Do you agree with the author's reasons of why there continues to be issues with auditor independence? Does he provide a way to mitigate the issue? Please explain.

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The Myth of Auditor Independence Waking Up to Unconscious Bias

The AICPA Code of Professional Conduct requires that members in public practice be objective, free of conflicts of interest, and independent in fact and appearance (section 300.050). The SEC likewise requires independence by the external auditors who perform an audit of managements assertions in the registrants financial report.

Auditor independence has been debated for decades and is in the news again. In The Way Audits Work is About to Change, Michael Rapoport recently wrote that regulators have found about one-third of the investigated Big Four audits to be deficient Then, in What Goes Wrong When Accounting Firms Become Consultants, he raised the matter of consulting, noting that in 2019 Deloitte earned 22% of its revenue from auditing but 60% from consulting Rapoport asked whether this trend makes auditors more beholden to management.

Rapoport also examined activity overseas in How the U.K. Is Trying to Prevent Accounting Scandals The United Kingdom is undertaking some soul searching about its audit profession, including independence issues, after several large corporate failures and criticisms of the public accounting partnerships that audited them. These examinations have led to significant proposals by the Competition and Markets Authority in April 2019, a review of the quality and effectiveness of audits in December 2019, and revised rules by the Financial Reporting Council in December 2019 to fortify auditor independence.

The SEC, however, relaxed independence rules last June, and Chairman Jay Clayton has proposed modernizing independence rules by further loosening them (Mark Maurer, SEC Proposes Loosening of Auditor Independence Rules, Wall Street Journal, Dec. 30, 2019,

Francine McKenna criticized Clayton for his remarks in her Modernizing Auditor Independence Rules series at her blog The Dig. In Part 1, she argued that modernizing auditor independence rules is just doublespeak for capitulating to the Big 4s dominance She followed this claim by investigating many examples of audit failure and relating them to violations of the independence rules. In Part 2, she related the independence issues of PricewaterhouseCoopers, which are discussed below In Part 3, McKenna speculated about a potential spate of future independence violations

Independence is often referred to as the bedrock of the profession. Do these shortcomings, however, demonstrate that this presumed solidity is a myth? Independence places a presumed relationship between a business and its external auditor. Given the institutional arrangement of the audit and the conflicts of interest, one should not be surprised by this inference.

Recent Examples of Independence Violations

There are many examples of auditors who were not independent. One example is PricewaterhouseCooperss noncompliance with this principle. In an administrative release dated September 23, 2019, the SEC documented 19 engagements for 15 SEC registrants in which the firm violated its auditor independence rules. These activities involved designing and implementing multiple software projects and an internal audit co-sourcing engagement. The SEC also maintained that PricewaterhouseCoopers employees wrongly characterized these consulting assignments as audit work. This marks another instance of misconduct in consulting work, despite the constant reassurance that consulting has no influence on auditor independence.

Another example was in 2016, when the SEC brought charges against Gregory Bednar and Ernst & Young because of independence issues. Bednar had too close of a relationship with the CFO of an unidentified firm; they and their families attended professional football and hockey games together, played golf together, and vacationed together. Ernst & Young, through Bednar, incurred at least $109,000 in entertainment costs on this CFO. The SEC felt the relationship so close that it revoked Ernst & Youngs independence for the 2012, 2013, and 2014 audits. The SEC cited the firm as well because it had evidence of this lavish spending by Bednar and did not act on it.

Also in 2016, the SEC instituted proceedings against Robert Brehl, Pamela Hartford, Michael Kamienski, and Ernst & Young for lack of independence. Specifically, Brehl was Chief Accounting Officer for an unspecified company at the same time as he had a romantic relationship with Hartford, who served as the engagement partner on the audit. Kamienski was the coordinating partner on the engagement. When he suspected the romantic relationship, Kamienski did nothing; however, Brehls supervisors learned about the affair and informed Ernst & Young. Because of this entanglement, the SEC said that Ernst & Young was not independent during 2012 and 2013.

In 2019, the SEC cited RSM US LLP for violating independence rules when it provided nonaudit services to various firms; in addition, a partner had a prohibited employment relationship with a client The PCAOB censured Marcum LLP for promoting some of its audit clients to potential investors and it sanctioned KPMG Bermuda for re-executing independence confirmations, backdating them, and not telling PCAOB inspectors that they were not the originals

There have been many commissions that have examined independence and worked to strengthen it, including the Kirk Advisory Panel on Auditor Independence and the OMalley Panel on Audit Effectiveness.

More violations could be named, but this sample should be sufficient to declare that the profession has a problem. Either practitioners have biases that they do not recognize, which requires institutional changes; or they are unaware of the independence rules, which raises the issue of professional competence; or they are breaking the independence rules, which damages the perception of the professions integrity. While competence and integrity are at the heart of some violations, most problems arise because of biases.

Expressed Concerns about Independence

Concerns about independence are not new. Harvey Hendriksen wrote that when he was at the SEC, he noticed that auditors called meetings with the chief accountant when they were unable or unwilling to exercise professional judgment (Relevant Financial Reporting Questions Not Asked by the Accounting Profession, Critical Perspectives on Accounting, October 1998, At a minimum, the accountants lacked the power or the will to confront management. Hendriksen cited observations in 1936 by thenSEC Chairman James M. Landis that auditors displayed their loyalties to management rather than to investors. In 1994, Chief Accountant Walter Schuetze criticized auditors cheerleading for their clients, inferring a lack of independence; in 1997, Chief Accountant Michael Sutton echoed these thoughts as he asked the professions leaders to address independence issues. In addition, there have been many commissions that have examined independence and worked to strengthen it, including the Kirk Advisory Panel on Auditor Independence and the OMalley Panel on Audit Effectiveness. None has succeeded.

Steve Zeff has noted the historical changes in auditing. By 1980, he concluded, a deterioration in professional values appears to have set in (How the U.S. Accounting Profession Got Where It Is Today, Accounting Horizons, December 2003, With the growth of consulting came a concomitant decrease in the space separating auditor from client, as auditors felt pressure from their clients to advance their causes. Art Wyatt, a former FASB member, noted in a 2003 speech to the American Accounting Association that auditors no longer presented their independent assessments to the board but argued for accounting treatments desired by their clients Furthermore, the firms engaged in various consulting activities that endangered their independence.

Accountants who perform external audits typically counter these criticisms by stating that they comply with the requirements of the SEC and the profession, meticulously avoid loans with and stock ownership in client firms, and avoid personal relationships that are too close. Furthermore, they argue that consulting has no influence on their audit work, and any transgressions are sporadic and generally inconsequential. One wonders how many violations must occur before some practitioners admit that they are regular and consequential.

How can one reconcile the examples of independence shortfalls and the criticisms by Landis, Schuetze, Sutton, Zeff, and Wyatt with the rebuttals put forth by external auditors? The answer lies in the distinction between conscious and unconscious bias. While some CPAs deliberately decide to trample the rules, as did Friehling & Horowitz, the auditor for Madoff Investment Securities, most auditors seem careful to avoid conscious corruption or even its appearance. The profession remains quite susceptible, however, to unconscious bias.

Patronage and Conflicts of Interest

The sociology of professions undertakes a critical examination of professions like accounting to analyze their historical development and their place in modern societies. Terence Johnson, for example, is a sociologist who has theorized various professional arrangements and their power relationships. He calls one of these arrays the patronage system, in which a corporation recruits professionals to perform various services; accountancy is identified as the classic example. The patron chooses the professional, and the patron possesses most of the power, as it controls far greater resources and has the power to hire and to fire. The preferred auditor must not only have the desired technical competence, but also, and perhaps more importantly, values that are socially acceptable to the patron. This social acceptability is important if the professional desires to be hired and to sustain the relationship.

This uneven power relationship and the necessity for the professional to be acceptable to the patron lead to conflicts of interest. The Oxford English Dictionary defines a conflict of interest as an incompatibility between the concerns or aims of different parties. The incompatibility is evident inasmuch as the external auditor serves the public interest, especially investors and creditors, while simultaneously being bound to corporate management. Calling the corporation the client when in fact shareholders, creditors, and the investing public are the true clients exemplifies the inherent conflict of interest.

Consider the following example: a faculty member at Penn State teaches advanced accounting and has a reputation for giving low grades. A wealthy student in the class asks him for tutoring, offering $200 per hour. The faculty member, who has impeccable ethical standards, accepts the offer and tutors the student 50 hours during the semester, at the end of which the student receives an A. When asked about the arrangement, the professor displays the students exams to administrators, who observe high marks on each exam. Is there a conflict of interest? Of course there is! The professor has a responsibility to the school, the profession, and the other students to grade all exams equally, while at the same time he has the aim of tutoring well the student he coaches, especially if he would like similar engagements in the future. At a minimum, the situation is rife with unconscious bias.

There is an inherent conflict of interest in the auditor-client relationship because the auditor naturally moves toward agreement with the clients views in an effort to strengthen and maintain the relationship.

In their article Why Good Accountants Do Bad Audits, Max H. Bazerman, George Lowenstein, and Don A. Moore point out that the real trouble is the professions vulnerability to unconscious bias (Harvard Business Review, November 2002, External auditors seem unaware of the underlying nexus between client and auditor and do not address these challenges to independence. The engagement fee may be characterized as a periodic cash flow in an annuity stream; the value to the audit firm is the present value of this perpetuity. Partners are evaluated positively on the business they keep and the business they bring in, but evaluated negatively on lost clients. In such a setting, there is pressureeven if only subconsciouslyfor the partners to accept a little misbehavior here or there to keep or to win the business.