They Weren’t There: Auditors And The Financial CrisisBy Francine • Dec 7th, 2009 • Category: Latest, Pure Content, The Big 4 And Globalization
“When the power brokers of the business world meet, the accountants are never far behind.
While other industries have downsized through the turmoil of the financial crisis, the “Big Four” accounting firms — PricewaterhouseCoopers, KPMG, Deloitte Touche Tohmatsu, and Ernst & Young — will end the year with more employees than before the crisis started. Despite a rocky decade that included the Enron scandal — whose accounting shenanigans also took down Arthur Andersen, then one of the world’s largest accounting firms — and the financial crisis, the accounting industry has emerged stronger than ever before.
“When I called the CEO of one of our very large clients in the U.S. — it would be inappropriate to tell you who — there was a time when you would call them and his secretary would say, ‘he’s very busy, he’s tied up in a meeting,’ ” said James Quigley, CEO of Deloitte. “What they say now is, ‘he’s on the plane right now — would you like me to patch you through?”
CNN’s Kevin Voigt from the APEC Conference November 12, 2009
Fellow bloggers Adrienne Gonzalez and Caleb Newquist have already ripped up this CNN interview. We are all embarrassed for this journalist. He listened to a bunch of horse manure orchestrated by the audit firms’ public relations flacks and they published it with no verification, challenge, or context.
That’s the other “expectations gap” we face as journalists when trying to add an independent, objective, and inevitably critical voice to the story of the accounting industry. If a journalist doesn’t cover the audit firms and the business of accounting on a regular basis, they “expect” accounting industry stories to be boring and maybe a little tedious or hard to understand. They also “expect” it to be difficult to verify numbers, statistics, and trends about the revenues, profits, and headcounts of the largest audit firms. So… Maybe they take their word for it. After all, they’re accountants. (It’s sadly true that there’s a dearth of publicly available financial information about the audit firms, especially in the US.)
But I was struck, actually flabbergasted, by the fat head remark above from Jim Quigley of Deloitte. He claims that big-time CEOs answer his phone calls these days. Exactly what is the CEO of Deloitte Touche Tohmatsu, Deloitte’s global, non-auditing, “coordinating” umbrella firm doing calling CEOs about anything important nowadays? Seems like meddling to me. Deloitte, in particular, has a lot fewer clients to call these days anyway. Maybe instead of the CEO of the global firm calling, the local partners should have shown some spine, such as with Bear Stearns and Washington Mutual?
I’ve been writing about the subprime crisis, the one that morphed into the financial crisis, since 2007. My first post to mention subprime was March 14, 2007. In that post, discussing KPMG and New Century, I talked about something that even the esteemed short David Einhorn missed: Repurchase risk was not being disclosed. I’m still writing about repurchase risk and the banks are still obfuscating it with the acquiescence of their auditors.
In one sense, the auditors were there all along. They’ve been riding sidesaddle, cantering obediently a few strides behind the investment banks, mortgage originators, commercial banks, ratings agencies, and monoline insurers who made the real estate bubble and, therefore, the CDO/CDS/MBS bubble what it was. On the other hand, no matter how much I encouraged the auditors to step up, expected them to insert themselves, and hoped they would have an oversight impact, there clearly was no “there” there.
Some very smart men have told me… The auditors are irrelevant to this crisis. The financial crisis, unlike Enron or WorldCom, was not about accounting fraud. Everything does not revolve around the auditors. The auditors were marginalized or maybe just deemed useless. The auditors are not the villains here. The auditors play no role when the stakes are this high. A GAAP valuation is not a “real” valuation.
These wise men may think they’re talking me down.
But, in fact, they’ve bolstered my case.
What is my case? Why do I keep writing critically about the audit industry?
From my “About” page:
The Roman satirist Juvenal asked, “Sed, quis custodiet ipsos custodes?”
But who guards the guardians?
Unprecedented changes in the accounting profession, and professional services in general, mean the current approach to safeguarding shareholder interests, as well as the other stakeholders of the modern publicly traded global enterprise, is no longer efficient nor effective.
I would think that somewhere in the 544 pages of engrossing detail that purports to be, “the inside story of how Wall Street and Washington fought to save the financial system and themselves…,” you might see the Big 4 audit firms mingling with the rest of the masters of the universe. You might see them mentioned in the index. You might read about their influence over asset valuations and “fair value” and “mark-to-market.” After all, this latest crisis put accounting and GAAP on the front page again, on the lips of CNBC commentators, on the desks of Congressmen and Senators who would have liked to forget the last time accounting was at the center of a financial crisis.
None of the audit firms, not even Mr. “CEOs take my calls” Jim Quigley, are mentioned in Sorkin’s cast of characters. Although I’ve found a few references to PricewaterhouseCoopers already in the first 200 pages, the audit firms are not listed in the index. The references to PwC, related to the AIG/Goldman Sachs counterparty collateral dispute that began in 2007, leave more questions unanswered than resolved.
I found these PwC references after tiring of the book’s storytelling style after fifty pages. It’s my cross to bear that not much of what is written about the crisis is new to me. I’ve been living with these issues for the last three years and I’ve probably read everything, especially that Mr. Sorkin and his colleagues at the New York Times have written, about any of the companies or personalities involved. And I really don’t give a flying tomato about Paulson and Fuld as people…
But, to paraphrase Andrew Ross Sorkin in a video from BookTV on CSPAN November 2, 2009: “A book that reads like a movie is a book that will be made into a movie.”
So I smiled to myself with extreme satisfaction when Mr. Sorkin mentions PwC at 37.35 into the CSPAN video. It’s part of an answer to the following questions:
“Where was Goldman on the line? Was Goldman really at risk?”
In “Too Big To Fail,” Mr. Sorkin tells me, on page 160, something interesting I did not previously know. AIG had publicly disclosed the existence of a collateral dispute with Goldman Sachs over CDOs in November of 2007. What I did not know before is that it was AIG Chairman of the Board Bob Willumstad, according to Sorkin, not PwC, who originally raised red flags in January 2008 regarding the growth of the collateral gap. Willumstad called in PricewaterhouseCoopers to review the situation and,
“PwC eventually instructed AIG to revalue every one of the credit default swaps… and embarrassingly disclosed that it had found a “material weakness” in [AIG's] accounting methods.”
Most media gave PwC credit at the time for “getting tough with AIG.” I called the actions by PwC “too little too late” and a clusterschmuck. Why was PwC still AIG’s auditor? Afterall, they were being sued by AIG’s shareholders for a prior restatment. In the end, AIG “admitted” that their management may have held back or even lied to the auditors. AIG had actually given PwC an out, I said, to keep them close in the event of litigation or worse. Some called my assessment harsh.
A few pages later, on page 175, Sorkin describes a Goldman Sachs June 2008 board meeting where the issue of their collateral dispute with AIG boils over.
“In a videoconference presentation from New York, a PwC executive (PwC is Goldman Sach’s auditor, too) updates the board on its dispute with AIG over how it was valuing or in Wall Street parlance, “marking-to-market,” its portfolio. Goldman executives considered AIG was “marking to make-believe” as Blankfein told the board…the afternoon session proceeded with upbraiding PricewaterhouseCoopers:
“How does it work inside PwC if you as a firm represent two institutions where you’re looking at exactly the same collatteral and there’s a clear dispute in terms of valuation?”
How does it work, indeed. Jon Winkelreid, Goldman’s co-president, may or may not have received an answer that day. Sorkin does not report one. I have never heard one.
Actually, I reported rumors at the end of 2007 that Goldman was looking to dump PwC, or at least maybe give away some of their fees to Deloitte. But I guess they changed their minds.
And so when I ask, “Where were the auditors?” and decry the fact that “they weren’t there,” it’s not due to some unreasonable, unfair focus on the most milquetoast of potential culprits.
As my dad would say, “I represent resemble that remark!”
I bang this drum because the auditors should have been there, as a last stop, where the buck should have stopped, as gatekeepers, watchdogs, advocates, and the last bastion of standards and expected values shareholders can look to.
But they weren’t.
I’ll wrap this up with an excerpt from a post I wrote on September 17, 2008. Most of it is still true:
I have no news of an auditor assignment for the new Fannie Mae/Freddie Mac under conservatorship. It may be that the new Boards required to be formed by the Fed will dump Deloitte and PwC and hire EY, given the connection with one of the new non-Executive Chairmen, Laskawy, who is a retired head of EY.
I have heard no news of who will audit AIG, as it is now owned 80% by the Fed. Will the Fed allow PwC, so much a part of their problem and their problematic past to continue, or will they start fresh with someone else? We don’t know. It was not on the list of big concerns for those making announcements, since PwC neither helped AIG avoid problems nor were they obviously instrumental in helping resolve them.
And Merrill will be audited by B of A’s PwC instead of Deloitte, as the acquirer is usually the one dictating those terms, much like Bear Stearns is now also under the thumb of JPMChase’s auditor PwC.
Lehman, a long time EY client, will have to say goodbye to their friends. I say friends because EY did Lehman no favors in letting them get away with so much for so long. With some of Lehman disappearing or being sold off in pieces and much of it going to Barclays, there are any number of firms (well, really only four, the Big 4) that will end up as auditors of these businesses.
If you’re seeing a pattern here it’s no coincidence. All of the Big 4 audit firms have been very much involved, complicit, aided and abetted and/or been AWOL when it comes to the problems these firms faced and will continue to face. The Big 4 audit firms neither helped them avoid these “crises,” nor helped warn others of the severity of the issues in enough time.
We find out how bad things really are once a year, only when pushed, or as a result of a lawsuit. Or, in these cases, we found out only when the firms were pushed to the edge of the abyss.
I wonder if their audit partner was there with them, looking over the edge, and apologizing.
Main page photo credit