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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