"Breaking the Rules and Admitting It" is the title of Floyd Norris’s column describing the accounting by Société Générale for the losses incurred by their rogue trader Jérôme Kerviel; the title is provocative enough, but it’s still not adequate to describe this amazing story. Although I am reluctant to come off as a prudish American unfairly criticizing suave and sophisticated French norms, what Société and its auditors have perpetrated would be regarded here as the accounting equivalent of pornography.
I don’t aim to re-write Norris’s excellent column, who rightly asks what a case like this says about the prospects for IFRS adoption in the U.S. But, I want to make two additional points. To tee them up, here’s an encapsulation of the sordid tale:
- Société Générale chose to lump Kerviel’s 2008 trading losses in 2007’s income statement, thus netting the losses of the later year with his gains of the previous year. There is no disputing that the losses occurred in 2008, yet the company’s position is that application of specific IFRS rules (very simply, marking derivatives to market) would, for reasons unstated, result in a failure of the financial statements to present a "true and fair view."
- You might also be interested to know that the financial statements of French companies are opined on by not just one — but two — yes, two — auditors. Even by invoking the "true and fair" exception, Société Générale must still be in compliance with IFRS as both E&Y and D&T have concurred. How could both auditors be wrong? C’est imposible.
The first point I want to make is that Société’s motives to commit such transparent and ridiculous shenanigans are not clearly apparent from publicly available information. My unsubstantiated hunch is that it has to do with executive compensation. For example, could it be that 2007 bonuses have already been determined on same basis that did not have to include the trading losses (maybe based on stock price appreciation)? Moreover, pushing the losses back to 2007 could have been the best way to clear the decks for 2008 bonuses, which could be based on reported earnings — since the stock price has already tanked.
The second point was made by Lynn Turner, former SEC Chief Accountant in a recent email. The PCAOB and SEC are considering a policy of mutual recognition of audit firms whereby the PCAOB would promise not to inspect foreign auditors opining on financial statements filed with the SEC. Instead, the U.S. investors would have to settle for the determination of foreign authorities. Thus, if the French regulators saw nothing wrong with the actions of local auditors — even operating under the imprimaturs of EY or D&T — then the PCAOB could not say otherwise.
Never mind the black eye the Société debacle gives IFRS, this sordid case must surely signal the SEC that mutual recognition would be a step too far; however, I’m not counting on the current SEC leadership to get the message.