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Deleterious Effect of Standards

Standards (e.g., generally accepted auditing standards aka GAAS) and principles (e.g., conceptual framework of internal control over financial reporting, generally accepted accounting principles aka GAAP) induce uniformity in conduct among professionals, who know what it means to obey these commands and what is outside the scope of these commands (cf. convergent and discriminant validities). They carry substantially similar mental models within their practices. The resultant homogeneity of inspection and oversight by gatekeepers makes great fails (e.g., lack of adequate, public notice provided by independent contractors of existential threats to the going concerns put at risk shortly before, during, and after the recent Great Recession, c. 2008) explainable.

The temptation to characterize the preparation and publication of misleading (financial) statements as fraud is not difficult to resist where significant incentives exist to do so (e.g., persistence of business partnership, professional prestige and remuneration). The temptation to challenge rigorously management’s assumptions, estimates, and valuations affecting financial statements is easy to ignore where the prevailing perception is that other professionals both inside and outside the gatekeeper at issue (i.e., the relevant peer group) would likely respond to such information with a light touch.

These professionals have not only become commodified (i.e., their work is primarily assessed by the quantitative factors such as number of hours, staying within budget) but robotic (i.e., their professional judgment is eroded by primarily automated procedures).

Consequently, responses that seem like unexplained variances from professional expectation (e.g., great fails of asset valuations within the mortgage-backed securities distribution chain) are explainable in terms of the convergence of professional opinion and methodology and the widespread organizational practice of not allowing the exercise of divergent thinking skills (and risk being characterized as “not a team player”) on the part of their professionals positioned to have firsthand knowledge of the relevant evidence.

Neither (intentional) fraud nor material (unintentional) misstatement of financial figures are unforeseeable in the high-stakes environments of public and private finance | investment | operations.

Addendum: holding onto one’s occupational position demands adhering to professional standards, which, if followed for several years, would likely confer skilled expert status on the practitioner. Divergent thinking, sometimes colloquially referred to as “thinking outside the box,” is, in brief, not necessary to achievement of skilled expert status. Also, divergent thinking should be distinguished from creative accounting, which is a phrase nearer financial engineering and earnings management than real enhancement of the existing models of interpretation of economic events (e.g., GAAP) that sometimes fail to accurately and completely present and disclose economic reality (cf. repurchase agreements of Lehman Bros.)

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