Investigative Journalist – Private Eye Magazine, and author of Bean Counters: The Triumph of the Accountants and How They Broke Capitalism.
Investigative journalist, Richard Brooks, has written a fascinating book chronicling the history of accounting, from Medici to modern day tax havens.
CIARAN RYAN: This is CFO talks and today we’re joined by Richard Brooks, he is an investigate journalist for Private Eye Magazine, he writes on a range of subjects, including financial crime, public services and taxation. His work has appeared in many other outlets, including The Guardian and on the BBC. He was awarded the Paul Foot Award for investigative journalism in 2008 and 2015, and his work was highly commended in the 2016 British Journalism Awards. Richard joins us from Reading in the United Kingdom. Welcome, Richard, you’re the author of Bean Counters: The Triumph of the Accountants and How They Broke Capitalism. I was actually given this book by Nicolaas van Wyk or I was recommended the book by Nicolaas van Wyk from the South African Institute of Business Accountants, so I got it a few weeks ago and I went through it. I must say, it’s a monumental work and I’ve got to ask you, you must have been working on this for years because this is such a compendium of the history of accounting, right up into modern times.
RICHARD BROOKS: It took me a couple of years, I think it always helps when you’ve been interested in a subject for a while anyway, you’re not starting from scratch. The reason I did it really was I thought what was missing from the debate was an awareness of the importance of the role of the accountant but also the history, to the extent that accountants have been talked about in the last few years, there’s been a kind of here they are again, another scandal. It seemed important to me to say, well, who are they, where do they come from, what’s their importance, what should they be doing, how did we get here, that was the point of the book and, hence, the title.
CIARAN RYAN: You are an accountant by background, I presume, I see that you were a tax inspector in the UK beforehand, is that right?
RICHARD BROOKS: Yes but that didn’t make me a qualified accountant, although the training to become a tax inspector involved quite a bit of accountancy, so I was familiar with the technical side of it to a certain extent. But what interested me more was the history, what underpinned it and what was the point of it. I also thought that accountants themselves, the profession itself, was probably unaware of it.
CIARAN RYAN: I see that in the book you do go into some fascinating detail about the history of accounting and how they steered us from one crisis to another. I’ve got to say, this is nothing new, you talk about the case of Lyon’s branch of Medici Bank in 1460 and where they were hiding bad debts, it sounds very similar to what’s been happening in fairly recent times.
RICHARD BROOKS: Yes, this was the fifteenth century and what became a banking crisis really was echoed in the 2008 banking crisis and the lead up to that. While you had pretty good accounting and that meant tracking your assets and liabilities properly, then the business prospered and the Medici Bank prospered. But when it started looking the other way and ignoring risky loans, bad debt and so on, then it fell apart, and that was really bad accounting. You could actually trace it; in the case of Medici you could trace it to the changes in the way that they accounted.
Many financial crises through the ages can be traced back to bad accounting
CIARAN RYAN: This is one of the themes that does come through very strongly in the book that a lot of these crises that have happened through the ages, you trace it back to bad accounting.
RICHARD BROOKS: You have to ask why is there bad accounting and, of course, there will be a prevailing culture that militates against good accounting, so there will be a desire on the part of management, shareholders, the markets generally, to see good results at any cost and not to want to hear about problems. That’s why the accountants are so important because they should be the ones who should be standing up and saying hang on a minute, it’s not all as it seems, and when they do, that business succeeds, and when they don’t, then it fails. That’s what we saw in the case of the Medici, they had a good accountant, who died and then was not replaced, and the thing was then handed over to a very reckless one, who wanted to be part of the glamour of the day. That’s pretty much what happened with the banks in the early part of the twenty-first century, the accountants were more interested in the sexy side of the financial services than in the boring bit of saying hang on, there’s a problem with the value of these risky loans that you’re making. So you get a problem when accountants stop being accountants, you see that through history.
The Big Four are ‘no longer accountancy firms’
CIARAN RYAN: When we talk about the Big Four because the industry really is about the Big Four, you highlight in the book that was has really happened here is they have moved away from what was their core function, which was auditing and verifying the accuracy of the figures, they’ve now really become consulting firms, about 60% of their revenue now coming from consulting-type activities, and it looks like every crisis is an opportunity, whether it’s climate change or integrated reporting or change management. There was a book brought out a few years ago called The Witch Doctors: Making Sense of the Management Gurus by John Micklethwait, he was a journalist with The Economist, and this book went into this in quite some detail and the damage that had been done to big businesses through change management and the consulting industry. You, again, have highlighted some of the damage that’s been done through the behaviour of the Big Four over recent years, is this an existential problem, do you think, to business in general?
RICHARD BROOKS: Yes, I think it is because it has devalued accountancy. So the major accountancy firms, in fact the dominant ones, the ones that have complete control of the top end of accountancy, they are not primarily accountants and that’s the big issue. So they don’t take pride in pointing out where accounting needs improving, where it’s gone wrong, they don’t reward their partners for doing that, they essentially want business to tick-over so that they can make their money from consultancy. Essentially a lot of the argument about what’s gone wrong focuses on the idea of a conflict of interest between accounting and consulting and the Big Four respond to that by saying, well, we don’t do much consulting for our audit clients, so that conflict of interest is gone. That’s largely true but I don’t think that’s the real issue, I think the real issue is a bigger cultural one that those firms are no longer accountancy firms, it doesn’t matter who they’re doing the consulting for. The fact that they’re auditing one bank, for example, and providing much more in the way of consulting services to another similar bank is the real issue, that’s what changes the character of the firms and then it means that we don’t have effective financial watchdogs.
CIARAN RYAN: You mentioned that bean counting is too important to leave to the bean counters, what do you propose in its place?
RICHARD BROOKS: I said today’s bean counters…
CIARAN RYAN: Today’s bean counters, yes.
RICHARD BROOKS: You’ve got to be left with some bean counters, but you’ve got to have them really being bean counters. The point of the first part of the book really was to show how important this is, in a way I was hoping that accountants would read that and think, ah, right, actually my job is a pretty important one, it’s a very valuable one in society and take some pride in that. One of the problems I see at the moment is that accountants have a little bit of an inferiority complex and they want to move on from accountancy as soon as they can. So graduates who go into the Big Four and train to be chartered accountants, they are generally looking to move on and become consultants or become company executives or whatever but they don’t want to hang around checking the numbers and I’m trying to make the point that actually that’s something really important and it should be valued.
CIARAN RYAN: There’s a lot of reform, even in the UK, about breaking up the Big Four, audit rotation is another solution that’s been proposed. Just give us one or two ideas that you suggest as a solution to this problem that we’re facing in the accounting profession.
RICHARD BROOKS: As I said earlier, you want accountants to be accountants, so I would completely, I would have the major accounting firms just doing that and providing no consultancy services. I think that would reintroduce some professional pride to accountancy. Secondly, that still leaves you with an inherent conflict in what they do, which is that they’re being paid by their client, so they’re being paid by a company, whose numbers they have to check. So that can be a problem in the bigger cases, so you resolve that I think by making auditing for major institutions like banks, systemically important institutions, a public function. That’s not something that the big private accountancy firms make that part of the public regulatory infrastructure, so you essentially have a state auditor. I think that’s what you need for the banks. So those are the two main things, one, you completely break up the big accountancy firms and, in any case, for the very important businesses you have state auditing.
The impact of limited liability companies on accounting
CIARAN RYAN: There’s an interesting section in the book called boom and bust, and you discuss the appearance of limited liability companies and the impact this had on accounting. I found that very interesting in the whole history of limited liability. Why was that an important milestone for accounting?
RICHARD BROOKS: At the time it first came in there was no need for auditing to accompany limited liability in the UK and then there was a whole batch of scandals culminating in some major banking crises towards the end of the nineteenth century and it demonstrated the need for auditing and auditing eventually at around the turn of the twentieth century became a legal requirement for all companies. So that whole era shows dangers of limited liability for companies in general that the managers of those companies were not playing with their own money, so they became very reckless. It also should have taught us the lesson that limited liability, while it has some value in that it encourages people to set up business and many people would say it was a key part of industrial business development, but it’s really only suitable for certain types of enterprise and it’s probably not what you want for the professions. But, as I go into a bit later in the book, by the 1990’s the accountancy firms had persuaded government that they too should have limited liability, that their partners should only be liable up to the point of how much money they’ve put into the business, which as a profession was not very much, and that, in the era that that happened, the 1990’s, with finance really turbocharging, that was a particularly dangerous development and led to some of the reckless accounting we saw in the lead up to the financial crisis.
CIARAN RYAN: Yes, you do mention in the book how the Big Four accounting and their consultants are basically sometimes dispensing fairly dangerous advice with no personal or entrepreneurial risk of their own and we’ve seen a lot of that going on in South Africa too.
RICHARD BROOKS: Yeah, the South African situation is interesting because in places like South Africa where the Big Four dominate, just as they do everywhere else, you’re more remote from their centres, from their HQ’s, and the sense of responsibility gets diluted even more, it looks to me. Whilst we had the big financial crisis in the US and the UK, some of the scandals that the Big Four have been involved in have been in other parts of the world, like South Africa, like China, like India, are just even more egregious. So you sense that the Big Four are just allowing their names to be used in these places but not taking any kind of responsibility for it.
CIARAN RYAN: If we could just move on quickly to the Panama Papers, you were involved in investigating this a few years back and I think as a former tax investigator you were probably able to make more sense of this, it’s something that baffles tax regulators worldwide, tax havens like Luxembourg and its role in tax avoidance schemes that were effectively authored by the Big Four. Can you explain, in simple terms, how these tax avoidance schemes work or is it that their complexity is what makes it so hard for them to police?
RICHARD BROOKS: The complexity, does it make it harder, I’m not sure it does make it that much harder. The point about the complexity is let’s take Luxembourg, for example, places like Luxembourg, which are within the European Union, and there are others, Ireland, Netherlands, even the UK to an extent, they act as tax havens but they can’t overtly be tax havens, so they couldn’t just say move your profits here and we won’t tax them. So they have to produce very complex systems and laws that if you know how the right people who can exploit to produce the right tax results and that’s where the Big Four come in. They have the knowledge and they say, ah, right, we can work out how to shift profits from the UK or wherever into Luxembourg in a way that means they won’t be taxed in Luxembourg. Even though Luxembourg had a corporate tax rate of 25% or whatever it was, we know the wrinkles to ensure that we actually get pretty much a zero rate and that’s where all these weird and wonderful financial transactions come in to generate that zero rate and make sure that the income you move into Luxembourg isn’t actually taxed. But the high street accountant couldn’t do that, you have to be real experts in that part of the law and that’s where firms like PwC can dominate because they have the resources, they have the expertise, they can figure out all the schemes that you need in order to produce that result and, just as importantly, they become big economic players in these small countries like Luxembourg. So they become very close to the government, they effectively write the tax laws that allow them to play these games and, as I tried to describe in the book, they effectively run, administer the system. They effectively signoff their own schemes, they’ve completely captured the senior tax officials in Luxembourg, who’s job it was to sign them off or to question them. So they were effectively operating a tax avoidance industry from within the Grand Duchy of Luxembourg. That was their power and it comes down to combination of their expertise and their economic power that produced that result.
CIARAN RYAN: It’s quite astonishing that you go into this in the book, where these accountants go into the tax officials’ office with these directives, hundreds of them, it looks like, per week, and he’s just rubber-stamping these schemes. So, as you say, they are writing their own tax laws.
RICHARD BROOKS: Yeah and Luxembourg gets something out of it, it gets a small amount of tax, it gets lots of accountants working there. PwC opened a massive new office in Luxembourg with the prime minister cutting the tape, it’s big business.
Certain territories realised they can facilitate tax avoidance
CIARAN RYAN: You mentioned Dublin’s role in reducing the worldwide tax rates of companies like Google and Facebook. That’s also quite an interesting development. Now, the economist, Michael Hudson, wrote a book called Killing the Host, and he goes into some detail about transfer pricing, how oil companies operate under Panamanian or Liberian flags of convenience but they book their profits in tax havens in the Caribbean, even though most of their oil is sold in the US. So it looks like this tax avoidance thing or this transfer pricing thing is as old as tax itself?
RICHARD BROOKS: Yeah, certainly as old as tax havens, it’s probably as old as international trade. If you go back to the late nineteenth century with the developments in shipping and telegraphy and those kinds of things that effectively multiplied the rate of international trade, that’s when companies started to play tax systems off against each other, they noticed that they could manipulate prices in order to put profits somewhere favourable from a tax standpoint. Soon after that certain territories started to realise, ah, we can provide a service here, facilitating that kind of tax avoidance. The growth of tax havens, particularly post-World War II, post-independence from the British Empire in particular, tax avoidance became an industry and places started to specialise in enabling companies to reduce their tax bills in that way and that goes on. It’s interesting, I think that the fact that places like Ireland and Luxembourg and the Netherlands are now the big players in that is interesting, that itself demonstrates the power of the Big Four because what they’ve done is they have managed to contrive laws that will enable them to be tax havens while being in the big economic clubs like the European Union, like the OECD, and as a member of those clubs you are not supposed to do that kind of thing. But if you are very clever about it, you can do it quietly, you can become those tax havens very quietly and that’s where the Big Four have come in, they provide the cleverness. They go along and they say if you set up your laws in this way, you’ll attract a lot of business, a lot of tax avoidance business. So I think the Big Four have played a major role in moving the tax haven game from the palm-fringed islands to the countries within the major economic blocks.
CIARAN RYAN: They’ve moved from the periphery to the centre of the economic world. Can you talk about the key performance indicators of audit firms very briefly? Just one or two final questions. What is the problem with the way that auditing firms measure their own performance?
RICHARD BROOKS: What they tend to do is they value, the consultants value how much money comes in. But for the auditors, for the senior partners, who are doing the auditing, they are not rewarded for finding problems. They’re rewarded for developing relationships, general contributions to the firm, as they call it, the scores that their clients give them, effectively customer service scores. So if that’s how you are rewarded and that’s how you feel that you are valued, your priority is not going to be exposing defective accounting, which is really what it should be as an auditor. I think that is a serious problem. Effectively it’s the mechanism by which this kind of cultural problem in the Big Four firms that we talked about, translates into reality. So they don’t want to be troublemakers, they want to be consultants, they don’t want to be the bean counters who say there’s an accounting problem.
CIARAN RYAN: It looks like the public oversight function here has been lost somewhere along the way and they’ve become partners with their clients. Would you agree with that?
RICHARD BROOKS: Yeah, completely, they are a bit more careful now that they face a fair bit of criticism but if you go back three, four, five years, you’ll find that they were actually using those words, we want to be and we consider ourselves partners in helping you to make money. I think I quoted a couple of them in the book but that’s very much how they saw themselves.
CIARAN RYAN: Final question, Richard, are you working on any other books?
RICHARD BROOKS: No, it’s quite a tough one doing a book on something like this. The reason I did this was I thought there was a book to be done here, I thought there was a need for it, I suppose. I think you need to feel some kind of need before you commit to the kind of torture that it becomes. So, no, not at the moment.
CIARAN RYAN: You can only do one of these every ten years or so, is that what you’re saying?
RICHARD BROOKS: Yeah but I think someone should do this one again, I would be interested to see the version of this in maybe 15 years’ time.
CIARAN RYAN: It is a wonderful book; it’s called Bean Counters: The Triumph of the Accountants and How They Broke Capitalism. Very highly recommended, if you want an understanding of what is happening in the world, not just of accounting, but of business. It is a fascinating read and a wonderful exploration of a history of accounting. Richard, I want to thank you very much for joining us and I wish you the very best of luck in whatever new ventures you are on.
RICHARD BROOKS: Thank you very much, it was a pleasure.