4 ms·

This is a regulatory oversight problem, pure and simple, and it has existed forever. The incentive structure is far too conflicted for self policing. See also:

by maxmax 6y ago

This is a regulatory oversight problem, pure and simple, and it has existed forever. The incentive structure is far too conflicted for self policing. See also: ratings agencies. https://www.nytimes.com/2014/08/22/business/regulators-struggle-with-conflicts-in-credit-ratings-and-audits.html https://www.nytimes.com/2014/08/22/business/regulators-strug... Fraud and Ponzi schemes will persist until regulators get real.

jedmeyers 6y ago
What about the incentive structure for the regulators? Are we going to change that one as well?
- maxmax 6y ago
  Can you explain your question?
  - nickff 6y ago
    Not parent poster, but I can take a shot at this. WRT the 2006 financial crisis, there were about 10-20 regulatory agencies that had the power/responsibility to maintain stability. Each of them failed, but none were held to account; they each just made some excuses, and demanded more power and money. Every time there's a crisis, the relevant regulator is exonerated of any responsibility, so their incentives are even weaker than those of the executives getting bailed out.
    - jedmeyers 6y ago
      I agree. In addition regulators have zero incentives to serve the interests of the regular people. They do, however, have a huge incentive to block the market for the new competition (aka regulatory capture) and then comfortably rest and vest in a major corporation after quitting their government job with full benefits.
nickff 6y ago
I agree that it's an incentive problem, and that it is directly analogous to what happened with the ratings agencies, but I don't think regulation will help much. Auditing worked when the shareholders were paying for it, because they were interested in getting 'tough' reports, and they were holding the auditors to account. As soon as you make it mandatory, and the companies are paying for it, the audit becomes de rigueur; more of a formality than a search for truth. I don't think regulators are part of the solution here. I think that having 'crowdfunded' audits by shareholders would work much better, but it probably won't happen while audits are required for all public companies. You'd have to put the onus of auditing back on the shareholders, and expect that some results will go un-audited.
- maxmax 6y ago
  Regulations would help if they were truly enforced and, in the case of fraud, criminal charges were pursued. White collar prosecutions are so rare, there is no longer any real deterrent.
  - nickff 6y ago
    I am not sure how regulation will really solve a problem of incentives. I know that locking up corporate executives is very popular, but I don't think it works. You just end up with a bunch of audits that are technically correct, but fail to detect big problems. I recently read "The Smartest Guys in the Room", and I'm not sure how you regulate that kind of problem out of existence; I don't think Sarbanes–Oxley really fixed it, but I am not sure regulations really can. Look at Theranos and Nikola; these should have been found out earlier, but their deceptions were not covered by auditors.
    - maxmax 6y ago
      Of course there will still be fraud, but enforcement of regulations provides powerful disincentives to cheat. Right now it's wild west, and when systemic risk shows up, the Fed bails everyone out without consequence.
staysaasy 6y ago
Analyst firms (Gartner, Forrester, et al) suffer from this as well. They both rate and draw subscription revenue from IT and technology companies.
- doctor_eval 6y ago
  Gartner, at least, is pay-to-play. You want in to the Gartner quadrant, you pay for it. I don't know why it has any credibility at all.
  - TacoToni 6y ago
    It’s all my boss and upper management talk about during meetings. I have a friend who use to work at Gartner. It’s very much pay-to-play.
remote_phone 6y ago
Auditors do not look for fraud. Plain and simple. It has NEVER been their job. I have at least a dozen auditors/accountants as close friends. Talk to any auditor and that’s the first thing they will tell you. If they happen upon fraud they need to tell the authorities immediately but otherwise don’t expect auditors to be the ones who are also fraud detectors.
- rwallace 6y ago
  I am surprised! I always thought that was precisely their job. So if it's not, what is their job instead?
  - howlgarnish 6y ago
    Auditing is about legal compliance: it's an external verification that a company's books are drawn up according to prevailing requirements.
    - rwallace 6y ago
      So why exactly does anyone want that, if not as a subgoal of spotting fraud? (I mean, if the first link in the chain is "because that's what's necessary and sufficient to comply with the law" then why was the law written that way?)
      - davidgay 6y ago
        I would presume that the (not unreasonable) assumption is that "verification that a company's books are drawn up according to prevailing requirements." makes it harder to hide fraud.
      - howlgarnish 6y ago
        Because governments want to make sure companies are declaring all their earnings, so they can be taxed.
- ISL 6y ago

by maxmax 6y ago

jedmeyers 6y ago

What about the incentive structure for the regulators? Are we going to change that one as well?

maxmax 6y ago
Can you explain your question?
- nickff 6y ago
  Not parent poster, but I can take a shot at this. WRT the 2006 financial crisis, there were about 10-20 regulatory agencies that had the power/responsibility to maintain stability. Each of them failed, but none were held to account; they each just made some excuses, and demanded more power and money. Every time there's a crisis, the relevant regulator is exonerated of any responsibility, so their incentives are even weaker than those of the executives getting bailed out.
  - jedmeyers 6y ago
    I agree. In addition regulators have zero incentives to serve the interests of the regular people. They do, however, have a huge incentive to block the market for the new competition (aka regulatory capture) and then comfortably rest and vest in a major corporation after quitting their government job with full benefits.

nickff 6y ago

I agree that it's an incentive problem, and that it is directly analogous to what happened with the ratings agencies, but I don't think regulation will help much. Auditing worked when the shareholders were paying for it, because they were interested in getting 'tough' reports, and they were holding the auditors to account. As soon as you make it mandatory, and the companies are paying for it, the audit becomes de rigueur; more of a formality than a search for truth. I don't think regulators are part of the solution here. I think that having 'crowdfunded' audits by shareholders would work much better, but it probably won't happen while audits are required for all public companies. You'd have to put the onus of auditing back on the shareholders, and expect that some results will go un-audited.

maxmax 6y ago
Regulations would help if they were truly enforced and, in the case of fraud, criminal charges were pursued. White collar prosecutions are so rare, there is no longer any real deterrent.
- nickff 6y ago
  I am not sure how regulation will really solve a problem of incentives. I know that locking up corporate executives is very popular, but I don't think it works. You just end up with a bunch of audits that are technically correct, but fail to detect big problems. I recently read "The Smartest Guys in the Room", and I'm not sure how you regulate that kind of problem out of existence; I don't think Sarbanes–Oxley really fixed it, but I am not sure regulations really can. Look at Theranos and Nikola; these should have been found out earlier, but their deceptions were not covered by auditors.
  - maxmax 6y ago
    Of course there will still be fraud, but enforcement of regulations provides powerful disincentives to cheat. Right now it's wild west, and when systemic risk shows up, the Fed bails everyone out without consequence.

staysaasy 6y ago

Analyst firms (Gartner, Forrester, et al) suffer from this as well. They both rate and draw subscription revenue from IT and technology companies.

doctor_eval 6y ago
Gartner, at least, is pay-to-play. You want in to the Gartner quadrant, you pay for it. I don't know why it has any credibility at all.
- TacoToni 6y ago
  It’s all my boss and upper management talk about during meetings. I have a friend who use to work at Gartner. It’s very much pay-to-play.

remote_phone 6y ago

Auditors do not look for fraud. Plain and simple. It has NEVER been their job. I have at least a dozen auditors/accountants as close friends. Talk to any auditor and that’s the first thing they will tell you. If they happen upon fraud they need to tell the authorities immediately but otherwise don’t expect auditors to be the ones who are also fraud detectors.

rwallace 6y ago
I am surprised! I always thought that was precisely their job. So if it's not, what is their job instead?
- howlgarnish 6y ago
  Auditing is about legal compliance: it's an external verification that a company's books are drawn up according to prevailing requirements.
  - rwallace 6y ago
    So why exactly does anyone want that, if not as a subgoal of spotting fraud? (I mean, if the first link in the chain is "because that's what's necessary and sufficient to comply with the law" then why was the law written that way?)
    - davidgay 6y ago
      I would presume that the (not unreasonable) assumption is that "verification that a company's books are drawn up according to prevailing requirements." makes it harder to hide fraud.
    - howlgarnish 6y ago
      Because governments want to make sure companies are declaring all their earnings, so they can be taxed.
ISL 6y ago