March 24, 2022
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SVB: Accountants failed to prepare for disaster
The Oscars were awarded earlier this month, and I always watch because a) I love movies but, b) now it also reminds me of accountants’ role in the awards and how one time they really really screwed it up. About a year after all the hubbub, I wrote about how PwC had failed to predict—even consider—the worst-case scenario and how even though they prepared to prevent mistakes, they didn’t act on those preparations. The results were devastating all around—especially if you were rooting for La La Land.
On the one hand, I understand; the likelihood that one of the partners responsible for handing presenters the envelopes would pass someone the wrong envelope seems low, very low even. The likelihood that this would happen for the most important award of the evening—Best Picture—is even lower, and yet, that’s exactly what happened!
So that’s why I ultimately came down on the side of, “Yeesh, you guys really goofed.” The firm’s only job for this particular engagement was to ensure the right envelope got into the right hands. Not too hard! Mistakes should be virtually non-existent.
I’m thinking about this, yes, because the Oscars just happened, but I’m also thinking about the Silicon Valley Bank (SVB) situation. In case you hadn’t heard, it went down for the dirt nap. Now, I’m not going to point fingers, but anecdotally I can tell you that I’ve heard a few people call the SVB failure a black swan event. Let me just calmly state: NO IT’S NOT! NO IT’S NOT! NO IT’S NOT!
A black swan event, to paraphrase the definition a bit, is rare and unpredictable. SVB’s failure does not meet these criteria because: 1) bank runs have a long and storied history, and 2) a hedge fund predicted its collapse two months before it happened!
Why is this important, you ask? Semantics, yes. But also, mainly because some big accountants—KPMG this time—are in the crosshairs. They’ve audited SVB for years and gave them a clean audit opinion for their most recent year-end. If SVB’s failure was truly unpredictable, then KPMG would have a pretty good excuse for missing the risks hiding in plain sight. Here are Jonathan Weil and Jean Eaglesham in the Wall Street Journal:
Both bank audits were for 2022, so auditors weren’t scrubbing the banks’ books for the time period when they ran into trouble. But auditors are supposed to highlight risks faced by the companies they audit. They are also supposed to raise important issues that occur after companies close their books and before the audit is completed.
[…]
Silicon Valley Bank’s deposits peaked at the end of the first quarter of 2022 and fell $25 billion, or 13%, during the final nine months of the year. That means deposits were declining during the period of KPMG’s audit. If the decline was affecting the bank’s liquidity when KPMG signed off on the audit report, that information likely should have been included. Since it wasn’t, the question becomes, did KPMG know or should it have known what was going on?
I mean, yes. But also, who knows. Like, the financial statements—as far as anyone can tell— were free of material misstatement. (Blame the accounting rules if you disagree.) I’m willing to bet that the audit team followed its audit methodology; ergo, it complied with auditing standards. The bank was a going concern. Until it wasn’t. Should the “critical audit matters” have addressed the declining deposits at the bank? Should they have mentioned that the bank was highly vulnerable because their low-interest bonds were being held in an environment of rapidly increasing interest rates? Should they have mentioned that “nobody on Earth is more of a herd animal than Silicon Valley venture capitalists,” and those herd animals are SVB’s most important clients? In hindsight, sure!
But accountants/auditors don’t have a great track record when it comes to preparing for bad things to happen, predictable or not. And whether your clients are in Hollywood or Silicon Valley, you shouldn’t expect them to give you a pass.
SVB: What should accountants do next?
Even if the warning signs were there, SVB’s failure caught a lot of people off guard. Still, it’s more than arguable that many of these people could’ve prepared their businesses better. For example, if you have a lot of cash lying around, maybe don’t leave it all lying around in one place? Sure, maybe this is common practice, and sure, maybe FDIC-insured limits are meaningless now. But, in general, there’s something to be said here for: 1) understanding where a business has exposure to risk and 2) taking the necessary precautions to address that risk.
Which is to say: should accountants be doing this for their clients?
One thing that we used to talk a lot about around here is the question of what accountants should do next. We’ve talked about people advisory services, of course, but there are plenty of ideas out there, and a couple might be:
Accounting firms that will serve as their clients’ treasury department
Accounting firms that will serve as their clients’ risk management department
I don’t have any idea when a company needs to build out a treasury department to manage all their cash, and my hunch is that many businesses will never have one. But if a business wants to keep an eye on every nickel, they sure could have their accounting firm do this, especially if that firm is already doing the bookkeeping.
Likewise, every business has risk. The ultimate risk is, of course, the risk of failure. Risk, and therefore, failure, can come from many different places, but let’s just use the SVB situation as an example. A bank holds a business’s deposits and sometimes makes loans to a business. A payroll company, using a number of intermediaries, processes a business’s payroll. Collectively, these are counterparties a business has no control over and simply has to trust that they know what they’re doing. The risk that they either a) don’t know what they’re doing or b) do it just bad enough that things go sideways is what’s commonly known as counterparty risk or simply third-party risk.
Many of these risks can be minimized if proper precautions are taken. But what are all the risks? What are the proper precautions? Gosh, I don’t know. But an accounting firm would probably be able to figure it out. Right? And I have to think that, given current events, more businesses would be looking for that kind of service right now. Think about it! Could be something.
How’s the EY split going?
Not great, Bob!
Ernst & Young’s breakup plan is in jeopardy and the accounting firm’s leaders are trying to salvage the deal by placating restive U.S. partners without pushing its overseas executives too far, people familiar with the matter said.
The Big Four accounting firm has suffered a series of delays in its plan to split its global auditing and consulting businesses. Now, top executives are considering several backup options, including selling off just the non-U.S. consulting operation, likely to a private-equity buyer, the people said.
The contingency plan puts pressure on the U.S. partners at the 390,000-person firm. They are demanding that the future audit-focused firm get a bigger piece of the firm’s lucrative tax business.
To make matters only slightly worse, Deloitte’s CEO is talking trash, and EY has been sued by the administrators overseeing a financially troubled client of the firm—NMC Health PLC—and admitted in a court filing that the deal wasn’t going anywhere:
“NMC will be aware from press coverage … that the potential separation under consideration is paused,” the [filing] said.
An EY spokesperson said in a statement: “This transaction is complex and will be the roadmap for re-shaping the profession, so it is important we get this right.
We’ll be waiting!
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