of the technical resources required to draft and review standards, and technical resources are frequently ‘seconded’ at no cost from the firms. And for a good reason; such secondments ensure that their people contribute to the development of the standards, it also ensures that the firms have resources with in-depth knowledge to trot out to their clients.

An AI-heavy audit is a threat to their business model. It is difficult to add a premium to the audit fee for a reduction in the amount of work that will be performed by humans. After all, if the human time is the primary cost factor, when a reduction in the total human inputs should translate into a reduction in the audit fee. Firms have been down this road before. Audit automation and through automated work-papers contributed to a reduction of the audit fee, but was offset by increases in the costs of labour and the total amount of effort required.

Sarbanes-Oxley section 404 was an excellent example. Following the Enron and Worldcom frauds, the additional requirement for a CEO/CFO certification statement resulted in a windfall to the Auditing and consulting firms, boosting total numbers of hours on audits, and the cost-per-hour of now scarce resources. First year accounting graduates were suddenly seeing offer letters at 15% to 20% higher than their friends received the year before. Internal Audit consulting firms found that they were able to raise their rates by more than 50% to 70% in a year, with that particular gravy train lasting almost a decade. It took that long to build a population of internal auditors sufficient to service the new need, in order to once again begin to push rates down.  

This is after ignoring the fact that two Auditing firms facilitated the frauds at Enron and Parmalat. Ironically, such frauds, while costing individual firms dearly, actually raised the overall revenues across the industry. In the case of Anderson’s, it destroyed the firm. In the Parmalat case, the local accounting major’s firm was expelled from the network, and their international clients in Italy were instructed to contact EY on their first day back in January 2004.

Another area where the business model will not be permitted to be undermined by actual practice is the relationship with Internal Audit. Long considered the slightly dim cousin in the auditing world, Internal Audit arguably plays a more critical role in the actual success of companies. Not only does Internal Audit provide real comfort to the Board (along with Risk Management and Management), it can also contribute to process improvement and organisational efficiency.  IA should also be able to contribute to a reduction in the cost of External Audit.

I’ve long argued that improved Internal Audit should enable the External Auditors to place greater reliance on the system of internal controls, and therefore reduce the amount of external effort and cost required to provide an audit opinion. Yet year after year, regardless of the depth or coverage of Internal Audit, the External Auditors provide trite comments about the need to confirm the quality of IA’s work, and that perhaps next year there could be a reduction in External Audit activity. Next year never comes, regardless of how thorough IA has been, or how effective management has been at the implementation of IA recommendations.

After all, effective IA is a threat to the External Auditors’ business model.

And the business model trumps any other consideration.

Artificial Intelligence will encroach on the audit, but it will not successfully do so until the Audit and consulting firms have figured out how they can incorporate it into their business models, or until their business models are changed..