Last week’s column discussed Caterpillar’s huge write-down of its acquisition of 2012 ERA Mining Machinery after discovering “multiyear, coordinated accounting misconduct.” Emory Williams, the former chairman of ERA, issued a statement on Monday in which he declared he was “shocked” that there was fraud at his former company.
THE ERA DEAL LOOKED EXPENSIVE at the time given its deteriorating financials. Media reports have said that Ernst & Young
I am a CPA. This is something I know a little bit about.
(1) A financial audit is not designed to detect fraud. Audit costs would be prohibitive if it was.
(2) Auditors take reasonable steps to verify the accounts are correct, like, for example, verifying a sample of A/R, but if management is "cooking the books" and intentionally hiding things even the best auditors can be misled.
(3) All of the "Big-4" accounting firms have had fraud come to light among their audit clients. It is a tiny percentage, but it does happen.
(4) E&Y is subject to peer review and oversight by the PCAOB like all of the large firms that audit SEC clients. The PCAOB reviews their audit files (e.g., "audits the auditor") on a regular, ongoing basis. The firms also all have extensive internal standards and controls to maintain high audit standards.
(5) All of the large firms, including E&Y, are extremely sensitive regarding their firm reputation. One too many slip-ups, and they are out of business - remember Arthur Anderson?
Bottom line - Caterpillar's experience is completely irrelevant to XIN.
"One person who took part in the initial negotiations to acquire Siwei told the EO that he believed that someone working for Caterpillar's acquisition team accepted bribes from Siwei, noting that "it happend inside a high-end entertainment center in Zhengzhou". High-level executives at Caterpillar only found out about the fraud after Ernst & Young was asked to re-examine Siwei's books after the original deal had been completed."
Source is a well-regarded Chinese newspaper known for its investigative reporting, The Economic Observer.
"The Economic Observer learned that the team assigned to oversee the takeover was well aware of the financial problems that existed at Siwei, but they still recommended going ahead with the deal. Those connected to the affair say that John Lee and Emory Williams Jr., two former large shareholders in Siwei, bought the company cheap and then sold it on to Caterpillar at a high price in a case of "Americans cheating Americans". Caterpillar refused to comment on this, saying "we don't comment on any rumors or conjecture""