Accountants in the firing line

By Felix Salmon
December 23, 2010
Caleb Newquist notes, most financial reporters cover the accountancy industry "once in a lunar eclipse on the winter solstice". So it's fantastic to see Bloomberg's Jonathan Weil coming out with two incisive, hard-hitting columns in succession on the subject.

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As Caleb Newquist notes, most financial reporters cover the accountancy industry “once in a lunar eclipse on the winter solstice.” So it’s fantastic to see Bloomberg’s Jonathan Weil coming out with two incisive, hard-hitting columns in succession on the subject.

Last week, Weil drew a bead on PricewaterhouseCoopers, which has signed off on a $2.2 billion accounting benefit at MBIA. That number represents “estimated recoveries,” most of which are due to come from Bank of America; they’re essentially bonds which MBIA is allowed to put back to the lender because they didn’t conform to the lender’s own representations and warranties.

At the same time, however, PricewaterhouseCoopers is also happy signing off on Bank of America’s accounts, which include no liabilities to MBIA at all.

Weil concludes:

The job of an independent auditor should be to ensure that the numbers make sense.

At MBIA and Bank of America, they don’t.

Is this illegal? Probably not. But this week, Weil comes out swinging at Ernst & Young, dismissing its defense against Cuomo’s charges as “insane” and “nonsense,” and placing it in the broader context of E&Y’s corporate culture:

Allegations of misconduct at E&Y have become such a routine part of the firm’s business that they’ve come to be expected…

E&Y had established itself as a repeat offender long before Governor-Elect Cuomo filed his suit. In recent years we’ve seen four former E&Y partners sentenced to prison for selling illegal tax shelters, while other partners have been disciplined by the SEC for blessing fraudulent financial statements at a variety of companies, including Cendant Corp. and Bally Total Fitness Holding Corp.

(Note Weil’s mastery of the hyperlink: would that all journalists were as good.)

Weil effortlessly dismantles E&Y’s statement that “there is no factual or legal basis for a claim to be brought against an auditor in this context where the accounting for the underlying transaction is in accordance with the generally accepted accounting principles,” by pointing out that Cuomo’s whole case is based on the assertion that the transaction was not in accordance with GAAP:

In the footnotes to its audited financial statements, Lehman said it accounted for all its repurchase agreements as financings. This was false, because Lehman accounted for its Repo 105 transactions as sales, a point the Valukas report chronicled in exhaustive detail.

As any freshman accounting major can tell you, it’s a violation of GAAP for a company to tell investors it’s using one type of accounting treatment when it’s actually using another, especially when the method it’s secretly employing makes its balance sheet look stronger.

Meanwhile, Francine McKenna is doing sterling work on this case as well, pointing to the parts of the Valukas report where E&Y comes off as particularly obstructionist:

I think the NY AG’s investigators questioned EY and its partners first as part of building a case against Lehman executives. When EY was as difficult and non-cooperative as they seem to have been with Valukas, the NY AG decided to redirect their energies to the auditors. They had the Lehman Bankruptcy Examiner’s report as a road map, an almost-ready for prime-time template for a complaint against the auditors.

McKenna singles out this passage from Valukas:

Prior to this invitation and during [E&Y partner William] Schlich’s four‐day interview as an Ernst & Young representative, the Examiner invited Ernst & Young to opine on why Repo 105 transactions were proper and did not result in Lehman filing materially misleading financial statements…Schlich replied that the transactions were proper if they complied with Lehman’s self‐defined Accounting Policy. Despite an additional invitation from the Examiner, Ernst & Young has not offered any further explanation.

There are echoes, here, of the way in which Cuomo decided to file suit against Steve Rattner after being angered by his incomplete responses to initial questioning. It’s natural for individuals and companies not to want to incriminate themselves when being questioned by the attorney general. But when dealing with Cuomo, it seems that being as cooperative as possible as early as possible is the way to go. He hates being given incomplete information.

2 comments

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Agreed that the Bloomberg story sure looks bad, but that’s why I’d prefer to see more background on what the accounting standards. As is, it’s structured in kind of a slimy way: “PWC did something that looks horrible. *Some say* that it was perfectly OK under GAAP, but it really, really looks horrible.”

Or: it’s standard MSM journamalism, albeit brought to bear on a topic that doesn’t get much play elsewhere.

Posted by jpe12 | Report as abusive

I agree with your general criticism that accounting firms need to work on their PR and that maybe more upfront cooperation with Cuomo would’ve yielded an ally further down the line.

But I have three disagreements with the above post;

1) The E&Y-Lehman suit was a foregone conclusion, even moreso after the Valukas report (which stated there was evidence of a colorable claim, which, in legalese, requires less presumption of wrongdoing than a civil or criminal charge). I have doubts that E&Y really could’ve avoided this lawsuit, and it is telling that only civil charges have been filed using expanded powers of the Martin Act.

2) The Main Stream Media’s coverage of accounting matters is, as you state, abysmal. But there is a reason why, accounting rules mirror those used in law, except tend to be more technical and thus, more boring. I see no attempt by the MSM to cover the particulars of accounting literature, or even the over-arching purpose – which is not to protect us from all failures or fraud, but to have some type of system of consistency in standards which is verified by an independant third party. E&Y will wage a losing battle trying to communicate this to the masses without assistence by an informed member of the MSM.

3) There are 4 major accounting firms auditing tens of thousands of companies and with 100k plus employees each. Cherry picking specific failures is no great accomplishment or evidence of general erosion of standards. In this case, the tax and audit divisions share little overlap in leadership or standards, and a couple failures are no implicit presumption to change the entire structure or internal workings of an organization.

Posted by ScottVE | Report as abusive