Managerial Accounting role of external auditors and their interactions with client companies

Managerial Accounting role of external auditors and their interactions with client companies

What ethical threshold did Mr. Jack Grubman cross when he started advising the board of WorldCom? How does this relate to the role of external auditors and their interactions with client companies?

As an analyst, Mr. Jack Grubman had the authority and objective expertise to pass judgment on WorldCom stock for prospective investors. This included making buy or sell decisions for the stock and providing research for consumption by retail and institutional investors.

However, by being associated with WorldCom in a position other than that of an analyst leads to a conflict of interest where Mr. Grubman is now advising the board of the company (PBS Frontline: The Wall Street Fix., 2007)– this means that the decisions that he makes regarding buying or selling WorldCom stock will be influenced by the inside information that he is privy to; information which other analysts do not have. There is also a second issue in that now Mr. Grubman may not provide objective evaluations of WorldCom because he theoretically owes some allegiance to the company by being part of its advisory board.

External auditors have the responsibility to protect the integrity of their role in transacting with a client that involves independence from any business dealing with the said client, expect for checking the veracity of their books. If the external auditor starts advising the client on financial matters, then a question begs to be asked as to whether the independence of the auditor to provide a judgment on the client’s accounting records has been compromised. The result is that investor confidence in the client’s firm may be negatively impacted.

Given the close relationship between Jack Grubman and WorldCom, do you believe that he was ignorant of the $9 Billion accounting fraud? Perform an internet search and describe what the fraud essentially was?

I do not think that Jack Grubman would be ignorant of the $9 billion accounting fraud. He was considered a star telecom analyst whose views on specific companies, especially WorldCom were treasured by investors. He also had a good working relationship with Bernie Ebbers and was the only analyst to attend private board meetings – all in all, Jack Grubman knew the company inside out as both an analyst and a member of the advisory board.

Executives at WorldCom hid expenses for more than two years between 2000 and 2002 in order to provide an image of a company growing during depressed economic conditions. The understatement of expenses boosted profits and sustained the company’s stock price, thus causing for people to make optimistic assessments about the future, not knowing that the company was suffering based on economic fundamentals (CNNMoney: WorldCom charges broadened, 2002). As a result, the company overstated close to $9 billion in profits which led to its subsequent bankruptcy.

Finally, what conflict of interest exists at the large investment banks? Are there lessons from the accounting world that can be applied to investment banking?

A conflict of interest occurs between the research and investment banking functions at large investment banks. The bank may be encouraged to publish research that prioritizes the interest of the investment banking clients over retail and institutional investors. For example, the bank may be providing research for a client to whom it also provides investment banking services.

The client may ask the bank to provide an optimistic outlook for it in return for the client agreeing to provide business to the bank. Also, the independence of the research analysts will be compromised since they may be privy to inside information related to the client as the client is being serviced by the investment banking arm of the financial institution.

Auditors usually have a pre-approved list of services that they can do for clients in the categories of audit and taxation (External audit firms: The ING Group., 2007). Investment banking firms can perhaps create a list of acceptable services that they can offer to clients that does not compromise the integrity of the research that the firm produces.

Audit professionals provide assurance on the financial statements and the annual accounts in connection with statutory or regulatory filings and are considered objective and independent through minimal non-business related interaction with the client. Investment banking provides similar services in helping a company meet financing and investing needs – however, a lot of non-business relationship-building takes place between investment banking firms and clients. This perhaps needs to be curtailed because it leads to the investment banking firm being privy to information that may be only for the consumption of the client.

REFERENCES

CNNMoney: WorldCom charges broadened. (2002). Accessed on May 30, 2007 at:

http://money.cnn.com/2002/11/05/news/companies/worldcom/index.htm

External audit firms: The ING Group. (2007). Accessed on May 29, 2007 at: http://www.ing.com/group/showdoc.jsp?docid=063421_EN&menopt=cog%7Ciaa

PBS Frontline: The Wall Street Fix. (2007). Accessed on May 28, 2007 at: http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/view/