The demise of WorldCom and Enron, and the resulting Sarbanes-Oxley legislation, has revolutionised the way accountants and reinsurers interact, explains Mairi Mallon.
Corporate scandals, technology, new laws and regulations have all changed the way accountants deal with reinsurance and insurance companies. The revelations of accounting irregularities in a string of controversies such as Enron and WorldCom have encouraged accountants to become more cautious in what they do and they are now less willing to go beyond the strict limits, pointing out any potential pitfalls and mistakes.
Most of the big accountancy firms have closed down their consultancy arms, which were set up to answer demands by clients looking for more input and better service. But the perceived conflict of interest of doing the books and then advising the client to use your IT systems was seen as too much in a scandal-ridden corporate environment. Now services have been well and truly separated, but the fact that insurers and reinsurers can no longer get advice from their accountancy firm has left a gap waiting to be plugged. "The changes have come in part because of Sarbanes-Oxley, but also because some of the accountancy firms have separated their accountancy and consultancy arms because of conflict of interest issues," said Robert Hartwig, chief economist at the Insurance Information Institute in New York. "Ironically, Arthur Anderson spun off its consultancy firm just before it went under."
The introduction of tougher accounting procedures through Sarbanes-Oxley has also led to more stringent practices being taken up. There was a new record of 414 restated financial statements in 2004, up 28% in large part due to Sarbanes-Oxley - including 15% that were repeat filers. Hartwig added: "I agree that it has been an issue that accountancy firms do not give the same service they used to, but they are probably still smarting from the string of scandals from Arthur Anderson to Enron and all the worldwide debacles they have been involved in. They have been forced to settle billions of dollars so you can understand them being a bit cautious."
Hartwig said that the same advice that routinely used to come from accountancy firms for free (or at least as part of the service) would now have to be obtained from other sources, such as legal firms, and this would not be an ideal solution for many companies which do not have the time or inclination to explain their inner workings to a new party. "That is an expensive and time-consuming process," he said. "And it is not what people are used to doing. Change can be a difficult thing sometimes for everyone." But he went on to say that the quality of financial reporting had probably improved because of the changes in the accounting profession: "On net, the quality of accounts has improved, while the (consultancy) spin offs are still selling good advice - now we just have to pay more for it."
The spate of bad news for accountants started with Enron, the largest corporate bankruptcy in US history. In little more than a decade Enron had soared from obscurity to become the US' seventh largest company, with over 20,000 employees in 40 countries. But it was revealed to have lied about profits, had off-the-books energy deals and investigations found its accounting was erroneous and misleading. But Enron was just the beginning of a long chain of corporate scandals, as example after example of corporate greed and accounting malfeasance came to light, shaming huge accountancy companies in the process. There was Tyco International, one of the world's largest conglomerates, operating in over 80 countries with revenues of $36bn. But the company's fast and loose approach to its accounting nearly cost the company its livelihood. Only new management saved the day after financial irregularities in its booking of acquisitions was revealed.
American stock markets - and world markets - were perhaps most shaken by the demise of WorldCom. Its balance sheet lists assets of $103bn, and net income for the calendar year ending 31 March 2003 of over $1bn. It was eventually revealed that fraudulent accounting hid $3.8bn in losses. Arthur Anderson, formerly one of the big four international accounting firms, was convicted of obstruction of justice for destroying Enron-related documents. It was also the accounting firm for WorldCom. KPMG, like the other major accounting firms, now faces a host of potentially costly lawsuits over its audit work for companies that have disclosed accounting irregularities.
Pre-Enron, in response to demand, some accountants were offering more financial management and consulting services as they assumed a greater advisory role and developed more sophisticated accounting systems. But since the wave of scandals, US federal legislation now prohibits accountants from providing non-traditional services to clients whose books they audit. However, accountants are still able to advise on other financial matters for clients that are not publicly-traded companies and for non-audit clients, but the easy access and cross fertilisation from accountancy to consultancy has been halted in the US. Also, due to the increasing popularity of specialised firms and computer software, accountants have also shifted away from tax preparation. And as computer programs continue to simplify some accounting-related tasks, clerical staff are increasingly able to handle many routine calculations.
Iain Coke, head of financial services at the Institute of Chartered Accountants in England and Wales, the largest professional accountancy body in Europe, says that the relationship between insurers and reinsurers and their clients has had to change because of the changes in international reporting standards following the chain of scandals. But Coke says the changes are not as severe in Europe as they are in the US because of a different way of dealing with clients and regulation on that side of the Atlantic: "It is new for the insurers and new for the auditors," he said. "There are changing rules between the auditors, accountants and insurers. The relationship has developed which means that auditors have taken on a greater responsibility - particularly on the life side - than previously." He said that in the old regime a consulting actuary would sign off on the insurance liability number or the actuary was in-house, where as now independent auditors are brought in. He also said many companies in the UK now had to comply with Sarbanes-Oxley if they were listed in some form in the US.
A new dawn
Sarbanes-Oxley's section 404 set out to improve corporate governance and reliable reporting, but it has caused an almighty reporting headache. A survey of 224 public companies, conducted by Financial Executives International in July 2004, showed that businesses with more than $5bn in revenue expected to spend more than $8m each year implementing Sarbanes-Oxley 404 in the first year of compliance. These costs included consultants, lawyers, auditors and new software.
Sarbanes-Oxley 404 became effective for fiscal years ended after 15 November 2004, and requires that management assess and report on the adequacy of internal accounting controls and the insurer's independent auditor to attest to the adequacy of management's statements on internal control. Some companies were given an extension to 15 July 2006 to comply.
"(Sarbanes-Oxley) does put pressure on documentation and some parts of this have crept over to the UK," said Coke. "We don't have a Sarbanes-Oxley equivalent. We are a lot more principles-based when it comes to the regulation of the accountant and auditor. We are strengthening the documentation where we need to do it, but it is more flexible here."
Coke went on to say that today there are more restrictions on the type of advice accountants can give post-Enron, even in Europe, and now companies will have to go elsewhere to get the same kind of advice. "Auditors generally can't sell additional services to the extent they could before. So if someone knows of a new product or a new way of managing risk with new IT systems, they will not be able to give it." But he said that while insurers and reinsurers may not get the same level of advice or service they once did, the public and corporations were now better served by their auditors: "It has reinforced the status of the audit. The audit is, as it should be, the main focus of what the accountant or auditor does. It is important that the audit is seen as a credible process and seen to have integrity. There is an added integrity to the audit as a standalone product."
Executives do miss the old accountancy/consultancy firms and the breadth and depth of knowledge they could offer. However, it is difficult to get them to speak up publicly - they do not want to be seen to be going against the grain when it comes to complying with new regulations. "I do miss the input we used to have from our accountancy firm," said one Bermuda senior executive. "You knew they were selling you things at the same time - but they were usually things you wanted to buy. What we need to do is find a way of getting that kind of service from someone you trust - someone who is not your accountant. And we have not found that yet."
Mairi Mallon is a freelance journalist.