Enron scandal of 2001 was a landmark case that resulted in reforming the auditing standards for public companies. One of the case’s significant outcomes was that Arthur Andersen – then one of the five largest audit and accountancy partnerships globally – was effectively dissolved. Enron’s accounting firm, Arthur Andersen, was accused of applying reckless standards in its audits because of a conflict of interest over Enron’s significant consulting fees. During 2000, Andersen earned $25 million in audit fees and $27 million in consulting fees. Let’s check if this behaviour is similar to the classification societies that act as auditors in the shipping industry by doing consulting projects for the same clients. The question is whether Shipping also needs an ENRON moment to reform this practice?
Let’s look at ways in which the classification societies practice these ways.
- Compromise in Safety
When a classification society is engaged in a consulting project, the consulting division prepares design and drawings, whereas the approval division clears it. There is no second level checking, and hence there is a compromise in safety. On paper, these two divisions are supposed to be silos. However, as long as there are financial and ownership relationships, this arrangement is only meant to fool the regulators.
- Conflict of Interest
We can illustrate this with two examples. The software division of classification society sells design approval software to shipyards and design houses while their approval division approves these ship designs.
As a recognised organisation (RO) by flag states, the classification society acts as an approving body for EU-MRV, IMO DCS. At the same time, they also sell a software solution to enable data collection and submission. Interestingly classification society refuses to validate the software from other companies citing that they are in the same business.
- Anti-Competitive Measures
As a classification society, the organisation has access to critical drawings like ship lines plan, which in the last few years shipyards do not provide to the shipowner. When there is a future modification on the vessel that requires access to the lines plan, the classification society has an unfair advantage. The consulting division gains access to these documents and can generate additional business without competition from other consultancy firms.
Will classification societies, especially IACS members, set higher standards and end this practice? Or should we wait for an ENRON to hit Shipping?
- https://www.youtube.com/watch?v=_2lek28Mw3k (The accounting oligopoly: What’s next for the Big Four? | CNBC Explains)