By Tom Kaufman and Christian Hudson
Originally Published in the Santa Cruz Sentinel: 06/22/2008
Financial SWAT teams, increased power and more regulation are just some of the catchphrases currently volleying back and forth between Wall Street and Capitol Hill. Although it's clear change is coming, its silhouette is still as blurry as whether we've reached the bottom in the credit crisis.
The debate will certainly intensify, but before we lose the proverbial forest through the trees, what's important to remember is that there are options available that won't strangle innovation, force firms to move overseas and won't cost taxpayers more money.
Consider one question: would you eat at restaurant that first got to interview the health inspectors, then got to pick who got the job? Oh, and if the restaurant didn't like the report, it then got to make sure the inspector never came again. Reservations anyone?
That's what Wall Street gets to do. In fact, Wall Street calls it a beauty contest when the Big Four accounting firms by that we mean Deloitte & Touche, Ernst & Young, Pricewaterhouse Coopers and KPMG show up to interview with one of the venerable banks or investment houses for the job of auditor. It stands to reason that if an accounting firm hopes to get rehired, then the product might look more like what the client wants to hear than what you or I need to hear. Can anyone represent the true public interest and yet be selected by the company being reviewed? Benign neglect anyone?
Even better, consider that both the rating agencies and our current regulatory system use the numbers from the auditors. So even if the government creates aggressive new financial SWAT teams filled with Crouching Tiger Hidden Dragon-style fighters wielding laptops and calculators, how good are they really going to be if the information is still a product of a conflict of interest?
What to do? Kill the beauty contest and replace it with a lottery system.
Let the Securities and Exchange Commission or whatever marble government building ends up as last man standing after Treasury Secretary Paulson shuffles the deck determine the selection. If you think that institutionalizes the Big 4 as a monopoly, then here's a headline: Status Quo Results in Fewer Accounting Firms. Still, a test to lottery entry for accounting firms aspiring to bigger clients can certainly be written.
If you are a politician who thinks the Fed's move on Bear Stearns was a bailout, then you should like this plan because it helps all parties shine the flashlight on the fancy math. And, say, if you're a politician who thinks the market should be left alone, then you should like this because the lottery system doesn't step on Wall Street's most dynamic and innovative minds.
Now, if you are reading this saying, "Yeah but won't this result in the Big Four phoning it in?" Well, if you don't do your job, then you're out of the lottery or get a reduced share. How's that for motivation? And, if you're the Big Four, the good news is that you get the jobs, maybe more respect, and maybe more protection from litigation for doing your job.
Lastly, many of you may correctly point out that this is similar to what the British do and they didn't dodge the mortgage bullet either. That's true, but if you look at the reports, the finger is pointed at how the government regulators actually regulated companies -- not the auditors.
Our suggestion doesn't necessarily replace the other ideas floating about. We just think without it the other ideas don't really have a chance to do what you think they'll do. Apply this idea to rating agencies, too? How simply revolutionary.
Tom Kaufman is the Capital Markets Committee Chairman for the American College of Real Estate Lawyers.
Christian Hudson, a former Santa Cruz resident, now practices law at Hunton and Williams LLP in Washington.
Posts
