Audit Firms and Compliance Responsibilities

Nicholas J Price

Audit firms are part of the checks and balances that ensure that corporations are in compliance with laws. Under the Proceeds of Crime Act, accountants and auditors have a legal duty to report suspicious or fraudulent activity to the proper authorities. While the rules for compliance are fairly straightforward, problems can arise when audit firms develop too close a relationship with major corporations. Unscrupulous auditors may be tempted to cover up accounting issues to protect their own reputations or their relationships with their clients. Instead of admitting their role in discrepancies, some companies may try to downplay the situation or claim innocence.

The cover-up often does more harm than the original wrongdoing. Recent issues that have hit the media demonstrate how easy it is for audit firms to get caught up in problems with compliance responsibilities.  

What Is a Compliance Audit?

compliance audit is an independent evaluation that ensures a company is following external laws, rules and regulations, as well as internal guidelines. It’s not merely a financial audit. A compliance audit includes reviewing the corporate bylaws, controls, policies and procedures. An audit should reveal whether an organization is conforming to a governmental or other agreement.

Compliance is just one part of GRC, which refers to governance, risk and compliance. Boards must be in the loop with the compliance audit because they are ultimately responsible for any problems that arise that could cause legal or other difficulties.

Corporate compliance audits may be conducted by an internal auditor, CPA, third-party auditor or government auditor. Boards or audit committees may also request outside assistance, if necessary. Audit committees usually recommend improvements and corrective actions that a company can take to prevent future accounting deficiencies or nonconformities. The goal is to ensure that the board is doing what it said it would do.

Auditors’ Cover-up of Drug Money

EY, which was formerly known as Ernst & Young, is one of the largest professional services firms in the world. It is one of the Big Four accounting firms, along with Deloitte, KPMG and PricewaterhouseCoopers. A recent investigation found that EY failed to report suspicious activity at Kaloti, one of the largest gold refineries in the world. There is also suspicion that EY altered the compliance report to hide the crime.

The investigation describes how a drug gang laundered money by selling 3.6 tons of gold to the Kaloti refinery in Dubai. Kaloti allegedly collected cash from drug dealers in the United Kingdom and in other European countries. The gang then laundered the dirty money by buying and selling black-market gold. EY asked to conduct a review of Kaloti’s compliance rules that were designed to keep gold away from illegitimate sources to preserve the integrity of the global supply chain.

During the investigation, EY discovered that Kaloti had paid out US$5.2 billion in cash in 2012. They didn’t report this suspicious activity to the money-laundering authorities. Kaloti showed the audit team what appeared to be bars of silver from Morocco. Investigators later learned that they were actually gold bars that were coated in silver, and Kaloti admitted to buying them. The smuggled gold was owned by the money-laundering gang’s company, called Rendade International.

Amjad Rihan was the lead auditor for EY in Dubai in 2013. Rihan wanted to report the finding, but his bosses obfuscated the reports and told him not to report it. In this way, EY helped to cover up the crime. In the end, 27 members of the money-laundering gang went to a jail in France in 2017. EY and Kaloti have denied any wrongdoing on their parts.

Rihan lost his job because of the scandal and has had difficulty finding a new one. He feels that his life was destroyed because he became a whistleblower.

The toy company Mattel Inc. also became embroiled in a major compliance scandal. At the beginning of 2018, Mattel was struggling financially. It had experienced a weak Christmas shopping season. Toys “R” Us had filed for bankruptcy and Mattel had rejected a takeover offer from Hasbro. Mattel’s shares had dropped by half year over year.

Mattel experienced an accounting problem that was tied to their ownership of the brand Thomas & Friends, which features toys based on the animated show about talking trains. Brett Whitaker, Mattel’s director of tax reporting, and the finance team recommended fixing the problem with the full realization that Mattel would have to admit that there were errors in its accounting and reporting procedures.

As it turned out, Mattel’s senior financial executives and Mattel’s auditor, Pricewaterhouse Coopers, decided to bury the problem by changing their accounting procedures. The audit committee decided not to tell the board or the CEO of the problem.

The general vein of thought at the time was that Mattel would rather risk getting a slap on the wrist than disclose a material weakness that was sure to be the kiss of death for the company. Brett Whitaker resigned because of the matter. Mattel later admitted to the accounting error and acknowledged that an internal investigation had found weaknesses in its procedures. CFO Joe Euteneuer is also expected to resign. Whitaker claims that Euteneuer was aware of the situation and he was in on the decision not to disclose it. Josh Abrahams, a Los Angeles PwC partner who led the audit team, is also expected to resign amid allegations of violating independence rules after recommending candidates to Mattel for senior finance positions.

Mattel still claims that the issue was nothing more than an honest mistake. Mattel shares fell 2.7%, to $12, after the issue became public.

Modern governance tools are important for boards, senior executives and committees so that they can get information and insights to aid them in better decision-making. Diligent Corporation offers a highly secure board management software program that’s perfect for boards, executives and committees to collaborate and communicate securely. The secure platform provides an online collaborative space in which senior leadership can work together to prevent the types of problems that have surfaced with EY and Mattel.

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Nicholas J. Price
Nicholas J. Price is a former Manager at Diligent. He has worked extensively in the governance space, particularly on the key governance technologies that can support leadership with the visibility, data and operating capabilities for more effective decision-making.