Biting the hand that feeds you? The case of Bankia brings the relationship between audited company and its auditor back to the public light
In Spain, yesterday's economic headlines were fully covered by news related to Bankia’s rescue, which is going to require an extra injection of 19 billion euros from public funds.
These news about the public intervention of Bankia (this injection is going to take the form of public participation in Bankia’s equity) were jointly released with the fact that Bankia’s 2011 will be substantially reviewed: from the original results announced last February (309 million euros of profit) to a loss of EUR 2.979 million (i.e., a "slight" downward revision in an approximate percentage of 1064%).
Bankia’s auditor (Deloitte) refused to sign the accounts for year end 2011 due to a discrepancy in the equity valuation of 3.5 billion euro in BFA (the parent company of the group), yet the fact is that Deloitte had released positive evaluation reports of Bankia on two previous occasions during 2011: First, in connection with the preparation of the initial public offering (IPO) report dated June 17 and then the intermediate states of this year (report dated July 28, 2011).
On both occasions, the auditor provided a positive report opinion stating that “In our (Deloitte’s) opinion, the financial statements have been prepared properly in all respects, in accordance with accounting standards that are applicable."
Thus according to some inside sources from Bankia’s trade union1, the relationship between Deloitte and Rodrigo Rato (the outgoing president of the entity) had strained when it was discovered that Banco de Valencia's accounts were riddled with holes, accounts which Deloitte signed without any exception.
Deloitte was the auditor of Caja Madrid (main saving bank origin of the group Bankia), Bancaja and Banco de Valencia, three of the entities involved in the merger process, which, according to financial sources, could mean that when they provided audit services for the IPO they could have been incurring in a case of conflict of interest (Bancaja and Banco de Valencia merged with Caja Madrid after being rescued by the Bank of Spain to avoid their bankruptcy).
All this history brings the relationship between audit firms and their customers back again into the spotlight.
The dual role of the auditor, being responsible of providing an independent professional opinion on the accuracy of company’s accounts while he is being paid by the same company that he is auditing, gives floor to an almost inevitable conflict of interest (where being too harsh with your client means biting the hand that feeds you).
In this situation, it is clearly logical to propose more logical ways to clearly dissociate the client of the audit process from the auditor and the audited company, to break this apparent vicious incentive scheme mentioned above.
One possible way to break this system could be that the Public Administration would hire auditing firms through a competitive tendering process (for instance, in cases such as large companies or at least for listed companies) and that at the time, the Administration would charge a fee (tax) to these companies to cover these costs of audit. This amount could be calculated as the sum of the average market price of conducting this audit plus the proportion that contract costs that would generate the Administration).
This simple mechanism would allow that the contents of the report would not be affect the prospects of the auditor to be elected again as the company's auditor for the following year as the audit firm would only respond to his client (the Administration that hired him to do the job).
The “outsourced”/indirect public audit mechanism would eventually generate positive externalities in aggregated terms for the country, decreasing economy funding costs of the companies thanks to the reduction of the risk associated with the moral hazard caused by the current system of contracting external audit firms.
That way, auditors would not be biting the hand that feeds them when revealing financial inconsistencies in the companies they audit.
