Investors of the world, unite! The Motley Fool declares mayday on the U.S. stock markets, the most powerful capitalist force on the planet. Individual investors are increasingly important to the vitality of the stock market, yet, in terms of policy and regulation, our voices are a mere whisper compared to the organized lobbying efforts of the business, exchange, and institutional investor constituencies. Events over the last year have highlighted some significant flaws in the way that the U.S. markets are run. This is a direct threat to our economic well-being, for honest markets are certainly part of the reason that the U.S. is the destination of choice for so much capital from overseas.
Well, guess what? The markets need us, individual investors, to help keep it vital. It is our responsibility to demand that they be run in a way that is equitable, transparent, and benevolent, not just for us, but for all constituencies. We are willing to take risks that companies will succeed or fail as businesses; we should not be willing to risk that we are being deceived, or that the information we are provided is not an accurate representation of a company's economic condition.
Starting today, and for each of the next five business days, The Motley Fool will present its ideas for best practices in the marketplace. We hope that these ideas will stir debate among individual investors. We have set up a discussion board for just that purpose. We will be releasing a new Declaration each day at noon.
We, as individual investors, insist that corporations cease direct-pay relationships with auditors.
Problem: Auditors of public corporations provide a service to the public. They certify the veracity of company financials to outside shareholders. Recent events have shown the weakness of a system where the auditor -- whose responsibility is to validate the accuracy of company financials -- is compensated by the corporation itself, which has the responsibility to "increase shareholder value."
Dr. Abraham Briloff, professor of Accounting at Baruch College, says this about the current role of accounting audits of public statements: "The public's myth regarding the independent audit is just that, a myth."
We believe that the time has come to address the conflicts inherent in having companies select their own auditors. An auditor's role is a professional covenant with those who have no access to the inner workings of public corporations. We look to the auditor to search for the truth dispassionately and without collusion with or rancor against the company that is the recipient of that audit.
Robert Montgomery once said: "It is the auditor's responsibility to fight the figures and find the facts and to assemble the figure and to set them forth truthfully so that all who run can read." In short, the auditor is supposed to uncover the truth and only put its seal of approval on financial statements that the auditor feels accurately represent the truth.
This may seem obvious, but after hundreds of censures by the SEC naming auditing firms as being either complicit or derelict in cases where corporate financial restatements are mandated, it seems that the pressure by the corporate clients -- those who directly contract with and pay the bills to the auditors -- has undermined the professional covenant of auditors to the investing public. An audit becomes less than useless if the auditor discovers accounting errors in its client company's financial statements and does not force the company to correct them. It is dangerous to the financial standing of investors when the auditor certifies those statements in spite of its misgivings.
With this in mind, we believe that the tie between public companies and their auditors must be broken. Further, we believe that no accounting firm should be able to provide consulting services to their auditing clients. We propose that companies pay a fee to the exchange upon which they are listed, and the exchange then assigns an auditor to each company. The exchange could thus manage the relationship between auditors and companies. This serves several purposes:
1. It severs the provider/client relationship between the auditor and the public company, thus removing a moral hazard for auditors to serve the needs of the company rather than the public.
2. It places direct responsibility upon the exchanges for upkeep of its reputation. Simply put, if multiple companies on the New York Stock Exchange have accounting problems within a short time frame, the exchange itself will develop a reputation for being unreliable. Better to place both the responsibility and the solution under the same umbrella.
3. It restores public trust in the process. We now have evidence of potential fraud being done by Arthur Andersen on behalf of its clients, Enron and Global Crossing. Although it is impossible to regulate morality, it lies within the public's interest to remove moral hazards where they exist.
What you can do
This is a call to action. We intend to make the opinions of individual investors heard about issues that directly affect their ability to participate in the public markets. Please take a moment to comment on this and subsequent Manifesto points that will be released over the next five market days, even if just to say, "Hear, hear!" or "I agree and would further say..." or "I disagree because.... " We will deliver these comments to the SEC, members of Congress, and the exchanges prior to the SEC Investor Summit scheduled for May 10, in which our own Bill Mann will be a panelist.
Further, educate yourself on consulting services being provided by auditors to companies. Call the company's investor relations and ask them. If you get a good, straight answer, tell them you appreciate it. If you do not, tell them it is unacceptable and that you'll put your money elsewhere. Believe us, if enough people do this, they'll get the picture pretty quickly.
We would prefer that auditors be blocked from providing consulting services, but, ultimately, it will not be up to us. The next best route is to convince companies that it is in their own best interest to ensure that shareholders are comfortable with their auditing relationship. We believe the best way to this is through an intermediary at the exchange.
More from The Motley Fool
Why You Should Work at Least 35 Years Before Retiring
The impact on your retirement income will surprise you!
3 Stocks That Look Just Like Google in 2004
These three rocket ships look ready for takeoff.
Solar Companies Are Set Up for a Strong Earnings Season
Rising demand and prices for solar panel prices bode well for manufacturers.