The role of auditors in financial scandals: the case of EY

Financial scandals have been plaguing the industry and these past years have seen the downfall of several huge companies. Nonetheless, a controversy, money laundering, accounting, or otherwise, has several layers. There is not just the firm in question that can be considered guilty. There are several factors at play: auditors, regulators and external institutions.

Let’s have a look at two of the biggest corporate scandals that took place in 2020. These involve the financial company Wirecard and the Chinese coffee giant Luckin Coffee. Both firms were involved in high-profile accounting scandals and one of the things that they have in common is that their auditor was EY (Ernst and Young). What role did EY play in these controversies?

The Wirecard scandal

Wirecard is a financial company that was founded in 1999. It offers its clients several services such as electronic payments, risk management, card issuing and processing and others. The firm grew at a very rapid rate and it attributed this international growth to the acquisition of local businesses and the use of latest tech. However, even during the early days of its incorporation, there have been several allegations of malpractices against the firm. Wirecard has been accused of being engaged in, not one, but a series of fraudulent accounting activities to increase its profits. Things started going down for the firm in 2019 when The Financial Times published a series of investigations, internal documents and whistleblower complaints. In 2020, the firm filed for insolvency.

The Luckin Coffee scandal

Luckin Coffee is a coffeehouse chain that was incorporated in Beijing in 2017 and it grew at a very rapid rate. By October 2018, it had already opened 1300 stores and it had been working to become the biggest coffee brand in China and to surpass Starbucks, which it did. It managed 4,507 kiosks in January 2020. However, things were not all rosy. In the same month, the firm Muddy Waters Research published an anonymous report accusing Luckin Coffee of falsifying financial and operational figures. According to the report, the number of purchases per store were inflated by at least 69% in the third and by 88% the fourth quarter of 2019. While at first, the firm denied these allegations, a few months later, it revealed that that its chief operating officer had fabricated sales revenue by up to US$310 million. Stock price crashed, executives were fired, trading was suspended, the company was delisted from NASDAQ and it filed for bankruptcy in the US in February 2021.

More scandals with EY as auditor

Some might say that these are just two cases among several companies that EY handles. Well, these are not remote cases. According to a research, several of other EY clients have been involved in high-profile accounting scandals. For instance, the hospital operator NMC Health PLC and its sister company Finablr PLC had $5 billion in undisclosed debt and the office space company WeWork had to pull its IPO following several accounting issues.

While EY being an auditor is not the cause of these scandals, we cannot deny that it is a common thread between all of these controversies. One possible explanation behind these cluster of blowups could be certain elements in the auditor’s business strategy.

Failures: E&Y’s operating method

Investigators dealing with the accounting scandals have raised questions about the quality of EY’s work. According to reports, their work may have been tainted by the relationship shared by executives. Indeed, there are reports of “extensive ties between EY and executives and board members at some of its troubled audit clients”. This implies that the audits were not carried out in a fair and independent way.

Secondly, as advanced by EY itself advanced, it charges lower fees for its audits. While this might be a good way to attract more clients, experts advance that could have pushed the firm to lower the resources it has devoted to audit operations. Instead of accounting firms, it has focussed more on auditing young, fast-growing technology firms. So, the question arises: Is there something wrong with EY’s operation method?

EY will invest $2bn in improving its audit quality

It seems that the auditing firm has realised that it has to improve the way it operates. It has recently announced that over the next three years, it is going to disburse $2bn (£1.4bn) to improve the quality of its audits. This is part of a larger $10bn investment plan to finance staff training and improve the company’s fraud detection capabilities, more specifically, it will use this money for artificial intelligence technology, machine learning for Canvas, its audit platform and training in fraud detection for its staff. Thanks to these, it will be in a better position to conduct more efficient audits and will increase its ability to detect fraud.

Additionally, it advanced that it is strengthening its process of “accepting and continuing clients”. This means that it is conducting more in-depth investigations about current and future clients. This involves an in-depth research into social media sites.

What about other firms?

 EY is not the only firm that is having to deal with such issues. In fact, several other auditing firms have faced criticisms with regards to their operations or quality of work. As such, as companies, it is essential as you are careful when choosing the institution that you want to work with.

Working in jurisdictions where the companies are well-regulated is a definite advantage. For instance, Mauritius has enacted anti-money laundering/combating the financing of terrorism (AML/CFT) legislation to deal with corruption, fraud, financial crime, money laundering and terrorism activities. It has set up the Financial Intelligence and Anti Money Laundering Act 2002 (FIAMLA), the Prevention of Terrorism Act 2002 and the Prevention of Corruption Act 2002 and the Financial Intelligence Unit (FIU) to ensure that firms operating in the country are well protected and regulated.

Leave a Reply