How Regulators and PwC Fooled Reporters—Again

Francine McKenna
Francine McKenna
Francine McKenna is an independent journalist who authors the newsletter, The Dig, covering accounting, audit and corporate governance issues at public and pre-IPO companies. She was previously the Transparency reporter at MarketWatch, a leading online financial news outlet published by Dow Jones & Co., where she covered financial regulation and legislation beginning in 2015. Her work has been featured frequently in The Wall Street Journal and Barron’s; her reporting and commentary have also been featured in the Financial Times, Accountancy Age, Accountancy Magazine, the University of Chicago Booth School of Business Chicago Booth Review magazine, and various other financial, media, and technology publications. She previously authored regular columns on corporate accounting issues for Forbes and on the intersection of financial services and professional services for American Banker. McKenna was a Journalist in Residence at the Stigler Center at the University of Chicago’s Booth School of Business in 2017. McKenna is an adjunct professor in international business in the MBA program at American University’s Kogod School of Business. Her perspective as an financial journalist and commentator is informed by more than 25 years of experience in executive roles in professional services, financial services, and manufacturing firms. In 2006, McKenna created the blog re: The Auditors to explore in an independent, objective, and often critical way the role, responsibility, and regulation of the audit and accounting industry in the global capital markets, and in particular, the business of the Big Four audit firms. Prior to transitioning to journalism beginning in 2006, McKenna was a director in PwC’s internal audit and governance advisory services group, where she audited PwC’s post-Sarbanes-Oxley response to heightened compliance and regulatory scrutiny. Before that, she was regional vice president for the Midwest at Jefferson Wells (a subsidiary of Manpower); led the industrial, automotive, and transportation practice as BearingPoint’s (formerly KPMG Consulting) first female managing director in Latin America; and directed the Y2K project management office for JPMorgan Chase’s Latin America operations.

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Is the PCAOB really investigating PricewaterhouseCoopers (PwC) for its role in the Mattel auditing mess? I may be wrong, but I seriously doubt it. Since the PCAOB and the SEC are captured by the Big Four auditing firms, regulators use the same PR tactics to preserve their own—and the audit firms’— survival.

Despite my previous warnings, some of my readers remain hopeful that the politically captured PCAOB, which was created by the Sarbanes-Oxley Act of 2002 in response to the Enron failure and the collapse of its auditor Arthur Andersen and tasked with overseeing audits of public companies and auditing firms, is still doing its job, protecting investors, just because there was a story in Bloomberg in November that the regulator is investigating PwC for its role in the Mattel “Big R” restatement. 

A “Big R“ restatement is when the correction of an error in the financial statements, whether due to a mistake or fraud, is significant enough to require an SEC 8-K material event filing, withdrawal of prior period filings and the auditor’s opinion on those filings, and revision of the prior period financial information before refiling with the SEC. “Little r” restatements occur when a firm’s errors are decided to be immaterial errors to be corrected on a go-forward basis.

“Accounting giant PwC’s work for Mattel Inc. is being reviewed by the top U.S. audit watchdog after the toymaker said it would restate some previous financial results because of a bookkeeping error, according to a person familiar with the matter.”

Don’t be a dupe.

The report of an investigation comes from a person familiar with the matter, because the PCAOB is precluded by the Sarbanes-Oxley law from commenting on any of its investigations or pending enforcement or disciplinary activities against the audit firms or their partners until completed and approved by the SEC.

(It’s also a bit infuriating that such a material error, a reversal of a previous position that affected deferred tax balances, is referred to as a bookkeeping error. Way to downplay this and keep it niche, Bloomberg!)

The prohibition against PCAOB enforcement action transparency has been a constant source of legislative activity, with many trying over and over to get the PCAOB out from under it so the regulator could talk openly about just such investigations, just like the SEC, if only to reassure investors and the markets that the PCAOB is on the job. Alas, the Big Four audit firms, and even some Democrats, beat the transparency proposals down every time.

Bloomberg had no choice but to report that the PCAOB and the SEC declined to comment on the record on the matter. PwC declined to comment, too.

PwC’s Mattel partner, Joshua Abrahams, and his team were pulled off the Mattel engagement after Mattel’s filing. Abrahams has now left PwC after the Wall Street Journal quoted a second whistleblower, Brett Whitaker, saying PwC and Abrahams were complicit in Mattel’s attempt to cover-up errors in reporting its deferred tax balances.

It’s not unusual for major media to claim a “scoop” when it exclusively reports that the SEC, or in this case the PCAOB, has commenced an investigation.

It’s good ink.

Take, for example, the November 2014 Wall Street Journal story in which Michael Rapoport reported that the PCAOB was looking into PwC’s tax advice to Caterpillar, also for potential auditor independence violations:

“The regulator’s review dates back several months and hasn’t previously been reported. The review follows an April request from Sen. Carl Levin (D., Mich.) for the PCAOB to look at the matter after he alleged earlier this year that Caterpillar had deferred or avoided $2.4 billion in taxes under strategies devised by PwC.

Neither PwC nor Caterpillar have been charged with any wrongdoing. PwC and Caterpillar have said that PwC’s advice and Caterpillar’s actions complied with all tax laws.

In April, Sen. Levin sent a letter to the PCAOB requesting that it “conduct a formal review” of the services that PwC provided to Caterpillar. The letter, a copy of which has been reviewed by The Wall Street Journal, also asks the PCAOB to review whether its rules should be strengthened to prohibit an auditor from auditing a company’s tax obligations when those obligations rely on a tax strategy developed by the same firm.”

I wrote about this story here. I also wrote about Caterpillar and PwC for Forbes. I don’t know for sure where Rapoport got this scoop, but the effect was the same: It took the heat off the regulator and bought the PCAOB time.

If you don’t recall an enforcement action against PwC for Caterpillar-related auditor independence violations by the PCAOB or SEC, it’s because there never was an auditor independence violation enforcement action against PwC for its work to create tax avoidance strategies for Caterpillar, despite PwC being Caterpillar’s auditor since 1923.

(Caterpillar did, however, disclose in its 2017 10-K that it faced $2.3 billion worth of back taxes and penalties as the result of Internal Revenue Service audits—of tax strategies created by PwC—that impacted its 2007-2012 tax returns, including a loss carryback to 2005. Caterpillar said that it is “vigorously contesting” the penalties. In December 2019, UK tax authorities billed Caterpillar for £37.5m for “tax avoidance methods” used in 2010 to 2017 after a review of Caterpillar’s transfer pricing agreements.)

The PwC building in London. Photo by Greger Ravik, via Flickr [CC BY 2.0]

There was never an enforcement action by the PCAOB or SEC against PwC for the 100-plus additional audit clients PwC provided tax avoidance advice to under the Luxembourg program disclosed by the #LuxLeaks revelations, either.

I exclusively wrote about PwC’s numerous potential independence violations related to the Luxembourg tax leak case.

No one listened.

The loophole left in the Sarbanes-Oxley law of 2002 allowing auditors to give some tax advice was “big enough to drive your entire diverse staff through in a rainbow colored double-decker bus,” I wrote at the time.

“However, PwC and others crossed the line by designing and mass-market selling speculative, aggressive tax avoidance schemes to audit clients, too.  That’s prohibited by SOx and by general auditor independence principles, for sure.”

So, why in the Mattel and the Caterpillar cases, for example, are anonymous sources quoted as saying that the PCAOB will investigate and then nothing happens?

In my opinion, the reporters, starved for scoops, have been used. The scoop was planted just for show.

Since the PCAOB, and SEC, are captured by the Big Four via the revolving door and the joint objective of preventing another Arthur Andersen-like collapse due to a crisis in investor confidence, regulators use the same PR tactics to preserve their own—and the audit firms’— survival.

In general, the Big Four audit firms, PwC in these cases, do a spectacular job keeping their names out of or way down in any stories written about corporate fraud in the US press.

PwC was likely caught off-guard by the WSJ Mattel story, where Whitaker was so brutal in his assessment of PwC’s culpability. (They are probably not too crazy about Whitaker teaming up with PwC whistleblower Mauro Botta and the Project on Government Oversight in a letter calling for Congressional hearings on PwC and the audit firms, in general, either.)

There are a few key ways the Big Four keep their names out of the news.

When audit firms like PwC are to be mentioned in new stories, they are always asked for comment in advance by reputable media. So, they are well aware when stories are coming out and are given every possible opportunity to comment. (I also gave them plenty of opportunity to comment when I reported on Disney, for example, and on the three client bankruptcy cases where PwC was going to trial.)

The first tactic is to try to get the firm’s name out of the story completely, or the story killed. That’s usually done by discouraging the reporter, or their editor in most cases, from mentioning the firm or its partner if it has not yet been named publicly as an investigation target, if it has not yet been formally charged, or if the accuser is a whistleblower.

Whistleblower claims get the “disgruntled ex-employees with an ax to grind” attempt to discredit and disparage. (That tactic has also been attempted to disparage and discredit a reporter that is a former employee of the audit firm.)

When that doesn’t work, they escalate quickly. One Big Four firm, in particular, regularly escalated complaints about stories to Forbes and WSJ lawyers in an attempt to disparage me and my reporting. In both cases, spokespersons were told they would not kill a story just because the firm didn’t like the tone, that if they had no errors to report and if they had a chance to comment they could go “Go jump in the lake.”

I suspect PwC tried as often as it could to get its name taken out of the Caterpillar stories completely. It would have been tough to do that in the WSJ Mattel story and in the LuxLeaks stories, certainly, since the firm is the focus.

When the request for comment comes in, audit firm professionals start working the phones with the reporters who regularly write about the industry and, in particular, about specialized issues such as tax (a small group), to get a more favorable story out first. They also work very hard to put the firms’ position out there early and often, like any other big corporation with a gigantic communications staff.

Typically, when there is too much damaging information out there already, they’ll say the audit firm has been lied to or duped. That was the claim for Colonial Bank, Satyam, and Tesco. (The Wall Street Journal had a good, balanced perspective of PwC’s role in the Luxembourg Leaks in its version.)

The Big Four firms also have an easy time convincing business reporters they did nothing wrong or that they are a better source for complex, technical stories than a target. In the Luxembourg Leaks case, they probably pulled out the old chestnut about how there’s nothing wrong with a corporation “maximizing shareholder value by minimizing taxes” and also that they were a victim of someone who stole confidential information.

Luxembourg’s Court of Appeal eventually affirmed former PwC employee Antoine Deltour’s status as a whistleblower, as recognized by the European Court of Human Rights (ECHR), and acquitted him of all charges concerning the copying and use of PwC documents.

You also should know there is nothing in the law that imposes a duty on directors or officers to maximize shareholder value or minimize taxes. 

Even retired Chief Justice of the Delaware Supreme Court and former Chancellor of its Chancery Court Leo Strine has written:

“I do not mean to imply that the corporate law requires directors to maximize short-term profits for stockholders.  Rather, I simply indicate that the corporate law requires directors, as a matter of their duty of loyalty, to pursue a good faith strategy to maximize profits for the stockholders.  The directors, of course, retain substantial discretion, outside the context of a change of control, to decide how best to achieve that goal and the appropriate time frame for delivering those returns.

For now, however, the important lesson is simple. For-profit businesses have incentives toward current profit-maximization that make them poorly positioned to evaluate risk and be safe regulators.”

But this Energizer Bunny tale of a “fiduciary duty to maximize shareholder wealth” just keeps on going because of gullible journalists.

Tesco was another PwC case, in the UK, that never got much media coverage in the US, considering how big and awful it was for the auditor. I wrote on Medium about how PwC immediately pulled out the “We’ve been duped” excuse. That’s despite the fact that the UK has had a “Critical Audit Matters” regime for a while and all the boxes were ticked.

“Tesco’s latest annual report, published in May, says that PwC warned Tesco’s audit committee that commercial income, the income statement line where the problems were hidden, was an “area of focus…”

PwC told investors and other users of the financial statements: “We focused on this area because of the judgment required in accounting for the commercial income deals and the risk of manipulation of these balances.

PwC missed the fraud anyway.”

PwC’s media and regulatory lobbying strategy was successful. The firm escaped any censure over Tesco. The Financial Times reported in June 2017:

“The Financial Reporting Council began probing PwC in December 2014, after Tesco admitted its first-half profits had been overstated by an amount that eventually reached £208m. The grocer appointed Deloitte to undertake a “comprehensive review” of its accounts, and ultimately stripped PwC of an audit contract it had held since 1983.

But on Monday the regulator said there was “not a realistic prospect” a tribunal would find PwC guilty of misconduct at Tesco. A person familiar with the inquiry said the FRC had concluded it could not credibly contend that the Big Four firm had failed to ask the right questions, or that its auditors had failed to act appropriately on the information they were given.”

Editor’s note: A previous version of this article appeared in The Dig, Francine McKenna’s newsletter. You can subscribe hereFrancine McKenna is an independent journalist whose newsletter, The Dig, covers accounting, audit, and corporate governance issues at public and pre-IPO companies.

The ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy.

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