Kevin LaCroix D & O Diary: “On July 30, 2009, Eastern District of New York Judge Thomas C. Platt entered an order (here) preliminarily approving the settlement of the securities class action lawsuit that had been filed certain directors and officers of American Home Mortgage Investment Corporation and their auditors. The total value of the settlement is $37.25 million, which alone makes the settlement significant. However, the settlement is also significant because it appears to be the first subprime-related securities lawsuit settlement to which the target company’s auditors and offering underwriters contributed toward settlement.”
I’ve been following the trials and tribulations of the mortgage originators and their auditors for a while. I wrote about American Home Mortgage and Deloitte for the first time in August of 2007.
I’ve been talking about the mortgage originators for more than two years and more than one year before the sudden, unexpected, no one saw it coming, it’s a black swan, impossible to foresee “financial crisis” that hit us like a ton of bricks in the fall of 2008.
From my blog post, “It’s Deloitte’s Turn To Get “Sub-Primed“” of August 1, 2007:
The warnings have been coming steadily from American Home Mortgage, in sharp contrast to the rosy picture painted by New Century before it dropped off the cliff. They have also been increasing reserves significantly during this time. However, you have to ask the question whether there is something fundamentally flawed in the business model such that even lenders like American Home who don’t focus technically on the “sub-prime” market have been severely impacted by the US housing market slide.
One area they did potentially over concentrate on is the high loan-to-value, stated income loans that resulted in the great majority of their delinquency related charges. There were only three lenders who bought up 50% of their portfolio, Countrywide Financial Corporation, Deutsche Bank and Wells Fargo Bank, N.A. , which accounted for 20%, 19% and 11%, respectively, of total loan sales.
Yesterday’s announcement focused on the disappearance of their credit facilities. I really like the way they worded this, “…hindering of access…”
“American Home is currently experiencing a hindering of access to its traditional credit facilities. Additionally, American Home’s lenders have initiated margin calls in response to the decline in the collateral value of certain of the Company’s loans and securities held in its portfolio. The Company has received and paid very significant margin calls in the last three weeks and has substantial unpaid margin calls pending.
Notice the use of the term, “sub-prime” in the title. I was still hyphenating it. It was a new term, but not the first time I used it. That was on March 14, of 2007, before American Home, when I wrote about New Century Financial for the first time
New Century Financial, the US subprime lender scrambling to avoid bankruptcy, hit further troubles on Tuesday as it revealed that it was facing a preliminary investigation by the Securities and Exchange Commission and that it had received a grand jury subpoena from the Department of Justice. The struggling backer of high-risk mortgages revealed that it was under criminal investigation by the US Attorney’s Office in the Central District of California at the end of February. It had already admitted that the SEC had asked for a meeting…no matter how much auditing and disclosing goes on, we continue to see “rapid, unexpected declines” in once high-flying companies that suddenly teeter on the edge of bankruptcy, even though the best and the brightest are supposedly “Keeping Watch” for us as their auditors.
I have written about New Century (KPMG) and American Home (Deloitte) many more times.
August 3, 2007 American Home – A Self-Fulfilling Prophecy
August 15, 2007 Jonathan Weil in Bloomberg At Mortgage Banks, `Going Concerns,’ Going, Gone
“You think your job is tough? Think about the poor schlimazels from Deloitte & Touche LLP who blessed the books at American Home Mortgage Investment Corp., mere months before it went belly up.
The Deloitte accountants faced a crucial decision as they finished their audit work in March. Deloitte could resign and walk away. The firm could qualify its audit opinion by saying there was “substantial doubt” about American Home’s ability to continue as a “going concern” through the end of the year — as many short sellers already had concluded. Or it could give the company a clean opinion, expressing no doubt, which is what Deloitte did.
September 4, 2007 Deloitte and American Home – Have They Quit Yet?
September 7, 2007 Deloitte Disappoints – A Case of Subprime Interruptus (NovaStar)
I also wrote about more than once about Beazer (Deloitte), Northern Rock (PwC) and the burgeoning subprime malaise in Europe. This was all during 2007 and early 2008, before the “subprime crisis” turned into the “financial crisis” and the global recession.
But back to American Home Mortgage…
Kevin LaCroix characterizes the settlement as “significant because it appears to be the first subprime-related securities lawsuit settlement to which the target company’s auditors and offering underwriters contributed toward settlement.”
Yes. It’s the first to settle and include an auditor’s contribution. But the amount Deloitte has to throw in is equivalent to the partner’s monthly Starbuck’s budget. (The $37.25 settlement is actually a reflection of three separate settlement stipulations: a settlement of $24 million with ten individual defendants; a settlement of $4.75 million with Deloitte; and a settlement of $8.5 million with the seven underwriter defendants.)
Considering the $1 billion cloud hanging over KPMG for New Century, Deloitte was wise to settle American Home for a pittance to avoid any details going to trial. They can cross this one off their list. After all, Deloitte has a long list.
Because if anyone had cared to look more deeply, they would have found plenty of mistakes on Deloitte’s part to add fuel to the fire of a negligence or accounting malpractice claim. Deloitte had been warned by the PCAOB about its shoddy work on the 2007 audit of AHM.
From the PCAOB final report on Deloitte’s 2007 audits of 2006 fiscal year activity issued May 19, 2008:
In this audit, the Firm failed in the following respects to obtain sufficient competent evidential matter to support its audit opinion –
The Firm failed to perform sufficient procedures to assess the valuation of certain of the issuer’s privately-issued mortgage-backed security holdings, which the Firm assessed as possessing “low inherent risk” with respect to valuation, … The Firm failed to perform sufficient procedures to assess the valuation of the issuer’s mortgage loans held for sale…Firm failed to assess whether the issuer’s credit-based valuation approach for delinquent loans held for sale was appropriate given that the approach did not consider changing interest rates and market demand. The Firm failed to evaluate whether the issuer’s use of hedge accounting for interest rate swaps was appropriate…failed to perform procedures to determine whether the issuer had contemporaneously prepared appropriate hedge documentation in accordance with SFAS No. 133. The issuer calculated its allowance for loan losses by applying specified percentages to two categories of delinquent loans, determined by the term of the delinquency. The Firm failed to evaluate whether this method was appropriate The issuer transferred loans to intermediaries prior to their sales to the ultimate investors, and portions of the consideration to be paid to the issuer by the intermediaries were withheld pending the final sales…no evidence…that the Firm had analyzed all the terms of the arrangements…in order to evaluate what effect these terms may have had on the accounting for the transfer of these loans.
Sources tell me that Deloitte is still not off the hook with the SEC on this one. (AHM engagement team members were recently interviewed by the regulator.) Who knows if there were additional prior warnings by the PCAOB.
Between the 2007 and 2008 audits, Deloitte changed audit partners on the engagement. Tim Forrester was the partner on the engagement until 2007 before AHM collapsed. Gene Alliegro became the engagement partner while Tim still served as Advisory partner in 2007/2008. I was told by a source there was another engagement of his which also got reviewed and commented by PCAOB. Gene Alliegro is reportedly still with the firm.
However, Deloitte has a history of keeping partners who are under investigation, supporting the firm’s defense, or who’ve been sanctioned in non-Audit roles until whatever trouble they got into goes away or they serve no more use to the firm. I see Mr. Forrester here still identified in October 2008 as a Deloitte partner. Tim Forrester left Deloitte at the end of 2008.