Back in November 2007, I wrote a post entitled, “Do You Believe In Santa Claus – The Auditors and The Subprime Crisis.”
“…PwC is auditor of Freddie Mac and now the behemoth banks JP Morgan Chase and Bank of America, as well as Goldman Sachs and Northern Rock. PwC hasn’t either adequate or qualified staff for their current responsibilities let alone more of the same. Neither has it proven it has the moral right to take on more such work….”
The American Bankers Association has data available for the top US Bank Holding Companies by Assets. Data was compiled independently identifying the auditors of the Top US Bank Holding Companies both by number of banks audited and total assets audited. This data shows the following:
2007 by number of bank audit clients – 122 companies
KPMG – 33%
EY – 27 %
PwC – 19%
Deloitte – 14%
All others - 7%
2007 by Assets:
KPMG 39% (Citigroup is biggest client)
PwC – 30% (Percentage higher on this basis primarily because two of their clients are JPM Chase and Bank of America.)
EY – 18%
Deloitte – 11%
All others – 1%
In 2008, pre-crisis and before the major acquisitions by JPM Chase (Bear Stearns and WAMU) and Bank of America (Merrill Lynch and Countrywide):
2008 by number of bank audit clients ( 121 banks)
KPMG – 35%
EY – 25%
PwC – 17% (-3)
Deloitte – 14%
All other – 10%
KPMG – 43%
PwC – 29%
EY – 16%
Deloitte – 12%
All other - 1%
Top 100 Firms SIFMA 2006
EY – 28%
KPMG – 25%
Deloitte – 21%
PwC – 20 %
All Other – 6
KPMG – 27%
EY – 26%
Deloitte – 18%
PwC – 18%
All Others – 11%
As you can see, PwC is in third place by number of large banks audited for 2007 and 2008 and in fourth place for number of top securities industry firms audited in 2006 and 2007.
How does an audit firm like PwC, one that’s really not a player, a dominant financial services industry expert in the past, become the dominant auditor for the industry post-crisis? By default, with the acquisitions of JPM Chase and Bank of America, and by design, with their close relationship with Goldman Sachs as both an audit client since their IPO and as the source of the current administration’s Treasury toadies.
On an anecdotal basis, I can also say that a quick survey of the Big 4 competitive position in the Chicago financial services market is telling. PwC’s complete lack of financial services audit presence is an example of how bereft they are both critical mass in terms of financial services experience and significant industry credentials.
ABN AMRO was audited by Deloitte when they bought Chicago’s LaSalle Bank. PwC had significant consulting work at LaSalle but it was focused on Anti-Money Laundering type work. Very provincial, compliance-type work.
The only other significant independent bank headquartered in Chicago, The Northern Trust, is audited by KPMG.
The Chicago Mercantile Exchange has always been a very nice prize for any service provider, even more so after their acquisition of the Chicago Board of Trade and NYMEX. They are audited by EY.
, the local investment research company, is audited by EY.
AON and Allstate, the Chicago area insurance companies are audited by EY and Deloitte , respectively.
The infamous Chicago area trading firm Refco
was audited by Grant Thornton.
Suffice to say, PwC has no financial services audit presence in Chicago, the second largest financial services market in the United States, especially in the area of complex securities, options and derivatives trading, brokerage, securitized lending, and other topics of importance in the current financial crisis.
So tell us PwC… Where are all the auditors, GAAP and IFRS experts, and technical futures, options and derivatives trading experts you need now for all of your current clients, Goldman Sachs, a bigger and more risky JPM Chase and Bank of America, Freddie Mac, AIG, and the new TARP work going to suddenly come from?
Are you growing them on trees?
Many others have now questioned the awarding of the TARP contract to PWC and EY and the lack of transparency in the overall bailout contract award process. Some have also echoed my questions regarding why the auditors are not on the lists of those to blame for the crisis and lamented the fact that instead they are reaping the benefits of their own ineptitude, malpractice and spineless synchophancy.
So, at this time, I’d like to reprint my arguments for why the auditors should be taking more responsibility for the crisis, as I explained back in November with reference to the subprime crisis. The same arguments apply today.
As I was writing yesterday’s post about CEOs losing their jobs over sub-prime write offs and wondering why the auditors don’t lose theirs too, Dennis Howlett was penning similar thoughts, albeit with a slightly different focus and additional details.
I also got a call from a reporter from the FT who asked me to explain why I felt the auditors were part of the problem. This reporter stated, “…the problem is not one of internal controls or lack thereof, but of building up portfolios of illiquid assets that were tricky at best to value in the best of times. So is that an auditor issue?”
Hopefully, my comments will end up somewhere in a column in the paper. In case not, I will summarize them here.
1)The essence of Sarbanes-Oxley is to validate controls exist to mitigate risk that threatens a company’s ability to meet its business objectives.
2)By getting into the sub-prime loan business, these banks and investment companies hoped to profit extraordinarily from above average to high risk activities.
3)The banks, mortgage and investment companies have an obligation to manage risk at all levels by implementing the proper controls to mitigate it, or at least to identify and monitor it so that the level and types of risk being accepted by the company can be properly disclosed to their investors and other stakeholders.
4)An important part of identifying, monitoring and disclosing these risks is to value them according to GAAP and to the extent a reasonable investor would expect. Another would be to reserve according to GAAP and to the extent that a reasonable investor would expect in the event of a change in economic or other circumstances.
5)As part of the external audit process, auditors must form an opinion on whether their clients are complying with GAAP (or the other applicable standards) and whether activities such as valuation of the investment portfolio and estimation of required reserves for potential portfolio losses have been properly performed. Does the client have the internal controls in place to assure that valuations and reserve estimates are correct according to accounting standards and provide a fair presentation in the financial statements of the assets and liabilities of the company?
Add to these obligations, the responsibility of the auditors to ascertain Tone at the Top, that is, whether senior executives have communicated the right tone regarding controls and completeness and validity of financial information so that managers are not afraid to alert them when a strategy or approach is no longer correct or when significant losses are probable or foreseeable.
In other words, serious financial problems don’t usually happen as suddenly as some companies like to make you think, because of foreign competition or some other boogie man for example. They are building up, slowly but surely, based on a lack of internal controls over managing risk.
The reporter asked me about the valuation issue. “Isn’t it a reasonable excuse to say no one could have seen this train coming?” she asked. I reminded her that valuation is one of the quality problems that the Big 4 keep having when the PCAOB comes around. They can’t get it right or don’t think they are doing anything wrong. Unfortunately, the auditors, most of which at the partner level have spent their whole lives being auditors, always one step behind the financial innovators and potential sham artists they are attempting to audit, will always be playing catch up to the financial services masters of the universe.