AUDITING

BogusAuditedStatementsAre
HoldingAfricaBack
byNdubuisiEkekwe
AUGUST22,2016

The Great Recession revealed one of the weakest links in Africas quest to build strong capital
markets bogus audited statements. After the fall of Lehman Brothers, the cascading dominoes
spread around the world crippling markets and decimating companies. Despite the Wall Streetengineered nancial avalanche, investors lost money in African equities largely because some
audited statements were revealed to be patently deceptive.

As investigations exposed all the myriad contributions to the market collapse, the asymmetries
between the audited statements and what was happening in companies were mind-blowing.
Regulators failed markets, as some public companies and auditing rms orchestrated

monumental misdeeds, which continue to haunt the region. Yet since those epic letdowns, few
bold regulatory reforms have been enacted in most African exchanges.

From Nigeria to South Africa, retail investors are still below pre-Great Recession levels. They have
deed assurances by market regulators that they oer fair products and services in the
exchanges. Recent problems in Kenyas banking sector have rekindled the necessity for regulators
to push for tougher auditing reforms as well. When investors lack condence in the books, they
rarely invest, which deprives markets of liquidity. Even the elite auditing rms, usually
subsidiaries of the Big Four, have sold their professional opinions on companies, some of
which have turned out to be extremely problematic. Notwithstanding, the regulators remain
ineective as Africa goes through cyclical boom and bust, where great companies emerge only to
collapse in scandals.

Investors are genuinely concerned that regulators are incapable of making sure that published
nancial statements of companies in their exchanges accurately reect the true operating
positions of the rms. As audit quality, auditor independence, and consistency in audit execution
remain poor alienating pension funds and major global investors in the process ingenious
regulatory reforms are urgently needed for Africas capital market to blossom.

Regulators must innovate and create structures that correct inherent aws which continue to
stymie market eciencies. But a reform must go beyond simply replicating processes in the SEC,
NASDAQ, and NYSE; it must pioneer new ways to address problems in places with edgling legal
systems and criminal justice institutions. This means establishing a regulatory system
underpinned on the understanding that punishing a crime is less desirable than preventing it,
especially when pensions of vulnerable citizens are risked on equities. Also, that system will
ensure that auditing rms serving markets will experience adverse business impacts if their work
with companies proves to be false in overstated income and falsied business growth.

A key step will be for regulators to change the relationships that exist among auditors, public
companies, and the exchanges. Specialty insurance companies may need to be created to protect
investors from audit-fueled risks, as companies should be required to buy special insurance
policies (audited statement insurance, as I call it) to compensate investors if their audited
nancials are found to be deceptive. The premium charged by the insurer will track the risk
prole of the auditors work. To reduce the insurance premiums, traded companies must
cooperate and engage better with auditors. In situations where the present insurance companies

cannot handle this type of risk, African governments and regulators should create opportunities
for new insurance companies. These companies should be built for the digital age, requiring
public companies to link critical business data like trading and transaction volumes to insurers in
real time to help them assess risks. Companies that fail to share such data may be asked to put
money in an investor protection fund. For those that prefer buying insurance, they have
incentives to lower premiums, which can only be achieved if they allow auditors unfettered
access in their rms.

In addition, African exchanges need to revamp the engagement process for how auditors are
retained and compensated by traded companies. Public companies in Africa should not be
allowed to hire their external auditors; the exchanges should do so for them. The auditors should
be paid from a reserve fund carved out from the raised capital by the public companies. This will
x the biggest aw in the auditing model, where auditors are nancially dependent on the
companies they audit. Auditors must be rst quality to be added into the pool, and then
exchanges must ensure there is constant internal competition for jobs. This rivalry will keep
auditing costs low while improving quality, since a high-quality audit will be expected to
translate to lower insurance premiums, and vice versa.

Auditors who continue to see the premiums of their audited companies rise will know they are
not delivering value and will be systematically removed from the pool. Under this framework,
the auditor has a clear incentive to innovate and do more than oer high-priced opinions, while
the companies have responsibilities to reduce their insured premiums tied to audited statements
by working with auditors to deliver reliable nancial statements. The companies understand that
investors will not just scrutinize their insurance expenses on audited statements but will also use
the numbers while determining their nancial valuations.

By strengthening corporate governance through auditing quality especially in public companies,

African companies will last longer, and exchanges will be open to new capital as local and global
investors put more condence in their operations. Indeed, for all the mileages accumulated by
African market regulators as they travel around the world promoting their markets, nothing
could be more impactful than building trusted institutions where audited statements are reliable.

NdubuisiEkekweisafounderofthenon-protAfricanInstitutionofTechnologyandChairmanof
FasmicroGroupwithinterestsintechnology,nance,andrealestate.

ThisarticleisaboutAUDITING
FOLLOWTHISTOPIC

RelatedTopics: FINANCE&ACCOUNTING |

RECESSION |

AFRICA

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reniervanrensburg

2hoursago

AlthoughIagreewithmanyofthesolutionsproposed,Africa'schallengesliedeapbeneathinitslegacyissues.
Educationisinmanywaysa"kindofsilverbullet"forthegenerationstocometoaddressthevaluesystemwhich
operateswithinAfricaandifEducationisnotimprovedgenerationstocomewillcontinuefollowingthevalue
systemtheyseeintheirleadersandthisunfortunatelyisnothelping.Everythingrisesandfallsonleadership,as
manywisepeoplehavesaidbutinAfricathisissoverytrue.Auditingisattheendoftheprocessandweneeda
certainkindofAfricanwhereauditingisnotapre-requisitebutactuallyjustaprocesstotickthebox.Sohowwe
doit,isonlyimportanttoapoint.Weneedgreatbusinessleaders,whichexistandletsmentortheyounger
generation.
00

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