The dogs that don’t bark

The dogs that don’t bark

The lexicon of accounting infamy welcomes “Repo 105", courtesy Lehman Brothers. A US court-appointed examiner reported earlier this month that right before it collapsed and triggered a global panic, the New York investment bank was falsely reporting repurchase, or repo, transactions—taking a short-term loan by offering securities as collateral, but then quickly getting them back as the loan is repaid—as actual sales of those securities.

The first reactions, in most such situations, are about the accounting shenanigans perpetrated by the company in question and the damage caused. However, the accounting chicanery only covers up the discovery of bigger problems. In this case, it is stunning that the transaction was apparently disclosed to auditors and regulators. Why didn’t these watchdogs bark?

To this, we add the Greek tragedy of Athens misreporting budget deficit numbers (a familiar refrain for Indians?), artfully achieved by dressing up certain debt transactions as sophisticated cross-currency hedges. Well-known investment banks apparently came to the aid of the party in this “all legal under the law of the day" effort.

Surprisingly, a lot of window dressing is actually apparent, once the data is reviewed. Last year, people gasped at how an elaborate fraud was perpetrated by Satyam’s founder over a number of years with nary a controversy. But this was evident to those who bothered with a little forensic accounting: In the fiscal year ended March 2002, despite adding $104 million to its annual revenue, Satyam’s net receivables position—money owed to the company, minus bad debt—decreased from $92.6 million to $88.2 million. So, Satyam’s collections team achieved an astounding feat, a fantastic course record. Curiously, Satyam’s management did not accord even a passing mention in its 20-F filing in the US to this achievement.

Companies often cherry-pick accounting rules from different accounting standards. But analysts seem to play along by not questioning the accounting in a thorough manner. At its worst, such accounting chicanery may be hiding a fraud, but even at its best it is misrepresenting facts. The prevalence of window dressing is not flabbergasting, but the lack of calling of the bluff by regulators, auditors and analysts surely is.

Why do several analysts (especially on TV) just parrot company press releases with little genuine analysis? Are regulators worried about a likely clean-up job on their hands if they call the bluff? Is the problem some kind of “group think"? Are auditors worried about the loss of a well-paying client? Shareholders mandate auditors to act as their enforcers in the company—so do they ask tough questions or just check vouchers?

Contrast this situation with that of an investor with even less information, who decides to go short on a specific stock. That investor had better do his homework before putting his money where his mouth is. He is willing and able to gain the operational financial knowledge needed to bet against a stock, but it seems regulators, auditors and analysts aren’t. This is the heart of the problem: The latter lack this experience. If they had it, they would also have the thoroughness and confidence to ask questions.

The Securities and Exchange Board of India (Sebi) had come out with a list of proposed changes to the companies’ listing agreement in September. Auditors have opposed the provision mandating rotation of auditors—to prevent one company from “capturing" an auditor—stating that they will lose the working knowledge of companies if they rotate. Sebi has suggested that audit committees of listed companies vouch for the financial knowledge of CFOs and CEOs. Similarly, the hiring process of regulators and analysts should ensure operational financial experience of such hires.

It is time to get a move on with these reforms.

Puranika Narayana Bhatta runs a finance and operations consulting firm in Bangalore. Comment at