Ethics and governance in the European Financial centers

The IRE (Institut des Réviseurs d'Entreprise), which is the regulatory body for external auditors in Luxembourg, is currently reviewing its quality control process.
One must underline the transparency of this review with a public consultation that is evidence of a will to be credible.

A first draft was proposed last fall; contribution received were commented and integrated when estimated relevant.

A new draft was released last Friday. A couple of weaknesses remain in the new version that is anyway better than the first one:
- The text doest not seem to take into account the international role of Luxembourg : when assessing breaches in Luxembourg auditors should not define a national view but integrate foreign fiscal doctrines and judicial cases involving auditors;
- Disciplinary cases should be communicated without the name to demonstrate that the disciplinary matter is actually working and provide with accurate information on the disciplinary doctrine;
- Files that are disregarded due to a judiciary procedure should be kept in mind by the committee to be examined when the judiciary procedure is completed for debrief.

In a nutshell because Luxembourg is a small country where everybody knows everyone and where tolerated dysfunctions may be traced in public and official sources, the jurisdiction cannot transpose minimum requirements from directive or international texts (IFAC, FATF...). Such texts are designed by and for bigger jurisdictions that do not have the stake of financial center that cannot afford standardised negligence.

Know more (IRE Website)

Every Big Four firm has a strict code of ethics. KPMG and E&Y use a similar portal to report unethical situations. Anyway, after the collapse of Arthur Andersen, auditors’ credibility and strict behaviour is critical to the reputation of business. Lesser issues must not be ignored, since they make unethical behaviour an everyday matter, which becomes almost normal and invisible and in this context the ethical speech may turn out to be charade.
More especially Big Four firms that dominate the market must be an example.

The following template was sent to:
- The International Federation of Accountants
- The European Commission
- The ethics teams of the Big Four

Let me ask you a couple questions in order to prepare a course for a Master's degree and a conference this spring. The same questionnaire will be sent to your competitors and has been sent to the IFAC and the European Commission.
In the framework of initiatives from the US Senate against tax havens, auditors’ behaviour in financial centres is critical to the reputation and the credibility of auditors and of the financial community worldwide

1. Can Big Four firms promote knowingly (the fiscal doctrine is perfectly known) tax evasion in their brochure for advisory services (Cf. AOL case)?
2. Can Big Four firms and auditors certify without reserves accounts of companies that built litigious tax organisation (Cf. AOL case…)?
3. Can Big Four firms and auditors be reliable when they condone or deny even public and official dysfunctions and/or repudiate those who point out these dysfunctions (as far as SOX is concerned the institution of whistleblowing is not credible when there is a silence and/or repudiation of those who point out such issues)?
4. Can Big Four firms and auditors be reliable when public and official facts are not compatible with their ethical speech?
5. Can Big Four firms be member of professional associations that consider officially (in their annual report for instance) that offences like forgery, use of forgery, false balance sheets, use of false balance sheets or unauthorised use of corporate property are vague and ambiguous?
6. Should Big Four firms repudiate the statement that offences like forgery, use of forgery, false balance sheets, use of false balance sheets or unauthorised use of corporate property are vague and ambiguous (how can they audit seriously such clients with the business stake)?
7. Can management of a Big Four firm participate to an action relating to Corporate Social Responsibility with management of a company that did not tell the truth at the tribunal about its shareholders, supported knowingly a dishonest CFO and is involved in many trials with stakeholders (employees, suppliers…)?
8. Can Big Four firms that are audited in the framework of the quality control by a colleague request that files they “consider as litigious” should be removed from the list of controlled files?
9. Is your brand credible in Ethics when supporting such jurisdictions especially small ones where everybody knows everyone which increases the risk of conflict of interest and corruption?

Is there a reputational risk with such standardised public and official negligence that has definitely replaced pragmatism in some jurisdictions?

Sources about auditors' ethics

Ernst & Young
KPMG
PwC
Deloitte
IFAC (Credibility Task Force)
European Commission

When one analyses the laws and regulations relating to compliance that professionals must abide by, either from international sources (FATF, European Union…) or national sources (circulars from the body responsible for the prudential supervision), these are both costly and/or do not reach the expected goal: the result may be a Potemkine Village: apparent laws, regulations, training, compliance function, audits… but a pragmatic effect i.e. a limited effect in practice. Anyway, compliance is much more a question of “touch” than a question of knowledge.

The creation of the FATF was positive. Unfortunately the assessments do not comply with the reality as many financial centers despite the fact they belong to the FATF do not respect the recommendations, and even their professionals do not respect the authority of the FATF: the FATF list does not reflect the AML reality as there are actually objectively many more non cooperative countries than the official list. Furthermore, it is not fair to impose strong requirements when a center and its professionals do not condone issues and are willing to tighten up the ship of dysfunctions.

A certification to ethics for financial center should be implemented taking into account the evidence of the fight against money laundering.

I. The model of certification

A certification to ethics could be based on 6 criteria.

1. Credibility of the statements

A financial center cannot be ethic when official statements doe not comply with the reality. In such case, the center cannot be trusted. This area is probably more sensitive for small centers where such dysfunctions are much more visible than in a larger center.
Requirements are not easy to define objectively but they could be for instance the absence of contradiction between what is stated and what is seen...

2. Means for detection

A financial center cannot be ethic if organizations that are responsible for the detection and sanctions either administrative (regulatory body) or judiciary (FIU) do not have the relevant means.
Requirements could be for instance the rate of staff responsible for the control compared to the staff in financial institutions, the rate of staff responsible for the control compared to the assets in financial institutions...
International comparisons should be very interesting.

3. Credibility of sanctions

A financial center cannot be ethic if sanctions for professionals that do not have a proper business conduct are not dissuasive enough. If the sanctions are ridiculous compared to the amounts of money laundering or frauds, there is no dissuasion.
Requirements could be for instance a dissuasive minimum for fines, the effective communication of cases...

4. Transparency

A financial center cannot be ethic if issues are hidden or denied to show a Potemkine village. Two sub areas should be especially taken into account:
- On the one hand, the behavior of the media: do they play their role of fourth power or not?
- On the other hand, the transparency of Justice: are cases easily available or not?
Requirements are not easy to define objectively but they could be for instance the availability of judgments online, the presence of articles on the issues relating to the center in the media...

5. Independence of auditors

A financial center cannot be ethic if auditors are close to auditees because there may be influences. This area is probably more risky for small centers where such dysfunctions are much more visible than in a larger center.
Requirements are not easy to define objectively but they could be for instance the absence of personal links between the management of auditors and the management of auditees to prevent any conflict of interest, the capacity of auditors to raise issues relating to the financial center...

6. Protection of the client

A financial center cannot be ethic is the client is not protected.
Requirements are not easy to define objectively but they could be the jurisprudence in favor of the client when there is litigation with a financial institution, the active role played by the regulatory body to actually protect client's interests...

II. Customized requirements

It is not fair to impose strong requirements when professionals and politicians do not condone issues and are willing to tighten up the ship of dysfunctions in their company and their financial centre: when tolerated negligence has unfortunately replaced pragmatism and when professionals including auditors are upset when dysfunctions are stated or condone issues even from public and official sources, this definitely means they do not have the Professional standing they claim they have.

Furthermore, as far as the SOX requirement relating to the institution of whistleblowing is concerned, how can the subsidiaries be reliable in their ethics when every professional in the centre deny or condone even public and official issues? In this perspective, the Luxembourg case in very interesting : a dishonest employee has more opportunities to he hired than an honest one, which can be traced in official sources in this small centre where everyone knows everyone else and what others are doing, which would allow a kind of self-policing in effect (See official statements in the OECD and the GRECO reports on corruption in 2004) and where professionals and administrators are not clear with offences such as forgery, use of forgery, false balance sheets, use of false balance sheets or unauthorized use of corporate property (See ABBL (Bankers’ association) annual report 2003). There are many "red flags" that demonstrate the observation of the GRECO in 2004 that everyone sheltering behind a complicit silence rather than running the risk of being considered indelicate (GRECO, Evaluation report on Luxembourg, 14 May 2004). Professional standing and experience turned out to be charade, so turned out to be charade the myth of the self regulated place. As the proverb says: “Once a liar, always a liar” (See Cf. Naturam expellas furca, tamen usque recurret - Horace, liv. I, ep. Ix).

Such behaviors and thoughts that are not repudiated are not acceptable in a business world where transparency and ethics are more and more required and where means of communication allow the dissemination of news worldwide in a fraction of second. How can such professionals be aware of what money laundering and corruption are if they are not clear enough with basic offences?

Compliance requirements should be adapted to financial centers and financial institutions taking into account the ethics and compliance awareness: the more credible is a centre/company the less pressure it should have.

But there should be no tolerance for professionals that have replaced pragmatism by negligence and who deny dysfunctions, which standardize bad management and bad governance with all potential risks. By excluding those who do not condone even public or official issues, professionals demonstrate that their ethical and compliance framework turn out to be charade, which weaken the credibility of financial centers and financial institutions worldwide.



A rough analysis of the financial centers shows that there is currently none that meets every area despite the FATF positive assessments. Among these, Luxembourg is probably not the worst financial centre but the size and the lack of responsibility of many actors allows identifying ethical weaknesses, and realizing the limits of current international assessments in business ethics and compliance.