These disclosures were a result of pressure brought to bear by Congresswoman Maxine Waters and several other congressional members who sent a letter to the OCC and the Fed on October 28. This letter expressed the legislators’ displeasure with the way the OCC and the Federal Reserve Bank had so far run the “independent” foreclosure review process that is intended to overhaul mortgage-servicing processes and controls and to compensate borrowers harmed financially by wrongdoing or negligence.

Congresswoman Waters cited my October 6 column for American Banker in this letter to the OCC and Fed when demanding that the regulators manage conflicts of interest in the foreclosure review process as well as make a full disclosure of vendors and their engagement letters with the banks.

On December 6, I wrote again in American Banker after I reviewed the engagement letters that were posted by the OCC. I had several concerns. Congresswoman Waters did, too.

“[The OCC] issued a report on the actions of a dozen national bank and federal savings association mortgage servicers aimed at complying with the consent orders issued in April 2011 to correct deficient and unsafe or unsound foreclosure practices. (The two remaining consent order recipients — GMAC/Ally and SunTrust — have not yet finalized their terms with vendors and as a result their overseers, Fed Chairman Bernanke and the Federal Reserve Bank, have not yet responded to the request for full disclosure, according to the Water’s office.)

Waters was less than impressed with what she saw and so am I.  She told me, “My letters specifically asked for information on conflicts of interest between the banks and the consultants — which is precisely what the OCC redacted in the information they released last week. A cursory look into the banks and their consultants indicates that in some cases, there are substantial pre-existing relationships between the firms.”

Redacted is an understatement.

Here’s what was redacted, according to OCC spokesman Bryan Hubbard:

Limited proprietary and personal information has been redacted from the engagement letters including, but not limited to:

• Names,titles and biographies of individuals;
• Proprietary systems information;
• References to specific bank policy;
• Fees and costs associated with the engagement;
• Specific descriptions of past work performed by the independent consultants.

So what’s left? It’s interesting enough, as a start, to look at which consultants and law firms were selected by which servicers. It’s also interesting to look at the scope of services to be performed and the time and volume estimates for project activities where they were not redacted.

From my December 6 American Banker column:

The disclosure of the consultant engagement letters for each servicer has already had a huge impact. The Financial Times reports that the New York Attorney General “launched an investigation into possibly unlawful foreclosureson the mortgages of active-duty members of the US military.” The foreclosure review engagement letters posted by the OCC included estimates prepared by the banks and their consultants suggesting, according to the Financial Times, that 10 leading lenders may have seized the homes of about 5,000 service members in violation of the Servicemembers Civil Relief Act, which restricts foreclosures on the homes of active duty members of the U.S. armed forces.

There’s also the issue of attorney-client privilege:

Some of the engagement letters invoke attorney-client privilege and attorney work product privilege over the whole process and confidential treatment of engagement letter itself. It appears all the servicers used their general counsel’s office to engage the consultants and outside counsel and some name their general counsel as project lead. Some servicers engaged additional outside legal counsel for the review directly rather than through the primary consultant.

OCC spokesperson Hubbard says, “although some of the engagement letters make claims of attorney-client privilege, these claims are by statute inapplicable to the OCC and FRB, which have complete access to all documents produced by the independent consultants and servicers as part of the independent foreclosure reviews required by the Consent Orders.

I certainly hope so.

I was the first to report on December 6 the irony of Deloitte having been selected by, of all banks, JP Morgan Chase. The high likelihood of a conflict between the bank and the audit firm, and possibly the individual Deloitte partners assigned to the JP Morgan Chase review, should have been obvious to anyone at the OCC. I said on December 6 that it would be great if we could see the names of the partners and staff assigned to the engagements and check their credentials and prior client work for conflicts.

It would be enlightening, for example, to see whether any of the Deloitte partners proposed as consultants as part of the foreclosure solution at JP Morgan/EMC, were previously part of the mortgage origination/securitization problems as auditors at Bear Stearns or Washington Mutual.

Bear and Washington Mutual, both former Deloitte audit clients, are now part of JP Morgan Chase, and Deloitte is defending lawsuits over alleged audit failures at those firms.

Lo and behold, partner Ann Kenyon of Deloitte, who testified at a December 13th Senate hearing on the issue, said under oath that she is the engagement partner on the JP Morgan Chase foreclosure review. An internet search revealed a conference biography that suggests that amongst Kenyon’s representative clients was Washington Mutual, now owned by JP Morgan Chase and a significant part of the review. This would be a clear conflict with her role as engagement partner for the review.

Ms. Kenyon [who leads Deloitte's Securitization Advisory practice] works with issuers, comprised of both attest and non-attest clients, who have encountered difficulties in accounting for and reporting on their securitizations.

At the 126:20 mark of the archived webcast of the Senate hearing Kenyon describes the organizational structure, level of experience and source of professionals for the Deloitte JP Morgan Chase review team. (She says it’s all Deloitte staff.) She also says that a large team of Deloitte partners who are subject matter experts report to her and are leading each team.

Someone should check their conflicts, too.

Two of the other three Big Four audit firms were selected for multiple review assignments. KPMG, auditor of Citigroup, New Century, Countrywide, Wells Fargo, and Wachovia, is conspicuously but thankfully absent from the list of consultants.

Examples of firms involved in multiple reviews include Ernst & Young (involved in three reviews as both a primary consultant and subcontractor), PricewaterhouseCoopers (involved in two reviews as a primary consultant), and Promontory Financial Group (involved in three reviews as primary consultant). Law firm Gibson Dunn is legal counsel for three reviews (retained by the consultant in two cases and by the bank directly in one).

For example, one firm could be charging different rates to different banks for what is supposed to be a consistent review across servicers. That not only indicates banks can leverage their influence with vendors to get the review they want (and the monetary exposure estimate) at the price they want to pay, but that we may not get consistent results for borrowers that were harmed by multiple servicers.

Some of the concerns I mentioned in my December 6 column were pursued by Senators at the December 13 Senate Committee on Banking, Housing, and Urban Affairs hearing: Helping Homeowners Harmed by Foreclosures: Ensuring Accountability and Transparency in Foreclosure Reviews.

Some additional interesting interchanges during the hearing:

At the 45:30 mark of the archived webcast, Senator Reed asks the OCC’s Julie Williams why the OCC and Fed could not select and contract with the consultants directly. Williams says that would have been difficult because it would have necessitated the regulators to use a “procurement process” that included consistent “standards” for selection.

That sounds to me like a Request for Proposal process and a vendor selection process that is in place  - for many of these same vendors already – as a result of the finical crisis. Instead the OCC and Federal Reserve bank abdicated the vendor selection process to the services and, therefore, will reap the numerous potential conflicts they have sown.

At the 49:00 mark, Senator Reed asks a critical question, perhaps thinking about the Deloitte/Bear Stearns-EMC/Washington Mutual issue with regard to a JP Morgan Chase review. If a consultant runs across a set of transactions that the firm or those consultants had direct involvement in is the consultant obligated to report that conflict to the regulator?  Williams says that they would expect to hear about such a conflict.

Reed presses to ask if there is an “obligation” versus an “expectation”.  Williams sounds evasive in her answer, implying that this specific obligation is not explicit in the engagement letters.  I sure didn’t see it.

My December 6 column, in particular the parts regarding the Deloitte conflict and the attorney-client privilege issue were mentioned in the written and oral testimony by Alys Cohen, Staff Attorney  at the National Consumer Law Center.

With regard to the attorney-client privilege potential issue, the OCC and the Federal Reserve Bank should make sure all legal counsel that is intended to be part of the foreclosure review team should be retained by the consultant not the bank.  Otherwise, I see an assertion of attorney-client privilege by the outside legal counsel for the reviews as inevitable.

Some additional areas where strong monitoring by Congress and the OCC/Fed might be helpful going forward include:

• Checking consistency of level of effort estimates across project plans for each consultant’s proposal. Estimated hours for each task may vary based on the size and complexity of servicer, difficulty of obtaining information, and level of cooperation in resolving issues. But consultants will bill on a “time and materials” basis and variations in length of time estimated, for example, for each initial loan review and the quality assurance process could make millions of dollars of difference in fees given the tens of thousands of documents to be reviewed.

• The complaints process, managed as a coordinated approach for all servicers by Rust Consulting, needs to be synchronized with each servicer’s plan for their reviews. Although the OCC strongly influenced the design and implementation of the “coordinated” process, Rust Consulting signed a contract each servicer, risking the possibility of some servicers skimping on the effort or being unprepared based on their lack of progress in other dependent activities.

Thank goodness for the plaintiffs’ bar and class action lawsuits.

And state attorneys general.

Without them, there’d be very little justice yet – or compensation – for any of the mortgage-related fraud perpetrated during the recent real estate bubble.

Chad Johnson, a partner in the litigation practice at Bernstein Litowitz Berger & Grossmann LLP, posted in the Harvard Law School Corporate Governance and Financial Regulation Forum (on behalf of colleague Ross Shikowitz who wrote the article) that private litigants, in spite of some significant impediments, are picking up the slack for the SEC and Department of Justice.

Now, more than ever, private lawsuits are needed to supplement the existing regulatory structure, both to ensure that shareholders are adequately compensated for their losses and to send a strong message that fraudulent conduct will not be tolerated. Indeed, institutional investors continue to vigorously prosecute suits against the companies and executives at the heart of the mortgage crisis, well after the SEC and DOJ have shuttered their civil and criminal investigations.

While it remains to be seen whether government regulators will eventually force Wall Street executives to answer for their improprieties, it is clear that sophisticated public pension funds will continue to play an essential role in obtaining compensation for injured investors and deterring future wrongdoing by corporate executives.

Even when institutional investors like pension funds try to work within the system, using their significant, long-term shareholder standing to exert influence on corporate boards, they have been turned back. The banks and financial institutions won’t own up to their mistakes and their executives to their culpability willingly.

Eliot Spitzer explains the phenomenon in his recent broadside, “Government’s Place In The Market,” published by Boston Review Books and MIT Press.

“Only government can ensure integrity, transparency, and fair dealing…even though private companies compete, only government can ensure that there is competition. Everyone wants to be a monopolist.”

In January, my column, Accounting Watchdog, described the potential impact on bank stocks of a letter sent to Bank of America, Citigroup, JP Morgan Chase, and Wells Fargo by New York City Comptroller John Liu. This letter, sent on behalf of a coalition of seven major public pension systems, called on the banks’ Audit Committees to launch independent examinations of their loan modification, foreclosure, and securitization policies and procedures.

Liu had proposed these reviews, initially on behalf of the New York City pension plans, back in November. The banks were cold to these proposals, as well as the one in January by the larger coalition. The pension funds called for immediate action.

Time passed with no willingness by the banks’ boards, in particular their Audit Committees, to conduct independent reviews in the normal course of business. So, the coalition submitted shareholder proposals for the banks’ annual meetings. Throughout this period, the boards of the four banks were generally unresponsive to the coalition’s requests to discuss and meet on the proposals. Audit Committee members would not meet with them at all.

It’s a sign of the banks’ unwillingness to own up to the problems we know so much more about now that the only way for these institutional, long-term investors to be heard was to submit an advisory-only  shareholder proposal viewed as antagonistic by the banks’ boards.

“The banks and financial institutions won’t own up to their mistakes and their executives to their culpability willingly.” Chad Johnson

I said at the time that the letter didn’t go far enough. The reviews should also have demanded an accounting of the reserves for loan losses and for litigation. These numbers have been slow to come and, when they did, hard to decipher.

Gretchen Morgenson in the New York Times on January 8: While it is unfortunate that the Bank of America deal won’t recoup much for taxpayers, the resolution could have one important benefit. It might just open the door to a much-needed reckoning of the liabilities created by questionable mortgage practices at the nation’s largest banks. These institutions have not yet made a full and realistic accounting of their liabilities.

I agree.

On September 30, 2010, before the SEC issued its letter to bank CFOs reminding them to follow the standards and book adequate reserves, I wrote that Bank of America had admitted it had “repurchased, during 2009, $13.1 billion of loans from first lien securitization trusts as a result of modifications, loan delinquencies or optional clean-up calls.”

I couldn’t easily see what the actual reserves were for estimated future liabilities and how they came up with a number given the total loans sold by type and the current claims by various parties. I said it’s time for someone, perhaps the SEC, to demand more detailed disclosure about reserves for repurchase risk.

When I challenged the SEC to push harder on the reserves issue they stepped up. But disclosures are still not complete.

Here’s an excerpt from the New York City Comptroller’s shareholder proposal that did appear in the Bank of America proxy document dated March 30, 2011:

…Resolved, shareholders request that the Board have its Audit Committee conduct an independent review of the Company’s internal controls related to loan modifications, foreclosures and securitizations, and report to shareholders, at reasonable cost and omitting proprietary information, its findings and recommendations by September 30, 2011.

The report should evaluate (a) the Company’s compliance with (i) applicable laws and regulations and (ii) its own policies and procedures; (b) whether management has allocated a sufficient number of trained staff; and (c) policies and procedures to address potential financial incentives to foreclose when other options may be more consistent with the Company’s long-term interests.

Board’s Response to Proposal 7

The Board recommends a vote AGAINST Proposal 7 for the following reasons:

• our company has already taken significant steps to ensure that appropriate internal controls are in place, including additional controls and processes we have implemented following a comprehensive self-assessment of our foreclosure processes, as well as an environment of heightened regulatory scrutiny by state and federal authorities, including certain bank supervisory authorities ;

• we actively manage the loan modification and foreclosure processes to ensure that we have strong internal controls over our mortgage service operations;

• we have been a leader in providing foreclosure alternatives, assisting homeowners and constituent groups to resolve home loan issues through loan modifications or other solutions where possible; and

• our company has already provided extensive public disclosure regarding the requested information, which makes the report sought by the proposal unnecessary.

In each case where the Comptroller’s shareholder proposal made it to an April Annual Meeting agenda, management recommended a “no” vote for the proposal.

The proposals all failed to gain a majority vote.

At Bank of America, the shareholder proposal gained a strong 40% “yes” vote. At Citigroup, the “yes” vote was just shy of 30% and at Wells Fargo a little less than 23%. At JP Morgan Chase the coalition’s proposal did not make the Annual Meeting Agenda because a similar proposal, according to the JPM Chase Board, was in line ahead of theirs.

Michael Garland, Executive Director for Corporate Governance for the New York City Comptroller, told me that his office will continue to press for the independent reviews. These reviews, the Comptroller insists, should not be performed by the banks’ auditors since, “we do not consider the existing audit firm to be independent since they previously signed off on the internal controls.”

New York City Comptroller John Liu: “ Our pension funds are long-term investors. We’re going to be around a lot longer than any of the management or the board members of these banks. As shareholders we will continue to insist bank boards clean house until we see independent audits of their mortgage and foreclosure practices.”

Other interested parties have been pressing since the spring of 2011 for reviews of, and changes and improvements to, the banks’ policies, procedures, and processes around loan modifications, foreclosures, and securitizations. There have also been several calls for more transparency, and honesty, in the banks’ allocations of reserves for loan losses and litigation.

On May 12, FDIC Chairman Sheila Bair testified before the Committee on Banking, Housing, and Urban Affairs of U.S. Senate:

Serious weaknesses identified with mortgage servicing and foreclosure documentation have introduced further uncertainty into an already fragile market.The FDIC is especially concerned about a number of related problems with servicing and foreclosure documentation. “Robo-signing” is the use of highly-automated processes by some large servicers to generate affidavits in the foreclosure process without the affiant having thoroughly reviewed facts contained in the affidavit or having the affiant’s signature witnessed in accordance with state laws.

The other problem involves some servicers’ inability to establish their legal standing to foreclose, since under current industry practices, they may not be in possession of the necessary documentation required under State law. These are not really separate issues; they are simply the most visible of a host of related problems that we continue to see, and that have been discussed in testimony to this Committee over the past several years…

Our examiners participated with other regulators in horizontal reviews of these servicers, as well as two companies that facilitate the loan securitization process. In these reviews, federal regulators cited “pervasive” misconduct in foreclosures and significant weaknesses in mortgage servicing processes. Unfortunately, the horizontal review only looked at processing issues. Since the focus was so narrow, we do not yet really know the full extent of the problem.

In April 2011, the Office of the Comptroller of the Currency (OCC), the Federal Reserve Bank (Fed), and the Office of Thrift Supervision (OTS)  - the IndyMac regulator – ordered fourteen large mortgage servicers to overhaul their mortgage-servicing processes and controls, and to compensate borrowers harmed financially by wrongdoing or negligence.

An article in Thomson Reuters’ News and Insight on May 19 describes the problems some were having with the setup of this Consent Order, specifically the way the “independent” reviews required by the Order were expected to be performed.

U.S. regulators are pinning their hopes on independent consultants picked by large U.S. banks to uncover the true depth of foreclosure misconduct seen at lenders. Regulators are close to signing off on these consultants, which are expected to include Promontory Financial Group, Treliant Risk Advisors and PricewaterhouseCoopers…

The key thing is that the independent consultant needs to recognize that the client is the regulators… and not the bank,” said Joe Evers, a large bank deputy comptroller at the OCC. “They need to be taking direction from us and they need to be meeting our expectations.”…

One issue is who would do the review if not the consulting firms. Regulators say they don’t have the manpower, and so they are looking for firms with the required expertise. Senator Reed suggested the regulators at least hire the firms directly rather than approve the banks’ choices. Evers said regulators decided not to take this approach because it would have raised government contracting issues that could have slowed when the reviews begin. He said the agency also has had success using third party reviews in past enforcement actions.

The problem with this approach and the inherent conflicts of interest should be obvious to all but the most naïve observers.

It’s a joke for any government agency, especially one says they’re in the enforcement versus the supervision business, to defend an approach that allows the entity found guilty of wrongdoing to select the consulting firm that tells them how bad they were and how much they have to pay for the bad behavior.

It’s not like the agencies – Treasury, the General Accounting Office, the Federal Reserve, the SEC, and others like them – don’t have procurement teams that contract with professional services firms on a direct basis all the time. One only has to look at the assistance that all the Big four audit firms  - and lawyers and other consultants – provide to the Federal Reserve Bank, The SEC and the Treasury on the TARP program and related initiatives as a result of the crisis. The process, controls, and the rationale for direct contracting is already in place.

And let me assure OCC spokesperson Evers that audit firms like PwC will not look at the regulators as their clients instead of the banks unless someone makes them. They know where their bread is buttered and where their next meal is coming from.

The SEC and the PCAOB, the audit industry regulator, have said so.

The reforms from early this decade notwithstanding, I believe more can and should be done to emphasize the importance of independence and the auditor’s duty to shareholders and the public. It is integral to the foundation of the reason for requiring an audit in the first instance…I’m not suggesting that the role of an auditor should be that of an adversary; but it also cannot be, either in fact or in appearance, that of an advocate for the management of the company it audits. In a world where the mantra “the client is always right” can be typed in to Google and return over 8 million results in .30 seconds, I would suggest it is time to give serious consideration to changing the perceived “client” in audit relationships.

Auditors are, after all, paid by the clients they are charged with policing. As in other professions, auditors want to advance in their chosen profession which often means keeping the client happy and growing their business.

Auditor independence requirements serve as counterweights to those forces. One example of those counterweights may be found in the SEC rule that says an accountant will not be considered to have the necessary independence from its audit client if an audit partner earns or receives compensation based on selling non-audit services to the audit client. The purpose of this rule is to keep auditors singularly focused on the quality of their audits and not on nurturing a relationship that will make management more receptive to cross-selling efforts.

Despite those requirements, PCAOB inspection reviews of partner evaluation and compensation processes find examples of seemingly unrestrained enthusiasm — in partners’ self-evaluations, in their supervisors’ evaluations of their performance, and in agreed performance goals — for selling services to audit clients…We don’t see these problems in all the files we look at, but we have seen them in sufficient number to raise troubling questions, not the least of which are whether these audit partners are unaware of, or simply unconcerned about, the independence rule that should make such considerations irrelevant to their compensation, and why a firm would allow such unawareness or unconcern to continue unabated.

So let’s look at the proposed consulting firms. Promontory Financial Group, Treliant Risk Advisors and PricewaterhouseCoopers are professional services firms that serve the large banks directly on other consulting assignments.

The banks that must be reviewed are their existing or target clients.

PricewaterhouseCoopers (PwC) is the auditor of two of the banks that must be reviewed – Bank of America and JP Morgan Chase. That’s an independence conflict that can’t be overcome. PwC can not be involved in the reviews at these banks. Recently, retired PricewaterhouseCoopers’ Chairman Sam DiPiazza joined Citigroup as a Vice Chairman in the Institutional Clients Group and a member of the bank’s strategic advisory board. There’s another conflict for PricewaterhouseCoopers.

Where PwC is not serving a bank as auditor - namely Citigroup and Wells Fargo - they are already serving as a consultant. These three consulting firms want consulting business from these banks, now and in the future. If PwC is allowed to participate in reviews at Bank of America and JP Morgan Chase, PwC’s will seek to protect their audit relationships and avoid highlighting their own or their clients’ serious errors.

PwC will also seek to protect their fellow Big Four audit firm – KPMG – which audits Citigroup and Wells Fargo, owner of Wachovia one of the large mortgage originators. Although each audit firm has their own level of tolerance for client’s bad behavior and for accepting clients’ “judgments and estimates” there’s a least common denominator bottom line that keeps all the firms in line at all their large financial services clients.

As we saw during the crisis, any one of the Big Four auditors could at any time, by virtue of failure, acquisition, or merger, become the auditor of any of their fellow firm’s clients. No firm wants to inherit a client that’s too far out on the edge. As a result the largest firms are all as good – and as bad  – as each other in enforcing the standards in the most controversial areas.

In addition, given the firms’ self-insured status using a captive offshore vehicle that all the largest firms participate in, litigation against one audit firm as a result of finding mortgage fraud at their client hurts them all – in the pocketbook as well as reputationally.

The plans for independent reviews required by the banks’ Consent Order with the OCC, OTS, and the Fed are due July 13. Additional self-assessments were orderd for all banks, not just those under the consent decree.  Those are due September 30. According to HousingWire’s Jon Prior, the reports of the reviews will not be made public. Would it be possible keep the reports secret if the regulators had contracted for the reviews directly?

I think not.

On June 13, the Huffington Post’s Shahien Nasiripour disclosed that New York State Attorney General Eric Schneiderman had turned up the heat on Bank of America and other banks, servicers, and trustees of the mortgages that were securitized.

New York Attorney General Eric Schneiderman has targeted Bank of America, the biggest U.S. bank by assets, in a new probe that questions the validity of potentially thousands of mortgage securities and their associated foreclosures, two people familiar with the matter said.The investigation, which began quietly in recent weeks, is part of a larger inquiry that is scrutinizing whether mortgage companies and Wall Street firms took the necessary steps under New York state law when creating mortgage-backed securities.

There was a movement by all the state attorneys general to force a global settlement on the banks to remedy the wrongs of the crisis, in particular with regard to bad documentation and unjust foreclosures. That effort has repeatedly been hit by defections and roadblocks.

From William Greider in The Nation on June 28:

As facts about the banks’ ugly behavior gathered headlines, the fifty state attorneys general came together to demand reforms. The effort was chaired by Democrat Tom Miller of Iowa and actively coached by Washington officials from the Justice Department and HUD. The Obama administration is eager to get a settlement, fearing that state-by-state litigation will injure the banks and maybe derail the foreclosure process.

The AGs first suggested a settlement of $20–25 billion—even though the true public loss would probably be much greater—plus a commitment from the banks to clean up their procedures. In exchange, the AGs would agree to release the banks from potential liabilities that states might pursue. The banks’ counteroffer was a trivial $5 billion, which suggests that they are not taking the AGs too seriously.

[New York Attorney General Eric] Schneiderman agreed to participate with other AGs, but warned from the start that New York would refuse to give up its right to hold banks liable—to sue and collect damages or impose court-ordered reforms. Other strong states, including California and Massachusetts, evidently agree. That alone would presumably doom the deal-making, since any settlement that does not include New York and California would probably not be worth much to the bankers.

In January, Bank of America settled with Fannie Mae and Freddie Mac over repurchases but there are several other suits outstanding with the Federal Home Loan Banks and private investors. Bank of America recently caved in to another group of investors. On June 29, the Financial Times FT Alphaville blog reported that a settlement had been reached between Bank of America and some bondholders.

…several news outlets (the Wall Street Journal had it first, and here’s the FT) reported last night on the expected $8.5bn settlement reached between the bank and the aggrieved parties, and earlier this morning BofA confirmed the details in a statement.

The key driver of the expected loss is the representations and warranties provision of $14.0 billion, including $8.5 billion for the settlement agreement on legacy Countrywide mortgage repurchase and servicing claims, and an additional $5.5 billion increase in the company’s representations and warranties liability for non-GSE exposures and, to a lesser extent, GSE exposures.

The company also expects to record $6.4 billion in other mortgage-related charges in the second quarter of 2011…

Audit firms PricewaterhouseCoopers and KPMG, as well as the other two members of the Big Four, are all around this crisis – in the banks, the ratings agencies, and in the regulators. And there’s a pervasive revolving door between the regulators and the banks and institutions they regulate, as well as between the regulators, the regulated, and the auditors and attorneys that serve us as watchdogs and guardians of the public interest.

But the Taylor, Bean & Whittaker convictions prove that mortgage fraudsters can be prosecuted.

The best way to get truly independent assessments of how much is wrong with the processes and the paperwork and how much compensation should be paid is for regulators to step up and take direct responsibility for the problem.

Independent individuals and firms, people who are not beholden to the large banks and financial institutions, do exist. Many next tier and regional or boutique firms have the expertise and are not in the day-to-day business of auditing or taking on large projects with these institutions.

It’s time for the regulators to build a more permanent task force of public servants rather than private profiteers to tackle these issues. The problems are really big, they’re going to get worse before they get better, and they’re going to be around for a long time.

The main page image comes from this site and this essay on the challenges to the criminal justice system, penned in 1997.

Post Script: This was a great movie about plaintiffs’ lawyers.

Post Post Script:  When I told readers in January to sell or short the banks – in particular Bank of America – the bank’s closing price was $14.667.  On Friday July 1, Bank of America closed at $11.09.

Not so long ago, Dennis Howlett and I went public with a bet:  

Which Big 4 audit firm is the next to fail?

This may seem like a dead pool – a quite depressing and morbid fascination with something that will add pain and misfortune to so many.  I have been accused of being so totally negative that I strain credibility.  After all, isn’t there anything good to say about any of the firms?  

Isn’t some audit failure natural? Isn’t some error and omission in the audit process the result of a rational cost/benefit formula at work – one that determines how much more testing, sampling, investigation, questioning, and verification work should be done to reduce risk of material misstatement to an “acceptable” level?

Isn’t everyone cutting staff in this recession? Why can’t the audit firms run a business like any other capitalist and make a profit? Why are auditors any more responsible for the public interest than lawyers?

Aren’t plaintiffs’ lawyers too aggressive and going after audit firms only because they have “deep pockets” ? Aren’t auditors responsible only for certifying based on what management tells them? Can anyone hold them responsible if they were “duped” by bad guys? 

The litany of crybaby defenses goes on and on.

Frankly, it’s getting a little tedious.

Let’s face facts. Dennis may be right.  It may be EY that’s next.  

Even before the conviction this week of four current and former partners of Ernst & Young for criminal tax fraud involving tax shelters, EY had a bundle of other trouble.  They were the auditors of Lehman Brothers and are being sued for their role in that failure. They have Madoff exposure.  They are also co-auditors for Societe Generale and auditor for UBS – two problem children, for sure. There is speculation about EY in other quarters, and although I don’t agree with their reasoning, the conclusion is the same.

Dennis believes that I’m betting on PwC as next to fail.  I don’t honestly remember committing to that, but I’m willing to go with it for the sake of argument.  This is in spite of the fact that the other Big 4 have plenty to worry about and the next tier firms are in no way ready for prime time.  Wishful thinking that BDO can somehow win their appeal in the Banco Espiritu Santo case, that Grant Thornton won’t get hurt by Refco, or that McGladrey is innocent in the Sentinel case is trumped by the fact all have additional exposure to Madoff.

KPMG, of course, has New Century, Anglo Irish Bank, Citi, Siemens, and others.

Deloitte, well, too many to count. And the Parmalat case is a potential model changer. And a very embarrassing insider trading scandal. Then there’s the loser consulting gigs and a declining demand for consulting, all of which makes for never ending cuts and a not so rosy outlook.

And yet, for my money, PwC is still the closest to the precipice, if only now because of Satyam.

Think about it.  It’s their third strike (at least that we know of) internationally after Japan and Moscow.  Two of their Indian partners, for God’s sake, are still in jail – thrown to the prosecutorial sharks by the Indian Central Bureau of Investigations. The Chairman (soon to be retired ) of Pricewaterhouse International Limited, Sam DiPiazza, has pulled out all stops in investigating what occurred in India, sending US and other professionals to “assist” colleagues in India with comprehensive audit quality reviews, and personally meeting with Indian government officials and others worldwide to try to repair the “lost trust.”

And then there’s PwC’s Madoff exposure.  

And the lawsuit for wage and hour violations in California that they’ve already lost on the facts but are vigorously appealing. They completely flubbed the administrative responsibility test in this case and will lose the licensing argument.  Why?  Because the fear mongering they’re trying to stir up through proxies (there have been friend of the court briefs filed by business organizations sympathetic to PwC) are just that. Empty threats. The law firms have nothing to be afraid of if audit firms are required to pay overtime to not-yet-licensed associates. The law firms exposure is minimal.  After all, you pass the bar and are a licensed attorney in most states by late fall of the year you graduate.  Most law firms don’t tolerate a delay or a failure to pass the bar the first try, especially for top graduates. Contrast this to the audit firms. You can work for five to seven years, eighty hours a week during busy season, before making Manager level, the typical cutoff for future promotions without a CPA.  

And there are still questions lingering over their role in Northern Rock. And their forays into gambling audit have not been so successful all the while they’re advising the US to open up online gambling in order to reap the tax revenues.

The rumbling has also started in the comments on this blog over PwC’s stealth “reductions in force” and their broken promises over start dates and starting salaries to graduates. It’s fully expected that additional staff cuts will come soon and be of such a volume that it will be hard to hide behind the “didn’t fit with our performance culture” excuse.  

Finally, there’s the strategically disastrous purchase of BearingPoint’s Commercial Services practice.  Sources tell me due diligence has been non-existent, it’s solely an ego-trip for current leadership, and there’s a shell game going on in public statements regarding their interest in full blown systems integration services. The probability that  integration of the operations, financials, staff and infrastructure will be smooth and trouble-free is in the low single digits.

Yep.  Of the Big 4, my bet is with PwC US to fail in the next twenty-four months.

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On YouTube.

Part 2 from Jon Najarian is here.

 

I have been updating this information throughout the weekend as other banks failed and other deals have been done.

A summary of “the mother of all bailouts” from The Corporate Counsel.net.

I have also been on Twitter, passing information along to those that follow me there and remarking on developments as they happen.

Stay tuned for updates to this post and more on the financial crisis.

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Originally posted September 26, 2008

The Big 4 are no Chicken Little.  They’re not even the boy who cried wolf.     

If only we had received the benefit of warning, however early, potentially exaggerated, and conservatively based.  If only the Big 4 had told us, in the form of significant deficiencies, material weaknesses, going concern opinions, or some other way of signaling, that some of the banks were technically insolvent or potentially illiquid under certain scenarios.  

And what if the FAS 5 required statements on contingencies had been used to signal something other that the probability of a legal catastrophe or a natural disaster?  What if they had been, instead, made useful in pointing to less than doomsday market breakdown contingencies and that company’s readiness to weather them? Unfortunately, they’ve decided to shelve those proposals for fuller disclosure for now.  And we get more and more and more opaque…

My esteemed friend Richard Murphy in the UK states the obvious.  Who has not yet been called to account for this mess?  The Big 4.  

So let’s look at an update of where things stand , at least from a competitive position and as the shifting sands may have a potential impact on the staff and partners of the Big 4.

My expert assessment:  Feds better watch how much toxic risk JPM and B of A have taken on in addition to what they already have.  Both are audited by PwC and we know what I think of those guys….

And Citi (KPMG) has been suspiciously silent during all of this. What’s going on over there???? Update: Citi is in the running to take over Wachovia.   Update (2) Looks like Wells Fargo is getting Wachovia instead and Citibank is suing.  Yeah, thats a good use of capital. 

Red

AIG – Taken over by the Feds.  Why is PwC still the auditor when they are paying off their clients, the shareholders, for misleading them? Why isn’t this an independence violation?

Bear Stearns – Purchased by JP Morgan who uses PwC (Formerly Deloitte)

Merrill Lynch – Was Deloitte, bought by Bank of America (PwC)

Lehman Brothers – (EY) Bankrupt.  Pieces being picked up by Barclays and Nomura. Dick Fuld gives less than satisfying performance in front of Congress on 10/6.

Washington Mutual – Deloitte

Northern Rock – Nationalized (PwC)

New Century - (KPMG)

Countrywide (KPMG) – Bought by Bank of America (PwC) B of A to $8.4 billion to settle claims that Countrywide defrauded mortgage customers.

Wachovia (KPMG) – This article does not paint a pretty picture. Update: Potential takeover by Citi (KPMG) or maybe Santander or Wells Fargo.  Looks like Wells Fargo. 

Fortis – (PwC and KPMG) Update  Looks like they are now on the way out, perhaps as soon as the weekend of the 9/27-28.  Update (2) Looks like BNP Paribas will pick up most of Fortis.

Bradford and Bingley UK  - Nationalized over the 9/27-28 weekend.

Royal Bank of Scotland (Deloitte) moves from Green to Red on news of a run and potential bailout.

LLoyds (PwC)

   

Yellow

 

Fannie Mae -Suing Former auditors KPMG, now with Deloitte and recently put under US government conservatorship.

Freddie Mac – PwC and recently put under US government conservatorship. (For a nice timeline and commentary on Fannie/Freddie issues and takeover check out this report from Currency Trading.net)

Morgan Stanley – (Deloitte) – Morgan Stanley has agreed to sell a 21 per cent equity stake to MUFG, Japan’s largest bank, for a cool $9bn.

Goldman Sachs – Recently accepted capital infusion from Warren Buffet (PwC)

HSBC – (KPMG) Largest European bank by market value is also teetering.  Cut 1100 jobs on 9/26

Societe Generale (Deloitte and EY)

Credit Suisse –  (KPMG)

UBS - EY

Wells Fargo – (KPMG)

Green (for now) 

JP Morgan – (PwC) Has picked up Bear Stearns and now Washington Mutual, both formerly audited by Deloitte

Nomura – (EY)

Barclays -  (PwC) Buying US portion of Lehman 

Bank of America – (PwC) – Bought Countrywide (KPMG) and Merrill Lynch (Deloitte)

BNP Paribas (Deloitte, PwC, and Mazers) Looks like BNP will pick up Fortis.

Credit Agricole (PwC and EY)

Santander – (Deloitte)

Wells Fargo – (KPMG) – Wells Fargo moves to Green now that they theoretically have the strength to buy Wachovia.  However, Maria Bartiromo asked some tough questions of their CEO on Friday and I was not convinced. 

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As I mentioned in my Twitters on Thursday, I had the opportunity to speak with Deloitte’s National Director of Public Relations, Deborah Harrington, on the phone earlier.

I laughed out loud when a Google Alert pointed me to the FT article excerpted below.