Review: “Bean Counters: The Triumph Of The Accountants And How They Broke Capitalism” Richard Brooks

Posted by in Development, Economics, History, Politics, Reading

This book will really open your mind to the fragility and corruption of modern corporations. Brooks traces the path of today’s Big Four accounting firms – who audit nearly all of today’s top 100 UK-listed firms –  from their humble origins as honest external auditors for business to today’s role as the drivers of corporate tax avoidance, shareholder wealth maximisation, and the race to the bottom called national competitiveness.

The first western ancestor of today’s accountants was the Italian mathematician Fibonacci, who brought Arabic counting methods to the west in his Book Of Calculation published in 1202. This led to the development of double-entry bookkeeping, improved management of large Florentine merchant houses and ultimately underpinned the Italian Renaissance.

The next big historic change-point was the 1720 collapse of the UK’s South Sea Company, a ponzi scheme based on fraud which resulted in a recession more violent than the 2008 financial crash. In its wake, accounting academies sprang up across the UK, particularly in Scottish cities, and bookkeeping spread rapidly, developing into a sophisticated tool for understanding and managing the performance of large-scale enterprises.

Next stop, the frantic 1840s railways boom, when huge amounts of wealth were up for grabs and fraud again became commonplace. The man who gave his name to the world’s largest accountancy firm today, William Welch Deloitte, uncovered the dodgy dealings which sent the self-styled “Railway King” George Hudson to a debtors’ jail.  Four years later, he was called in by concerned shareholders in the Great Western Railway to become the first independent auditor of a major company.

From Great Beginnings to – Enron

Sadly, one hundred and fifty years later, the Deloitte’s name was on the audit of Royal Bank of Scotland just before its £45 billion bailout by the taxpayer.

A lot had changed, beginning with the 1856 Act to create limited liability companies, which led to 25,000 new incorporations in six years, and the 1879 Act which made bank audits compulsory.

Next came the shift of economic focus to the new world. American accountants on the fast-changing frontier saw their role more as diagnosing problems, compared to the traditional the British focus on assessing the soundness of a companies’ affairs. And in the wake of the 1929 depression’s company collapses, Roosevelt brought in the ‘Truth in Securities’ legislation which demanded regular balance sheets and profit-and-loss accounts for shareholders. Surprisingly, this is where is where modern accountancy started to go off the rails.

Accountancy’s intimate involvement in the challenges and innovations of leading companies provided American accountants with inside knowledge which they used to develop lucrative consultancy work. This was both a conflict of interest, and an incentive towards deceptive practices to please fee-paying business owners, both reinforced by the convenient American shift to self-regulation of the profession.

Brooks details a very long chain of these “innovations”; abuse of “goodwill” costs to hide the true cost of mergers (and support those lucrative consultancy fees on mergers), “scientific management” systems and the ever-increasing scale of consultancy, organisational restructuring, executive pay and appointments advice, government consultancy and contracting out, selling expensive and sometimes inappropriate computer system commitments to their clients, and on it goes.

A Theme Park For Falsehoods

By the 1980s, consultancy revenues were larger than auditing and growing faster too, so the biggest bonuses and highest salaries went to consultants, which diminished the role and prospects of auditors in accountancy – and businesses were getting smarter at hiding the truth to pursue what they wanted, more money for the already-rich.

Politically, with the election of Margaret Thatcher and Ronald Reagan, capitalism fell under the spell of ‘Chicago School’ economics. First, restricting the money supply to cure inflation caused by oil price rises kicked off a radical weakening of unions. Then, deregulation of banking and cross-border financial flows from the system of exchange controls exponentially widened the scope for deceptive business reporting.

For Brooks, “the financialised world economy would become a theme park for false accounting, tax avoidance and regulation-dodging, with the bean counters marshalling the customers from one ride to another.”

Ultimately, crises will expose dodgy accounts even if politicians won’t, and the 15% inflation of the late 1970s certainly did that for American savings and loans “mutuals”. To survive with their long-term mortgages fixed at lower rates, they had taken full advantage of deregulation to indulge in a predictable orgy of over-leverage, investment in junk bonds, riskier lending, theft and fraud. Over 1,000 failed – the main difference to 2008 being that back then, over 3,000 bankers were sent to jail!

The dramatically higher levels of debt and financial complexity in the age of financial freedom meant that accountancy distortions now posed serious systemic risks for the global economy – so accountants responded by protecting themselves via a concerted campaign to limit their liabilities in the event of more corporate disasters. Many US state legislatures succumbed to finances’ now-familiar (empty) threats of relocation by introducing ‘limited liability partnerships’, capping each partner’s liability for failings in the firm to what they had put into the firm – the much larger private wealth they skimmed off would now remain safe.

The collapse of Enron and WorldCom revealed the next stage of accountancy innovation – special purpose vehicles to hide risky or unprofitable assets off the balance sheet and overstate reported profits. Notably, both of these cases were exposed by female auditors who reached the limits of their conscience before the rest of the boys’ club.

And Then – Crash!

“Not long after most of the world’s largest banks had been bailed out with trillions of dollars of taxpayer money, one old lady (the Queen) wondered out loud: why had nobody seen the September 2008 financial crash coming?”

Its now well documented that predicting this crisis was easy. There’s even a highly entertaining movie about it, “The Big Short”. Several groups of small investors, pushed by the financial incentive of contractual bets against American loan company solvency, had no trouble identifying the rising risk of defaults in widely-sold packages of American loans. And that’s the point – they had incentives to find the problem, auditors had incentives to hide it (their consultancies to package and resell loans). Ethics and standards had long since fled the scene. Only this time, just a few small players went to jail. How times change.

And then there’s accountancy’s central role in hiding developing-world corruption, or the “legendarily corrupt privatisations” after the fall of the Soviet Union, which pulled apart the social fabric so much that average life expectancy fell a full 10 years – not to mention the incalculable national, regional and global cost of undermining prospects for legitimate business and government way into Russia’s future…

Brooks’ conclusion: “Around the world, the accountancy establishment will before long be controlled by men and women who have been recruited to become not expert auditors but profit-driven ‘professional services’ providers. Its leaders will have no memory of a time when auditing was their main task.

History shows that the Big Four accountancy firms have prospered by avoiding accountability for their part in false accounting, financial crises and the plundering of economies while paying more attention to ever-expanding commercial opportunities. The difficult question is: what will change that?” His recommendations:

  1. The separation of accounting and consultancy into separate firms
  2. Publicly funded auditing of systemically important institutions
  3. Independent regulation of accounting
  4. Accountability of auditors for failure to meet standards
  5. Breaking up the quadropoly of the Big Four firms
  6. Transparent auditing and ethical business practices within accountancy firms
  7. Greater openness in the secretive consultancy industry