@Forbes “Why Banks, And Their Auditors, Are Getting Away With Financial System Murder”

I wrote the post excerpted below for Forbes on February 25th, after seeing a great story by Jonathan Weil at Bloomberg on Citigroup.

Now the WSJ reports that, according to “sources”, the SEC and Department of Justice are having trouble making a case against Lehman executives and Ernst and Young in that case. I’m sure Anton Valukas, captain of the Lehman Bankruptcy Examiner Report ship will be interested to hear this. After all, he gave Goldilocks and the Three Bears quite a trail of “colorable” crumbs to follow.

Clearly the agencies, by leaking this information, are setting up the public and the media for the inevitable “no charges will be filed” announcement that will come late on a Friday afternoon, maybe over Memorial Day weekend. Everyone is busy worrying about everything else. Who cares about Lehman? That’s old news.

Now that Ernst & Young has asked to move the New York Attorney General’s fraud case against them to Federal Court and a friendly judge, we may see this case settle, too. I would be sorry to see that as I would prefer a messy and revealing trial.

The problem with the WSJ announcements about Lehman and Ernst & Young is they’re planted. They focus on the accounting instead of on Section 302 violations – which are criminal – or on the missing disclosures.

Lehman Probe Stalls; Chance of No Charges, Wall Street Journal, March 12, 2011: “…after zeroing in last summer on the battered real-estate portfolio and an accounting move known as Repo 105, SEC officials have grown more worried they could lose a court battle if they bring civil charges that allege Lehman investors were duped by company executives. The key stumbling block: The accounting move, while controversial, isn’t necessarily illegal.

In a possible sign that the probe has slowed, the SEC hasn’t issued a Wells notice to Lehman’s longtime auditor, Ernst & Young, according to people familiar with the situation. The firm had concluded that the accounting in the Repo 105 transactions was acceptable. Wells notices are a formal signal that the SEC’s enforcement staff has decided it might file civil charges against the recipient…”

That’s how I can tell the text was fed, word by word, with no time for reporters to think through, make some calls and ask if it really makes sense.

I’ll be writing more on this next week for Forbes.  Stay tuned.

In the meantime, here’s the story from Forbes of Citigroup and their Sarbanes-Oxley Section 302 sins. For the whole piece please go to Forbes.

Jonathan Weil goes digging in the documents left by the Financial Crisis Inquiry Commission and comes up with a shiny nugget.  On February 14, 2008, Citigroup’s CEO Vikram Pandit , its CFO Gary Crittenden, and its auditor KPMG were told by their regulator that the bank’s internal controls – and specifically the valuation models and methodology affecting its huge subprime loan portfolio – were crap.

The gist of the regulator’s findings: Citigroup’s internal controls were a mess. So were its valuation methods for subprime mortgage bonds, which had spawned record losses at the bank. Among other things, “weaknesses were noted with model documentation, validation and control group oversight,” the letter said. The main valuation model Citigroup was using “is not in a controlled environment.” In other words, the model wasn’t reliable.

Here’s where the timeline gets curious. Eight days later, on Feb. 22, Citigroup filed its annual report to shareholders, in which it said “management believes that, as of Dec. 31, 2007, the company’s internal control over financial reporting is effective.” Pandit certified the report personally, including the part about Citigroup’s internal controls. So did Citigroup’s chief financial officer at the time, Gary Crittenden.

So, we have a bank, let’s say it’s Citigroup this time, that’s told by their regulator – or maybe even their auditor – serious control problems exist, threatening the reliability and veracity of their financial reporting and disclosures to the SEC and the investor public.

And then nothing happens.