Open Letter to the OCC: Make Real Innovation Possible
A trifling blogger on banking #innovation writes to the Office of the Comptroller of the Currency, despite its historically apathetic view on such matters.
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Blockchain and the Auditing Revolution – Real Time Audit within the Capabilities of Blockchain
#Auditing is the process of conducting an independent examination of an organization’s accounts, books and/or documents in order to determine whether the organization’s financial statements present a fair view of the business. It is based on a set of pre-determined guidelines, normally the International Accounting Standards, or GAAP (generally accepted accounting principles).
Auditors themselves are normally independent third-party intermediaries who are employed to verify the accuracy of companies’ financial statements. Indeed, the financial statements themselves can be viewed as a summation of what happened in a company’s ledger throughout the accounting period. Ultimately, the auditor then decides that either the financial statements make sense, or they is a discrepancy between what the company’s management has provided and what the true numbers should be.
Auditor and Client relationship
Because the client is responsible for paying the auditor, an inherent bias emerges. This pecuniary relationship between auditor and client could tempt the auditor to provide a false (or rosier) assessment of its client’s accounts, for the chance of repeat business from the client at the end of the next accounting period. Moreover, the client may also present the auditor with false or exaggerated figures to inflate the company’s true value – this is known as ‘cooking the books’.
Whether the auditor can detect this or not is largely immaterial – the fact that potential exists for compromising the accuracy of the financial statements at the expense of the public is of grave concern. This has significant implications for how internal and external parties &8211; including regulators &8211; perceive the quality of the auditing process.
There have been high-profile cases where poor standards of auditing have been uncovered, and which have had significant consequences on the accounting industry. Enron is arguably the most high profile example. Arthur Andersen, the firm responsible for auditing Enron’s books since it started doing business in 1985, played a significant role in the scandal, particularly once it was revealed that the accountancy firm was guilty of obstructing justice by playing an influential part in the shredding of a huge number of incriminating documents just before the investigations commenced.
The scandal was just one in a number of cases involving auditing incompetency where corporate accounts were misrepresented, including the UK’s Polly Peck International, Germany’s Metallgesellschaft, and Cendant Corp and Sunbeam Corp in the US. Indeed, by the #time Enron collapsed in early 2002, it was revealed that 700 US companies had to restate accounts in the previous 4 years alone.
The collapse of Enron
The fall of Andersen highlighted the pressure on accountancy firms to boost profits, while the company itself compromised the integrity of the auditor’s role as an independent third-party by making partners effectively become salespeople. This made auditors agenda-driven, as they began empathising more with their clients, and in doing so, destroyed the auditor’s dual function of servicing its clients but also equally looking out for the public interest.
Indeed, the basis for many auditing failures since then has been the questionable business relationship between auditor and client, which has generated much conflict of interest. Instead of a company’s auditors being appointed independently by shareholders, many were chosen by the company&8217;s internal management, or even worse, they were hired to senior management positions, often with the intention of saving costs. Perhaps in the wake of the Enron scandal, the biggest fallout experienced by the global auditing industry was the loss in public trust.
Auditors are trusted upon to issue their opinion as accurately as possible, while the public also trusts that the company has not tried to cook the books. According to Ellen Masterson, former global head of #audit methodology at PwC, moreover, the priority for client management was to reduce the cost of the audit, meaning that auditors were “pressured to do the minimum”.
In the aftermath of Enron, the Sarbanes Oxley Act was implemented which required that top executives sign off on audits, fully in the knowledge that they would be held criminally responsible if the books had been cooked. Furthermore, auditors now have to report to an audit committee, which has widened the gap between a company’s management and the auditing firm. Audit-committee members can also be prosecuted by regulators for fraudulently influencing a company&8217;s auditors. While Sarbanes-Oxley has decisively improved the auditing process, there is still no guarantee that executives who sign off on audited accounts know for certain that what they are approving is 100% accurate.
Auditing today, therefore, is still lumbered with such inefficiencies, remains based on ‘reasonable assurance’, and is broadly unchanged from what has been practised for decades, meaning that the process is now ripe for a new, innovative transformation. At present, each account (such as assets, revenues or liabilities) is viewed as a set of combined transactions, which produces a final balance at the end of the period.
During the audit, the auditor will verify a certain number of these accounts with the trading parties and determine the accuracy of the balance using a sample of previous accounting entries. They may also, on occasion, speak to employees to detect whether ethical accounting practices have been followed or not.
Trust – the auditors most expensive good
Therefore, trust of the auditor and the company still remains at the core of the auditing process, and thus is still potentially subject to fraud and manipulation. Further still, there may very well be another auditor verifying the very same transactions at the other end. As such, the entire process remains inefficient, while the quality of the audit still largely depends on judgement calls by the auditor, meaning that it remains subject to accuracy disputes.
Despite Sarbanes-Oxley, moreover, auditors still have the pressure of generating repeat business from clients, so the temptation to stray from objective analysis still exists. Some studies have even shown that firms are reporting downward pressure on audit fees due to clients questioning the value of audit services, especially given that they are now increasingly ‘commoditised’ as a result of being heavily regulated, and thus there is little differentiation among the services being offered by various auditors.
Many believe that #blockchain could transform this process, in part because the #technology removes the need for auditing to depend on trust. Blockchain provides a globally distributed, decentralized ledger of which everyone has the exact same copy. Whereas auditing at present entails the confirmation of transactions and balances on a company’s accounting ledger at the end of the period, a transaction on the blockchain would provide a permanent and immutable record of the transaction almost immediately. In effect, blockchain allows the recording of the transaction to take place at the same time as the transaction itself.
All that would be required at the time of the transaction would be for the two trading parties to compare accounting entries while maintaining data privacy. To ensure the data can’t be changed, digital signatures would be used, whereby companies would publish their keys to a public authority who would verify their identities. “The existence of digital signatures from both parties implies that the transaction data is agreed upon” explains Roger Willis, former member of Ernst & Young’s (EY) forensic data analytics and audit teams.
Once posted to the blockchain, the transaction is time stamped and exists forever. As described by prominent #Bitcoin proponent and investor Trace Mayer, “Everyone agrees on consensus that those transactions actually happened, and boom you have that verification. You have the debit, the credit, and the confirmation by the network”.
CPA at Xen Accounting, Ryan Lazanis believes that “everything that is on the books of the company and therefore everything comprising a company’s financial statements could occur on the blockchain”. If true, then the blockchain’s existence would not require the employment of a third-party auditor for verification purposes; instead, everything is recorded and verified in #real-time.
The redundancy (or indeed, the wholesale elimination) of the auditor’s role, therefore, could transform the entire accounting industry. This would have a whole range of benefits. Charles Hoskinson, former CEO of revolutionary blockchain company Ethereum, for example, attests that because blockchain provides transaction histories that go back to their inception, the auditing process would be immune to manipulation, as “every single penny could be accounted for by this incorruptible entity”.
And what are the big-4 doing today
The ‘big four’ accounting firms – Deloitte, PWC, KPMG and EY &8211; are also investigating how blockchain can improve the auditing process. Deloitte, for example, is currently focused on developing automation for some of its audit processing. According to Deloitte Consulting principal Eric Piscini, the solution his company is developing will allow the company to post every transaction onto the blockchain in real-time. To audit the company then, Deloitte would simply look at the blockchain and all its transactions.
There would be no need for external verification of the records “because the blockchain is immutable and time-stamped”. Piscini also believes that blockchain will make the auditing process quicker, cheaper and more transparent for regulators, thereby substantially improving accessibility. EY’s Willis agrees with this sentiment, suggesting that auditing all revenues and expenses for multiple companies could be conducted “in literally a split second because the companies are capturing, signing and agreeing all the data at the time of transaction”.
This would ostensibly be good news for the Securities & Exchange Commission (SEC), who recently expressed the urgent need for a Consolidated Audit Trail (CAT), which would create a system that would enable the regulator to comprehensively track markets across various venues and systems, providing increased transparency and better access to critical data.
Given the immutability and decentralized accessibility of blockchain, however, the access and accountability of the SEC’s audit trail could be wholly improved. As highlighted by McKinsey, “blockchains contain detailed and precise histories of asset movements, which has the additional benefit of being attractive to regulators”, suggesting that consolidated audit trails could very well use blockchains for the purposes of capital market transparency.
The post Blockchain and the Auditing Revolution &8211; Real Time Audit within the Capabilities of Blockchain appeared first on Fintech Schweiz Digital Finance News – FintechNewsCH.
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PeerStreet lowers barriers for accredited investors who want access to real estate debt
Vive la révolution financière! #PeerStreet co-founders, Brew Johnson, Brett Crosby, and Alex Perelman, have been working alongside famed #investors like Dr. Michael Burry to provide investors #access to #real #estate #debt. Dr. Burry is famous for having been portrayed by Christian Bale in The Big Short. Historically, the only way to get exposure to real estate debt was to either make the… Read More -
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Blockchain – to Replace Government in Real Estate
When it comes to #blockchain, the immutable ledger #technology that underpins #bitcoin, much of the limelight thus far has been on its potential to disrupt the finance industry. However, the transformation that #real #estate may experience from applying blockchain could arguably be just as profound. Unlike financial services, where technological innovation has largely been embraced in the pursuit of profit, much of real estate’s business conduct remains firmly stuck in the past. Many operating methods within the industry have remained unchanged for 50 years, if not longer.
What is a land-registry in a blockchain?
Land registry systems contain records of a country’s land transactions, and operate on centralized ledger systems at present, with the centralized entity normally being a #government agency. At their best, the systems guarantee title of all land assets; however, in reality they provide incomplete security of tenure, are marred by corruption and frequently result in ownership disputes. In contrast, a blockchain land registry system would be decentralized.
This would mark a distinct improvement on the incumbent system, in that every authorized network member would have an authenticated copy of the registry, rather than just one centralized party. Given that everyone can see the records, therefore, the process would be more transparent, which again minimizes the potential for foul play. Removal of the centralized entity is also likely to be cheaper and more efficient – the operating cost of the land registry in England and Wales in 2013/14, for example, was nearly £240 million.
Ragnar Lifthrasir, who is President of the International Bitcoin Real Estate Association (IBREA), is among the pioneers in developing a real estate model which can operate on the blockchain. He identifies three specific uses of the technology in the industry – purchasing, escrowing and the recording of title ownership and associated transfers. Escrowing is perhaps the least developed idea currently, although ostensibly it would be similar to a common bank transfer, only in this case the transferable amount is first converted to bitcoins which are then put into escrow. Nevertheless, as long as both parties agree to use the blockchain over a government solution, Lifthrasir argues, then nothing can stop them.
What are the benefits?
A blockchain would allow someone to upload land title documentation to the network, which other users can record and verify if needed. This would provide proof that this person is the first owner of the documents, and decentralised network verification would prevent forgery. When it’s time to transfer title, the document simply requires ‘rehashing’ (encrypting) by the owner to prove he/she is in possession of the document.
During the actual transfer process, a ‘coloured coin’ system – which US stock exchange Nasdaq currently uses to settle securities – would be employed. A concept first outlined by Swiss computer scientist and Bitcoin core developer Mike Hearn, coloured coins are non-fungible tokens which provide the owner with private keys, thus allowing only the owner to transfer ownership while preventing fraudsters from corrupting the process.
The elimination of costs associated with title insurance and fraud, according to Lifthrasir, is the biggest advantage of using blockchain. This has been a persistent problem with the current system of centralised government records. Criminals are able to fake title ownership, often simply by using editing software to stipulate transfer of property ownership in their favour, and at negligible expense. Indeed, title insurance itself is a $ 20 billion industry, and Lifthrasir estimates that at present it is costing around $ 1 billion to combat title fraud.
Some argue for a replacement of the entire common law system, which currently requires a laborious examination process of public land records before a plot of land is transferred from one party to the other. Joe Dewey and Shawn Amuial, attorneys at US law firm Holland & Knight who specialise in real estate and finance, for instance, are in favour of replacing the government recording of deeds, mortgages and other instruments in land records with the blockchain, as government records are prone to human error and corruption.
Reducing Bribery and Corruption
Indeed, corruption within land registry has plagued much of the developing world, with insufficiently secure governmental systems being regularly prone to manipulation. Honduras is among the worst. USAid Land Tenure estimates that 80% of privately held Honduran land is untitled or improperly titled, while only 14% of citizens legally occupy properties, with less than a third of those citizens being officially registered. Land title disputes in Honduras have led to violent conflict and widespread fraud, with cases of the registry system databases being hacked into and bureaucrats being able to secure the most luxurious properties.
As a solution, US technology start-up Factom announced in May 2015 that it had agreed to build a secure land title record system for the Honduran government using blockchain technology, in conjunction with title software company Epigraph. Transferring land records onto the blockchain, therefore, could be a reality in the not too distant future.
In doing so, Factom CEO Peter Kirby believes that Honduras’ land registry system would leapfrog many systems in the developed world. Although recent reports suggest that the partnership has stalled, Factom is adamant that progress is still being made, so it may take longer for the project to come to fruition than initially thought.
Ghanaian NGO Bitland also claims to be developing a blockchain-based system for entering land title records, in a bid to correct for the numerous failed attempts by the government to develop a fair and efficient land administration system. At present, courts in Ghana are reportedly being inundated with land dispute cases.
Bitland hopes to reduce this burden, and will use the Factom/Epigraph technology, as well as satellites and GPS to verify the accuracy of plots of land. Buyers will also be able to discover the last owner of property rights and land ownership disputes, while the disputes themselves can be made visible to the network, thus ensuring greater security. However, as with Honduras, much work is yet to be done.
Registry system problems, moreover, are not solely confined to the developing world. The US State of Massachusetts has a specific court which has jurisdiction over the registration of title to real property, while in Canada, 95% of land in Newfoundland and Labrador is considered Crown Land, which results in land disputes regularly ending up in court. Kirby believes that the most important issue is for courts to have a true history of what has happened during such land dispute cases. Immutable records based on “evidence and precedent” will be instrumental in adjudicating land disputes, and can also then become part of the permanent record of the land, which the blockchain technology can ensure.
In terms of taking land title records away from government and onto the blockchain, it may prove to be more difficult in some countries than others. In the US, for instance, title companies exist and have large databases of land ownership records, in addition to the government’s own records.
The sheer number of landowners (and thus the number of records), coupled with the overall size of the US, makes the task of shifting from government records to blockchain a lot tougher. However, Dewey and Amiual point to the fact that title companies are likely to act as allies in the technology’s development, rather than enemies, especially if title insurance can still play a role in addressing those risks which are not eliminated by the blockchain.
Lifthrasir believes blockchain will offer significant improvements over the current government-administered system. It would allow the industry to avoid the inefficiencies that arise from the presiding record keeping practices used by government. While Kirby is willing to work alongside the government in the Honduran case, Lifthrasir does not think it is a worthwhile investment of people’s time to teach governments about blockchain. The opportunity to transact directly under blockchain means that the role of government becomes redundant.
Conclusion
Instead, IBREA’s intention is to gather together the real estate industry professionals who favour moving elements of the business onto the blockchain, especially operations pertaining to purchasing, escrowing, and recording of transfer of properties. As Lifthrasir puts it, “So, as long as people in the real estate industry start deciding to use the Bitcoin blockchain to record the transfer of properties, why bother with the delay, cost, and inefficiency of the government?” He is convinced that 2016 will be the year that title management moves onto the blockchain, and in turn, that the technology is developed enough to be used in the real estate industry.
The post Blockchain &8211; to Replace Government in Real Estate appeared first on Fintech Schweiz Digital Finance News – FintechNewsCH.
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