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Friday, May 30, 2003

Is Resona the tip of the iceberg?

Cozy auditor-client relationships may be breaking down

Staff writers

The whistle-blowing erupted a few days before May 17, the day Resona, the nation's fifth-largest banking group, announced its capital had tumbled below regulation levels.

News photo
Kohei Otsuka, an Upper House member of the Democratic Party of Japan, outlines the information brought to him by whistle-blowers a few days before the government's decision to bail out the Resona banking group.

During the week leading up to May 17 -- when the government promised it would inject 2 trillion yen into Resona Holdings, Inc. -- some reporters and politicians received tapes and documents apparently showing that Financial Services Agency officials pressured Resona's auditors into fudging the books and pretending no capital shortfall existed.

The confusion has unleashed a furor of doubt: What else are regulators trying to hide? Could Resona Bank, the banking group's core entity, actually be insolvent? What about the other major banks?

"The government has an obligation to reopen the books and show the public where Resona stands, if it is going to inject 2 trillion yen on top of 1 trillion yen injected previously," said Kohei Otsuka, a Democratic Party of Japan member of the House of Councilors.

Three or four informants -- all in positions to know about Resona Bank and its auditors' internal affairs -- contacted Otsuka, a former Bank of Japan official and the chairman of the DPJ's corporate accounting panel, on May 14. They met him the following day.

Otsuka had just set up a telephone hotline, hoping to hear firsthand accounts of corporate window-dressing.

According to Otsuka, who said the informants' claims seem valid, the story goes:

Resona Bank's auditors were refusing to approve the bank's calculation of deferred tax assets, and fierce negotiations were going on between the auditors and the bank.

FSA officials then approached auditors, asking them to boost Resona Bank's capital adequacy ratio to 4.6 percent or 4.8 percent. This would allow the bank to clear the 4 percent hurdle required to operate domestically.

Financial Services Minister Heizo Takenaka has repeatedly denied that there was any such pressure put on auditors.

Resona's fate was effectively sealed when one of its auditors, Asahi & Co., refused on April 30 to proceed with its audit.

Asahi & Co. had been auditing Asahi Bank prior to its merger with the former Daiwa Bank Holdings, Inc. in March to complete the formation of Resona Holdings. The other auditor, Shin Nihon & Co., was in charge of auditing Daiwa Bank.

"There were differences in opinion over deferred-tax assets, and there was also the sad suicide of one of the accountants working on the Resona account," a spokesman from Asahi & Co. said. "These led to our decision to withdraw."

At issue was 700 billion yen of deferred-tax assets that Resona Bank planned to claim as capital. The 700 billion yen represented five years' worth of excess tax payments that the bank believed would be paid back in the future -- if the bank were to make profits.

According to an Asahi & Co. internal memo shown to The Japan Times, the auditor asserted that the amount should be zero, not 700 billion yen. Asahi & Co. pointed to the bank's three consecutive years of losses and concluded that the bank would not meet the condition of profitability.

This would have left Resona insolvent.

At the same time, Shin Nihon & Co. approved three years' worth of deferred tax payments. But that dropped the 6 percent capital-adequacy ratio that Resona Bank had been counting on to below 3 percent.

"This represents a severe betrayal of trust we have developed over the years," fumed former Resona Holdings President Yasuhisa Katsuta during a May 17 news conference. Katsuta is well-known for his extensive political connections. "We worked to persuade Shin Nihon & Co., but to no effect."

Audits by certified public accountants are made in accordance with the Auditing Standards, codified by the Business Accounting Deliberation Council, an advisory body to Takenaka. They also follow the audit practice guidelines issued by the Japanese Institute of Certified Public Accountants.

But auditors are left to decide whether to include deferred-tax assets, depending on whether a company becomes insolvent or is seen to remain in the red for an extended period of time.

"It is true there are occasions that require a judgment call on the part of auditors, which is precisely why it is important that auditors' independence is secured," said Takenaka during an appearance before a House of Councilors committee Thursday.

But the financial industry appears to be split in two over the issue. One camp believes fudging the numbers is OK; the other fears potential lawsuits.

The split exists among bankers, other auditors and FSA officials who are supposed to be the banks' watchdogs.

There is even a rift within Asahi & Co. itself. One senior accountant, who was not on the Resona account and who asked not to be named, said he thought his firm's decision to cut all deferred-tax assets was a bit "abrupt."

"Has the general business climate changed that much since last year?" he asked. "Why should we approve deferred-tax assets one year, and then not approve them at all the next?"

According to the FSA, there are some 14,000 certified public accountants and 150 accounting firms. Roughly 95 percent of all listed companies are audited by one of the Big Four auditing firms, of which Shin Nihon and Asahi & Co. are among.

Asahi & Co., the nation's largest accounting firm, is in partnership with the KPMG multinational accounting group.

As for personal relationships between employees of these firms and their clients' executives, an insider admits cozy ties exist.

"We grow close to our clients," said a 39-year old accountant working for one of the Big Four auditing firms. "Over the years, there are golfing trips, gifts, wining and dining, you get to know people, you become friends, you become a team."

One of her clients includes a medium-size manufacturer based in Tochigi Prefecture, whose annual audit she has conducted for 11 years running. "In cases requiring judgment calls, you end up erring on the side of leniency," she said.

To complicate matters, auditors receive their pay from the companies they consult. Basic auditing fees are designated by the JICPA, and are set at between 8.6 million yen and 11.4 million yen for a company listed on the first section of the Tokyo Stock Exchange, with head accountants receiving 2.5 million yen each for 25 days of work.

As for accountability, auditors can be found fully liable to shareholders if a company's books prove unsound. In addition, accountants can have their licenses revoked and face civil or even criminal court procedures.

But auditors used to have an unspoken understanding with government regulators that they would not be found liable for occasional lapses. This understanding, however, was shattered following the implosion of U.S. energy conglomerate Enron Corp. and revelations of book-fudging by Arthur Andersen, the accounting firm that audited Enron's books.

There is "grave concern in the industry, which has customarily winked at window-dressing," Otsuka said.

The auditor for Aozora Bank, meanwhile, was apparently not in such a dilemma dealing with the bank's fiscal 2002 report.

The formerly nationalized bank included only one year's worth of deferred tax assets as capital, while the four major banking groups included five years' worth of such assets.

"It is difficult enough to predict what the economic situation will be a year from now," said Hiroshi Maruyama, Aozora Bank president. "How can we know what to expect five years down the road?"

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The Japan Times

Article 1 of 12 in Business news


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