PCAOB's Standing Advisory Group - Very, Very Interesting

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I'm getting back into a routine this morning after two days of intellectual stimulation in DC and NY. Until I have a chance to write up my review of the meeting in DC on Wednesday, look here for Edith Orenstein's take on the players and their comments, in particular with regard to the topic of supervision of audits. I'll have a lot to say on that one!

Suffice to say, it's a good thing Lynn Turner is still kicking ass and taking names. Most of the rest of the group are limp noodles intent on spinning the story and sustaining the status quo...

Also, big shout out to Mark Olson who said hi to me and stopped by for a few words. He recognized me from all the way back to the Compliance Week meeting last June where he told me he's a frequent reader of the blog.

Thanks, Mark, for being a such a gracious host.

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PwC Tough On AIG? Too Little Too Late

When will the class action lawyers force AIG to fire PwC?

AIG's acknowledgment of their exposure to writedowns in their derivatives portfolio came soon after their December disclosures that underestimated the losses. PwC, with their long, long relationship to AIG and the recent renewal of the relationship with the blessing of Levitt, are not so much tough as "scared witless."

Derivatives are bothersome fellows, especially in a crazy market. There's another client holding on to their longstanding auditor even though they can't get the derivatives story straight either.

Do the Big 4 really have the expertise to judge their clients on this issue?

Insurance giant American International Group(AIG - Cramer's Take - Stockpickr) said late Thursday it swung to a $5.3 billion loss in the fourth quarter thanks to $11.5 billion in writedowns on derivatives.

The company logged a net loss of $5.29 billion, or $2.08 a share, for the quarter, compared with earnings of $3.44 billion, or $1.31 a share, for the year-ago period. Excluding special items, AIG said it lost $3.20 billion, or $1.25 a share, compared with last year's earnings of $3.85 billion, or $1.47 a share.

Analysts on Wall Street were expecting earnings for the quarter of 60 cents a share, according to consensus estimates reported by Thomson Financial.

The company said its results included a writedown of $11.47 billion on mark-to-market losses in its super senior credit default swap portfolio. Earlier this month, AIG disclosed in a regulatory filing that its auditor, PricewaterhouseCoopers, concluded it had "a material weakness in its internal control" related to its accounting for that portfolio.

That stood out in stark contrast to the company's assurances in December that it had "little to no exposure" to asset-backed commercial paper, structured investment vehicles or collateralized debt obligations tied to residential mortgage-backed securities. It reported a $4.88 billion writedown in gross market value for its credit default swap portfolio in October and November -- more than four times the $1.15 billion executives reported earlier.

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Follow-Up - PwC Advisory Services Layoffs

During the last two days, comments and traffic related to my post about layoffs in PwC's Advisory Services practice have been huge. I am currently in NY attending other meetings and yesterday attended the PCAOB's Standing Advisory Group meeting in Washington DC. More on that meeting later. But I want to make a few comments about the PwC layoff issue and respond to some questions.

First of all, this is a blog, not a newspaper or magazine. If I receive information from informants or otherwise informally, I am not in a position to call PwC and confirm the information.

Nor would I.

I look at the source of the information, look at my own experience and knowledge about the situation, and make a decision whether to post the info for your review and analysis.

Caveat emptor.

I was interviewed by WebCPA on Tuesday, and that publication called PwC for confirmation. In that case, you had the opportunity to see my actions and a reaction to the information based on formal journalistic approach and make your own judgments. The bottom line is this process forced PwC to make a statement about layoffs, albeit through an "unnamed spokesperson." You would have never seen any statments, let alone a press release, otherwise.

Secondly, please look at an early post I wrote about how layoffs are used in professional services where I cited the example of a previous PwC layoff. Both the approach to carrying it out and the communication were poor. The fact that they are both cutting people and communicating that nothing unusual is going on, is not unprecedented.

Let's look at some of the excuses for layoffs made in the past, for example, by PwC.

Layoff Plans Are Announced By Pricewaterhouse and Scient

April 12, 2001 The Scient Corporation and PricewaterhouseCoopers announced layoffs yesterday, and both blamed declining demand for their advisory services. Executives at both firms said that clients were narrowing the scope of projects requiring consultants, slowing their pace and canceling them outright...PricewaterhouseCoopers, which is based in New York, will lay off 750 to 1,000 people in its domestic consulting unit, or up to 8.3 percent of the 12,000 consultants based in the United States...The layoffs at PricewaterhouseCoopers, which is privately held, are part of the company's efforts to eliminate consultants with skills that are not in demand, Ms. Eusufzai said. In today's market, valuable skills include knowledge of strategy and e-commerce marketplaces, she added.

Scott Hartz, global managing partner for the consulting practice, plays down the significance of the 400 layoffs: "We did separate about 400 staff, but frankly that's something we do every year -- we go through an annual evaluation cycle, and adjustments have to be made." Hartz does admit, however, that the 400 laid off were not the only ones to have departed. "The 400 were forced separations; there will be voluntary turnover as well," he says. Hartz claims the economic climate is to blame for the layoffs:"We're in a slowdown, and we're not growing as fast as we were, but fundamentally we are still a growing business. I would acknowledge that as we started the year, we anticipated higher growth rates, and we found ourselves long on resources in certain areas that didn't grow as fast as we guessed."

In October 1999 PWC announced that it would eliminate 1,000 administrative and support jobs. All but 250 of the job cuts are expected to come from layoffs across the country. The remaining cuts are to be achieved through a hiring freeze that is already in place. The cuts come as PWC makes a push to boost its e-commerce consulting business - the firm has plans to invest $3 billion over the next three years in this initiative. After the July 1998 merger of Price Waterhouse and Coopers & Lybrand, company officials had indicated that no layoffs would follow.

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Finally, PwC has now recently gone through at least four major staff cuts in addition to the one I reported:

1)The reorganization of their IFS or internal administrative staff which has resulted in involuntary terminations nationwide.

2)Reduction in staff, including professionals under the manager level in their SPA or Systems and Process Assurance group. This group is still part of the Audit practice and provides IT Audit and Security professionals (professionals with highly sought after skills by industry) to both the Audit and the internal audit and consulting practices at PwC.

3)Selective cuts of Managing Directors, Directors and Managers in their consulting businesses, due to "performance reasons, since the summer.

4)And now confirmed cuts across all Advisory practices and all markets of additional Directors and Managers, (official number at 120,) ostensibly as a result of the December mid-year performance evaluation process.

5)Additional rumored cuts, as reported by this blog, of up to 25% of all Advisory professionals across all practices and geographies, occurring at this time, one by one, two by two, but not in the large mass numbers that would attract attention other than inside.

My sources are both reliable and well placed. It is PwC and the audit firms' practice, in general, to conduct such "reductions in force" in this manner, as we have seen them do in the past, rather than make huge announcements.

I stand by my comments that PwC Advisory is in trouble, going to be "turned-around," and that cuts are part of that equation. Revenue is coming in at less than half of their goal per month and they're not going to keep people around under those circumstances, given PwC's own reporting of the dire, depressing economic outlook that CEO's have. If the number is going to be only 120, then between the comments, the additional offline communications I have received, and all the recently cut PwC Advisory staff that have asked to connect to me via Linked In the past few days, I have probably been contacted by almost all 120 of them.

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On The Road Again

I'm on the plane and on my way to Washington DC and the open meeting of the PCAOB's Standing Advisory Group. I will post during the day if anything "dramatic" happens, otherwise there will be a wrap up at the end of the day.

Yesterday's post on PwC's activities generated a daily page view total that was a significant multiple of any other day total ever. There were almost 10,000 page views yesterday and many , many new regular visitors and subscribers.

Thanks from the bottom of my heart for being interested, for whatever reason. Really, whatever...

I will also have some links later where I was quoted or where the blog mentioned. It's a shame it's bad news that makes the world go round...

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PwC "Advisory Services" Layoff

Word is that PwC is sending more than 25% of its consulting staff, "Advisory Services," to permanent "out of pocket" status.

As we speak, sources tell me that up to 1000 professionalswill be told they have no job, with many having their last day this Friday. The Global Leader of the Advisory Services Practice, Juan Pujadas, is rumored to be out and an internal turnaround guy from the Northeast said to be teed up to lead the practice or what's going to be left of it. Cuts are said to be not necessarily focused on any one group, but spread amongst all, with each partner asked to sacrifice a few to make the numbers. Pujadas is one of the few partners expected to suffer an actual job loss. That's just not how they do things there.

My contacts tell me that the partners have been attending workshops over the last several months to learn how to fire people.

So what went wrong? As if I hadn't already told you what was wrong with this gang...

Their growth targets for the last fiscal year ending June 30, 2007 were aggressive. They wanted to hit a US$ Billion and came up quite short. Partners were asked to take a cut in their payouts as a consequence.

Well, the audit partners could not have liked that much. When PwC sold what consulting practice they had to IBM in 2002, they also got rid of any one who actually knew how to do consulting. Recycling some more audit partners to try to revive the practice and hiring experienced consultants en masse the last two years was not going to work. The culture there does not accept outsiders easily. Consultants who knew what it takes to compete, and compete was what they had to do, were not going to function well under converted audit partners who didn't know how to run a consulting firm.

There are some practices there that work well... Tax, investigations, a few other niches that play on their strengths. But much of the rest, including their internal audit practice which was pulled out of the audit practice and put under Pujadas in mid-2005, were nothing more than glorified staff augmentation practices. There were a few scattered technical experts who sold the work to the client, but not enough experienced consultants to actually manage the work on an ongoing basis. That's not the audit partner style anyway, to actually be on the client site doing any work. The hands-on style I grew up with at KPMG Consulting/Bearing Point was not evident in the "consulting" practices of PwC. As we've seen, the audit practices have a hard time getting a partner to spend more than 2-3 % of their time on the engagement. That just won't work for high-stakes implementation project.

So the audit partners have pulled the plug. Rather than rationalizing expectations, focusing on a few select practice areas and trying to gain something other than "assess and recommend" credentials, they're retrenching. Probably a good idea, given all the cash that's needed for their ongoing litigation.

My experience, and the experience of many of the "experienced" hires who have been through the PwC meatgrinder and spoke to me, is this:

Their partners are:

• Secretive about goals, objectives and results.



• Don’t answer emails if the question is unpleasant, avoid conflict, encourage get-along, go-along attitude.



• Are better in a situation where they can judge past actions, not advocate or take a position on the future. (That's an audit mentality not a consulting mentality.)



• Expect a servile attitude from managers and staff.



• Expect that servile attitude to carry forward to clients. However, clients lose respect when you don't take a position, take a stand, make decisions.



• Don't know how to ask for the work, compete, or measure their effectiveness in delivering value to clients.



• Don't know how to leverage business development professionals to manage the sales process while the partners manage the sales content.

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DiPiazza - Wise Sage or Spin Doctor?

Every few years, when threatened with questions of relevancy and usefulness, the accounting firms manage to find a way to both turn the tables on the criticism and make more money in the process.

I was reminded of this by the recent commemorations of our Republican Presidential frontrunner's previous involvement in what was called the Keating Five.

The biggest financial debacle in American history was painful, it swelled the Federal budget deficit, it made a lot of people rich at taxpayer expense, but ultimately it had a modest impact on the financial markets and now, just a few years later, it seems like distant history. We've moved on. Which is not say there were not egregious crimes and losers as well as winners. The thrift industry collapsed in large measure because it was outmoded. Congress had designed it after World War II to focus on taking deposits and providing home mortgages to bring the dream of home ownership to more Americans.

But because the thrifts were singularly reliant on mortgages they were particularly vulnerable to being whipsawed by sharp jumps in interest rates, as happened in the late 1970's. Congress responded by allowing the thrifts to plunge into a variety of new businesses in which they had little experience. The coming disaster was turbocharged when the Government eased up on overseeing the thrifts. Crooks found the thrifts easy pickings. And the savings and loans, unprepared for their new business, threw away tens of billions of dollars in ill-considered investments. When the real estate market crashed, nearly everyone involved lost their shirts.

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The Government said today that Arthur Andersen & Company had agreed to pay $82 million to settle claims that negligent audits contributed to the collapse of several savings institutions, including Charles H. Keating Jr.'s Lincoln Savings and Loan Association. The civil settlement between the nation's biggest accounting firm and the Resolution Trust Corporation, which liquidates failed savings institutions, is the second largest obtained by the Federal agency from an accounting firm in a savings and loan case.

Arthur Andersen, based in Chicago, agreed to pay $65 million to help settle a Government lawsuit that accused the firm of negligence and breach of contract involving the 1989 failure of the Benjamin Franklin Savings Association of Houston....In a separate settlement, Arthur Andersen agreed to pay a total of $17 million to cover claims that it helped foster the collapse of Lincoln Savings of Irvine, Calif., because of negligent audits...The 1989 failure of Lincoln cost taxpayers an estimated $2.6 billion, the biggest savings and loan failure in the nation's history.
The failure of Benjamin Franklin is estimated to have cost taxpayers $976 million. The R.T.C. filed a $400 million lawsuit against Arthur Andersen on July 31, 1992, accusing the firm of negligence and breach of contract. The agency said losses at Benjamin Franklin had been caused by flawed audits. Of the $65 million settlement, Arthur Andersen agreed to pay nearly $37 million to cover claims stemming from the Benjamin Franklin case.

The remaining portion covered future claims tied to three other failed institutions: University Savings Association of Houston, Resource Savings Association of Denison, Tex., and HomeFed Bank of San Diego. The settlement also includes $250,000 set aside to cover a number of unspecified institutions. The settlement with Arthur Andersen ranks second to the $128 million Ernst & Young agreed to pay the Government in November. That pact was part of a larger $400 million settlement involving the agency and the Federal Deposit Insurance Corporation.

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Echoes of the Keating Five scandal were heard again last week as Sen. John McCain, the presumptive Republican presidential nominee, defended himself against allegations about his relationship with a lobbyist. This time, however, Robert Bennett, the special counsel appointed to investigate the Keating Five scandal, is the senator’s chief defender. McCain is the only member of the Keating Five still in Congress...

The accounting firms recovered from that debacle and grew nicely until some bothersome regulators started questioning how they were making their money. They had to back down until Enron happened. They won their point but lost the battle, because what should have been an indictment of the accounting industry and its model was instead an opportunity for windfall revenues by way of Sarbanes-Oxley.

The auditors have mixed feelings about increased regulation and stricter accounting standards. On the one hand, they mean the firms become even more indispensable to their clients and can often take the upper hand in any discussions. On the other hand, with the PCAOB reviewing their performance under these stricter rules and standards, they themselves are subject to the same scrutiny that they subject their clients to. It's not at the same level of intensity, as we have seen. We see more whimpering from the PCAOB, a little bit of barking for effect, and very little bite. However, the new laws, standards and regulations do mean the firms are more often targeted and targeted more quickly by the plaintiff's bar in securities litigation.

So, they are under some pressure to perform.

But every new crisis brings high-minded statements from the profession about getting tough, doing their job, bringing order and rational judgment to financial disclosure. If only this pontificating wasn't also a ploy to divert attention from their own culpability in the lack of integrity and usefulness of the average set of financial statements coming out of most public companies and also way for them to intimidate their clients into paying them more money for more work.

PWC chief is raising red flags over red ink
The days of Enron, and the solicitous accounting practices of that era, are long gone. That, at least, is the message that Samuel A. DiPiazza Jr., global chief executive of PricewaterhouseCoopers, is sending to banks, insurance companies and even non-financial companies that are dealing with write-downs of illiquid securities stemming from the credit crunch.

“It's not just in banks,” Mr. DiPiazza said earlier this month, according to a Reuters report. “These securities sit in cash-equivalent accounts of industrials; they sit in investment portfolios of pensions.” Mr. DiPiazza was referring to auction-rate securities—essentially long-term bonds that used to be treated like cash by many corporate investors because their interest rates reset every seven to 49 days. Last week the market for such securities froze as banks refused to back auctions that subsequently failed. “We are having to deal with this with thousands of companies, not just a handful of banks,” he said, adding that a “first wave” of write-downs would hit in this quarter's audit cycle.

A week after Mr. DiPiazza's comments, it emerged that PricewaterhouseCoopers had challenged American International Group on the valuation and accounting of its credit default swaps portfolio, which led the insurance giant to post a $4.88 billion loss—and suffer an immediate 11% drop in its share price upon release of the news. But Mr. DiPiazza's vigilance isn't recent; he has been among the most outspoken about various implications of the credit crunch for some time. Back in October, Mr. Di- Piazza suggested in a speech that major banks were hesitant to disclose their exposure to subprime mortgages because they thought the media would misunderstand the problem. He recounted what bank executives had told him: “They said, "If I go out and tell the world that we hold $10 billion of subprime debt, the media will write that we have $10 billion of losses and we're bankrupt.'” That hasn't happened so far.

But many are betting that Mr. DiPiazza, who was not made available for an interview, will be among the first to warn of whatever credit crunch fallout happens next...While most agree that accounting firms have become more rigorous since Enron, some question how pre-emptive PricewaterhouseCoopers was in uncovering problems in AIG's credit default swaps portfolio. “All across the board, auditors are tougher than they were five years ago,” said Jack Ciesielski, founder of R.G. Associates, an investment and research firm focused on accounting issues. “But I'm not so sure that PricewaterhouseCoopers brought AIG to heel. It had clean opinions on [AIG's] internal controls last year. If now we have a failure, they have to say there's a material weakness. So I don't know that they're "getting tough' now.”

Still, in his comments to Reuters, Mr. Di-Piazza implied that he's going to continue to get his hands dirty: “I will not underestimate the challenge we have working through a lot of complex securities and getting them valued,” he said. “We have to ask the question: What's under the surface?”

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Monday Update

Several new comments were posted over the weekend. My friends and family are getting a little irritated with me always on my Blackberry in the evenings. They think I have a secret boyfriend that I'm texting at all hours (wink, wink, nudge, nudge, say no more...) when actually it's my desire to post all the comments right away, which I can do while mobile.

So please check them out and join the dialogue, here and here, in particular.


Dennis Howlett over at Accman mentioned me today with regard to to focus and the importance of it when writing a blog. To gain an audience, I've found, it is absolutely necessary to focus. There's too strong a temptation to react to everty remotely interesting story with a post and I have tried to avoid that. I try to always bring it back to the Big 4. I will continue to try.


It's clear to me there is no other voice quite like mine raising these issues. Last week, I posted my 400th post. Having just started the blog in very late 2005, I think that's a lot of fairly interesting, quality content on the Big 4 and the accounting profession as a business.

Sometime a week or so ago, I also passed the 100,000 page views mark. The last few weeks have seen traffic double, then triple on a daily basis and I had three days in a row last week of unbelievable traffic, the likes of which I hadn't seen since the Patrick Fitzgerald posts. I can't point to any one thing that's driving it. There was no blockbuster link from a major media publication, for example, just more and more people reading more and more for a longer and longer time.

I thank you for your interest and attention.

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PwC's SocGen Report - Nothing New To Report

We should not be surprised that the PwC-assisted preliminary investigative report on the Kerviel - SocGen trading scandal is a superficial treatment, supporting management's theories and painting a picture of a bank generally "under control", with some low level management that could have performed better. But the picture is essentially one of a bank victimized by a "rogue trader." It's as management wants it to be and that's what PwC and the rest of the Big 4 get paid to accomplish.

The appointment of PwC, a non-independent party to the this mess, was done too quickly and the report comes to simpleminded conclusions too quickly, conclusions intended to scapegoat a poor working guy who just wanted to taste some of the French champagne and beluga cavier via a hard-earned and, it looks, deserved bonus. Watch for more subprime and other losses to come out of this bank once the Kerviel red herring has played out.

...An internal investigation by the bank, published by a three-member committee of inquiry, found that operating staff "did not systematically carry out more detailed checks" of Kerviel's long-standing activities which only came to light on January 18. SocGen was alerted by European derivatives exchange EDurex to strange dealings by traders as early as last November and has been charged by the French government and the Bank of France with failing to follow up on these warnings or commit enough trained staff to handle risk management.


The 20-page "progress report" published by the committee headed by former Peugeot Citroën chief Jean-Martin Folz also pointed to "the absence of certain controls that were not provided for and which might have identified the fraud". It comes on the eve of SocGen's annual results which are provisionally expected to show a net profit of €947m after accounting for the €4.82bn loss engendered when the bank "unwound" Kerviel's positions and a further €2.05bn losses related to the sub-prime crisis. Investors and analysts will scrutinise the figures to see if they indicate wider deficits, notably regarding the sub-prime related market and subsequent credit crunch.


SocGen has accused Kerviel, a 31-year-old back office administrator turned would-be star derivatives trader, of being a "fraudulent genius" who acted alone. But Kerviel, who is being held on remand in a Paris prison, has not been charged with fraud.


The report backs SocGen's main argument that Kerviel acted alone. It says: "At this stage of the investigations there is no evidence of embezzlement or internal or external complicity (ie the existence of a third party who knowingly assisted the fraudster to conceal his positions)."...

It also suggested that "on the whole" the bank's internal controls "were carried out in accordance with the procedures but did not make it possible to identify the fraud before January 18 2008".


The report reiterated that Kerviel started building up unauthorised trading positions in 2005 and 2006 for "small amounts", but they got bigger from March 2007 onwards.
The SocGen report reveals that Kerviel got a €60,000 bonus for 2006. He asked for a €600,000 bonus for 2007, after building up a €1.4bn profit but instead received half that. Leaked judicial documents suggest he had been sitting on a €2bn loss six months earlier. The report said Kerviel's deception included rogue deals on warrants with a deferred start date and futures contracts.

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Refco Execs' Pleas May Ease Auditors' Worries

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Although the Refco story is a global one, it is also a local one for us in Chicago. These guys were the quintessential "big swinging dicks."

As I've mentioned before, Grant Thornton and PwC stand to lose big if the lawsuits naming them ever come to trial. They may still lose big when, not if, they settle.

But they may have been given a gift with these guilty pleas. Having the principal actors admit as part of their plea that they "deceived" everyone is a potentially useful tool for the auditors' defense attorneys.

However, whether this "We were deceived" crap works from a purely legal defense perspective or not, I don't buy it. One of the first things they teach you in "auditor school" is the concept of professional skepticism.

Beginning with the codification of its first professional auditing standards (see SAS 1) the accounting profession has recognized the importance of skepticism in performing audits. Early audit standards defined skepticism as an attitude that includes a questioning mind and a critical assessment of audit evidence, which was often interpreted as neither assuming managerial honesty nor dishonesty. Recent audit failures have caused the profession to reassess and emphasize the importance of skepticism during an audit engagement, requiring auditors to "increase" their level of skepticism. Auditors are now asked to expand their skeptical perspective to the level used by forensic experts, which assumes that management is dishonest unless there is evidence to the contrary (POB 2000 p. 88; SAS 99, 2002).

This is a much higher standard than, "Trust but verify." But does anyone believe that the Big 4 view their "clients" with professional skepticism, assuming management is dishonest until it's proven otherwise? The problem is that the client is management instead of the shareholders, the party to whom they really owe this higher duty.

From Bloomberg:

Refco Inc. ex-finance chief Robert Trosten admitted he helped hide hundreds of millions of dollars in debt, becoming the third person to plead guilty in a fraud at the futures trader that cost investors more than $2.4 billion. Trosten, 38, entered his guilty plea to fraud and conspiracy charges today in Manhattan federal court, a month before he was to go on trial for deceiving banks, auditors and investors, including Boston-based buyout firm Thomas H. Lee Partners LP. He agreed to cooperate with the government in exchange for leniency at sentencing and to forfeit $2.4 billion plus property he owns....



Refco former Chairman and Chief Executive Officer Phillip Bennett pleaded guilty Feb. 15 to helping run the scheme and faces life in prison when he's sentenced in May. Trosten's plea leaves two men who face trial for their roles in the fraud. Former Refco President Tone Grant goes on trial March 17, and ex-Refco outside lawyer Joseph Collins faces a separate fraud and conspiracy trial. Both deny wrongdoing. Another ex-Refco executive, Santo Maggio, former CEO of the firm's offshore unit, pleaded guilty to fraud in December and agreed to cooperate with prosecutors...


Trosten said he helped make it appear as if the funds were owed to Refco from ``third-party customers,'' and not from a ``related-party entity.''


``I agreed with other Refco executives to hide the true nature of Refco's finances,'' Trosten said today in court.

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The Big 4 And The Ratings Agencies - A Self-Fulfilling Prophecy?

Earlier today, I pointed you to an article by Jake Zamansky on the role of the ratings agencies in the subprime crisis.

I would also point you to Jim Peterson's take on the issue. Jim concludes with some great points, too.

Whatever the defensive spin and the persistent denial of the deepening conditions of adversity, problems yet to ripen mean that we are not yet even approaching what Winston Churchill termed the “end of the beginning.” ...The agencies themselves are touting a menu of fixes, from Moody’s proposal to replace letter ratings with numbers – arguably no more than a switch from illiteracy to innumeracy – to massive downgrades of mortgage-backed securities with knock-on effects for other debt portfolios and the entire bond insurers speciality, to the blame-the-user invocation by Standard & Poor’s of more “investor education.”

But should the ratings agencies feel confident of dodging the bullets? Two lessons in history suggest not. First, the closely analogous model of the auditors’ participation in the securities marketplace has brought them to grief, with multi-billion dollar litigations threatening their very survival. Second, both plaintiffs’ lawyers and legislators, inspired by Sarbanes-Oxley, will pick on proximate targets. That’s where they will both fix the blame and aim their fire...

But let's back up a little bit.

Let's bring the auditors into the picture.

From the WSJ:

...Are the ratings agencies always the last to know, or just the last to acknowledge a problem? The agencies point out that they rely on facts presented by issuers, and that they are not responsible for conducting due diligence. In other words, if S&P and Moody's are asked to rate a pool of mortgage loans, they don't actually examine any of the individual mortgages within the pool. An S&P spokesperson tells us, "We are not auditors; we are not accounting firms." So if all the information about the assets underlying these bonds comes from the person selling them, and the credit rating agency never verifies any of it, investors might ask, what exactly does the rating agency provide? An opinion...

But does it get any better for the investor if the audit firms are involved in the process?

No way, José !

I have criticized the audit firms for their "too little too late" response to their banking and financial serviccs clients' accounting issues related to the subprime crisis. They're all involved in all of them. So if the auditors are supposed to be certifying financial statements and giving assurances on companies that are issuing mortgages and later mortgage-backed securities and the ratings agencies are counting on those disclosures, without doing their own due diligence to ascertain that those ratings are justified, who is monitoring the authenticity, integrity, and financial viability of the ratings agencies' business model?

That's right.

The Big 4.

The three largest ratings agencies, S&P (part of McGraw-Hill), Moody's, and Fitch (part of Fimalac, a French company) are all public companies that issue Big 4 certified financial statements. So the Big 4, that's right - only four firms, are on all sides of the equation:

1) They audit the companies that create the mortgages like New Century, Countrywide, Northern Rock and American Home.

2) They audit the firms that create, market and invest in the collateralized mortgage obligations such as Bear Stearns and Citibank and Merrill Lynch.

3) They audit the ratings agencies that put the seal of approval on the credit risk insurers and the securities for sale to the investor public.

4) They audit the monoline credit risk insurance providers MBIA (PwC) and AMBAC (KPMG).

And the ratings agencies rate the credit risk insurers.

From AMBAC's web page:

Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose affiliates provide financial guarantees and financial services to clients in both the public and private sectors around the world. Ambac's principal operating subsidiary, Ambac Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned AAA ratings from Moody's Investors Service, Inc. and Standard & Poor's Ratings Services and a Aa rating from Fitch, Inc. Moody's has placed Ambac's AAA on review for possible downgrade. Standard & Poor's has placed Ambac's AAA rating on "negative outlook." Fitch has placed Ambac's Aa rating on “rating watch negative.”

The auditor for Moody's has been PwC for a long time .

The auditor for Fimalac, owner of Fitch, has been PwC for a long time .

The auditor for McGraw-Hill, owner of S&P, has been E&Y for a long time .

All recent opinions for all three are clean.

Dontcha think that the audit firms should have had some kind of insight into how the pieces did or didn't fit together? Or did they just take the enormous amounts of money and run?

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KPMG "Hero" In Credit Suisse Mess?

Do tell.

Can this be true?

Credit Suisse sent a new and unwelcome shiver through financial markets after suspending a "small number" of traders suspected of inflating the value of asset-backed investments by $2.85bn (£1.5bn)...Credit Suisse's announcement was triggered by disclosure requirements relating to the listing of a $2bn bond. According to Mr Wheeler, the auditor, KPMG, discovered the mismarkings and errors during an audit for the bond issue and subsequently refused to sign off on the review. The bank declined to comment.

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Jake On The Rating Agencies

Another great review from Jake Zamansky on the role of the ratings agencies in the subprime crisis.

Investors: Beware any time a market player has a government protected, exclusive franchise to print money.

My take on this from the perspective of the Big 4 later coming later today.

Ordinarily we would just let market forces deal with such failure. However firms like Moody's, Standard & Poors, and Fitch are granted special competitive advantages because they are part of a select group of eight companies designated as Nationally Recognized Statistical Rating Organization (or "NRSRO"). Based on their record, the government should not be protecting them.

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More Big 4 Layoffs

If you were directed here by Google Search while looking for info on the latest Deloitte layoffs, go here for my more recent, August 2008 post.

****************************
From the weekend mailbag...

Do the incoming recruits get to use d'street?

Dear Ms. McKenna,

I was just reading about the PwC layoffs, and couldn't help but wonder if you knew about anything coming down the pike at Deloitte? They are really dragging their feet when it comes to giving out start dates to their new hires, and a few of my friends that work there are mum on the topic. I sent a friend an email asking if she was aware of any internal discussion about layoffs/ downsizing, etc. and she gave me a one line reply that was very out of character for her. And the recruiters are taking pretty long to answer any emails about the topic.

Seem's fishy. And they just displaced almost a 1,000 kids on visas, if I remember correctly...

Thanks...


Dear Reader:

There have been an enormous amount of google searches re: Deloitte layoff ( in particular from readers at Deloitte) bringing people to my PwC posts. Add to that, friends here in Chicago have been asking me the same question you are. It doesn't look good. They did screw the H1-b visa holders, too. That, I believe, is unconscionable.


Dear Ms. McKenna,

[Thanks for your quick response. ] You are one about the only person out there willing and able to cut through the bullshit, smoke and mirrors. Thank you for that.

I would also add the following, in reference to my initial comment: My counselor during my [Deloitte] internship left recently and moved to [another Big 4]. I looked her up and was talking to her today, and she mentioned that all the firms are slimming down, but that she hasn't heard of offers being rescinded, mostly because internally they are afraid it will give them a "PR black eye." (Her words.)

Dear Reader,
Yes, rescinding offers is the worst. Unfortunately, that's going to result in cutting new 2nd and 3rd years if the partners have not forecasted their staffing requirements well. But, that's why they call it "leverage."

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Blogs And Romance

A delayed response to that "contrived holiday for those who don't express their emotions spontaneously."





This may be my first foray into "monetizing" this blog...





So what's the re: The Auditors man or woman like?



From the blog, www.nextweb.org

...somebody who reads The New York Times would never date anyone who started the day with The New York Post. It goes for magazines too, a FHM man doesn’t want a high-brow New Yorker reader to spend his life with.
Right?



If you think of it that way, blogs could easily start dating services as well. They discuss a specific hobby, passion, business or sports team etcetera and differentiate from each other by using a different tone of voice and design. If you’re an eligible bachelor in London, it mustn’t be that hard to meet an attractive tech-minded girl (correct me if I’m wrong guys), yet when you live in Liverpool you might need some help finding one. Wouldn’t it be great if a TechCrunch UK dating service came to the rescue?



Moreover, blogs have a big advantage compared to newspapers since they allow interaction between readers. You can judge on beforehand whether you like his or hers opinion on certain matters. Want some diversity? Check out an article that discusses an important topic and see if he or she has as totally different view on things.



One doubt about dating on blogs, I’m not sure about the man/woman ratio though as male readers are probably still a majority...

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David Walker Sells Out

I'm obsessive about looking at my stats and the searches that bring people to my site. A few minutes ago, someone for the General Accounting Office Googled "David Walker Resigns."

Well, here's the scoop:

David M. Walker, head of the Government Accountability Office since 1998, is resigning to become president of a new $1 billion private research foundation, the GAO said Friday. Walker, 56, will step down as GAO comptroller general on March 12 to take over as president and chief executive officer of the Peter G. Peterson Foundation.


Peterson, senior chairman of The Blackstone Group and former Commerce Department secretary, has pledged to contribute $1 billion over the next few years to the foundation, which is to focus on such national sustainability issues as entitlement program and health care costs, trade and budget deficits, energy consumption and the education system.

Blackstone and its cronies suck in another audit guy. It's no wonder Mr. Walker presided over such an impotent set of non-action items in the GAO's latest report on the "competitiveness" of the Big 4.

No way he'd upset the status quo.

How come no one asked why?

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Future Plans

I wanted to extend the invitation to my readers to meet in person when I take a road trip to New York and Washington DC at the end of March. I will be attending the American Chamber of Commerce's 2nd Annual Capital Markets Summit on March 26, 2008.

My tentative plans are to be in Manhattan on March 23-25 and Washington DC on 26-27.

Please email me at retheauditors@gmail.com to discuss logistics. I am looking forward to meeting you.

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WSJ Swallows Big 4 Public Relations

Update: At least Bloomberg isn't buying the Big 4 firm PR line. They cared enough to give us the detail on PwC.

American International Group Inc., the world's largest insurer by assets, fell the most in 20 years in New York trading after its auditor found faulty accounting may have understated losses on some holdings.

So-called credit-default swaps issued by AIG, which protect fixed-income investors against losses, declined by $4.88 billion in value in October and November, four times more than previously disclosed, the company said today in a regulatory filing.

AIG said Oct. 11 that it rehired PricewaterhouseCoopers after considering other auditing firms as part of its February 2006 settlement with then-New York Attorney General Eliot Spitzer.

PricewaterhouseCoopers, AIG's auditor for more than two decades, had approved financial results from 2000 to 2005 that were restated amid Spitzer's probe, lowering earnings by $3.4 billion. AIG in 2006 agreed to pay $1.64 billion to end probes of its accounting and sales practices under Greenberg.

David Nestor, a spokesman for the accounting firm, and Ken Frydman, a spokesman for Greenberg, declined to comment.
*******************************************

I've been complimentary of the WSJ lately, in particular of the WSJ Law Blog. Despite everyone's concerns about Rupert Murdoch taking over, it seems that the WSJ has been out of the gate fast and hard with stories about Wal-Mart, for example.


But just as I was about to give up looking for a good story for Wednesday's post, I came across this piece of cotton candy fluff. I usually don't show the journalist's name when I reprint segments of the story. You can look that up with the link. But when a journalist does an exceptionally poor, an exceptionally stupid, or an exceptionally good job of covering the story, I want you to know right away who it is. In this case, this is not the first time David Reilly has disapponted me.


This piece of "journalism" seems to have been dictated directly by Deb Harrington .


After Losses, Auditors Take A Hard Line
By DAVID REILLY


Many big Wall Street firms were asleep at the switch in the years leading up to the credit crisis. At least another group -- the auditors -- seems to be minding the store.
They fell down badly during the tech-stock bubble, but their standards seem to be pretty tight these days.



The most recent evidence: The apparently hard line taken by American International Group Inc.'s auditor, PricewaterhouseCoopers, when it came to how the insurer valued credit default swaps -- which are contracts AIG wrote as insurance against default on securities sometimes linked to subprime mortgages. That resulted in AIG upping its loss estimates for these contracts by about $3.6 billion, a move that shocked investors and sent its stock plunging.



Markets tend to be healthier when auditors insist that companies value their assets conservatively. (Blogger Note: Duh Di Duh Duh!)


The result: Investors can place more faith in the numbers they are getting.



There's other evidence that auditors have been on the job. Companies aren't restating previously reported results as much as they used to. Restatements fell in 2007 for the first time in the post-Enron era, according to separate studies by research firms Glass Lewis & Co. and Audit Analytics. Audit Analytics said the number of restatements in 2007 was 1,237 compared to a peak of 1,801 the year before. Glass Lewis said the number of companies restating fell to 1,172, compared with 1,346 in 2006. Back in 2001, as the last financial crisis gathered steam, there were only about 600 restatements...


I guess Mr. Reilly has not considered the fact that PwC has been AIG's auditor for a while. In fact, they were just reappointed with the blessing of Arthur Levitt, in spite of having advised and approved previous valuations and presided during the period when they were investigated and fined by the New York Attorney General.


I guess Mr. Reilly also forgot that the auditors were the ones that advised and approved on the accounting for all of their clients that went through all of those restatements. I don't think the supposed reduction in restatements is so much due to the fact that the auditors are getting tougher. After all, they are still asking to be able to use their judgement finally instead of just ticking the boxes. They want auditor liability caps before they start using any judgement.



I think the reduction in restatements is because the firms are tired of arguing with their clients and getting fired or resigning. Just look at Pwc and AIG. PwC is hanging on despite being sued by their client and being the one who presided over all of their other messes.


It would be nice if the traditional media did not disguise PR as reporting. The markets and investors would be better served in not being encouraged to have confidence in what has become worthless paper - the auditor's annual certification of financial statements.

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PwC Layoff - Paying The Pesky Employees To Go Away

[When you see] the FAQs they distributed, you immediately notice the part with regard to Severance Packages. In fact, the Severance offer that was in the original FAQ for Wave 1 (and was promised throughout all 3 waves) was majorly, severely changed by Wave 2.

Every once and a while I get a call from a friend or family member who has been terminated who wants to know what they should do about it. It's a very common phenomenon amongst all kinds of professionals anymore, ostensibly both for some type of performance reason (either the company's lack of performance or the employee's,) or for no reason whatsover than can be discerned readily.

In most cases, it's too late to do anything except move on. In many cases, the employee has been presented with some kind of "package" that most often includes a waiver of rights to sue. They want to know if the amount and terms offered are "fair" or if they should get a lawyer and "sue the bastards."

I am an independent consultant and writer for many reasons, not the least of which is I never want to work again for someone that is not of my choosing. I work now under my terms and with a level of detachment and independence that is not possible under most employer-employee relationships. I would also never work for anyone else again without an employment contract. Even at the highest levels, (short of officer-level in a public company) this is not as common as you might imagine. In the US, except for those covered by a collective bargaining agreement, (union workers) most employees are employed "at will".

An employee is employed "at the will" of the employer for as little or as long as the private employer wishes, and in whatever lawful capacity the employer requires. The employee may choose to work at the employee's will for the length of time he or she desires. An employer need not provide any reason for terminating an "at will" employee, so long as the termination isn't unlawful or discriminatory (based on age, sex, national origin, disability).

Reasons for terminating an at-will employee may include, but aren't limited to:
-Merger
-Workforce reduction
-Change in company direction and business focus
-Poor company performance

In spite of this seemingly cold, detached relationship, various companies, sometimes voluntarily and sometimes per state law, have established severance policies to compensate employees who are terminated for reasons other than the most egregious ones such as unlawful behavior.

(However,) the ECI data indicate that severance coverage in the United States was incomplete in 2001. Only one-quarter (26 percent) of the full-time workforce was covered by a formal severance plan in 2001, with large differentials by occupation, work hours status, firm size, and industrial sector. Occupationally, 42 percent of professionals and administrators were covered, but only 29 percent of clerical and sales workers, and 16 percent of blue-collar and service workers.

There is considerable evidence, historical and current, that severance coverage (in the US) is primarily motivated by employer desires to limit the morale impact on the remaining work force of negative job actions...

Severance is a common concept everywhere but the US. Elaborate processes that insure that employees are treated fairly when terminations and lay offs occur are taken for granted outside of the US. Just look at Jerome Kerviel of SocGen fame. Have they fired him yet?

The Bureau of Labor Statistics provides this definition of severance pay:

“Monetary allowance paid by employers to displaced employees, generally upon permanent termination of employment with no chance of recall, but often upon indefinite layoff with recall rights intact. Plans usually graduate payments by length of service” BLS (1998, p.61). Although these payments may be distributed as a lump sum or as a series of periodic payments or “continuation of pay,” they are distinguished by the fixed sum nature of the employer’s financial commitment.

SEVERANCE

From the July 18, 2007 FAQs

Has the approach to severance changed for Wave 2?
Yes. At the outset of the SSR process earlier this year, we made several Wave 1 decisions that we have since revisited, as we have had the opportunity to reflect on some of the unintended outcomes of the process. One area where we have applied the lessons learned from Wave 1 regards our severance practices. Our approach to severance took into consideration both the needs of our business and the needs of our people, and we will continue to look at that balance. We designed our approach to severance to provide assistance to those individuals who were not matched to a role based on the reorganization and to support their search for a job outside of the Firm. The spirit of our policy was also to provide it in the manner of a Great Place to Work organization.

For Wave 2, we will continue to provide "enhanced" severance to those who are not offered a role as a result of the matching process. In addition, we will provide the enhanced severance to those who are matched but decline a role that has "significantly different" responsibilities, is in another location, or is at a lower grade level or has a lower level of compensation. (Decisions or questions as to what constitutes a "significantly different" role will be determined by the appropriate IFS functional leader and Gary Pell.)

As previously communicated, the enhanced severance package is calculated based on current level and years of service. It combines the "standard" severance benefit and is enhanced by a number of additional weeks of compensation based on overall years of service. The enhanced severance package also includes additional healthcare allowance related to COBRA benefits and outplacement assistance.

If I am not matched, what severance package can I expect to receive?
All employees that are not offered a position as a result of the matching process in their function's Wave will receive an enhanced severance package. This enhanced severance package has been used previously by PwC and includes additional benefits beyond the standard package, such as a number of additional weeks of compensation based on overall years of service. The severance package also includes additional healthcare allowance related to COBRA benefits and outplacement assistance. Any individuals not matched to a role will receive a comprehensive package of information about their severance benefits.

What if I decide not to go through the talent assessment process or am matched but decline an offer?
Those individuals who opt not to go through the talent assessment and subsequent matching process, but who agree to stay on and continue to add value through the transition period, or who reject a comparable role at the same salary, level and in the same location, will be eligible to receive standard severance.

Those who choose to leave the Firm prior to the transition will be treated just as any other employee who resigns, and, consistent with our policy around resignation, will not be eligible to receive severance benefits.

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Say No To Auditor Liability Caps

I have consistently disagreed with the Big 4's claim that auditor liability caps are necessary to avoid losing one of the remaning firms to catastrophic litigation.

I have lamented the fact that the auditors don't get sued often enough for my tastes and, when they do, they often settle.

I've also said that they don't deserve our pity, as they are less than transparent regarding their true financial capacity to address ongoing litigation.

While cruising around the news sites and blogs today, I ran acoss the site for the US Treasury's Advisory Committee on the Auditing Profession.

In case you didn't know that someone is thinking really hard about this issue:

"The Treasury Department established the Advisory Committee on the Auditing Profession to examine the sustainability of a strong and vibrant auditing profession. "

The inaugural meeting was in October of 2007. Their third meeting was held on February 4th, 2008. One of the speakers was John P. Coffey, the Co-Managing Partner of Bernstein Litowitz Berger & Grossmann LLP, a fifty lawyer firm with its principal offices in New York and San Diego.

I was glad to see Mr. Coffey agrees with what I have been saying on this blog all last year.

It is with this perspective that I address one of the questions the Committee is
considering, namely, whether there ought to be a cap on auditor liability. I respectfully submit
that the case for such a cap has not been made...

...the fact that, in today’s environment, auditors are rarely named as defendants in these actions. In a three-year period immediately before the PSLRA was enacted – April 1992 through April 1995 – auditors were named as defendants in 81 of 446 private securities class actions filed, for an average of 27 suits per year, or 18% of all private securities class actions.

As the reforms of the PSLRA and the concomitant jurisprudence took hold, that number dropped precipitously. Auditors were named as defendants in only five suits in 2005, and only two cases in each of 2006 and 2007.

The number for 2007 is especially telling because approximately one out of every eleven companies with U.S.-listed securities – almost 1200 companies in all – filed financial restatements in 2007 to correct material accounting errors. Further, an analysis of securities actions filed in 2006 and 2007 demonstrates a significant decline in the number of cases alleging GAAP violations, appearing to suggest “a movement away from the focus in recent years on the validity of financial results and accounting treatment.”

Analysis of settlement payments by audit firms as a result of the cases filed during the recent “corporate crime wave” further confirms that claims of catastrophic liability exposure are exaggerated. Despite several multi-billion dollar scandals involving false financial statements of client companies, audit firms avoided suffering any serious blow, let alone any catastrophic threat. Our survey of settlements indicates that, if audit firms paid at all, it was typically a fraction of what other market actors paid. (A statement we frequently hear in settlement discussions is that Big Four firms will not pay a settlement that is more than 10% of what the issuer audit client paid.)

...The failure to assess reasonably the supposed litigation risk to audit firms is coupled with another material defect in the case for a cap on auditor liability: the absence of any meaningful exposition of the financial wherewithal of these firms to pay a potentially large verdict.

Notwithstanding their plea to be treated more leniently than other market actors, audit firms do not publicly disclose their financial status like issuers or investment banks, and it is not possible to assess whether the claim of vulnerability to “catastrophic liability” has merit...

Another important piece of any analysis of an audit firm’s financial vulnerability is an
assessment of available insurance. Here, too, the essential facts remained obscured. Audit firms have not been sufficiently forthcoming on matters such as the amount of coverage from classic insurance underwriters or their efforts to self-insure. As for the latter, audit firms appear reluctant to explain why more of the cash they chose to distribute to partners year-in and year-out cannot be set aside in reserve for the litigation charge they seem so assured is coming.

In making a plea for special treatment based on what they claim is financial peril, it is incumbent on the audit firms to be forthcoming about their true financial capacity to withstand a “mega judgment.” They have not to date, and appear unwilling to do so in future. That alone should end the discussion.