Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Satyam and accounting regulation

In 2002 after the Enron debacle in the US, I wrote (sections 9.3.1
and 9.3.2 of this paper)
that though the US system of review of accounting filings by the SEC
did not work in the case of Enron and other frauds, it was still
necessary for India to have a system of review of accounting
filings. What I proposed (for the US as well as for India) was a
system where short sellers could force regulators to review any
specific filing by paying a fee. I even estimated the fee that should
be charged.

In the same paper, I also argued that a credible body to oversee
the audit firms in India is also needed.

The Raghuram Rajan Committee (of which I was a member) did
recommend regulatory review and audit oversight in its report
(see page 139-140). It also recommended the use of XBRL in all
accounting filing to facilitate the system of regulatory reviews.

I think the world also needs to figure out ways of making auditing
a more competitive industry. In my Enron paper, I argued that it
should become easier to create new audit firms and for auditors to
advertise directly to shareholders.

Nakedshorts points
out
that three of the big four audit firms
(PricewaterhouseCoopers, Ernst & Young and KPMG) are potentially
in the dock as auditors of the Madoff feeder funds in the
US. (PricewaterhouseCoopers were also the auditors of Satyam). If the
post Enron experience (the demise of Anderson) were to be repeated
post Madoff with no regulatory forbearance, it is not inconceivable that a majority of the big four auditing firms would cease to exist in 2009. Stunning as that would be, it would not be more surprising than the disappearance of the majority of the Wall Street investment banks in 2008.

In this context, we need to fundamentally rethink the industry
structure of the auditing industry. More competition is absolutely
critical.

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