220 InManagersWeTrust
require. That is a crucial step (though by no means a sufficient one)
in giving assurance that, in the words of the traditional SEC stan-
dard, “a reasonable investor, knowing all relevant facts and circum-
stances, would perceive an auditor as having neither mutual nor
conflicting interests with its audit client and as exercising objective
and impartial judgment on all issues brought to the auditor’s atten-
tion.”
Only then are financial statements worth analyzing. Auditing is
an area over which the board of directors must take control and
provide leadership. Boards that consistently do this deserve credit.
Those which do not should be penalized—and they should be pe-
nalized long before the outside auditor gets around to blowing the
whistle, as shareholders of Rite-Aid discovered to their chagrin and
loss in late 1999, when its outside auditors resigned from their audit
engagement on the grounds that they could no longer trust man-
agement to tell them the truth!
Important as the auditor, audit committee, and board are in their
key jobs, there remains one person holding the torch for investors—
the CEO. Buffett says:
The term “earnings” has a precise ring to it. And when an earn-
ings figure is accompanied by an unqualified auditor’s certifi-
cate, a naive reader might thin kit comparable in certitude toπ,
calculated to dozens of decimal places.
In reality, however, earnings can be as pliable as putty when
a charlatan heads the company reporting them. Eventually truth
will surface, but in the meantime a lot of money can change
hands. Indeed, some important American fortunes have been
created by the monetization of accounting mirages.^18
Avoiding charlatans is even more important than identifying ex-
cellent boards, so let’s move on to the corner suite.