They Weren’t There: Auditors And The Financial Crisis

“When the power brokers of the business world meet, the accountants are never far behind.

While other industries have downsized through the turmoil of the financial crisis, the “Big Four” accounting firms — PricewaterhouseCoopers, KPMG, Deloitte Touche Tohmatsu, and Ernst & Young — will end the year with more employees than before the crisis started.  Despite a rocky decade that included the Enron scandal — whose accounting shenanigans also took down Arthur Andersen, then one of the world’s largest accounting firms — and the financial crisis, the accounting industry has emerged stronger than ever before.

“When I called the CEO of one of our very large clients in the U.S. — it would be inappropriate to tell you who — there was a time when you would call them and his secretary would say, ‘he’s very busy, he’s tied up in a meeting,’ ” said James Quigley, CEO of Deloitte. “What they say now is, ‘he’s on the plane right now — would you like me to patch you through?”

CNN’s Kevin Voigt from the APEC Conference November 12, 2009

Oh really?

Fellow bloggers Adrienne Gonzalez and Caleb Newquist have already ripped up this CNN interview.  We are all embarrassed for this journalist.  He listened to a bunch of horse manure orchestrated by the audit firms’ public relations flacks and they published it with no verification, challenge, or context.

That’s the other “expectations gap” we face as journalists when trying to add an independent, objective, and inevitably critical voice to the story of the accounting industry.  If a journalist doesn’t cover the audit firms and the business of accounting on a regular basis, they “expect” accounting industry stories to be boring and maybe a little tedious or hard to understand.  They also “expect” it to be difficult to verify numbers, statistics, and trends about the revenues, profits, and headcounts of the largest audit firms. So… Maybe they take their word for it.  After all, they’re accountants. (It’s sadly true that there’s a dearth of publicly available financial information about the audit firms, especially in the US.)

But I was struck, actually flabbergasted, by the fat head remark above from Jim Quigley of Deloitte. He claims that big-time CEOs answer his phone calls these days. Exactly what is the CEO of Deloitte Touche Tohmatsu,  Deloitte’s global, non-auditing, “coordinating” umbrella firm doing calling CEOs about anything important nowadays?  Seems like meddling to me. Deloitte, in particular, has a lot fewer clients to call these days anyway. Maybe instead of the CEO of the global firm calling, the local partners should have shown some spine, such as with Bear Stearns and Washington Mutual?

I’ve been writing about the subprime crisis, the one that morphed into the financial crisis, since 2007.  My first post to mention subprime was March 14, 2007.  In that post, discussing KPMG and New Century, I talked about something that even the esteemed short David Einhorn missed: Repurchase risk was not being disclosed.  I’m still writing about repurchase risk and the banks are still obfuscating it with the acquiescence of their auditors.

In one sense, the auditors were there all along.  They’ve been riding sidesaddle, cantering obediently a few strides behind the investment banks, mortgage originators, commercial banks, ratings agencies, and monoline insurers who made the real estate bubble and, therefore, the CDO/CDS/MBS bubble what it was. On the other hand, no matter how much I encouraged the auditors to step up, expected them to insert themselves, and hoped they would have an oversight impact, there clearly was no “there” there.

Some very smart men have told me… The auditors are irrelevant to this crisis.  The financial crisis, unlike Enron or WorldCom, was not about accounting fraud. Everything does not revolve around the auditors. The auditors were marginalized or maybe just deemed useless. The auditors are not the villains here. The auditors play no role when the stakes are this high. A GAAP valuation is not a “real” valuation.

These wise men may think they’re talking me down.

But, in fact, they’ve bolstered my case.

What is my case? Why do I keep writing critically about the audit industry?

From my “About” page:

The Roman satirist Juvenal asked, “Sed, quis custodiet ipsos custodes?”

But who guards the guardians?

Unprecedented changes in the accounting profession, and professional services in general, mean the current approach to safeguarding shareholder interests, as well as the other stakeholders of the modern publicly traded global enterprise, is no longer efficient nor effective.

I’ve been reading Andrew Ross Sorkin’s “Too Big To Fail.”

I would think that somewhere in the 544 pages of engrossing detail that purports to be, “the inside story of how Wall Street and Washington fought to save the financial system and themselves…,” you might see the Big 4 audit firms mingling with the rest of the masters of the universe.  You might see them mentioned in the index. You might read about their influence over asset valuations and “fair value” and “mark-to-market.” After all, this latest crisis put accounting and GAAP on the front page again, on the lips of CNBC commentators, on the desks of Congressmen and Senators who would have liked to forget the last time accounting was at the center of a financial crisis.


None of the audit firms, not even Mr. “CEOs take my calls” Jim Quigley, are mentioned in Sorkin’s cast of characters. Although I’ve found a few references to PricewaterhouseCoopers already in the first 200 pages, the audit firms are not listed in the index. The references to PwC, related to the AIG/Goldman Sachs counterparty collateral dispute that began in 2007, leave more questions unanswered than resolved.

I found these PwC references after tiring of the book’s storytelling style after fifty pages. It’s my cross to bear that not much of what is written about the crisis is new to me.  I’ve been living with these issues for the last three years and I’ve probably read everything, especially that Mr. Sorkin and his colleagues at the New York Times have written, about any of the companies or personalities involved. And I really don’t give a flying tomato about Paulson and Fuld as people…

But, to paraphrase Andrew Ross Sorkin in a video from BookTV on CSPAN November 2, 2009: “A book that reads like a movie is a book that will be made into a movie.”

So I smiled to myself with extreme satisfaction when Mr. Sorkin mentions PwC at 37.35 into the CSPAN video. It’s part of an answer to the following questions:

“Where was Goldman on the line?  Was Goldman really at risk?”

In “Too Big To Fail,” Mr. Sorkin tells me, on page 160, something interesting I did not previously know.   AIG had publicly disclosed the existence of a collateral dispute with Goldman Sachs over CDOs in November of 2007.  What I did not know before is that it was AIG Chairman of the Board Bob Willumstad, according to Sorkin, not PwC, who originally raised red flags in January 2008 regarding the growth of the collateral gap.  Willumstad called in PricewaterhouseCoopers to review the situation and,

PwC eventually instructed AIG to revalue every one of the credit default swaps… and embarrassingly disclosed that it had found a “material weakness” in [AIG’s] accounting methods.”

Most media gave PwC credit at the time for “getting tough with AIG.” I called the actions by PwC “too little too late” and a clusterschmuck. Why was PwC still AIG’s auditor?  Afterall, they were being sued by AIG’s shareholders for a prior restatment. In the end, AIG “admitted” that their management may have held back or even lied to the auditors.  AIG had actually given PwC an out, I said, to keep them close in the event of litigation or worse.  Some called my assessment harsh.

In retrospect…

A few pages later, on page 175, Sorkin describes a Goldman Sachs June 2008 board meeting where the issue of their collateral dispute with AIG boils over.

“In a videoconference presentation from New York, a PwC executive (PwC is Goldman Sach’s auditor, too) updates the board on its dispute with AIG over how it was valuing or in Wall Street parlance, “marking-to-market,” its portfolio. Goldman executives considered AIG was “marking to make-believe” as Blankfein told the board…the afternoon session proceeded with upbraiding PricewaterhouseCoopers:

How does it work inside PwC if you as a firm represent two institutions where you’re looking at exactly the same collatteral and there’s a clear dispute in terms of valuation?”

How does it work, indeed.  Jon Winkelreid, Goldman’s co-president, may or may not have received an answer that day. Sorkin does not report one.  I have never heard one.

Actually, I reported rumors at the end of 2007 that Goldman was looking to dump PwC, or at least maybe give away some of their fees to Deloitte.  But I guess they changed their minds.

And so when I ask, “Where were the auditors?” and decry the fact that “they weren’t there,” it’s not due to some unreasonable, unfair focus on the most milquetoast of potential culprits.

As my dad would say, “I represent resemble that remark!”


I bang this drum because the auditors should have been there, as a last stop, where the buck should have stopped, as gatekeepers, watchdogs, advocates, and the last bastion of standards and expected values shareholders can look to.

But they weren’t.

I’ll wrap this up with an excerpt from a post I wrote on September 17, 2008.  Most of it is still true:

I have no news of an auditor assignment for the new Fannie Mae/Freddie Mac under conservatorship.  It may be that the new Boards required to be formed by the Fed will dump Deloitte and PwC and hire EY, given the connection with one of the new non-Executive Chairmen, Laskawy, who is a retired head of EY.

I have heard no news of who will audit AIG, as it is now owned 80% by the Fed.  Will the Fed allow PwC, so much a part of their problem and their problematic past to continue, or will they start fresh with someone else?  We don’t know.  It was not on the list of big concerns for those making announcements, since PwC neither helped AIG avoid problems nor were they obviously instrumental in helping resolve them.

And Merrill will be audited by B of A’s PwC instead of Deloitte, as the acquirer is usually the one dictating those terms, much like Bear Stearns is now also under the thumb of JPMChase’s auditor PwC.

Lehman, a long time EY client, will have to say goodbye to their friends.  I say friends because EY did Lehman no favors in letting them get away with so much for so long.  With some of Lehman disappearing or being sold off in pieces and much of it going to Barclays, there are any number of firms (well, really only four, the Big 4) that will end up as auditors of these businesses.

If you’re seeing a pattern here it’s no coincidence.  All of the Big 4 audit firms have been very much involved, complicit, aided and abetted and/or been AWOL when it comes to the problems these firms faced and will continue to face.  The Big 4 audit firms neither helped them avoid these “crises,”  nor helped warn others of the severity of the issues in enough time.

We find out how bad things really are once a year, only when pushed, or as a result of a lawsuit. Or, in these cases, we found out only when the firms were pushed to the edge of the abyss.

I wonder if their audit partner was there with them, looking over the edge, and apologizing.

Main page photo credit

25 replies
  1. Anonymous
    Anonymous says:

    The too big to fail point is an important point. Having lived through Andersen’s demise, I am not at all convinced that the big 4 are too big to fail. However, my sense is that most big 4 partner do not take seriously risk that their firms may fail. In fact, in my experience many big 4 partners really do believe that their firms are too systematically important and would intervene to prevent another Andersen happening. If that really were true then partner earnings should be punitively taxed by the governments that agree they are so systematically important (as consideration for the effective government guarantees). If the firms are not systematically important then another Andersen-type is very possible and the case for breaking up the big 4 into the big 8+ becomes compelling.

    Take a different perspective: At the individual audit partner level, except amongst the truly arrogant, the risk of audit failure is real. However, that risk comes from failing a file review rather than the fear of litigation – because on the litigation risk, individual partners trust their firms will stand by them provided they can demonstrate compliance with firm policy. That causes auditors to focus on demonstrating compliance with firm policy and auditing standards (alongside managing client relationships and revenue targets) rather than trying to identify fraud and business failure risks that would be in the public interest. The government should be interested in getting auditors to focus more on identifying fraud and business failure risk at their clients. Auditors are already well paid enough not to need a carrot to do this, therefore the incentive should come from a threat. And that threat already exists in the form of litigation. The challenge to government(s) is to get that threat felt at the individual partner level. Making it clear that firms are not too big to fail would be a significant step toward that.

  2. Francine
    Francine says:

    @2 Actually, the phrase most often used with the auditors is “too few to fail.” The security comes from some explicit guarantees, especially after the government chose not to indict KPMG for the tax shelter mess, that no large firm would be allowed to go under. There were now too few large audit firms and the capital markets would suffer if the audit firms could not deliver their product.
    Yeah, like it can get any worse…

  3. Anonymous
    Anonymous says:

    What would the government do if one of the big 4 were to incur unaffordable liabilities from litigation?

  4. Anon
    Anon says:

    Fran – I am a partner at a Big 4 firm who was recently told about this blog. I’ve been reading it regularly of late and I have a variety of emotions each time I come to the site…..sometimes I’m amused, sometimes angry, but almost always I am amazed at the amount of vitriol pointed by you to the Big 4. We’re not that bad (at least my wife doesn’t think so 🙂 and I take a lot of care with my work.) Contrary to popular belief, I actually try to do a good job and I actually take pride in my work – even if you or the PCAOB would never acknowledge it. I will admit, I’m one of the “rank and filers” that you so often speak of…I am not drinking the Kool-Aid as there is plenty my firm can do better. I lay that out, so you know where I’m coming from.

    The posting above, I believe is slightly unfair…do auditors share some culpability in the financial crisis?….probably, to some extent, and that would come, as you pointed out in the valuation aspect of the audit. I’m not sure that auditors bear as much of the blame as you would suggest in your post. If auditors were really focused on advising their clients about the unnecessary risk these clients were taking, why is it that I’m hearing a little voice in my head saying that we should focus more on accounting and less on consulting and business advisory?

    Anyway, my real question relates to a comment you make @3….”Yeah, like it can get any worse…” Fran, what exactly is your proposed solution? How do you make it better, in the current environment in which we are working? (If you have posted this previously, please point me to that…as I said, I’m a bit new to the site and I haven’t worked my way through the whole site)

  5. Edith Orenstein
    Edith Orenstein says:

    Thought provoking post as usual, with a lot of food for thought.

    On the question at hand, as to the role of auditors in the financial crisis – if indeed it is correct to say they had a ‘role’ in the crisis per se – I believe the answer
    may lie somewhere between the two extremes presented in your post, i.e. between your view and that of the VSM (“very smart men”). (Based on some of your Twitter convo’s – I’d concur with your characterizing them as VSM.)

    On the one hand, I think your view may be a bit overreaching, when you say: “I bang this drum because the auditors should have been there, as a last stop, where the buck should have stopped, as gatekeepers, watchdogs, advocates, and the last bastion of standards and expected values shareholders can look to.”

    On the other hand, the position of the VSM may be slightly oversimplified, when they say: “The auditors are irrelevant to this crisis. The financial crisis, unlike Enron or WorldCom, was not about accounting fraud. Everything does not revolve around the auditors. The auditors were marginalized or maybe just deemed useless. The auditors are not the villains here. The auditors play no role when the stakes are this high. A GAAP valuation is not a ‘real’ valuation.”

    However, on balance, my opinion on this particular issue is more in line with the VSM camp, particularly on the points that “The financial crisis, unlike Enron or Worldcom, was not about accounting fraud,” and “Everything does not revolve around the auditors.” While I wouldn’t call accounting & auditing ‘irrelevant’ in any arena having to do with business, I’d say its hard to pin the recession on auditors whose job was – as described in the auditor’s report – to conduct certain procedures in support of issuing an opinion on whether the financial statements were stated fairly in accordance with GAAP.

    So, if a particular product carries a certain valuation under GAAP up to a point in time in which GAAP changes – let’s say, for example, fair value is computed one way and then a new fair value accounting standard is issued changing the way fair value is to be determined – and if, let’s say, the assets in question were previously relatively liquid and the market suddenly freezes up, rending it difficult if not impossible to determine a ‘marketplace participants’ view when there is, in effect, no ‘market,’ (but the asset may still be a performing asset throwing off cash flows in accordance with the original terms, or in accorance with modfied terms,but still throwing off cash), things can devolve fairly quickly, and I don’t think you can necessarily hold auditors – with their prescribed ((proscribed? circumscribed?) role – responsible for not predicting something that experts from the Secretary of the Treasury, and Chairman of the Federal Reserve Board, on down could not get a true handle on in advance, only, to a large extent, after the fact.

    Although I don’t agree with your position on this particular issue, I believe that its useful for you to keep the role of the auditor in the public eye, and in a reader-friendly vehicle like your blog.

  6. Francine
    Francine says:

    @4 A good place to read a discussion of what the regulators might do if another large audit firm was in danger of going under due to overwhelming litigation or perhaps a criminal indictment can be found at Jim Peterson’s re: Balance blog. Short answer? They have no plan.

    @5 Anon Thanks for reading. I’m often misunderstood. I try not to spout “vitriol” indiscriminately. My targets are the business model of the firms and firm leadership. Some of my oldest and best friends work in the firms and some are even partners and in leadership roles. They understand that my spotlight is actually an upside-down kind of support for the return of “professionalism” to public accounting. Search on that term and on “independence” and you’ll read more about the things I think are missing now that public accounting firms have become global, profit maximizing, pseudo multinational corporations.

    What’s the solution? I’m in favor of most of the “assurance” that investors require now to either be due diligence that is done anyway by independent investors and investor groups with the aid of full transparency to real time information that XBRL will bring or by government agencies when it comes to the organizations that are now majority owned by taxpayers. Heres a post that talks about that.

    @Edith Orenstein Always glad when you add your technical expertise to the discussion. I will never debate you in that arena. My concern about the “absence” of the auditors is much more fundamental. I thought the example from the book of the AIG/GS collateral dispute was a perfect example of what went wrong within the closed circuit. All information was known by a few audit firms and none of them acted assertively enough to fulfill their duty to shareholders to prevent, mitigate or warn them of the huge risks that were being taken and the disparate values and aggressive accounting methods that were adopted in order to create profits and, therefore, exorbitant compensation for those in charge.

    I am not “pinning the recession on the auditors” or even the failures of some organizations on them alone. But I think we give everyone an easy out when we talk about the impossibility of predicting or forecasting the “crisis.” Sorkin talks about the tipping point for him being BearStearns failure. But the issues with the mortgage originators were known and causing them to fail and impact the others down or upstream well before that. And I’ve been writing about them since the beginning of 2007! None of this happened overnight or even over only a few months. It should have been no surprise to anyone with “perfect” knowledge such as the Big 4 audit firms, the Secretary of the Treasury, and the Fed.

    I’m only saying that the auditor’s public duty is to provide an opinion on whether the financial statements are presented fairly according to GAAP and to opine on whether the organization is a going concern. In the case of the firms that were taken over, bailed out or went bankrupt, they failed to perform these responsibilities well, in my opinion. Given the number of shareholders and their plaintiff’s lawyers that agree with me, we shall see…


  7. David
    David says:

    “There will be growth in the spring.” I loved that movie.

    Some things to point out:

    (1) It’s inconsistent for the auditor to have different valuations for credit default swaps held by Goldman and payable by AIG. If anything, Goldman’s value for the credit default swaps should have been less than AIG liability for those swaps. That is because Goldman’s auditors should have known that if the swaps were worth what Goldman was saying they were worth, AIG would go under from paying Goldman and other holders for the swaps. (Unless the government bailout of AIG that really ticked this writer off could have been assumed.)

    (2) If the auditors did their job auditing Lehman Brothers, AIG, Bear Stearns, Citicorp, Washington Mutual, etc., what is the value of having a certified audit? Is there any value?

    (3) Although considered an energy company, Enron was in many ways a financial institution and one major reason it went bankrupt was because of its energy tradiing operations. It vastly overvalued its “price risk management assets” (by more than $20 billion) that it acquired from energy trades? Was there really any difference between Enron and Bear Stearns or Lehman with respect to overvaluation issues?

  8. David
    David says:

    What assets can you get from an accounting firm that goes bankrupt? The assets are mostly in the form of goodwill. That will be lost if a firm is put out of business. What did the Enron, Worldcom, Qwest, Mountain Bell i(merged with Qwest) and Global Crossing investors get from the remains of AA. Nothing compared to the losses that they incurred from AA’s gross negligence. Isn’t it a problem that AA never reimbursed those investors for their real economic losses?

    IWhat would my solution to that problem be? Maybe each firm performing audits should have to put up a bond that would be available to creditors in the event of malpractice lawsuits. Let’s say that bond was equal to at least two years of the firm’s audit revenues. The bonding company isn’t going to let the partners off the hook. Most of those partners are going to have to put their homes as collateral to get the bonding company to write the bond. You could even have an experience rate type of adjustment so firms that had a bad claim history had to increase the amount of their bond and firms with a good claim history could reduce the amount of their bond.

    Any thoughts?

  9. jd
    jd says:


    Do you really think that if a billion dollar company goes bankrupt and the auditors are found negligent should they be liable for the billion dollar losses of investors?

Trackbacks & Pingbacks

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  3. […] Did they comply with any of the auditing standards? It seems not, since the auditors failed to detect, warn, mitigate or issue a “going concern opinion” […]

  4. […] auditors’ public duty.  It’s about protecting the status quo.  The one that’s worked so well for us leading up to the financial crisis. “…auditors already have “a great deal of […]

  5. […] Fellow female financial blogger, Francine McKenna, does a great job of highlighting (and testifying about) all of the fallout from the Big Four accounting firms’ lack of independence in company after company and crisis upon crisis, at her site entitled “re: The Auditors.” One of my favorite posts of hers is “They Weren’t There: The Auditors and the Financial Crisis.” […]

  6. […] If you’ve been reading the stories on this site, however, you may have come to the conclusion that I did a long time ago: […]

  7. […] designed to identify related party transactions that are material… Satyam again and the AIG/Goldman Sachs counterparty asset valuation discrepancy issue. In general, the use of SPEs, VIEs, and the QSPE concepts specified in FAS 140 had been […]

  8. […] fact, Aaron Ross Sorking told us in his book, Too Big To Fail, Goldman Sachs was still not satisfied in June of 2008 that PwC was […]

  9. […] 2007 that AIG’s conflicts with Goldman Sachs over collateral for the CDOs became heated. I wrote in December, based on reports by Andrew Ross Sorkin in his book, Too Big To Fail: AIG had publicly disclosed […]

  10. […] 2007 that AIG’s conflicts with Goldman Sachs over collateral for the CDOs became heated. I wrote in December, based on reports by Andrew Ross Sorkin in his book, Too Big To Fail: AIG had publicly disclosed […]

  11. […] 2007 that AIG’s conflicts with Goldman Sachs over collateral for the CDOs became heated. I wrote in December, based on reports by Andrew Ross Sorkin in his book, Too Big To Fail: AIG had publicly disclosed […]

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