4 Landmark scandals The impact of earlier cases
In accounting, rules may be hard and fast, but it is the interpretation in the specific circumstances of nature, timing and extent which really matter. Accounts are a complex representation of reality and there is an uncertain and entropic element. An overly strict analysis of the rules may not lead to a true and fair view.1 Nothing is certain and one can never be sure. However good the auditors are, and however tight the regulatory framework is, scandals will still happen, and auditors will still fail to spot them all. And sometimes they will actively assist in them.
Global financial crisis failures In several past cases, the auditors were unambiguously at fault. Whilst we accept that the Enron and Waste Management incidents with Arthur Andersen as auditor could never happen again, we think the Repo 105 situation with Lehman Brothers (involving EY) and MF Global (bankrupt in 2011, auditors PwC) could happen in a different guise, even though the rules have changed. Repo 105
Repo 105 is the name for an accounting manoeuvre where a short-term repurchase agreement is classified as a sale.The cash obtained is then used to pay down debt, allowing the company to appear to reduce its leverage by temporarily paying down liabilities – just long enough to reflect on the company’s published balance sheet. After the company’s financial reports are published, the company borrows cash and repurchases its original assets. So, in essence, a short-term loan is classified as a sale. This allows loans in the liabilities side of the balance sheet to be reduced – disguising their true leverage. The assets sold in the ‘sale’ are used in reports which were accounted for as disposals and removed (temporarily) from the
