PCAOB Waiting For Godot: Reporting On Auditor Performance During The Financial Crisis

My previous post summarized the findings by the UK audit regulator, the Audit Inspection Unit (AIU) of the Financial Reporting Council (FRC).

Recent reports from the UK Audit Inspection Unit (AIU under the FRC) and the US PCAOB (under the SEC) highlight several very serious issues that should force regulators and legislators to act on wholesale reforms and sanctions against firms and individuals.

More importantly, these criticisms – that auditors failed to follow professional standards, were insufficiently skeptical of managements’ assumptions, and did not obtain sufficient evidence for their audit opinions – should first and foremost make investors furious.  Where is the outrage when government sponsored guardians of shareholder interests have failed the public so miserably?

Today I’d like to discuss the PCAOB’s most recent summary of observations from their inspections process, Report on Inspection Observations of Auditing During the Economic Crisis.

The report is based on PCAOB inspections that examined portions of audits of financial institutions, financial services companies, and other companies that posed audit risks and challenges specific to the disruption in the credit and financial markets and the broader economic downturn… Some of the information in this report has previously been reported in public portions of inspection reports on individual firms; but the report also includes information not previously made public.

Also, from the report itself: Information received or prepared by the Board in connection with any inspection of a registered public accounting firm is subject to certain confidentiality restrictions set out in Sections 104(g)(2) and 105(b)(5) of the Sarbanes-Oxley Act of 2002 (“the Act”). Under the Board’s Rule 4010, however, the Board may publish summaries, compilations, or general reports concerning the results of its various inspections, provided that no such report may identify the firm or firms to which any quality control criticisms in the report relate.

Regular readers know that I am a very vocal proponent of full disclosure of the PCAOB’s meetings, reports, findings and enforcement activities. Unfortunately, some of the improvements to transparency that I advocate are obstructed by the Sarbanes-Oxley law itself.

In anticipation of the Supreme Court decision on the PCAOB, I made several recommendations for improvements to the PCAOB and the Sarbanes-Oxley law that would have actually helped them do their job faster and protect investors better:

1. Eliminate the revolving door

2. Eliminate obstacles to inspections of international firms

3. Make Part 2 of the inspection reports public in all instances

4. Enforce stronger sanctions on a more timely basis and more clearly delineate responsibility for sanctions between the PCAOB and SEC

5. Give the PCAOB the power, under law, to review or stop mergers and acquisitions by the firms that may not be in the public’s interest or may cause independence violations

6. Put bigger teeth into the inspections process

Subsequent to the decision by the Supreme Court, the SEC issued Release No. 34-62575 giving the agency a greater role in PCAOB inspections. Audit firms can ask the SEC to review PCAOB findings. The SEC’s chief accountant can now also step in and override PCAOB decisions if they were “arbitrary or capricious.” This rule was passed with no public notice or comment. I believe it thwarts potential improvements in transparency and auditor accountability.

In fact, I think the SEC trumped the PCAOB’s own announcement a week later that the PCAOB would request Congress to amend the Sarbanes-Oxley Act to make all PCAOB disciplinary proceedings public.

PCAOB Request to Congress to Amend Sarbox

Finally, PCAOB Acting Chairman Daniel Goelzer asked his legislative team to draft a request to Congress to amend the Sarbanes-Oxley Act to change the PCAOB’s rules regarding the assumption of privacy for PCAOB disciplinary proceedings. Here’s the press release.

“No other auditor, investor, audit committee, or member of the media is entitled to know what the PCAOB considers to merit discipline, whom it has charged, what issues are being litigated, or whether the PCAOB staff has prevailed or not,” said Acting Chairman Goelzer. “The public is in the dark about how the Board uses its enforcement authority until there is a settlement or an SEC decision on the Board’s sanctions…

There’s subtle tension right now between the PCAOB and the SEC.  The commissioners who are left at the PCAOB, in my opinion, are some of the most passionate and vocal regarding auditor accountability. They are not representative of the original “captured” crew I often criticized heartily in 2007-2008.

Unfortunately, I think this bright, shiny and new post-Madoff SEC continues following the implicit policy of the federal government regarding the fate of the Big 4 firms themselves – “Too few to fail.”

That policy was first voiced by Attorney General Alberto Gonzalez when he let “KPMG the firm” off the hook for tax shelter transgressions in 2005.

KPMG Weighed Bankruptcy as U.S. Threatened Charges, Memos Say

“KPMG LLP, anticipating criminal charges would be a “nuclear bomb” that would wipe out the accounting firm, pleaded with federal officials in 2005 not to indict it for selling fraudulent tax shelters, newly released internal documents show. Expecting the worst, KPMG partners sought advice from bankruptcy lawyers, the internal documents show. The firm’s attorneys told prosecutors that KPMG’s demise would disrupt capital markets, leaving more than 1,000 companies without an auditor.

The argument was dismissed as “ridiculous” by David Kelley, then the U.S. attorney in New York in charge of the case.“You are not the only firm in trouble and not just from criminal exposure,” Kelley said, according to the memos. “The industry is going to crap.” …In the end, the documents reveal, the U.S. Justice Department’s top two officials interceded, and KPMG avoided the fate of Arthur Andersen LLP…

Comey said he was “struck by the scope of the wrongdoing,” according to the internal documents. He also expressed concern that audit firms after the Andersen case might believe they were immune from prosecution.
Does the notion of corporate criminal liability mean anything for the Big 4?” Comey asked.

About two weeks after meeting with Comey, the KPMG legal team met in New York with Kelley and his aides and got the good news: Comey and Gonzales decided against an indictment of the firm, the papers show…The resolution, Gonzales said, “reflects the reality that the conviction of an organization can affect innocent workers and others associated with the organization, and can even have an impact on the national economy.”

The “too few to fail” policy has been mentioned off the record and in many conversations I’ve had and overheard since. As one of the 2010 Compliance Week speakers blurted, “We now know the collateral damage from putting one of these audit firms out of business and no one wants to see that repeat…”

What that means is the SEC will go after individuals at the audit firms but not the firms themselves in any way that might precipitate their failure.  (And the firms, like KPMG and most recently Deloitte re: Flanagan, will throw partners and employees under the bus to appease prosecutors and redirect attention away from a firm and its current leadership.) No one wants to be blamed for the “collateral damage” that will occur if a “nuclear bomb” is dropped on the profession as in the Arthur Andersen case. The damage would be extensive, I agree, since there is no Plan B for meeting investors’ needs for timely, sufficient, reliable, and true financial information.

But what that truly means is the global audit firms do have a free pass, immunity from criminal prosecution, and they know it. (I’ve said that a Big 4 audit firm would have to be suspected at the highest leadership level of conspiracy to commit mass rape and murder of minors in New York to be even seriously investigated, let alone actually called to account.)

The rest of the Big 4 risk management strategy consists of running ahead of catastrophic litigation – which they’re doing as fast as their mostly skinny white legs can carry them  – and getting their “not-ready-for-prime-time” next tier firm brethren to lobby for liability caps on their behalf.

The Financial Times, September 28, 2010: A cap on the market share of UK auditors needs to be introduced to reduce the systemic threat posed by the dominance of the four biggest firms, Grant Thornton has urged.

The country’s fifth-largest auditor claims that financial markets would be thrown into chaos if one of PwC, KPMG, Deloitte or Ernst & Young – which collectively audit the majority of FTSE 100 companies – were to collapse.

Exasperated by previous attempts to dilute the power of the Big Four, Grant Thornton’s UK arm is now pushing for radical intervention by regulators and investors.

In its submission, Grant Thornton said the collapse of one of the Big Four was a “tangible rather than a purely academic risk”…If one of the four did fail, Grant Thornton said the stricken firm’s audit partners would probably not move to one of the second-tier operators because of the smaller sums they would earn there.

“Instead they would seek to join one of the three remaining largest firms, leading to an audit market concentrated on just three large firms,” it argued.

In a submission to the committee, BDO, the number six UK auditor, said the failure of one of the Big Four was “a distinct possibility” because international attempts to cap their exposure to potentially ruinous litigation had been patchy.

Staying in front of litigation is getting harder and harder for the audit firms, however.  There’s so damn much of it, both in the US and abroad.  And what’s been filed is only the tippy-top of the potential pile.

The PCAOB has issued a scathing report describing auditor failure during the crisis that mirrors, in many respects, the findings of the AIU in the UK.  In fact, the issues are quite similar and the firms’ stubborn refusal to acknowledge them is equally familiar.

There is one issue that’s unique to the UK – the acknowledged diminution in quality when a non-partner leads an audit and reviews/signs off on the workpapers.  I was very surprised that UK accounting standards do not require a partner to actively participate in the audit and review and signoff on final work product. In the US partners have been sanctioned for fudging hours charged to engagements and their signatures on documents in order to prove to internal and external inspectors that they spent sufficient time on the job and exercised proper supervision. What’s ironic is that the UK will now require a real person to sign the audit opinion letter, but that’s a major sticking point in the US, as we never know the names behind the work until there’s litigation. Liability fears drive partners to make sure they do the work but individual liability concerns mean audit firms hide the names until forced to reveal them by courts.

So what did the PCAOB find? (The links I’ve provided with the bullets point to articles I’ve written about audit failures related to these issues and PCAOB warnings in inspections reports.)

1. PCAOB inspectors identified instances where auditors sometimes failed to comply with PCAOB auditing standards in connection with audit areas that were significantly affected by the economic crisis, such as:

  • Fair value measurements (How are the banks getting away with this back and forth, write-up and write-down, pin the tail on the donkey style valuation that seems to serve only their limited need to buy time? The auditors, specifically KPMG (Citigroup, Countrywide prior to B of A’s purchase, Wells Fargo and Wachovia) and PricewaterhouseCoopers (Bank of America and JP Morgan), are sitting on their hands, twiddling their thumbs and collecting payola while banks are doing as they wish. In some cases the auditors even allow the same assets to be valued differently at two of their clients. The data proves it. See “Accounting for Banks’ Value Gaps,” Michael Rapoport, The Wall Street Journal, December 29, 2009)
  • Impairment of goodwill (In December of 2008, the PCAOB issued their Report on the PCAOB’s 2004, 2005, 2006, and 2007Inspections of Domestic Annually Inspected Firms (KPMG US, PwC US, Deloitte US, EY US and KPMG Canada.)  Goodwill impairment issues makes it to the “Top Ten” list of repeated deficiencies. PwC has been repeatedly cited for deficiencies in auditing goodwill impairment – in 2008 all of the deficiencies cited in their firm report were about goodwill. Then their client, Huron Consulting, suffered a significant scandal regarding their goodwill accounting.)
  • Indefinite-lived intangible assets, and other long-lived assets
  • Off-balance sheet structures (“How can anyone — regulators, investors or anyone — understand what’s in these financial statements if they have to dig 15 layers deep to find these kinds of interlocking relationships and these kinds of transactions?” See my quote in a New York Times story about a Lehman SPE, ““Lehman Used ‘Alter Ego’ To Transfer Risks.” Of course the most notorious off-balance sheet strategy to come out of the crisis was Repo 105.  Start here for a set of links describing the technique and Ernst & Young’s response to the criticisms.)
  • Revenue recognition (No one should be surprised by the recent SEC sanctions against Dell and its founder and executives.  This firm has been a problem for PwC for a while. “The investigation raised questions relating to numerous accounting issues, most of which involved adjustments to various reserve and accrued liability accounts, and identified evidence that certain adjustments appear to have been motivated by the objective of attaining financial targets.” So why is PwC still the auditor of such an incorrigible client?)
  • Inventory

2. Firms have made efforts to respond to the increased risks stemming from the economic crisis. The deficiencies identified by inspectors in their reviews of issuer audits suggest that firms should continue to focus on making improvements to their quality control systems. (This continues to be a problem, has been cited numerous times before and the firms are defiant.

From the PCAOB Report on the PCAOB’s 2004, 2005, 2006, and 2007 Inspections…:

“In some instances, inspection teams found various matters that provided cause for concern about firms’ partner evaluation and compensation processes. These included situations where audit quality did not appear to be a significant factor in the partner evaluation process or its role in the process was unclear.
In some cases, partners received high ratings on technical competence even though there were significant deficiencies in their audits that were reviewed in the firm’s internal inspection program or in the PCAOB’s inspection program. In addition, inspectors observed situations where concurring review partners or internal inspectors were not held accountable for failing to identify significant deficiencies in audits they reviewed and where partners’ quality ratings were affected significantly by the results of client satisfaction surveys or the profitability of their audits or their ability to increase revenues.”

Well… 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” for any of the failed, bailed out or more or less nationalized financial institutions at the center of the crisis in the US and abroad.

And do the firms really take the PCAOB inspections seriously? It’s apparent to me, based on personal observation and documented incidents, that audit firm leadership does not take the inspection results seriously.  They may pay lip service to the findings, but in the same way they advise their clients, they know how to respond to the letter of the finding without putting any heart or soul into it. In some cases they publicly embarrassed the PCAOB by openly disagreeing with them.

The PCAOB report is issued without consideration of the full impact of some very serious scandals that occurred at the same time as the financial crisis  – Madoff and Satyam.  The report of the PCAOB’s spring 2008 inspections of Indian audit firms and their clients, including PwC India and Satyam, has still not been issued and the level of accountability of the auditors of Madoff feeder funds not determined via trial.

And then there’s the still lingering problem of firms in foreign jurisdictions that can not be inspected.

Because of the position taken by authorities in certain European countries and in China, the PCAOB is currently prevented from inspecting the U.S.-related audit work and practices of PCAOB-registered firms in certain European countries, China, and, to the extent their audit clients have operations in China, Hong Kong. The PCAOB continues to work to eliminate obstacles to inspection in those countries.

The PCAOB issued a press release describing a revised approach to this challenge:

This is a good step, but…  What about all of those firms outside the US that were already granted registration and are conducting audits of public companies listed on US exchanges but the PCAOB is still denied access to information necessary to inspect those firms?

“…to provide notice of a development in its approach to registration applications from firms in non-U.S. jurisdictions where, because of asserted legal restrictions or objections of local authorities, thePCAOB is denied access to information from PCAOB-registered firms that is necessary to inspect those firms.

Effective for all pending and future applications from accounting firms in such jurisdictions, the Board will ask the applicant to state its understanding of whether a PCAOB inspection of the firm would currently be allowed by local law or local authorities.  The applicant may choose to keep its application pending until it can respond, with confirmation from the appropriate authority in the jurisdiction, that PCAOB inspection is permitted.  If the applicant, in order to obtain earlier action on its application, responds that PCAOB inspection would not currently be allowed, the Board will issue a Notice of Hearing to consider whether, in light of the obstacle to inspection, approval of the application would be consistent with the Board’s responsibility under the Sarbanes-Oxley Act of 2002.

Main image from Jenny Holzer, Dublin 2006, projection on the occasion of the Samuel Beckett Centenerary celebrations.

    (1934)Spend the years of learning squandering
    courage for the years of wandering
    through a world politely turning
    from the loutishness of learning.
37 replies
  1. Get off your high horse
    Get off your high horse says:

    What is the point of the daily audit bashing?

    It goes on and on and on…………………….

    Francine, you act as if you know all the facts and circumstances about every case subject to audit litigation and that the PCAOB is always right- although to my knowledge you are not a member of their review teams.

    Your daily pounding of the audit profession would have a lot more credibility if you worked for the PCAOB; as opposed to reviewing certain documents at a summary level and then concluding as if you have all facts.

    The audit firms, as all entities, corporations and people are not perfect, unlike your view of yourself.

    I have worked inside corporates and the Big 4, and these firms try extremly hard to do the right thing. Corporations and audit firms struggle with the insanely overengineered and complex accounting standards and many areas of financial statement preparation judgment and auditing everyday. It is very easy to say with 100% perfect hindsight all is the auditor’s fault. But this is a naive oversimplistic view of the world. You do not see or hear about all of the discussions that go on between auditors and management that result in changes of financial statements that attempt to get these issues right. You only report on the minute number of audit blow-ups relative to the massive number of successful effective audits. To me it is akin to after hearing about an airplane crash assuming air travel is unsafe.

    What is your goal with all of this stuff?

    Is your goal to put the entire audit profession out of business? If not, you have a funny way of showing it.

  2. Charlie Hayward
    Charlie Hayward says:

    Yeah, that Francine is really annoying, huh?

    Quite the opposite, from my view. She’s articulating a Socratic dialogue that I view as vital to a healthy perspective of our profession. And what kind of profession would we be without thoughtful self analysis?

  3. Stop and pull your head out
    Stop and pull your head out says:

    To many audit decisions are predicated on “what is the implication to me as a partner?”, “this is my largest client and my career at stake” etc. It is not doing the right thing and absorbing the consequence. How do you explain some of the ethical lapses at th Big 4 firms we keep reading about? They believe they are bullet proof or the rules don’t apply to them or the big companies they audit but just to us small timers.

    What would you do If your client you were auditing told you they committed major tax fraud (and they were a public company)? Just so you know the audit partner did not go to the audit committee (even though you knew you should) nor go to the CEO and take it up the chain. Why do you suppose that happened? Do you believe that this could happen in the post Sarbanes world? You bet it did and you did not read about it from the PCAOB or in the Wall Street Journal. It is keep under wraps.

    While I practice public accounting I dread ever being unjustly cast in a bad situation but that is what they pay us the big money we think we deserve. When I stop seeing examples like I mentioned above or other situations of when a partner is faced with the difficult choice they stick their head in the ground, I to will join the chorus and tell Francine to shut up.

  4. Francine
    Francine says:


    All in a day’s work. I get plenty of positive feedback from all quarters so a contrary opinion once and a while keeps me honest and careful.

    @Stop and pull… Glad you can see my interest is in asking the questions and providing the evidence and examples you don’t see anywhere else – or at least not all in one place with opinion and analysis. I hope the folks who are supposed to create the solutions see it. I may have people asking for my opinion now, but as my critics tell me al the time, there are others whose full time job it is to fix the problems.

  5. sean at deloitte
    sean at deloitte says:

    “Fair value measurements (How are the banks getting away with this back and forth, write-up and write-down, pin the tail on the donkey style valuation that seems to serve only their limited need to buy time? The auditors, specifically KPMG (Citigroup, Countrywide prior to B of A’s purchase, Wells Fargo and Wachovia) and PricewaterhouseCoopers (Bank of America and JP Morgan), are sitting on their hands, twiddling their thumbs and collecting payola while banks are doing as they wish. In some cases the auditors even allow the same assets to be valued differently at two of their clients. The data proves it. See “Accounting for Banks’ Value Gaps,” Michael Rapoport, The Wall Street Journal, December 29, 2009)”

    – If I have said it once, I have said it 1000 times. Two separate audit teams have NO DUTY and would actually be considered to be violating independence requirements if they were to compare the valuation of assets from two separate companies. Even if this was allowed, which it isnt, these firms wouldn’t do it for 3 reasons:
    1. It would piss the client off
    2. It would cause a disagreement between their clients.
    3. As large, efficient, and great as these firms are at conducting business, they are still very inefficient and do not work well, nor communicate well, with other teams. That is just the way it is.

  6. Francine
    Francine says:

    @ sean at Deloitte

    If I have said it once, I’ve written it a hundred and one times:

    There are specialists and risk and quality teams in these firms, PwC for example, who are supposed to be consulted, must be consulted, on these technical issues. They know all sides of the story, have access to all data and should insure consistency and flag anomalies to the right leadership.

    There were senior leaders, at PwC for example, who attended audit committee meetings at both clients, who were briefed about these issues, who were fully aware of these inconsistencies at their clients and did nothing.

    There were clients, Goldman Sachs for example, who asked their auditor – PwC in the case I discuss most although there were more of them – straight out what the heck was going on that a firm could approve different valuations for the same asset on either side of the transaction at the same time for two different clients. They never got a straight or satisfactory answer.

    You have either not been trained or are deliberately obstinate. I have never advocated anyone sharing confidential information with either team in an unauthorized manner. But knowing what’s going on in the industry, understanding specialized assets and validating valuations with third party independent objective sources, including the knowledge specialist and SME teams, and creating benchmarking info from clients data, is what the firms get paid for and is their duty.

  7. Private Dancer
    Private Dancer says:

    Francine, just let the valuation thing go. We know what you want, but like someone else said, hindsight is 20/20. Unless you have a clearinghouse valuing every single asset for every single client there’s no way to apply what you want to do equitably. How would it work? Would one company have to write down their assets and explain it as “well the counterparty calculates it a different way?” What if you have 100 counterparties, are you supposed to get every audit team on each side of the transaction together and figure all this out?


  8. Independent Accountant
    Independent Accountant says:

    The PCAOB is hopeless. Having been exposed to it, I think the majlority of its people are incompetent. They don’t understand discounted cash flow analysis among other things. I’ll stick up for the Big 87654 in their TBTF bank “audits”. Me, supporting the Big 87654? Yes. Why? Because they are told, that’s right, I believe the Big 87654 are told by the Treasury and Fed to accept almost anything the TBTF banks want to report. The PCAOB inspection process is a charade. Kill the PCAOB!

  9. Francine
    Francine says:

    @Private Dancer

    I am disappointed in the narrow vision of some commenters. It’s as if you are all assigned to your piece of the audit program and like horses you put on blinders to the rest of the picture. It’s not enough for any one staff to do their job well. It takes leadership, review, judgement at the highest levels to put the whole thing together and make sure that the financial statements have been presented fairly, as a whole. So if you are not the engagement partner or one of the folks who was a SME or specialist in these securities consulted on these cases, take a breath and just listen.

    “Would one company have to write down their assets and explain it as “well the counterparty calculates it a different way?””

    Yes, that is exactly the kind of input that the auditors should be looking at because that is the kind of info that management sees every day. Auditors are assessing management valuation, their models, their assumptions and their use of outside pricing and valuation services and tools. The firms, in turn use some of those same valuation services and tools. So one of the best external benchmarks is that a counterparty is marking down an asset and you are not. In the AIG/PwC case, we are talking about a material amount and about a conflict that was public and well known by both sides, including the auditors as was proven by Joe Cassano. Hindsight was not necessary. What is the excuse then?

    I do not have to keep explaining this. I have explained this case and others to relevant parties who can act on the information. I am satisfied they are taking the information seriously and understand its implications.

  10. Aubrey M. Farb
    Aubrey M. Farb says:

    I have been a CPA since May 1947. And the story is always the same. When push comes to shove, it is who pays the fees that counts. And that has all kinds of ramifications. Most impoprtant from the internal standpoint of the aujditing firms, partners are judged by thier fee structure and by their ability to atrtact and maintain clients.

    What is the solution? Change the manner of paying the auditors. Stop the flow of funds from the “client” under audit to the auditors.

    I have two suggestions:
    1. Create a national auditing resources fund. Each company would pay into the fund an asessment based on its capital structure. The national resource fund would assign auditors to perform the necessary examinations and would be paid out of the fund. Auditors would have no reason to protect the “client” and furthermore would be subject to litigation for careless and or unethical work

    2. Create surety companies in each state. If a business needs an audit to protect its creditors and shareholders, it would apply to a surety company for a performance bond. The surety company would retain the auditors and based on their work and the surety company’s own reseearch, the surety company would issue a performance band. This is very much like what takes place in the construction industry. Again the auditors work for the surety company. They are paid by the surety company and most important they bear legal responsibility to the insurance company.

    The title CPA includes a “P” which is for “PUBLIC.” Somehow the major accounting firms have lost sight of the fact that theirs is a a sacred trust to the public. Now all public means is that the CPa makes hay while the public suffers from the CPA’s love affair with its clients.

  11. Penny Dreadful
    Penny Dreadful says:

    @Audrey M. Farb – I like the second idea a lot, as we could quantify and cap our potential liability (based on the performance bond limit).

  12. @Francine
    @Francine says:

    Francine, you complain about write-downs being slow for some companies but not others. Have you considered the other side? What if a client were to write up an asset class under the fair value rules. Should the auditors be out requiring their other clients to take similar markups? Please consider it from all sides.

    Also, please take a look at the auditing guidance and what it requires audit firms to do in the area of management estimates. It requires them to understand the process, test the inputs (think confirmation of attributes), identify and assess significant assumptions for reasonableness and assess the methodology for reasonableness. There is no standard that requires a comparision between clients for consistency. Given that audits are taking place simulatenously, it is not even feasible to perform the analysis you seem to believe appropriate.

    The financial statements are the responsibility of management – and most importantly they are based on management’s estimates. Management must explain them to the analysts. It would be inexcusable to tell a management team to value a security using another management teams methodology. Ultimately, the managers must run the company and be accountable for it. They cannot delegate that responsibility – via the auditors – to competitors. That is why a critical component of sarbanes is to have management certification. The reason you do not hear shareholder outrage is that shareholders don’t want auditors running companies. They know these have been business failures, not accounting failures. Do you think the entire educated investing public is naive unless they receive your golden rays of insight? Hardly – this has all been treaded over and over and over. Sure, there are some cases out there where auditors did the wrong thing – but it would be poor logic to take some antecdotal evidence and condemn an industry.

    Economically rationale investors – with their legal teams – will let you know where there is really fire. You don’t need to flap around creating smoke.

    I fully agree with the first poster – I have countless times told a client that I object to a methodology, process or even single journal entry – and have watched them digest my feedback and ultimately change it. Those things never make the public eye – nor should they – but they happen ever single day. I have never once seen a client successfully bully an auditor into changing his/her mind on a material issue. The only time I’ve seen an objection dropped is for something that is trivial or inconsequential. If anything, clients feel auditors raise too many issues on clearly immaterial items.

    So I think your viewpoint is skewed and that is a function of the way financial reporting works and how professional standards have developed around audit reports (they all look the same). All the dirty laundry isn’t hung up to see.

    I don’t think you sat in the executive sessons of audit committee meetings where these things play out… or been on the consultations that occur between the SEC, FASB and accounting firms on a daily basis. There is a ton you don’t see. Please don’t be misguided simply because you can read the news – that is like walking past the check out lane at the supermarket and believe all celebrities are dying or have 3 wives. You should be wiser than that – just because you don’t see it, doesn’t mean it is missing.

  13. Francine
    Francine says:

    @3:11 pm

    Thanks for the thoughtful comments.

    Let me clarify a few things.

    There is no standard that requires a comparision between clients for consistency. I never claimed there was one. The consistent criticism of my comments about the inconsistent valuation of the same securities over more than a year between AIG and GS is based on some mistaken contention I am suggesting either sharing of confidential client information or wholesale cross-checks. I have never suggested either. I have been talking about one specific situation – AIG and GS – and have proven that information flowed to those in the firm that provide subject matter expertise on these issues to engagement teams, which is a requirement of your own audit quality and risk procedures. It also flowed to PwC senior leadership. It’s in the minutes of the audit committee meetings of AIG which are now public, and I have heard it from both inside sources at GS and read it in Andrew Ross Sorkin’s book. This conflict was longstanding, public, and material. It certainly fits into the framework of evaluating inputs and assessing valuation methodology. PwC finally decided that the controls over AIG’s valuation process for these assets had a material weaknesses, but that happened at a very late date. How did PwC sign off on all of the annual reports and provide the negative assurance at each interim quarter under those circumstances? There were more similar instances at other companies and I have that data, but is not as easily verified as this one. I will save it for another day or when those documents are made public by a major journalist or congressional committee or in a lawsuit.

    Although I do not have the resources of a traditional journalist, I do not write what I write based on only my personal experience anymore. The stakes are too high. I have cultivated sources in the firms, the companies they audit, regulators, and law firms. All can provide me the validation I need to put the story out there in the hope that those with greater authority and resources will further investigate. That has happened in many situations, and I am very gratified by that.

    I may not have sat in on executive sessions of the AIG or GS audit committees but some of those minutes are now public. I also have sources who were present or know of the discussions and some journalists have also sourced this information such as Andrew Ross Sorkin and Gretchen Morgenson.

    I did have first hand exposure to many discussions at the highest levels at one particular firm – compliance and legal and regulatory leadership – and to some of their discussions and correspondence with regulators. Although I can not discuss those specific situations, they inform my judgment and my assessment of other situations. In the case of other firms that I have not worked for, I not only have internal sources but also know at this point that many of the systems and processes around compliance and regulatory reporting are not much different from firm to firm. Systems, and what they call them, may be different but the objectives and general activities are the same. The behavior of partners is also pretty standard. I have made some pretty good conjectures about how things work, most notably in the Flanagan case, that have been verified by insiders and others who know. I’m satisfied.

    Whether or not this satisfies you or any skeptical reader I can not dwell on. You can choose to read, to comment, to correct, to discuss. As you wish. I welcome it all. But I would ask that, at this point, you suspend your disbelief a bit because I can assure you that the truth of how the firms really operate is stranger than any fiction I can supposedly dream up.

  14. Francine
    Francine says:


    I found your general tone and some of your comments condescending. I chose to ignore them in my prior response in order to address the substance. But as an anonymous commenter it’s a cheap shot. You can judge my credentials and experience but I can not judge yours. Until I can, you won’t get many more similarly reasoned and patient responses.

    “Do you think the entire educated investing public is naive unless they receive your golden rays of insight?”
    “You don’t need to flap around creating smoke.”

    “Please don’t be misguided simply because you can read the news..”

  15. waste of time
    waste of time says:

    the pcaob is not necessary and is a huge waste of time and money. they have comments on auditors, they always will, but most of the time the comments do not result in a restatement so who really cares? they have a bunch of 100k jobs to give out… what a waste

  16. Michael, from D&T
    Michael, from D&T says:

    I am going to respond for my fellow D&Ter:

    @ sean at Deloitte

    If I have said it once, I’ve written it a hundred and one times:

    There are specialists and risk and quality teams in these firms, PwC for example, who are supposed to be consulted, must be consulted, on these technical issues. They know all sides of the story, have access to all data and should insure consistency and flag anomalies to the right leadership.

    -R&Q Teams do not necessarily know the valuation criteria of for the audit clients, they serve more of an internal function than client facing fuction. They do not insure anything, they ensure that the firms are acting a low risk level.

    There were senior leaders, at PwC for example, who attended audit committee meetings at both clients, who were briefed about these issues, who were fully aware of these inconsistencies at their clients and did nothing.

    -I agree with sean here. The audit teams are supposed to verify that the each client is valuing the assets in a fair and legal manner, not that each client is actually valuing the assets the same way. This would ABSOLUTELY be overstepping their boundaries.

    There were clients, Goldman Sachs for example, who asked their auditor – PwC in the case I discuss most although there were more of them – straight out what the heck was going on that a firm could approve different valuations for the same asset on either side of the transaction at the same time for two different clients. They never got a straight or satisfactory answer.

    -The answer is exactly what I stated above.

    You have either not been trained or are deliberately obstinate. I have never advocated anyone sharing confidential information with either team in an unauthorized manner. But knowing what’s going on in the industry, understanding specialized assets and validating valuations with third party independent objective sources, including the knowledge specialist and SME teams, and creating benchmarking info from clients data, is what the firms get paid for and is their duty.

    – How dare you talk to one of your visitors like this, show some restraint and respect to your loyal readers! You are the one who seems like an amateur here; not knowing what an audit team’s responsibility is. Stop living in a dream land of what you WISH an audit team did and what their ACTUAL JOB is.

    You are advocating confidential information. The way that these companies value their assets is, in some cases, confidential. These methodologies and formulas can be, in some cases, considered intellectual property, which may not be shared with other clients.

  17. Francine
    Francine says:

    @Michael from D&T

    “How dare you talk to one of your visitors like this, show some restraint and respect to your loyal readers!”

    Last I remember you didn’t pay to read this and you don’t even have the guts to refute me non-anonymously. If you are reading this, it’s because you either find something interesting or useful. But I do not work for you. You are a guest here.

    If you think for a minute I say what I do without backing you are sadly mistaken. Why a D&T guy is so strongly defending PwC I will never know but the “omerta” shows itself in the strangest ways. Wait until you are on the other side, kicked out like all the other loyal D&T professionals. Maybe then you will see the light.

    Geez, you guys are really thick-headed. Again. And I will not say it again. I am not advocating sharing confidential information about one client’s methodologies directly with another client. The dispute about the valuation was public knowledge. When the detailed information behind that dispute ends up at the top of the firm, and in the specialist groups, there’s a reason why. It’s called evaluating external inputs and the market environment including trends and talking to your client if they are so far off in their models and assumptions they border on the fraudulent. You only have to see how AIG ended up to know that they were way out on a limb with their approach in comparison to others for way too long.

    (I guess you are not familiar with the New Century case and the smoking gun there. The partner ignored the internal specialists regarding errors in models used to estimate loan loss reserves. It’s in the pleadings and in the bankruptcy examiner report. The required role of these specialists is clear. Maybe you don’t know or have been told differently so you can ignore them too. KPMG and the professionals named in those lawsuits paid for that mistake.)

  18. @Francine
    @Francine says:

    ….many believe GS deliberately decreased the value of some of those securities to be able to call margin on the transactions. There are two sides to every story here – either is plausible until proven otherwise. I don’t know if they recovered in value… or defaulted.

    Coincidentally, the margin calls required by GS (and others) caused AIG to fail. What you are describing is a very very specific set of facts and circumstances where one of the largest companies in the world hinged on whether their broker was reporting cut-rate prices to gain a margining advantage or if the fundamentals of the securities dictated a price decline. No one on this blog knows which answer is correct. We only know GS believes the later, while AIG management (who claimed they would not lose $1 on the securities) believed the former [edit: the securities in question are actually credit-default swaps written on other CDOs, but that is an overcomplication].

    As an audit partner on AIG, hearing the other side of the story, looking at the models presented by management that show the values are good and having no visibility into any other client methodologies or assumptions – what is your judgement? There is no traded market for the swaps backing synthetic CDOs. The underlying are other CDOs, for which there has been no market since Bear Stearns went down.

    That is not a seat anyone would envy being in… and we do not know all the consultations, discussions – including discussions with the government – that went on around those values. We do know a massive cash payment was made to the counterparties.

    Please, please please – don’t take one of the most specific, complicated, political situations in modern American financial history and use it as an indictment against auditors overall. That is a very dangerous extrapolation; the only way to “fix” that situation is complete government involvement on both sides from the very start. Like all crises, we have a tendency to overreact and end up with much more regulation than is necessary (see the original SOX, which has been refined back due to cost and burden).

    As I said in my original post – the plaintiffs attornies will find the fires. It makes them easy to point out. Check out the bond insurers, for example. Or Madoff’s hedge funds. But let’s not forget pointing out all the non-burning companies out there.

    My request to you would be to cut down the hysterics and tabloid headlines – it didn’t feel good when I levelled a few hysterical comments at you, did it?

    Post some thoughtful pieces on the way forward and think carefully before you extrapolate specific situations to broader indictments of the entire industry.

  19. Francine
    Francine says:


    Hysterics? Typical male rhetoric directed at women. Supposed to make me feel sad and back down.

    I have 900+ posts here and lots of other articles on other sites. That doesn’t include all the quotes in major media. You are the one singling out one topic (of particular interest to you for some odd reason) to try to discredit my general thesis.

    The audit firms’ business model is irreparably broken. The firms no longer serve investors. The standard audit opinion as a product is worthless.

    Yes, there are two sides to the story, but there is a common actor in this one – PwC. That firm, and the rest of the Big 4 – is the focus of my writing. It’s unfortunate that the plaintiffs’ lawyers are the only ones fighting the fires.

    I am in good company these days in making broad indictments of the industry.
    It’s nice. And very satisfying.

  20. Tony Rezko from Deloitte
    Tony Rezko from Deloitte says:

    I work with a couple of boobs. Mike, do you read the knee-jerk reactions to Francine after each post? I’m not sure where you get the nerve to question her responses to the Courageously Anonymous and Snarky. It’s just sad that so many of you have such strong emotional ties to an employer with no concern for you.

    There were some good points brought up, but your posts are mainly semantics. Read Francine’s third paragraph in Comment #21.That about sums up the heart of the issue, which you have not addressed.

    I’ve worked extensively with our firm valuation specialists, and they know, and should know, general industry norms for valuation inputs. That isn’t the same as sharing confidential client info, so cut the crap. Enough with the histrionics about trade secrets, you both sound like you did a couple of searches on Deloittenet to throw in some buzzwords. That, or you work with incompetent specialists. But I’ve worked with excellent specialists who would have taken issue with the areas PwC glossed over.

  21. Aubrey M. Farb
    Aubrey M. Farb says:

    I keep reading the same old story. The auditors are not experts at vl;alue, the audiotrs don’t do this and don’t do that!

    The bottom line is that the personnel in charge of audit field work and review are supposedly CPAa and persons with good common sense and judgment. The biggest problem with most audits is that too much time is spent checkoing out things that can be easily measured. Audiotrs just love to calculate prepaid insurance, depreciation, accrued interest on liabilities etc, because when they are finished they have the satisfaction of knowing that they are right. The main problem is that auditors spend far too little time in areas that require judgment. It takes considerable thought and ability to fairly determine if the allownace for doubtful accouts is adequate. It takes a lot of hard work to find unrecorded liabilities.

    But it does not not take a gnious to find fraud if it is put on the books by journal entries that have no backup. When I taught auditing at two universities and for the AICPA, I emphasized that carefuol examination of the non cash journal entries was essential in uncovering fraud. WordlCom is a a perfect example. Bilions of dollars of losses were covered up by year end journal entries capitalizing curent year’s line chargea and setting them up as intangible assets. The key to Enron wa to look at the non cash journal entries. For example, Enron needed some additional income to make its quarterly numbers. So they charged one of the off balance sheet parnerships $36,000,000 for three years of management fees. They debitedreceivalbes and credited income and included all three years of fees in one quarteer of a year. Now how hard was that to find?

    Lets look at the sub prime loan scandal. It was found that a large majority of the bad loans did not have adequate loan files. Now I do not feel that the auditors should have been able to value the loans. But, I do feel that any auditor worth his meager salary shoudl have had suspicians when there was no evidence of an appraisal, credit reports, proof of borrower’s income, etc, etc,etd to support the loans. And yet every major lender that was audited received the same staatemt ias required by the AICPA to the affect that ” The client’s system of internal financial and managmernt conttols were sufficiently strion enough to prevent loans from being made to unqualified individuals.

    The problem is not bad auditing, it’s bad attitude. When it comes to fraud, the auditor looks the other way. He is paid by the client and jhis professional future depends on keep[iing the client and atracting new clients, not losing clients because he ignores his loyalty to the hand that feeds him.

    Lets face it folks, the problem lies not with athe majority of companies. The problm lies with those that are more interested in cutting corners and only think about keeping the pruice of thir stock up and dammed with the consequences. Sure Sarbanes-Oxley has beeen a help. BUT, it is naive to believe that if a clientt is committing fraud, he will tell the truth when he signs a piece of paper that happens to include a bit of perjury.

    What is the answer? Brak the cycle. Stop having the companies under audit from being the sources of fees to the auditor. Lets look at the title companies and the insurance companies who issue bonds for construction jobs. Here the siource of the knowledge for underwritting is paid for by the insurer. Let them pay the auditors. I agree that the Big 4 are too big to fail; however, if we change the system we will obtain better results and there will be fewer actions against auditors. I don’t think the problem is that auditors don’t know how to audit, they just don’t always have the incentive to audit honestly and report the facts.

    Lets put the word “Public” back into the title CPA with a vengeance and really protect all the citizens of our country. As a survivor of Iwo Jima, I say “Semper phi.”

  22. Partners are not Rock Stars
    Partners are not Rock Stars says:

    Hi Francine,
    Great articles and great to see you, a strong women, stand up to these pompous, egomaniac, slavetrading partners and managers at the Big Four. I worked at PwC, and while a great learning experience, it was marred and tainted by the politics and downright abusive environment. I had the great displeasure of having to work for and with the most arrogant, primadonna, snotty, brats I’ve ever dealt with. Like being in high school all over again and dealing with the richies thumbing their noses down at the little people. And that was just most of the other associates from the rich schools. Much worse were the majority of the managers and partners who were on some other planet in which their poop didn’t stink and they were God’s gift to the universe. An act better left to the rock stars, and rocket scientists of the world.

    Yes, these Big Four whores are delussional and believe themselves to be real men and women of genius and have huge overly inflated unjustified egos. Bullcrap! My dad was an astronomer discovered quasars in the 70’s and debunked a Russian claim of an exterterrestrial civilization sending signals to Earth. Now that’s what I consider a real genius. The intimidation tactics, backstabbing, turning associate on associate with grading scales designed to make one work for a dangling carrot that can never be caught is a business model that works for reaping huge profits, but is responsible for much human suffering.

    Yes, the bastards know what they’re doing and have it down to a science. Just consider the hypocricy and calculated recruiting methods, propaganda and literature they employ; and that’s just the start of the road to hell. Associates are nothing better than lab rats to these yahoos making vast sums of money off of others misery. They appear to enjoy destroying others health, relationships, careers, and a naive but positive view of the business world. Yes, dirty rotten scoundrels abound at the Big Four, but they’re are just as many in industry, where they go after they’ve had enough. It’s the way of business and capitalism in the World. No cure; human greed and arrogance will always reign supreme as long as we operate in a monetary economic system.

    Then there’s the issue of course of how the Big Four have completely sold out, and have sold their souls to the almighty dollar. Never mind serving the public. But, in fact, the profession really never did serve the public, only their bank accounts. One only need to do a bit of research on the history of the beginnings of the audit profession in England. Independence was laughable back when it started as the company had one of its internal junior accountants doing the audit work. Haha! Most of the early public companies in England failed due to management fraud. Finally audits were mandated but with the company paying, still, no real independence and nor will there ever be. Has anything really changed? No. Independence is still laughable. Wave after wave of corporate fraud and failures at the expense of the little people have remained a constant throughout the history of the U.S. As a result, we are now back to pre 1920’s wealth distribution levels in the U.S. where 1% of the population owns about 85% of its assets. Is this a receipe for disaster helped along by the Big Four. Yes, it is!

    My career at PwC was ruined due to my being horribly overworked, stressed out, underpaid, backstabbed, thrown under the bus, etc. But I only had the best of intentions as a CPA and truly felt I had the publics best interest at heart, not the client’s, or my partners interests. But the partners raked in the bucks and laughed in my face and thumbed their noses at the kid who went to a state university, hey just as good an education and no debt. Yeah, I was a damn good auditor, too good in fact and pissed off many a client what with all the adjustments they had to book.

    No one likes the auditor and certainly not the ones that find and point out all their crappy accounting mistakes or fraud. That’s how people lose their jobs. Better to protect it at all costs, cry wolf and blame the auditor. “He was rude to me”. So then you get taken off the engagement, reprimanded by your own for doing your best to uphold the spirit and code of the CPA, blah, blah, blah; keep the money coming in. Pathetic.

    The partners are sharks. Most got there by stepping on others during a time in the 80’s and 90’s when it was much easier, less regulation, less complexities in accounting, and audits were an after thought when consulting was where the bucks were at. That’s one of the reasons we are where. These partners got used to the big consulting money and know they don’t have it. But, they still care more about money than the profession. Back before the PCAOB, SOX, back before the government intervened on a supposed reverred profession it was all fun and games and pianos in the pool. These bastard partners are to blame and responsible for the lack of trust and faith the public now has for the audit and accounting profession.

    The time is nigh for a changing of the partner guard. Let’s get some young blood in their that aren’t a bunch of sell out, greedy, heartless jerks. Hmm? Yeah, good luck with that pipe dream right? Nothing will ever change until the laws get stricter and we start loping off hands and feet or even executing those that take down entire economies with their self-serving, evil greedy actions. Harsh perhaps, but hey, a great author once suggested we eat our young during a time of hunger. Whatever, I’m just sick of all these souless, heartless bastards and they can go to hell for all I care.

    Keep it up Francine and stay strong. The bastards, (i.e. the sell out Big Four partners and brown nosing managers, and beholden suck up university professors just to name a few members of the motley crew), will try to take you down and discredit you at every turn.

Trackbacks & Pingbacks

  1. […] The largest global public accounting firms are now, as a result of your decision, considered “too few to fail” by the Justice Department and SEC. The auditors have been very busy since 2005 missing new crimes […]

  2. […] It’s also highly unlikely – 1000 to 1 odds I’d say – EY will be fined by the SEC or the PCAOB, as a firm, in a civil or disciplinary […]

  3. […] If you’ve watched any medical-themed TV show, you know what lack of sleep, overwork, crappy food, and low pay means for emergency room health care delivery. You may also be able to afford the sweatshop approach to media. But can your 401k afford “slave labor” when the product of using the lowest cost labor input is fraud and failure? […]

  4. […] lackluster prior SEC enforcement against foreign registered audit firms has been. It also shows how crippled the PCAOB has been to even inspect many foreign audit firms, let alone pursue enforcement issues in a timely and […]

  5. […] If you’ve watched any medical-themed TV show, you know what lack of sleep, overwork, crappy food, and low pay means for emergency room health care delivery. You may also be able to afford the sweatshop approach to media. But can your 401k afford “slave labor” when the product of using the lowest cost labor input is fraud and failure? […]

  6. […] look out for the GSE shareholders – otherwise known as the US taxpayer. The Big 4 auditors are more worried about making hay of the crises while the benevolent sun of the US government’s “too few firms to fail” policy for their […]

  7. […] It’s also highly unlikely – 1000 to 1 odds I’d say – EY will be fined by the SEC or the PCAOB, as a firm, in a civil or disciplinary […]

  8. […] the UK, the Big 4 have even convinced the “next tier” firms to beg for limitations on liability for the Big 4.  GT and BDO must have given up on ever bulking up enough to compete with the Big 4. Maybe […]

  9. […] taxes on future profits. I’m guessing Citigroup is the unnamed “Issuer B” in the most recent inspection report for KPMGissued by the PCAOB, since one of the failures the regulator found was related to lack of scrutiny […]

  10. […] the UK, the Big 4 have even convinced the “next tier” firms to beg for limitations on liability for the Big 4.  GT and BDO must have given up on ever bulking up enough to compete with the Big 4. Maybe […]

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