What Happened to Objectivity and Integrity?

Includes: DIA, QQQ, RKH, SPY, XLF
by: Gary Millichip

Back in the day, when I was studying to become a South African Chartered Accountant (CA), one of the areas that received a lot of attention was the Code of Professional Conduct (COPC). I remember the emphasis placed on being objective and the need for integrity, and how these required values would distinguish us from the rest of the pack. With these values in place, the public could effectively place complete trust in us, knowing that we would do our best to identify activities that were not in compliance with relevant accounting standards.

The American Institute of Certified Public Accountants (CPA) has a similar COPC. In light of the recent financial crisis in the banking sector and the Bernie Madoff scandal, I think there is a need for us as a profession to revisit these two values.

Per ET Section 55 Article IV,

Objectivity is a state of mind, a quality that lends value to a member's services. It is a distinguishing feature of the profession. The principle of objectivity imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest. Independence precludes relationships that may appear to impair a member's objectivity in rendering attestation services.

Millions of dollars have been written off in the past few quarters by the banking sector, effectively wiping our reported profits for the past 4 – 7 years. How could we as CAs and CPAs have allowed such an event to happen? Part of the problem lies with FASB Statements No. 157 - Fair Value Measurements, not the requirement itself but its application. Here I agree with Jack Ciesielski when he says that

The problem with fair value accounting now is that it's telling investors that there wasn't much stewardship at all.

There was certainly no stewardship at all in the banking sector as they made loans using lax lending criteria. In addition, the banking sector was also directly responsible for creating all types of exotic assets that lacked stewardship. I’ll once again turn to Jack who puts this best by stating that

the kinds of financial crud now subject to fair value reporting have never been this plentiful, thanks to the imagination of lenders and investment bankers who concocted CDOs, CDOs-squared, CLOs and all the other alphabet-named implosion devices.

Yet surely we as CAs and CPAs, with the requirement of being intellectually honest, should have realized that lax lending practices were a major stimulus behind the explosion in property values, and thus should have questioned fair value measurements used by the banking sector in reporting asset values? After all, we use analytics to try explain why reported numbers one year and different from reported numbers the previous year.

Therefore, for instance, how did we feel comfortable with the fact that the value of houses increased upwards of 50 - 100% in a short period of time whilst knowing that salaries had only increased maybe 5 – 10% in the same period of time? I know this is a simplistic view but surely flags should have been raised somewhere regarding the reasonableness of property values? And knowing that exotic assets were hard to value should have also raised red flags about fair value assumptions. The worst part about all of this to me is that directors of these banking institutions paid themselves huge bonuses on profits that have now been revealed as false.

And what about Bernie Madoff and his $50 billion scam? Per ET Section 55 Article IV,

Regardless of service or capacity, members should protect the integrity of their work, maintain objectivity, and avoid any subordination of their judgment.

Yet we had major accounting firms such as PwC and KPMG overlooking implied returns that were highly questionable, especially given recent economic events.

The big accounting firms are likely to face queries about why they gave their seal of accounting to the astoundingly steady positive returns booked by a fund manager whose investment strategy was nearly completely opaque.

Of even more concern is the fact that no one questioned why a three-employee accounting firm was responsible for an operation as large as Bernard L. Madoff Investment Securities. It’s of no consolation that the accounting firm is now

the subject of a preliminary ethics investigation by the American Institute of Certified Public Accountants started after the scandal broke.

Per ET Section 54 Article III,

Integrity is an element of character fundamental to professional recognition. It is the quality from which the public trust derives and the benchmark against which a member must ultimately test all decisions.

This section also goes on to state that

integrity is measured in terms of what is right and just. In the absence of specific rules, standards, or guidance, or in the face of conflicting opinions, a member should test decisions and deeds by asking: "Am I doing what a person of integrity would do? Have I retained my integrity?" Integrity requires a member to observe both the form and the spirit of technical and ethical standards; circumvention of those standards constitutes subordination of judgment.

These recent events lead me to believe that we have a fundamental flaw in the way members of my profession have been conducting themselves recently. We need an immediate fix to restore the publics’ trust in CAs and CPAs and the profession as a whole.

As I was looking for a way to wrap-up all of this, I came across an article by Jan Dijkman. It’s certainly not a recent article but I think it sums up best the changes required in my profession.

A distinguishing characteristic of a profession is the acceptance of its responsibility to the public. The public relies on the integrity and objectivity of members to maintain the orderly functioning of commerce, and this public interest responsibility should influence the way that members act professionally in order to ensure the collective well-being of the community of people and institutions they serve. Strict adherence to the fundamental principles of the Code of Professional Conduct, and not treating them as mere suggestions, will enable the Chartered Accountancy profession to achieve its objectives, to the benefit of all. I would encourage members to adopt the wise words of Marcus Aurelius as their guiding ethical principle: "If it is not right, do not do it; if it is not true, do not say it".