Turn, Turn, Turn – Turner Does About Face re: The Auditors

Lynn Turner was the chief accountant of the SEC from 1998 to 2001, working for Commissioner Arthur Levitt, Jr.  Before that he served as CFO for Symbios Inc., an international manufacturer of semiconductors and storage solution products, and was a partner at Coopers & Lybrand (now PwC). He is currently a professor of accounting at Colorado State University, a consistent speaker on accounting and financial reporting issues and a constant member of all of the study groups, task forces and advisory committees.  He has been a reliably outspoken critic of the hypocrisy that often passes for the Big 4 audit firms’ policy statements, marketing efforts, and public relations.

Turner recently spoke, with Conrad Hewitt and the New York Times’ Floyd Norris, on a panel discussion in New York [March 4] hosted by Pace University’s Lubin School of Business.

As reported in CFO.com, Turner made some surprising statements.

“…During the discussion, Turner disputed a suggestion from moderator Floyd Norris of The New York Times that the accounting profession should shoulder part of the blame for the financial crisis. Instead, he criticized the Financial Accounting Standards Board for writing rules enabling companies to inappropriately dump securitized assets into qualified special-purpose entities.

Actually, Turner said he gives credit to “practicing accountants” — financial-statement preparers and auditors — for overseeing a dramatic falloff in financial fraud cases compared to the years immediately following the Enron and WorldCom scandals. “There’s a change from 10 years ago, and accountants do deserve some credit,” he said. “Certainly some of the audit firms get a lot of credit for what they’ve done in standing behind fair value and trying to get the numbers right.”

Unfortunately, as the current market crisis and credit crunch continues, new fraudulent investment schemes seem to be surfacing on a daily basis. A bad economy and unravelling frauds seem to go hand in hand. Like cockroaches scattering as soon as the lights go on. Many of the schemes being uncovered now have been going on for years. All the way back to when Lynn Turner worked for Arthur Levitt at the SEC…

Tom Gorman, a partner at Porter Wright who writes about securities law and SEC enforcement at SEC Actions.com, doesn’t think that fraud went away after Sarbanes-Oxley.  Just that it’s been hiding, obscured by lack of sufficient budgets for investigation and enforcement. 

“Key areas of emphasis for the [SEC] enforcement division in 2008 included the FCPA, insider trading and financial fraud. In the last few years, the SEC and DOJ have brought increasing numbers of FCPA cases and reportedly had a large inventory of open investigations in this area at year end. Likewise, the number insider trading cases being brought has continued to increase, while financial fraud will undoubtedly be a key area of emphasis in view of the current market crisis.” 

And:

The Market Crisis Continues To Spawn Financial Fraud Cases 

The market crisis continues to send stock prices to new lows. It is also unraveling fraudulent investment operations and schemes at a record pace. In recent weeks, the SEC has brought a stream of cases against Ponzi schemes and other fraudulent funds and operators who, like Bernard Madoff, have been exposed by the collapse of the finance markets.

Lynn Turner is giving accountants credit for the fact that the regulators were understaffed, under funded, and perhaps rather unenthusiastic about responding to tips and complaints regarding potentially fraudulent activities? Even though the auditors themselves keep saying they’re not responsible for finding fraud.  When fraud occurs, they are as much a victim as the shareholders, they say. 

Per an Accounting Web article in September, 2007: 

“In a November 2006 report, Global Capital Markets & the Global Economy, the CEOs of the six largest audit firms stated ‘there is a significant expectation gap between what various stakeholders believe auditors do, or should do, in detecting fraud and what auditors are capable of doing at prices companies or investors are willing to pay.’ The CEOs point out that fraud detection methods recommended under SAS 99 are not perfect, and that auditors are often restricted in their methods to detect the red flags of fraud. As an example, the CEOs cite the limitation of using indirect means during the audit, such as reviews of anomalies and interviews not conducted under oath, to ascertain if the possibility of fraud exists.” 

It seems quite a change of heart; completely uncharacteristic of Mr. Turner to give the audit firms such a big pass. This “new” Lynn Turner stands starkly in comparison to the Lynn Turner I had grown to respect as the voice of opposition to all of the “more of the same” discussions I’ve listened in on at PCAOB Standing Advisory Committee meetings, and other forums.

I was so proud to be included in the same article published by BNA regarding FAS 5. He never disappointed me with his comments about the “have your cake and eat it too” attitude of the Big 4 with regard to the global networks.  So his opening statements at the Pace University Breakfast Club made me gasp.  He sits comfortably, leaning back in his chair in this video, with his investment banker blue with a white-collared, French cuff shirt and utters the unspeakable:

Floyd Norris asks: In hindsight, what should have been done differently?

Turner: I don’t think the accountants were the people making the loans here.  So I don’t see the accountants as being the responsible party.  I see the mortgage brokers bankers who made the loans, those on Wall Street who participated in securitizing in some cases was clearly unsuitable paper to be selling on Wall Street. And to some degree I also think the regulators bear some responsibility. I would tell you the Fed and OCC bear a tremendous amount of responsibility…

It’s, therefore, an amazingly apposite and evocatively contrary position from the one he took immediately after Enron. In April of 2002 he told Frontline correspondent Hedrick Smith that the accounting firms were in integral part of the process of “financial engineering,” specifically the structuring of off-balance sheet vehicles that we learned so much about in Enron. Have things really changed that much since? Of course not.  His audit firm training ground, PwC, is the “financial engineer” for Northern Rock, AIG, Goldman Sachs, Barclays, JP Morgan, and Bank of America.

Frontline: How did those off-books partnerships get set up? Do people meet in Wall Street? Are there teams that get together? I mean, what happens?

Turner: If a company comes up and decides it wants to do some [financial engineering] and keep it off balance sheet, quite often they will have a financial advisor. That may very well be one of their underwriters, one of their investment banking firms, one of the well-known Wall Street firms. They will get together and it typically, it is in a room with the investment-banking firm there, the CFO, the company management. They’ll bring the auditors in, because you certainly want to know how to account for it.

And everyone will kick around the table, “How do we accomplish this, our goal as a company?” If I was still a CFO, it would be, “My goal as the CFO is to borrow this money, turn around and keep it off my balance sheet and get it to the lowest possible cost. You, the investment banker, you, my audit partner, I need you guys to go figure out how to do it and come back and tell me how to do it.”

Frontline: Well, what about in your accounting practice? You worked at Coopers & Lybrand. What kinds of things were being done when you were working on Wall Street for an accounting firm? I don’t mean specific cases, but the technique.

Turner: All the Big Five accounting firms have a group of accountants kind of like a financial services group, and that group of accountants works with Wall Street. In my prior life, we actually had a retainer arrangement with each of the major Wall Street investment banking firms under which we would help them financially engineer or structure hypothetical transactions for finding financing, keeping it off balance sheet, making companies look better than, quite frankly, they really were.

In this part of the interview, Turner describes how the mindset of the accounting industry has evolved from looking out for investors to looking out for business.

Frontline: So what’s the mindset in these companies? What’s the mindset in Vinson & Elkins, the law firm? What’s the mindset in Andersen, the accounting firm? What’s the mindset in Goldman Sachs, or Merrill Lynch, the investment bankers, when they’re dealing with Enron?

Turner: Having been in one of these Big Five international accounting firms, I can tell you that over the last 10, 15 years, the mindset has evolved from one of looking out for the investor and placing their interest first — because [auditing] is truly a public function, a public franchise — to one of, “We’re a great big international business, and business comes first. And that translates into how much revenue, how much profitability can we get out of each of these companies; not just Enron, but each of these audit clients.”

… They used to be principally auditing firms. Today they are a business firm, and the CEOs and culture at the top of these firms is, “What can we do make our business more profitable?”….You’ve got an audit partner, an auditing firm …where the auditors honestly believe the management team is their client. It’s not the board of directors. It’s the management team. The management team pays their fee. They know it’s the management team that will give them — or not give them — additional consulting revenues.

The partner knows that, to the extent that he builds a practice, that impacts his compensation, because his compensation is built in part on how much he’s able to sell in consulting. He knows consulting grows for him faster than just the audit fee.

So again, following the cash, the auditor is beholden to the management team. His job — especially once you start doing consulting — is to make that management team look as good as possible. You don’t make the management team look as good as possible when the audit partner turns around, runs to the board of directors and says, “Look at all these problems with these people.”

He also has in the back of his or her mind that if he goes and tells the audit committee, or tells the board of directors, about all the problems that are going on, that, quite frankly, that management team, given the power they have in some of these companies, they would very well just do away with them. And if they’re here today and gone tomorrow as the auditor for a firm, within their own firms I’ve seen situations where the audit partners, when they lost a big client like that, were here today and gone tomorrow, as well. …

Frontline: So the watchdog doesn’t bark, because they could wind up biting itself?

Turner: Yes. …

Frontline: If a company like Andersen is both fined by the SEC and hit by large stockholder suits in a case like Waste Management or Sunbeam, why does it then go ahead and get involved in the same kinds of problems in Enron?

Turner: What you’re really seeing, again, is — despite the fact of paying out tens, if not hundreds, of millions, having your reputation damaged by being charged with fraud, as it was in Waste Management, paying millions out to the government regulator — despite that, the number one priority in these firms, as you can see, is growing the practice, growing the business, maximizing revenues and take-home pay for the partners…