Len Brooks, business ethics and accounting professor, University of Toronto’s Rotman School of Management.
An appeal panel has upheld the censuring of three Deloitte & Touche partners by the Institute of Chartered Accountants of Ontario (ICAO), a move that could send a wake-up call to Canada’s accounting profession, say two university professors.
“It is a landmark decision of a very serious case that will have a huge effect on the individuals, the firm and the profession,” says Len Brooks, a business ethics and accounting professor at the University of Toronto’s Rotman School of Management.
“The ICAO appeal committee considered the defence arguments were not strong enough to overturn the original disciplinary committee’s decision that the partners’ exercise of professional skepticism did not go far enough.”
The decision upheld an earlier ruling against the trio for failing to perform their professional services in accordance with generally accepted standards of practice, related to their handling of the 1997 audit of live theatre producer, Livent Inc.’s annual statements.
The financial penalties — a $100,000 fine and investigation costs of $417,000 — handed out against each of Douglas Barrington, Anthony Power and Claudio Russo are the highest ever imposed by the ICAO. Deloitte would not comment on the decision in the short term, citing a need to meet with the partners involved before making any statement.
The impact on the trio will be substantial, says Karim Jamal, an accounting professor at the University of Alberta in Edmonton. “Two of the partners, Barrington and Power, are retired. Barrington was an FCA, and head of the national practice. So there will be huge loss of reputation for him. After a very successful professional career, he loses his reputation and leaves under a cloud,” Jamal says.
“For a younger partner like Russo, it may make it harder for him to have significant client responsibilities. He could get shuffled off to smaller or less important clients.”
“As the advisory or quality assurance partner, Douglas Barrington was not directly involved with the everyday activities of the audit,” says Brooks. “But the original disciplinary committee believed that it was his responsibility and found him culpable to the same extent as the other respondents.
“Typically, advisory partners are senior members of the firm who assume quality assurance duties — a form of internal peer review — and are consulted on different assignments. In future, such advisory partners may realize that their personal liability could be much greater than they believed. They may be less willing in future to take on such positions.”
“The original investigation uncovered evidence from another senior partner, Peter Chant, who was not in agreement with analysis and conduct of the audit,” says Brooks. “Partners may consider such statements more carefully because their disagreement is now more likely to become public.”
From another perspective, “ICAO has indicated its willingness to go after a big firm,” says Brooks. “That will allay public concerns that large firms can escape disciplinary hearings. The institute is telling the profession that from now on big firms will not be immune.”
However, Jamal says that such aggressiveness may also affect future conduct reviews. “To withstand procedural challenges such as the Deloitte appeal, the ICAO has to take what was a friendly peer-review process and convert it into almost a judicial and adversarial process,” he says. “As a result, conduct committee expenses will skyrocket. It is unlikely that such challenges or appeals can be successful.
“So the threat of costly investigation processes and possible appeals could push the ICAO to settle future cases rather than take them all the way.”
An ICAO spokesman said the institute had no further comment on its decision.
The original charges against the three partners included revenue recognition concerns involving, among other the items, the $9.2 million sale of naming rights to the Pantages Theatre in Toronto and a $7.7 million deal for the naming rights to the Oriental Theatre in Chicago.
Power and Russo also faced a second charge related to a failure to identify the changes in amortization of pre-production costs of various stage productions and to ensure the disclosure of such changes, and the effect of the changes on financial statements.
The original discipline committee hearings were lengthy — taking more than two years — and highly complex, involving 37 days of evidence, more than 200 exhibits, many of which were entire volumes, not to mention 8,000 pages of witness testimony. The appeal panel held five days of legal argument.
A key issue throughout was the concept of professional skepticism. At several points, the Deloitte auditing team accepted the client’s recognition of $5.6 million as revenue on the sale of development density rights over the existing Pantages Theatre when there were doubts concerning the statements.
“The panel recognized that if there is a reason to question the veracity of management, the auditing team should increase its level of professional skepticism,” says Brooks.
According to Brooks, if there is a comfort level within the normally accepted range of choices related to that particular assignment, then accepting management’s statements may be enough to satisfy the scope of work expected of the audit committee. “However, if red flags or danger signs arise, then the audit committee is expected to do more,” he says.
Jamal says, “The problem for the Deloitte partners is that Peter Chant, the firm’s quality control partner, dissented from the clients’ proposed recognition of revenue on a contract.”
Hanging over the proceedings is the fraud case against the Livent founders, Garth Drabinski and Myron Gottlieb. It is still before the Ontario courts. Deloitte was never implicated in the alleged fraud.