With Cassano Off The Hook, Where Does PwC Hide In The AIG Case?

Welcome to Episode 33 rpm of AIG and PwC and the Big Bad Wolf, Goldman Sachs. In this episode we attempt to slow things down and stop blaming our mother, I mean Goldman Sachs, for everything.

Let’s consider for a moment the unnaturally close, preternatural relationship between AIG and PwC over the years. The dramas these two have been through together evoke the classic dysfunctional family, hell bent on destroying each other before they let anyone or anything destroy any of them…

“For decades,” Gretchen Morgenson tells us last Saturday in the New York Times,  “Goldman and AIG had a long and fruitful relationship, with AIG insuring billions in mortgage-related securities that Goldman Sachs underwrote. When the mortgage market started to deteriorate in 2007, however, the relationship went sour…”

Goldman bought insurance against an AIG failure from large foreign and domestic banks, including Credit Suisse ($310 million), Morgan Stanley ($243 million) and JPMorgan Chase ($216 million). Goldman also bought $223 million in insurance on AIG from a variety of funds overseen by Pimco, the money management firm.

Back in 2005, during an earlier scandal, reporters and plaintiffs like the Ohio pension plans that recently settled with AIG and PwC for more than $800 million, questioned PwC’s independence from AIG:

The Washington Post, May 2005: “The relationship between PWC and AIG stretches back decades to when the firm still was called Coopers & Lybrand, before its 1998 merger with Price Waterhouse. Former AIG finance chief Howard I. Smith, who left the company earlier this year under pressure for failing to cooperate with regulators, spent almost two decades as an auditor at Coopers before joining AIG in 1984. Steven Bensinger, AIG’s new chief financial officer, also started his career at Coopers & Lybrand.

In the lawsuit filed earlier this spring in U.S. District Court in Manhattan, Petro, the Ohio attorney general, alleges that PWC’s independence was “impaired” by these long-standing ties and by nearly $137 million in audit and consulting fees it received from AIG between 2000 and 2003.”

They also didn’t buy the excuses AIG made for PwC at the time – that PwC had been kept in the dark – and claimed there were enough red flags to pin some of the liability on the auditor.

“In a boost to PWC, AIG in its release this spring also explicitly told investors that auditors and board members had been kept in the dark by management about some AIG accounting maneuvers, including the company’s dealings with Capco Reinsurance Co. Ltd., a Barbados reinsurance firm, and Union Excess Reinsurance Co. Ltd.”

In the latest scandal at AIG, we’ve seen PwC and AIG’s most senior executives such as former CEO Sullivan and CFO Bensinger attempt to divert attention from themselves. One example is the accusation against Joseph Cassano.  Mr. Cassano, albeit not the most likeable guy for numerous reasons, seems to have done everything he could to get it through the thick heads of PwC, Sullivan and Bensinger that there were wolves at AIG’s door, even though Cassano believes even now that enough time and a suitably stubborn attitude could have fought them off.

Everyone pointed at Cassano as an obdurate, incorrigible, obfuscating guy at the root of all of AIG’s problems.

The Wall Street Journal, July 22, 2010:

Joseph Cassano was once portrayed as a villain of our times.

Prosecutors… interviewed AIG senior management and the company’s external auditor, and came away thinking Mr. Cassano hadn’t properly disclosed multi-billion-dollar accounting changes that drastically cut the size of estimated losses, these people said…In interviews in 2008, Mr. Ryan told prosecutors he sometimes couldn’t get straight answers from Mr. Cassano when he asked him to justify how AIG accounted for the swaps, these people said…Senior executives at AIG’s parent company voiced similar misgivings to prosecutors a couple of years ago…However, Cassano was able to prove that he gave both PwC and Sullivan/Bensinger enough of a heads up to make their own decision what to tell investors in December.


The defense team rebutted the prosecution’s allegations, presenting a version of events that portrayed Mr. Cassano as repeatedly disclosing bad news to his bosses, investors and PwC…its efforts helped focus prosecutors’ attention on an obscure set of handwritten notes in their files, found scrawled on the bottom of a printed spreadsheet…the annotations, which were made by a PwC partner at a meeting with Mr. Cassano and AIG management a week before the key December 2007 investor conference…Prosecutors realized the notes were disastrous to their case… Mr. Cassano had in fact disclosed the size of the accounting adjustments to both his bosses and external auditors.

It wasn’t really news when the Wall Street Journal wrote about auditors’ “scribbled notes that scuttled the AIG probe” and the New York Times Deal Book followed with a “me too” blurb the next day.  We’ve known since late May that the Department of Justice no longer had a case against Cassano. He had apparently told the auditors and his bosses everything.

I wrote about Cassano’s apparent transparency in early April and then again at the end of June.

The investigations went south when, “prosecutors found evidence Mr. Cassano did make key disclosures. They obtained notes written by a PwC auditor suggesting Mr. Cassano informed the auditor and senior AIG executives about the adjustment…[and] told AIG shareholders in November 2007 that AIG would have “more mark downs,” meaning it would lower the value of its swaps.” So who’s telling the truth?

Why are we seeing more stories now with more color commentary on the Cassano vindication story?  There have been a number of parallel investigations and inquiries occurring – criminal, civil and congressional – of the entire AIG/Goldman Sachs affair as well constant reminders of the financial crisis conundrums.  As Gretchen Morgenson so aptly put it this past weekend:

“What did they know, and when did they know it?” Those are questions investigators invariably ask when trying to determine who’s responsible for an offense or a misdeed….a third, equally important question must be asked: “What did they do once they knew what they knew?”

All of these investigations are inevitably producing reams of information – lots of it in electronic form via emails and electronic records of conversations, meeting minutes, contracts and calculations.  But this information is being made available to journalists and the general public on an intermittent and inconsistent basis. As the information dribbles out in linkable, source-able, quotable form, the journalists write more stories.

Emails documenting internal conversations at AIG from 2007 were available to some journalists at the Washington Post as early as December of last year but were only recently posted to the Financial Crisis Inquiry Commission’s (FCIC) website for review by the general public.

The PwC documents proving Mr. Cassano’s contentions of good faith were probably available to the Department of Justice early this year. The substance of them was made available to some journalists in April when they started reporting Cassano would not face charges and then later in May when stories were written about charges being dropped. The actual documents show clearly that PwC knew everything in advance of the December 2007 AIG investor meeting. They were recently posted to the FCIC and House Oversight Committee sites.

The stories have been out there for a while. The details are now well known. AIG was under pressure from all sides since late 2006 and PwC stood side by side with them throughout:

Every time a scandal such as this occurs, earnest journalists believe the auditors will come under closer scrutiny.

They don’t.

American International Group Inc.’s admission this week that it engaged in improper accounting practices is putting the nation’s largest independent auditing firm in the spotlight: PricewaterhouseCoopers LLP…For now, the Securities and Exchange Commission, which in February subpoenaed documents from the firm about AIG, isn’t focusing on the accountants’ actions, people familiar with the matter said. Instead, SEC investigators, working with New York state officials, are trying to determine what AIG told its auditors about deals under scrutiny and whether that information was truthful, the people said. But at some point, investigators will press PricewaterhouseCoopers to explain the reasons it missed the improper accounting, the people added.”

Instead, in this case, PwC was reappointed to their jobs with the help of enabler Arthur Levitt.

PwC, as auditor also of Goldman Sachs, JP Morgan, Bank of America, Barclays, Freddie Mac, PIMCO funds,  and two of the Big 3 ratings agencies – Moody’s (until mid-2008) and Fitch – had a pretty good eye into both AIG’s and Goldman Sachs’ counterparty risk and the ratings roller coaster ride they all were on.

From Cassano’s FCIC testimony in June 2010: “In light of the auditors’ heavy involvement in the fair-market-model evolution generally, and their prior knowledge of the existence and magnitude of the negative-basis adjustment in particular, I also found the material-weakness finding surprising, to say the least. I know AIG senior management argued strenuously against it.”

PwC, with KPMG, continues to allow their clients to delay asset markdowns, thereby only delaying inevitable losses to shareholders.

I asked Tucker Warren, spokesperson for the FCIC, when or if any of the audit firms – EY for Lehman, Deloitte for Bear Stearns, WaMu, American Home and Merrill Lynch, KPMG for Citigroup, Fannie Mae, Countrywide, Wachovia, and New Century or PwC for AIG, Freddie Mac, Goldman Sachs or Bank of America – would testify before the Commission on the causes of the financial crisis.

Mr. Warren told me that much of the Commission’s work goes on behind the scenes, almost 7/8ths, like the proportion of a typical iceberg actually under the surface.  Rest assured, he assured me, the Commission was receiving input from all relevant parties, whether we saw them testify during public hearings or not.

On the direct question of whether the audit firms had given private testimony Mr. Warren would not comment.

I asked Mr. Warren why the names of the PwC partners had been redacted in several of the documents recently posted to their site regarding AIG. After checking with the Commission’s legal counsel, Mr. Warren told me that the individual auditors’ names had been redacted because PwC had asked the Commission to obscure them.

Why, I asked Mr. Warren, would the Commission agree to such a request given the central nature of these individuals in the issues and conflicts that were being investigated? Why was the Commission giving PwC a pass on accountability for their role in the AIG bailout and their epic collateral conflict with Goldman Sachs?

Mr. Warren responded that the Commission had considered PwC’s request in light of whether redaction would change the truthfulness of the documents or inhibit the illumination of the issues that are their primary mandate.  Would the Commission’s mission be compromised by redacting information?  The Commission also considered whether it was appropriate to subject “innocent” parties to public scrutiny if they were not central to the investigation. The decision was made that redaction would not harm the investigatory process.

I, of course, disagreed strongly and with particularity to Mr. Warren’s popular misperception.  We have evidence of apparent significant contradictions, of lies that seem to have been told regarding several aspects of the AIG investigation:  PwC partners at the highest levels of the firm did hear Cassano’s warnings early in their audit for 2007. They knew about Goldman Sachs’ and other counterparties’ increasing demands for more collateral given the widening spreads between AIG’s and other’s valuations. PwC knew AIG was out of synch with many of their counterparties as well as the overall market with regard to the valuation of the assets in question. They understood the potential for much bigger losses than anyone had previously anticipated.  PwC made misleading statements to investigators. PwC did not push AIG hard enough or soon enough to disclose these risks in earlier 2007 and perhaps 2006 quarterly reports.

I can see the attempt by PwC to have their cake and eat it too. They initially claimed to have been duped by AIG management including Cassano but now take credit as heroes for eventually forcing AIG to disclose a material weakness in the valuation process.

The key questions for PwC are:

  • Why did PwC finally force AIG to disclose a material weakness in internal controls over their SSCDO valuation process in February after putting up with AIG’s weaknesses, foibles and subterfuge for so long?
  • Who or what forced their hand and thereby forced AIG into an untenable negotiating position with other PwC clients such as Goldman Sachs and JP Morgan?
  • Why had PwC tolerated incomplete and disingenuous disclosures by AIG in 2007 and prior regarding the widening philosophical and financial gaps between AIG and its trading partners?

Many journalists have hinted at the contradictions inherent in these as yet unanswered questions without perhaps appreciating the full import of the suggestion of fraud, professional negligence or, at least, malpractice.

Do plaintiffs’ attorneys and their clients see these sins?

Will the SEC and Department of Justice finally conduct an investigation?

Will the Commissions and Committees of the US House and Senate finally call the auditors to account for their complicity in AIG and other financial firms’ failures?

Isn’t it about time to call a spade a spade?

Otherwise we must conclude that no one is guarding the guardians.

No one is acting as a watchdog for investors.

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11 replies
  1. Anonymous
    Anonymous says:

    It is confounding to the max. How the obviously complicit Accountants keep floating by. There could be zillions of reasons for this, or it could just be the blind spot of all blind spots. Aren’t all emporers nude?

    This is a situtation screaming for a glaring flash, boom, bang. On the other hand, the Accountants may be in a very sturdy boat. We’ll see. And thank you for keeping up the reporting Francine.

  2. David
    David says:

    The audiotrs don’t have to hide. Is there any evidence that the prosecutors are going after them? Probably not.

    I guess there could be a perjury count if the auditors testified under oath that Mr. Cassano hadn’t disclosed the information. But maybe theycould claim that they just misinterpreted what Mr. Cassano was saying.

    The federal prosecutors have charged almost nobody with crimes involving the finanical collapse no matter how much they deserve to be charged. It’s as if filing false financial statements isn’t a crime. Dick Fuld wasn’t charged. Stan O’Neal wasn’t charged. Kerry Killinger wasn’t charged. Angelo Mozillo wasn’t charged. Prince wasn’t charged at Citicorp. Raines wasn’t charged at Fannie Mae. Nobody appears to have been charged at New Century Financial. And, none of the auditors or CFOs of those firms have been charged either. If the government doesn’t plan to enforce the cuirrent laws, why are they passing new ones?

    I thought Bush’s Justice Department was real bad in this regard. But at least some people were charged at Enron, Global Crossing, Worldcom and HealthSouth.

    There isn’t going to be improvement on the financial reporting front uhtil someone thinks they may go to jail for these fraudulent acts.

  3. Ex Big 4
    Ex Big 4 says:

    I agree with your article although you seem to assume the various engagement teams (AIG, Goldman Sachs, etc) discuss their client’s internal matters with one another. The Goldman team would have been prohibited from releasing confidentional information to the AIG team, and vice versa. Therefore, nether team can rely on the other for valuations. You can not expect an audit team to force a financial disclosure on one client based on what they learned from another engagement team. There is client privacy and NSAs which prohibit this.

  4. Francine
    Francine says:

    @ Ex Big 4

    I’ve responded to this defense before, many times.

    Both teams should at least be talking to the same experts within the firm regarding valuation, structured products, alternative assets and derivatives. That’s where the consistency should come from first. For an example of how that should work and, when it doesn’t, how that leads to litigaton, look to the KPMG New Century case.

    If you believe for a minute that the partners who work in the same practice, work in the same office in this case – New York – and work on the largest most important clients in the firms don’t talk to each other about their client issues, I’ve a got a bridge in Brooklyn to sell you. In the case of AIG and Goldman Sachs, it’s been well documented that the highest level partners in the firm attended AIG audit committee meetings in 2007 and 2008 and heard all about their dispute with Goldman Sachs. They knew all about the differences and could have done something to fix it much sooner. Later they did. They pushed AIG over via a material weakness but it was too little to late and only to protect themselves from the public criticism that was starting to occur.

  5. Private Dancer
    Private Dancer says:

    This defense doesn’t hold water because it cannot be applied equitably. Unless you want to change the rules so that every party and counter party must have their auditors sign off that everyone’s numbers are kosher, then this is just a red herring.

    And even that idea opens up a huge can of worms.

Trackbacks & Pingbacks

  1. […] (PwC) – auditor for Bank of America, JP Morgan, Freddie Mac, Goldman Sachs, the Federal Home Loan Banks, […]

  2. […] With Cassano Off The Hook, Where Does PwC Hide In The AIG Case?, July 27, 2010: […]

  3. […] No one knows whether similar meetings were held between audit leadership and the Federal Reserve Bank and US Treasury.   No one has asked them to testify before a Congressional Committee. When their presence in meetings at Goldman Sachs and AIG, for example, was exposed via emails and correspondence subpoenaed by Congressional investigators, the names were redacted at their request. […]

  4. […] The Financial Crisis Inquiry Commission finally posted some documents from PwC with regard to the AIG failure.  The PwC partners’ names were redacted even though those same partners had been named as important actors in the resolution of charges against AIG’s Joseph Cassano. […]

  5. […] services firms, especially ones wracked by high litigation costs and lower fee income are loathe to spend money on internal activities.  That  requires 100 cents […]

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