1990 Bank of New Zealand Audit

Alternative Summarised version

This feature centres on the auditing (or more correctly the failure to audit despite certifying to having done so) of the Annual Accounts to 31 March 1990 of Bank of New Zealand by Ernst and Young.

All evidence is taken from the May 1993 publication of the Securities Commission entitled "Report of an Enquiry into Certain Arrangements entered into by the Bank of New Zealand in March 1988".

The "Certain Arrangements" consisted of a "captive insurance" which was claimed by the Bank and its advisers to be an acceptable way of spreading the reported profits of the Bank between years. Because the Auditors did not recognise the insurance as being genuine in their 1990 "Auditing" records it is not necessary to discuss the validity of the captive insurance scheme as a device for reported income spreading. This is a discussion of justification given for issuing an audit certificate despite not recognising the insurance scheme. While the action taken is quite inexcusable it is not necessarily any worse than use of the captive insurance scheme, which may be the subject of another assignment.

Relevant Extracts from the Securities Commission report can be accessed from here or alternatively those interested in studying the matter may wish to study a table of identified anomalies in the accounts which is available from here.

It will be seen that the table of anomalies has 12 entries, all but one (the captive insurance) have been treated by the auditors in a way that makes their version of the true BNZ profit higher than (a) what should have been the case or (b) what was reported. Of these 11 entries, 8 are claims of instances of where the Auditors believe the Bank has understated profit (4 of which are directly disputed) and the other three are overstatements of profit by the Bank which were purportedly not detected by the Auditors when they could reasonably be expected to do so.

These statistics and the nature of many of the "mistakes" made leads to the conclusion that the Auditor were looking only for plausible or fake profit understatements to offset the captive insurance "over" on their Overs and Unders schedule, so that it would appear that an adverse audit report was not required.These were not difficult issues. The wisdom of hindsite argument does not apply. Indeed Mr Garty recorded in the records (para 15.117) "I also informed the meeting that we were looking at the treatment of the perpetual note and the insurance policy". Haveing decided that these two items needed looking into there would be little or no possiblity of them remaining misunderstood, which is what other audit notes imply.

Ms E M Hickey, partner and National Director of Accounting for Ernst and Young , (and member of the Securities Commission at the time that the report was produced , although this fact was not contained in the report) is reported (at page 178, her page 161) of telling the Enquiry, in 1993, that she believed the treatment by the Bank of the captive insurance scheme was "an acceptable alternative in 1988" , "still an acceptable alternative in 1990" but people looking at the transaction then in 1993 "would not regard the matching as an acceptable alternative". This is despite her 1990 audit notes as saying that "the current treatment currently adopted by the BNZ is unacceptable on a matching basis". Surely her judgement at the relevant point of time would be the best one. She quotes reasons for it being unacceptable in 1993 (2 overseas pronouncements released in late 1991) but does not say what inspired her to (erroneously from her 1993 viewpoint) reject the arrangement at the time of the audit in 1990.

It did not seem to concern Ernst and Young that, given that the treatment in the accounts of the insurance scheme was acceptable at the time and so the $27m profit overstatement should not have been on their Unders and Overs schedule, the compensating entries on this schedule meant that there was a significant profit understatement.

On the other hand the Directors of the BNZ tended to justify the validity of the 1990 reported profit by reference to the auditor's Unders an Overs schedule. At page 193 of the report:

15.175 Sadler said at p241: Well I don't rely on the provisioning argument. I could fall back, and I don't think I need to. I could fall back on what was the overall impact on earnings for the year when you take account of the auditors' unders and overs. Nothing.

15.176 Pyne said at p 1552:

If you look at the bottom line the item was not material once you took into account the unders and overs that the auditors had gone through.

15.177 Fay said at p 1739:

...I do recall that there was some discussion as to the materiality which I suppose would impact on your view of disclosure to the extent it was material,...and I think we did have a netting off, a sort of unders and overs arrangement which did include the net pre-tax effect of using $54 of the provision to insurance policy against it ....

From this can be seen the makings of an absurd situation where the Auditors believe that reported profit was OK because the directors judgement was correct and the Directors thought it OK because the auditors got it right.

While the Securities Commission gave reasoned answers to many of its assertions of a direct accounting nature, it did not attempt to do so with respect to its decisions concerning the integrity of individuals. They generally only made these assertions in their summary or conclusion sections as if their reasons had already been dealt with. Examples are paragraphs 15.158 and 24.55(a). Their attitude seems to be that recognition of wilful malpractice is like recognition of a human face, either something clicks or it does not. In practice it has to come from objective and systematic consideration of
Still at Large. Ms E M Hickey, image from internet site of Securities Commission. the evidence as most juries have the agonising task of doing. The enquiry was initiated because of allegations of corruption
so the factors for and against needed to be discussed.

The New Zealand Society of Accountants (now the Institute of Chartered Accountants of New Zealand) were well aware of the release of this Securities Commission report and of the considerable critical comment of the Auditors contained in it. They had at least one complaint of the action of the Auditors made to it immediately after the release of the report. There is no acknowledgment of any disciplinary action having been taken by it over the matter or of any critical comment of this audit having been made by it.

Ms E M Hickey remains a member of the Securities Commission, having been appointed for a second term, and also still holds a long-standing appointment as chairperson of the Financial Reporting Standards Board. It is submitted that she holds these positions because of rather than in spite of the serious indiscretions here disclosed, on the basis that the more exalted one is the harder one is to topple.

The audit certificate for the 1990 Bank of New Zealand Annual Accounts was signed by Ernst and Young. It is submitted that the partners of this firm at that time must bear responsibility for so signing the accounts. It would seem likely that Ms Hickey would have consulted them widely of the situation before it was signed but they had chosen not to have a showdown with the then high-flying BNZ directorship, probably out of consideration for retaining that and other appointments.

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