Mainstream media, and the Financial Crisis Inquiry Commission, are focused mainly on Ernst & Young as the auditor whipping boy of the financial crisis. That’s really by default not by design and is thinly justified. No one has given fly-over journalists anything on a silver platter that would draw in the rest. Not that there aren’t a number of reasons to look hard at all of them. They are feigning outrage in the UK. But here in the US, we treat the audit firms as untouchable.
That doesn’t stop me from highlighting all the reasons why the rest of the Big 4 should be scrutinized as much or, perhaps, even more than Ernst & Young for their role in the crisis. And, of course, you know I believe there’s more than their behavior during the crisis to warrant significant scrutiny of the industry’s model and its methods. The popular perception is Ernst & Young is the most vulnerable of the largest firms because of its troubles with Lehman, but that’s more a public relations problem than a fact-based conclusion.
Granted, Ernst & Young hasn’t been very good at crisis communications. In fact, they’ve really sucked at it since last March. Their delay in responding to the original Lehman Bankruptcy Examiner’s report and the suit filed by the New York Attorney General is a case study in how not to respond. Because that’s what they did. Not respond. They either didn’t respond at all to journalists or issued the standard auditor response to any lawsuit. That’s the one with two sentences, or one long one, that includes the phrases “according to GAAP”, “followed all standards”, “stand by our work”, and “we just stand there”.
Give me a few minutes and I can make a case for PricewaterhouseCoopers as the one teetering on the edge of the abyss instead. Or KPMG. But today, let’s talk about Deloitte.
A few weeks ago I detailed the case of Arnold McClellan, the Deloitte Tax partner who is accused of using his knowledge of Deloitte client private equity firm Hellman & Friedman’s acquisitions to pass insider trading tips to his UK relatives. Deloitte, the firm, is cooperating with FSA, SEC, and DOJ investigations of these allegations, as they did in the SEC’s investigations of their other partner inside trader – former Deloitte Vice Chairman Tom Flanagan. Mr. Flanagan’s case was settled with the SEC last summer and McClellan’s will eventually be settled, too. In both cases, Deloitte’s cooperation will save them from fines and sanctions or even a consent decree requiring them to clean up their compliance act.
How does that translate into trouble for Deloitte? They’re skating away as a firm from major insider trading scandals, looking like the good firm. Two serious insider trading cases, both involving partners and high profile target companies, playing out during the same time frame equals holes in Deloitte’s internal compliance processes you can drive a Mack truck through. Whether the SEC or Deloitte admit it publicly, the heat is on and it’s only a matter of time before another case bobs to the surface. Or more than one. How long can Deloitte claim the firm was “duped” by their own partners? Eventually there will be an egregious case where the firm has to pay a fine or worse. I’m sure there’s already a lot more headaches in the annual independence process for partners and their families. If not, both the SEC and the firm are playing with fire.
Last week I wrote in Forbes about the victory for class action plaintiffs suing Bear Stearns executives and Deloitte for Bear Stearns’ part in the financial crisis. It’s a major accomplishment to get a crisis suit past the motions to dismiss, in general but especially significant, in particular, when thesuit also names the auditor as a defendant. Deloitte will now be subject to discovery and a trial – if they don’t settle first – to refute allegations they performed “no audit at all” at Bear Stearns.
That was the gist of allegations in the UK’s House of Lords regarding Deloitte’s audit of Royal Bank of Scotland. That failed bank was nationalized by the British government and never received a “going concern” qualification in enough time to warn anyone.
It’s especially galling that Deloitte escaped any mention in the Financial Crisis Inquiry Commission report released last week for the Bear Stearns “no audit”, in spite of the fact that the Commission claims Bear Stearns also used Repo 105 tactics to “window-dress” its balance sheet. Was there lack of disclosure of the “sale” treatment of these repo transactions in the Bear Stearns financial statements? Was Deloitte troubled by their use? Did they condone their use and insist on proper disclosure at their other clients such as Washington Mutual, Merrill Lynch, or Fannie Mae? Inquiring minds want to now but the official inquisition left these stones unturned.
Finally, The New York Times has a terrible tale today of corruption and fraud at Afghanistan’s Kabul Bank.
KABUL, Afghanistan — Fraud and mismanagement at Afghanistan’s largest bank have resulted in potential losses of as much as $900 million — three times previous estimates — heightening concerns that the bank could collapse and trigger a broad financial panic in Afghanistan, according to American, European and Afghan officials…Deloitte, a top United States accounting firm that had staffers in the Central Bank under a United States government contract over the last several years, either did not know or did not mention to American authorities that it had any inkling of serious irregularities at Kabul Bank. Deloitte was not responsible for auditing the bank’s books; a spokesman for Deloitte did not respond to requests for comment.
If Deloitte had been the auditor, the result may have been worse. Given their bank client MO of audit at all; the problems could have gone on for a few years more at least. Deloitte acted as a consultant, consistent with their reputation as the go-to firm for solving problems in tough places. Their acquisition of Bearing Point’s Federal Services practice only solidified that preeminent position as the masters of black ops magic. But notice that these kinds of operations go through the international firm not Deloitte US. Better to insulate the US firm form liability for doing what needs to be done;.
Hey New York Times: See if you can find Mr. Live Free or Die” Bob Webber – banker for hire, problem solver, road warrior. He might know something.
Webber was in Kabul during August and September [2005] working as a senior bank advisor with the international consulting team.
Afghanistan has approximately eight commercial banks. There also are a number of micro-finance non-governmental organizations (NGO) and one fully chartered micro-bank, which have specific niche areas of business.
The team was assigned to assess specific banks that were scheduled for liquidation or transformation and to plan and design a non-bank financial institution from one of the former banks.
The focus of the new institution would be rural lending and to help rebuild Afghanistan’s agricultural economy.
Webber knows the banking business. He was chief executive officer of four banks. In the Upper Valley, he served as president of First New Hampshire Bank, now Citizens Bank, and Bradford Bank before heading to Washington to run another bank.
In recent years, he has served as a senior advisor with major international consulting firms, including Deloitte Touche Tohmatsu.
Prior to Afghanistan, his consulting work has taken him to South Korea, Tajikistan, Kazakhstan, Bosnia and Kosovo.
Webber’s team, which was hired by Deloitte under a contract with the U.S. Agency for International Development (USAID), included three other senior bankers from the United States and two associates from India and one from Pakistan, he said.
