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The Fallibility of Sustainability Audits

3p Contributor | Thursday July 19th, 2012 | 0 Comments

By Daniel Hicks

Barclays, the UK megabank, has been making waves recently in the mainstream press after allegations of wrongdoing surfaced with a hefty multi-million dollar fine for manipulating Libor, a key London benchmark for setting interest rates within international financial markets. While the full extent of alleged collusion within the financial industry remains under investigation by government regulators, the revelations to this point have already resulted in contentious legislative hearings on both sides of the Atlantic. This massive breakdown in corporate governance at Barclays, in fact, cost the CEO his job and exposed the cozy axis supporting the modern hierarchy of central banking.

But the Barclays-Libor case illuminates another questionable axis that has not attracted as much attention, namely, the one between Barclays and the outside accountant charged with reviewing its record on corporate citizenship. Global accounting giant Ernst & Young is one of four firms that make up the world’s auditing cartel that supplies much of the corporate world with this most basic form of external financial regulation. While not responsible for assuring the megabank’s financial statements in this case, E&Y was responsible for assuring Barclays’ 2011 citizenship report or audit. And as E&Y’s assurance statement itself makes clear, “(the assurance engagement was) performed in accordance with management’s instructions…to provide a limited assurance engagement.”

A citizenship or sustainability audit is typically a review of the non-financial health of a business organization through use of generally accepted standards and globalized metrics. Currently, these audits are conducted by an internal department or individual designated by management, or by management hiring an external expert or firm. The culmination of the review usually results in a corporate social responsibility, citizenship or sustainability report that is made available to management, investors, news media, the general public and outside assurance accountants, such as E&Y. In the Barclays case, the megabank’s management compiled its own citizenship audit and E&Y was hired to give the report its stamp of approval.

For years, these reports made for interesting reading and positive public relations campaigns of little interest beyond an immediate group of stakeholders. The public at large and industry regulators had very few reasons to check these reports, assess their significance or broaden their relevance. In fact, they were very much secondary or tangential to the organization’s financial statements, the core reporting information of most interest to the corporate status quo.

The recent Barclays scandal highlights an uncomfortable fact about sustainability audits and non-financial reporting, especially as it pertains to large corporations. The decision by Barclays managers to hire E&Y was inherently flawed due to the fact that E&Y is an accounting firm largely focused on the compilation and/or auditing of financial statements. However, E&Y and the other big accounting firms have quietly moved into sustainability auditing and assurance without much outcry from the sustainability community at large. In fact, one can find E&Y sponsoring community events and hosting community leaders frequently throughout the year in order to gain a critical foothold.

The problem here is that the independence or objectivity of the sustainability audit or review was compromised from the very beginning because Barclays’ executives determined the breadth and scope of the audit, much like a financial audit. But an inclusive, material or responsive financial audit is very different in terms of the sustainability context. For example, E&Y did not find any key stakeholder groups excluded from the megabank’s citizenship dialogue, although several non-governmental organizations would likely contest the megabank’s definition of inclusiveness. On the principle of materiality, E&Y found “nothing that causes us to believe that Barclays’ management has not applied its processes for determining material issues to be included in the report.” The findings of U.S. and UK regulators probing the Libor matter proved otherwise. And finally, when it came to “material topics of interest to stakeholders,” E&Y again found nothing, although rumors and speculation about Libor manipulation had been circulating in the mainstream press since at least 2007.

This should be viewed for what it is. E&Y and the other major accounting firms like Deloitte and KPMG have already shown the world that the profession is in desperate need of deep reform after a series of financial meltdowns and massive accounting debacles since the turn of the current century. When a firm like E&Y signs off on an organization’s financial statements, it is in essence also signing off on material factors behind how those assets, liabilities, cash flows and income were generated, even if those factors do not appear in the financial statements or fall outside the current economic parameters of mainstream business administration. That’s where the citizenship or sustainability audit is supposed to come in.

Therein lies the problem. If an individual or firm hired to compile or audit the financial statements is also charged with conducting a sustainability audit, there are no objective checks and balances against ignoring or marginalizing critical information that may impact the bottom line. In other words, a credible sustainability audit will frequently impose potential costs on an organization requiring management’s defense of how it intends to handle or not to handle a hypothetical supply chain issue or governance problem. This conversation never takes place without a multi-disciplinary and independent approach to evaluating an organization’s overall operations.

The U.S. Securities and Exchange Commission should be taking furious notes on how the Barclays case serves as an example of worst practices.

image: Ben Bodien via Flickr cc (some rights reserved)


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