The Button-Down Mafia: How the Public Accounting Firms Run a Racket on Investors and Thrive While Their Clients FailBy Francine • Feb 9th, 2011 • Category: Food for Thought
This was my first post at Huffington post on March 16, 2009, and the only one not a reprint from something published on this site. I am reprinting it in full here, given the uncertainty presented by their acquisition by AOL.
There’s a popular Sicilian proverb: Cu è surdu, orbu e taci, campa cent’anni ‘mpaci.“He who is deaf, blind, and silent will live a hundred years in peace.”
Enron, WorldCom, HealthSouth, Tyco, Parmalat, Adelphia, AIG…You would think enough lessons had been learned. The financial markets are a mess and the capitalist system threatened. The systems in place to anticipate and preempt market risk failed completely. Financial firms leveraged their capital to an unprecedented extent with no checks and balances. Companies took on enormous risks with minimal disclosure to their shareholders.
And the largest global public accounting firms — KPMG, PricewaterhouseCoopers, Deloitte, and Ernst & Young — again failed to prevent, warn, or mitigate the desperate financial situation, the national crisis of significant proportions we now find ourselves in.
“…There were systematic failures in the checks and balances in the system, by Boards of Directors, by credit rating agencies, and by government regulators…”
Even the US Treasury Secretary doesn’t hold the public accounting firms accountable for the problems we now face. The Big 4 public accounting firms haven’t yet been asked the hard questions by governments, legislators, or regulators.
They’re getting a free pass.
The global public accounting firms have worldwide, government-sanctioned franchises as market watchdogs. They are supposed to be working to protect shareholders’ interests. Financial statement audits are required by most global exchanges — to provide a seal of approval on the financial disclosures of public companies. The accounting firms employ accountants, licensed by local authorities and trained as auditors. These “professionals” audit the financial statements of public and private companies, governments, and not-for-profit organizations worldwide. Public accountants must express an opinion on those financial statements.
In the United States, certified public accountants are the only authorized non-governmental type of external auditors who may perform audits of financial statements and provide reports of those audits for public review, submission to the SEC, and to comply with exchange listing standards. In the United States, the firms and their licensed professionals are required to be independent of the entities being audited.
The Big 4 public accounting firms are very big business themselves. As an industry, the top firms generate more than $100 billion in total revenues globally and employ hundreds of thousands of people. As auditors and advisors, they work inside the banks, brokerage firms, auto manufacturers, mortgage brokers, and homebuilders. They’re “in the know” about every public company and most large private companies, earning millions of dollars in fees, for audit opinions that have ultimately proved worthless. They were right there in the boardrooms when the US government took over Fannie Mae, Freddie Mac, and AIG. They are still at executives’ right hands, earning more fees helping the US federal government under TARP to organize and control the taxpayers’ new investments in subprime loans, non-liquid assets, and exotic financial instruments. The public accounting firms make money whether companies thrive or whether they fail. The Big 4 firms are now charging billions to advise each other’s clients as those companies file for bankruptcy protection.
According to a study by David L. Carter, Ph.D. at Michigan State University’s School of Criminal Justice, the basic characteristics of organized crime are:
• Profit accumulation• Longevity• An organizational structure that facilitates criminal activity• Efforts to corrupt government officials, police, and corporate official• The use of violence
Profit accumulation Big 4 firms continued to see significant double-digit growth in top line revenue during 2007-2008, even though the recession had already started. Who else besides pimps, loan sharks, and illegal gambling had such a great year last year? Such monopolistic growth and profit is due in large part to the lack of competition within the industry. The largest four global public accounting firms audit almost 99% of public company revenue in the United States and all but one of the UK’s top 350 companies.
Since the passing of the Sarbanes-Oxley legislation in 2002, public companies have complained that audit fees have tripled or even quadrupled. They are still increasing, albeit at a slightly decreasing rate. But the combination of mandated audits and the addition of Sarbanes-Oxley requirements prompted many companies to use words like “extortion” and “protection money” to describe their feelings regarding the cost of pieces of paper that seemed to provide so little tangible value to shareholders. Paying for an audit, defined as broadly by the auditors as they chose, became an “offer you can’t refuse.”
Longevity The Big 4 public accounting firms are loose confederations, combinations of firms, many of which started all the way back in the late 19th Century. Firms have merged and grown, some dying along the way, and others becoming predators of the weaker ones. The largest four firms compete on paper, yet coexist in a cooperative manner — much like the five New York City crime families: the Bonannos, the Colombos, the Genoveses, the Gambinos, and the Luccheses — in order to achieve common objectives via industry lobbyists such as the Center for Audit Quality.
An organizational structure that facilitates criminal activity The public accounting firms are organized as partnerships, like law firms. They recruit and promote less like a business, based on merit, and more like a secret society or fraternity.
“Becoming a made member of La Cosa Nostra requires serving an apprenticeship and then being proposed by a Boss. This is followed by gaining approval for membership from all the other families.”
Acceptance and success in the Big 4 public accounting firms requires selection based on university credentials, referrals from professors, family background, and business ties, as well as having political beliefs and economic philosophies that are aligned with firm values. Internal operations are conducted in a secretive manner. Financial results and common business metrics are minimally disclosed to the outside and on a “need to know” basis internally.
There’s a type of Big 4 omertà, the extreme form of loyalty and solidarity in the face of authority usually attributed to the Mafia. Once initiated into firm culture, survival requires adoption of this informal oath of allegiance that makes it shameful to betray even one’s deadliest enemy, your competitors, to legal and regulatory authorities. Examples of this extreme sense of loyalty to even those who’ve disgraced the profession can be found when partners that have been sanctioned by the SEC, forbidden to audit public companies, are later reinstated by the SEC. Deloitte, for example, maintained the partners responsible for Delphi and Navistar on their payroll during their SEC suspension and they lived to audit another public company another day.
Efforts to corrupt government officials, police, and corporate officials All the public accounting firms spend a lot of time and money publicizing their good works. There’s a ton spent on volunteerism and donations to foundations. There’s a press release a day about some or another warm and fuzzy diversity initiative in spite of the documented lack of progress in getting women and minorities to partner positions in proportion to their numbers in universities and entry level positions. They spend a bucketful of money to erase the fact that they’re otherwise sucking money out of the economy for essentially worthless audit opinions.
There’s also a big spend on political campaigns. For example, all of the US based public accounting firms like US Senator Christopher Dodd. It’s not the man, his party, or his politics, but his position that attracts the dollars. The Chairman of the Senate Banking Committee has significant influence over the legislation affecting the Big 4 public accounting firms.
Another big recipient of the audit firms’ largesse is US Senator Charles Schumer. Early in the subprime crisis, he was heard demanding action from, of all people, the accounting firms. This is comical. After all, the public accounting firms pay Schumer to protect their interests, not the other way around. Ernst & Young is one of his all time career big donors. Deloitte is one of his largest campaign contributors. As a matter of fact, E&Y and Deloitte are in his top 20 all time greatest contributors.
The use of violence Violence is the only thing left that the firms haven’t depended on to accomplish their goals. That we know of… However, their labor practices have been the subject of class action lawsuits in the US and Canada during the last few years. It appears they do not pay overtime when they should and work their professionals like the interns on TV’s ER.
We’ve all seen what sleep deprivation can to do the quality of medical care. Imagine what being overworked and underpaid does to the quality of accounting and audit work performed by thousands of new college graduates hired each year. These are the foot soldiers doing the hands-on work to insure the accuracy of the financial information published by your employer or the companies in your 401k. There’s even a case from 2007 when a poor young woman in Romania working for Ernst & Young died from exhaustion. She was working long hours without rest under pressure to keep her job.
The Ratings Agency Circle Jerk Controlling and making money from all sides of a transaction is another potential sign of a criminal organization at work. In the aftermath of the financial crisis, the press, global legislative bodies, and regulators all got sidetracked by concerns over the issue of culpability of the ratings agencies. What they missed is the unholy alliance between the rating agencies, the auditors of the ratings agencies, the companies whose bonds were being rated, and the auditors of those bond issuers.
• The public accounting firms certified financial statements and gave clean audit opinions for companies that issued mortgages and mortgage-backed securities.
• The ratings agencies counted on these audit opinions and performed no further due diligence to ascertain those opinions were justified.
• The public accounting firms audit the ratings agencies. The three largest ratings agencies, Standard & Poor’s (part of McGraw-Hill), Moody’s, and Fitch (part of Fimalac, a French company) are all public companies that are required to have their financial statement audited by KPMG, PricewaterhouseCoopers, Deloitte, or Ernst & Young.
• The public accounting firms audited the failed companies that issued the mortgages such as New Century, Countrywide, Northern Rock, and American Home.
• They also audit the firms such as Bear Stearns, Citibank, Bank of America, and Merrill Lynch that created, marketed and invested in the packaged mortgage securities — many of which ended up off balance sheets. And they audit the monoline credit risk insurance providers MBIA and AMBAC.
The public accounting firms and their hundreds of thousands of auditors should be an investor’s first line of independent defense. But these firms turned a blind eye to the excesses, mismanagement, and fraud of executives managing their client firms. The public accounting firms issued clean financial opinions for all of the firms that eventually, most less than a year later, failed, were taken over, or nationalized. And the regulators slept.
There’s something about the Big 4 public accounting firms, and to a lesser extent their next tier firm colleagues, that allows them to make money, to thrive, in spite of failure all around them. They continue on, oblivious to accelerating rates of litigation against them and the realistic threat of a catastrophic lawsuit.
Their solution to the legal threats resulting from their clients’ frauds and failures? Liability caps.
Governments all over the world are protecting and shielding the public accounting firms from failure under any circumstances, even in the face of repeated failure on their part. The current business model for global public accounting firms no longer promotes the safeguarding of shareholder interests in the modern publicly traded multinational. Shareholders, and other stakeholders, are being shafted. The firms and their partners may be corrupt. They are unequivocally self-interested.
When it comes to the Big 4 public accounting firms, the official word is still, “Too few to fail. Too powerful to call to account.”