Across the pond: Teaching at University of Cambridge

It's an honor and a privilege to be here on this hallowed ground, and I am having the time of my life.

Sep 20, 2024

...Quietly I am leaving,
Just as quietly as I came;
Gently waving my sleeve,
I am not taking away a single cloud.

From "On Leaving Cambridge," composed in 1928, by Xu Zhimo, one of China's foremost poets.

I have been in Cambridge, UK, the past week guest lecturing at the University of Cambridge Judge Business School Executive Master of Accounting Programme. My invitation came from Michael Willis, the Director of the programme and a Management Practice Associate Professor here. I head back to Philadelphia Sunday morning.

The agenda for my lectures is:

Session 1: Summary of Audit Issues
Session 3: Regulatory Structure/ New Proposals
Session 4: Private Equity/Audit Firm Ownership Structure
Session 5: Audit Committee
Session 7: Mattel Case

Today Michael presented the Molex case — Deloitte, had been Molex’s auditor since 1986 and resigned rather than continue to work with a CEO and CFO it no longer trusted. It was funny, as I was listening, it greatly reminded me of the Navistar case!

Deloitte exit puts Molex in a bind
By Chicago Tribune, December 5, 2004.
An extraordinary dispute has erupted between Molex Inc. and former auditor Deloitte & Touche, threatening the Lisle-based company’s listing on the Nasdaq stock market and showing how accounting firms are adopting more aggressive tactics with even large, longstanding clients.
The battle between Molex and Deloitte spilled into the public eye in mid-November, when Deloitte resigned after Molex directors unanimously refused to go along with the auditor’s request to remove Chief Executive Joseph King and former Chief Financial Officer Diane Bullock from their key executive roles. Deloitte, which had been Molex’s auditor since 1986, said it no longer could rely on their representations for its reviews and audits.

Less than two years later, Deloitte was "fired" from Navistar, also headquartered in Lisle, IL.

Deloitte Fired by 98-year Client Navistar
CFO.com, April 10, 2006
Navistar International Corp. said it will restate its results for 2002 through 2004 and for the first nine months of fiscal year 2005 as a result of an ongoing review of accounting matters that have prevented the company from filing its 2005 annual report and first quarter 2006 quarterly report on time.
In addition, the maker of commercial trucks and diesel engines said it has fired its long-time auditor, Deloitte & Touche, replacing it with KPMG LLP. Deloitte had served as Navistar’s auditor for 98 years, according to Reuters.
The company also said it cannot determine when it will file its 2005 annual report because of the auditor change.
Back in January, Navistar said in a regulatory filing that it would not file its fiscal 2005 annual report on time because it was still in discussions with its outside auditors about a number of open items, “including some complex and technical accounting issues.”
Back in July, we reported that the Public Company Accounting Oversight Board (PCAOB) was investigating Deloitte’s 2003 audit of Navistar, citing Bloomberg, which based its report on a document it said authorized the probe.
This would be the PCAOB’s first formal probe of a Big Four firm, the wire service pointed out back then. Bloomberg also noted that the two-page order, issued in May, was inadvertently disclosed by the Securities and Exchange Commission.

Five years later Navistar had the unmitigated gall to sue Deloitte for leaving it at the altar. I wrote about the case for Forbes:

Navistar Sues Deloitte Proving No Statute of Limitations On Idiocy
Forbes, Francine McKenna, May 31, 2011.
A recent lawsuit filed by Chicago-area truck, bus, and defense vehicle manufacturer Navistar against their one-time auditor Deloitte disproves the adage, “The customer is always right.”
Navistar claims that Deloitte, their auditor for nearly one hundred happy years until they were ignominiously fired in early 2006, lied, deceived, was utterly incompetent, and left a trail of broken promises.
Sounds like a bad romance…
Navistar feels compelled, more than five years later, to sue Deloitte for, “fraud, fraudulent concealment, negligent misrepresentation, deceptive business practices, and breach of fiduciary duty arising from the accounting advice, audit services and internal controls advice that Deloitte provided to Navistar relating to Navistar’s financial statements from 2002 to 2005.”

When The Chicago Tribune wrote about Deloitte's brinkmanship with Molex in 2004, it blamed the firm's bold move on Enron and Arthur Andersen.

Experts say Deloitte’s broadside against Molex management is a rare tactic, but not unprecedented, especially in the wake of accounting industry reform that followed the collapse of Chicago’s Andersen two years ago.
“That’s not that uncommon, believe it or not,” said Mark Cheffers, CEO of AuditAnalytics.com. “There’s more of it than you would think.”
Data from AuditAnalytics reveals 20 cases this year, including Molex’s, in which a firm changed auditors because the accountants said they couldn’t rely on management’s representations of its finances. In most cases, the auditor resigned, though it’s unknown how often the auditor first asked for the CEO to step down.
Auditors have to be able to rely on the word of top executives, Cheffers said.
“If you can’t, you can’t audit the company. You have to resign,” he said. “It may not be said, but for an auditor to resign based on an inability to rely on management representations, that’s a pretty serious thing.”
In the world of Sarbanes-Oxley, auditors are becoming more aggressive in challenging management, said Julie Lindy, editor of Inside Public Accounting.
“They’re definitely in the catbird’s seat,” she said. “They’re more likely to ask questions and get the answers they’re satisfied with.”
The scandals of recent years, Cheffers said, “have caused auditors to take a much more jaundiced view of any inability to rely on what management says.”
All told, auditors have resigned nearly 50 times this year after taking issue with a public company’s accounting practices, management representations or internal controls, or when the company objected to the auditor’s policy decisions, according to Atlanta-based Strafford Publications Inc.’s Auditor-Trak. That’s about six times the number from 2001.
Auditor changes and resignations, for any reason, have jumped significantly since Sarbanes-Oxley was passed in 2002, according to AuditAnalytics.

Which is why it is funny that a former Andersen partner figured prominently in the brouhaha between Deloitte and Navistar less than two years later.

Navistar’s problems began in late 2005 as Deloitte was wrapping up its audit for the fiscal year ending October 31, 2005. In December of 2005, Deloitte suddenly replaced the partner in charge of the audit - he was put on mysterious medical leave – with a new one.
The new lead engagement partner, a former Arthur Andersen partner, began questioning almost everything that had been done or approved previously, according to Navistar's suit. He refused to accept any of the work his former partners or the team had already done and basically, according to Navistar, started the audit over.
Navistar failed to file their 10-K on time as a result.

This blow-up cost Navistar dearly.

Navistar fired Deloitte in April 2006 and hired KPMG as their new auditor. They also hired a slew of consultants and other experts including Huron Consulting, Callaway Partners (now owned by Huron), PricewaterhouseCoopers, and Ernst & Young. Eventually Navistar spent more than $200 million dollars to re-conduct their 2002-2004 audits, re-do and complete their 2005 audit, and reevaluate and correct a never-ending list of material weaknesses and significant deficiencies in internal controls over financial reporting.
Their 2005 financial statements were not completed until December of 2007.

Full disclosure: I worked as a consultant on this case, supporting the new Chief Audit Executive to totally revamp the internal audit function and manage the outside consultants from EY that were re-doing all the Sarbanes-Oxley testing.

Later that Chief Audit Executive became a whistleblower and the CEO and CFO of Navistar because one of the first executives to be subject to SOX 304 clawbacks of compensation because of misconduct leading to restatements. The CEO kept his job, despite all that for a long time!

So, I am wondering if the Deloitte partner that took it to the limit at Molex was also a former Andersen partner. Maybe it was the same guy! If anyone knows, please drop me a note.

There have been a lot of stories in the news while I have been here that, ripped from the headlines, I have been able to talk about in class. Under the circumstances, all I had to do is look for Matt Levine's column every day to find a great example of what I was talking to the great group f students about.

On Wednesday the 18th Levine wrote about the SEC's paltry fines for Prager Metis for its audit of FTX Trading and for its auditor independence violations by having indemnificaiton clauses in its engagement letters. (That's forbidden!) We were talking the next day about audit firms and their regulators, and I had mentioned FTX and its audit firms on Tuesday.

I don’t know how important it was to the fraud at FTX Trading Ltd., the big crypto exchange that collapsed in 2022, that it had audited financial statements. FTX was not a public company, and its financial statements were not released publicly; crypto investors did not trust FTX with billions of dollars of their crypto because they read and relied on its audit reports...
My impression is that FTX’s investors were much more interested in Sam Bankman-Fried’s vision and personality, and the general crypto gold rush atmosphere, than they were in rigorous due diligence and audited financials. But, sure, FTX got audits — from a firm called Prager Metis CPAs LLC, not one of the Big Four accounting firms — which at least suggests that somebody cared about seeing audited results.
Whether or not the audits mattered, though, it does seem fair to say that they were bad. I have not seen FTX’s audited financial statements...

"Well," I wrote Matt and mentioned to my students, "I’ve seen the financial statements that Prager Metis, and Armanino, supposedly audited. They did not follow all the auditing standards and, so, they missed a lot of things.

I wrote about it at the time at Coindesk.

One thing that is odd, though, is that the audited financial statements have not been made public — not by any journalists that supposedly saw them, not by the new CEO of FTX who said a lot about them in his various complaints, and not by anyone else suing the firms, including the SEC. I was writing as a freelancer for Coindesk and, so, I was allowed to review them, but they are not mine to publish. I asked and was told no. However, I really wish someone would publish them."

Today we were talking about Audit Committees and, lo and behold, Levine wrote about the news that came out yesterday about the company 23andMe:

The basic rule is that the chief executive officer of a company works for the board of directors, and the directors work for the shareholders. Sometimes, though, the CEO is also the controlling shareholder, and this becomes circular: She works for the directors, who work for her. If they disagree, things get weird. If they’re unhappy with her, they can fire her, but then she can fire them.
Via the WSJ: All seven independent directors of DNA-testing company 23andMe resigned Tuesday, following a protracted negotiation with founder and Chief Executive Anne Wojcicki over her plan to take the company private.
It is the latest challenge for 23andMe, which has struggled to find a profitable business model. The stock price rose a penny on Tuesday to $0.35 per share. At that price, 23andMe’s valuation is just $7 million more than the cash on its balance sheet. That represents a 99.9% decline from its $6 billion peak valuation just after going public in 2021.
In a letter addressed to Wojcicki, the directors wrote that “after months of work, we have yet to receive from you a fully financed, fully diligenced, actionable proposal that is in the best interests of the non-affiliated shareholders.”
It is very rare for a publicly traded company to see so many directors resign simultaneously. The board members wrote that they differ with Wojcicki on the “strategic direction for the company” and because of her voting power, it was best that they resign.
Wojcicki controls 49% of 23andMe votes, giving her a level of control that blocked board members from shopping the company to other potential bidders. She is the only remaining board member after the resignations…

Tomorrow I present the Mattel case, which is turning out to be a popular request. I did it for Columbia GSB and will do it for the second time at Stanford with Maureen McNichols in October. I've written about this case quite a bit.

Before I got to Cambridge, I made a little side trip.

I'll leave you with this very cool video from Cambridge.

On Wednesday night we took a short tour of campus and stopped at the Corpus Chronophage.

Time is not on your side, it’s rather scary, so with the Corpus Chronophage I changed the cuddly image of a Walt Disney grasshopper into a rather frightening time eater. I thought it would be fun if in a minute he slowly opened his jaws wider and wider, and on the 59th second of every minute he went crunch, got that minute, chewed it up and swallowed it so you could never get it back.

The Dig

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