The Indictment of S.A.C. Capital Advisors: Where Was The Auditor?
What a difference a week makes.
In the space of only seven days, the Securities and Exchange Commission charged Steven Cohen, owner of hedge fund S.A.C. Capital Advisors, with “failing to supervise two senior employees and prevent them from insider trading under his watch,” and the Department of Justice charged Cohen’s firm with “criminal responsibility for insider trading offenses.”
Which global audit firm serves S.A.C. Capital Advisors, an investment advisor registered with the SEC that gave S.A.C. a clean opinion on its most recent report?
PricewaterhouseCoopers LLP.
Last week’s announcements add to prior SEC charges against S.A.C. portfolio managers Matthew Martoma and Michael Steinberg, who allegedly obtained material non-public information about publicly traded companies in 2008, and traded on that information. The SEC charged Martoma and his tipper with insider trading in an enforcement action last year, and charged Steinberg with insider trading in a complaint filed earlier this year. CR Intrinsic, an affiliate of S.A.C. Capital Advisors, also agreed to pay more than $600 million related to those charges, in the largest-ever insider trading settlement. Another Cohen affiliate, Sigma Capital, agreed to pay nearly $14 million to settle more insider trading charges.
Also last year, Diamondback Capital Management LLC, a hedge fund started by alumni of S.A.C, agreed to pay more than $9 million to settle SEC’s insider-trading charges related to some of the same investments named in the latest S.A.C. complaints. PricewaterhouseCoopers LLP. also audited Diamondback, which closed up shop at the end of 2012.
The SEC alleges that S.A.C. owner Steven Cohen ignored “red flags” after receiving “highly suspicious” information from Martoma and Steinberg that should have caused any reasonable hedge fund manager to investigate the source. Instead of setting a proper “tone at the top” and scrutinizing his employees’ conduct, Cohen praised them and rewarded Martoma with a $9 million bonus for the tip. According to the SEC complaint, Cohen’s funds earned profits and avoided losses of more than $275 million as a result of the illegal trades.
“Hedge fund managers are responsible for exercising appropriate supervision over their employees to ensure that their firms comply with the securities laws,” said Andrew J. Ceresney, Co-Director of the SEC’s Division of Enforcement. “After learning about red flags indicating potential insider trading by his employees, Steven Cohen allegedly failed to follow up to prevent violations of the law. In addition to the more than $615 million his firm has already agreed to pay for the alleged insider trading, the Enforcement Division is seeking to bar Cohen from overseeing investor funds.”
The Department of Justice, in its criminal complaint against S.A.C. the firm, says numerous employees, over more than a decade, allegedly traded in the securities of more than 20 publicly-traded companies based on inside information. The DOJ says so many illegal acts were possible because of the “institutional practices that encouraged the widespread solicitation and use of material, non-public information”.
In particular, S.A.C and its affiliates were subject to “limited” compliance policies and procedures that would have detected or prevented insider trading by S.A.C. staff. Compliance staff failed to routinely monitor employee e-mails for indications of insider trading until late 2009, a common industry practice. To his credit, it seems S.A.C.’s head of compliance had recommended such monitoring to management four years earlier.
Given what we know now about tons of cases of insider trading at S.A.C. – there were guilty pleas by six former S.A.C. Portfolio Managers and Research Analysts for repeated insider trading over long periods of time – it’s incredible that S.A.C.’s compliance department only identified one instance of suspected insider trading by its employees. In that one case, according to the SEC, those employees did not lose their jobs and S.A.C. did not report the conduct to regulators or law enforcement.
U.S. Attorney for the Southern District of New York Preet Bharara:
“A company reaps what it sows, and as alleged, S.A.C. seeded itself with corrupt traders, empowered to engage in criminal acts by a culture that looked the other way despite red flags all around…To all those who run companies and value their enterprises, but pay attention only to the money their employees make and not how they make it, today’s indictment hopefully gets your attention.”
To that statement I would add “To all those who audit companies but pay attention only to the fees paid by the clients…”
Investment advisors are not required to have an independent audit of their financial statements. S.A.C. Capital Advisors paid for a big-time audit by PwC because its investors probably demanded it. According to S.A.C. Capital Advisors most recent SEC Form ADV, the hedge fund provided investment advisory services for thirty-one clients, 84% of which are non-US residents, and had $50.9 billion under discretionary management.
Why does the SEC require disclosure of the auditor on Form ADV?
Perhaps two cases, in addition to Madoff’s strip-mall auditor that lied to its state board about auditing anyone at all, may help explain the rationale. In SEC v. Grant Ivan Grieve, et al., a hedge fund adviser was alleged to have fabricated and disseminated false financial information for the fund that was “certified” by a sham independent back-office administrator and phony accounting firm. In the Matter of John Hunting Whittier the SEC settled an action against a hedge fund manager for, among other things, misrepresenting to fund investors that a particular auditor audited certain hedge funds, when in fact it did not.
According to the Investment Advisers Act rule 206(4)-2, investment advisers that have custody of (the authority to access) client funds or securities are, however, now required to undergo an annual surprise examination by an independent public accountant to verify clients’ funds and securities. S.A.C., and private equity firm Bain Capital Partners, another PwC audit client I wrote about last year in a column at American Banker, are required to hire an “independent” auditor to do a “surprise” examination of the funds they have under custody. The auditor that performs the “surprise” examination must be registered with the PCAOB and subject to its inspections. The PCAOB, however, currently has no authority to review the “surprise” examination.
S.A.C. has not yet filed an auditor’s “Surprise Examination Report” form covering its controls over the custody of client assets.
Although an investment advisor is not obligated to have a full audit by an independent auditor, S.A.C’s private funds are required to be audited and its Form ADV says that financial information was prepared according to GAAP, its auditor PwC is “independent” and is registered with its regulator the PCAOB, and PwC is subject to inspections by the PCAOB. (PwC was recently cited by its regulator for very poor audit quality, in particular significant lack of professional skepticism.)
According to a recent SEC report, there are 10,754 advisers registered with total assets under management of $49.66 trillion.
Unfortunately, regulatory supervision of investment advisors, broker-dealers, and their auditors leaves a lot to be desired.
The audit regulator, the PCAOB, inspected ten broker-dealer audit firms and 23 audits performed by those firms between October 2011 and February 2012. The firms to be inspected were chosen before the bankruptcy of MF Global and the inspections were performed before the news of the fraud and failure of PFGBest. While we were waiting for this report, almost $2 billion of customer funds that are legally required to be segregated from the broker-dealers’ accounts went missing at MF Global and PFGBest’s Wasendorf stole hundreds of million of customer funds.
Customers of broker-dealers and investment advisors can’t count on the self-regulatory regime to cover their risks. In fact, according to Janet Tavakoli, investors may even be subject to clawbacks:
Now that Stevie Cohen’s “No. 1 goal is not getting personally indicted” for insider trading, where does that leave his investors?
If the SEC can prove its case and find that SAC’s gains were the result of a criminal activity, investors will likely face clawbacks. If investors accessed SAC through a fund of funds or a multi-advisor fund, they will likely sue the managers of those funds.
The SEC alleges that insider trading resulted in “hundreds of millions” of dollars in illegal profits.
According to the SEC’s 2011 annual report, the SEC and Self-Regulatory Organizations (SROs) like the National Futures Association have been doing fewer and fewer exams of broker-dealers during the last five years. The SEC also admits that sufficient coverage of investment advisors will never happen:
The anticipated decline in the number of registered investment advisers following the effective date of Title IV of the Dodd-Frank Act — the Private Fund Investment Advisers Registration Act (“Title IV”)12 — could result in a greater percentage of registered investment advisers being examined. The amount of any potential increase in examination frequency, however, may be offset by the need to divert examination resources to fulfill new examination obligations that the Commission was given by the Dodd-Frank Act. Moreover, the Staff expects the number of registered investment advisers to grow in subsequent years. While the Commission’s resources and the number of OCIE staff may increase in the next several years, the number of OCIE staff is unlikely to keep pace with the growth of registered investment advisers.
As a result, the Staff believes that the Commission likely will not have sufficient capacity in the near or long term to conduct effective examinations of registered investment advisers with adequate frequency. The Commission’s examination program requires a source of funding that is adequate to permit the Commission to meet the new challenges it faces and sufficiently stable to prevent adviser examination resources from periodically being outstripped by growth in the number of registered investment advisers.
Looks like investors can’t count on “independent” auditors like PwC, which was also MF Global’s “independent” auditor, to spot illegal activity either.
Steven Cohen paid casino magnate Steve Wynn $155m for “Le Reve”, a portrait of Picasso’s mistress Marie-Therese Walter. The photo on the main page comes from this Telegraph story about that purchase.
sounds like you need to be educated on the scope of a financial statement. takes SEC years with trading analytics, wiretaps, etc.. to develop an insider trading case. one has nothing to do with the other. also, what relevance does the “custody rule” and the scope of surprise exams have on insider trading? just waiting for your next article “the kennedy assasination, where were the audtiors?”
Francine
Was there a material misstatement in the accounts? No.
This piece should have focused on the fact that the auditor’s scope is too limited, misdirected or both.
As a practicing auditor, subject to recent review by the regulator, I can assure you that the regulatory focus is not helping either. Raising technicalities on low-importance parts of audits is frankly crazy. I would not mind some feedback on the judgement areas which are complex and tricky. Alas, all clean there. Yet the types of issues you are trying to flag need to be formally included in additional audit scope, rather than link to audit standards that are tenuous at best and therefore subject to no meaningful execution focus or regulatory supervision.
@Anon and @Henry
I think neither of you understand the full scope of what an auditor is already responsible for and have bought the liability-limiting PR argument: “the audit is not designed to find fraud and illegal acts.”
Auditors have an obligation, under laws and standards, to look at tone at the top and the firm’s compliance and risk management program. If they see poor internal controls and a higher risk of material misstatement based on illegal acts – insider trading is an illegal act – they have to do more or resign. If they see a firm resisting their suggestions for improvement to legal and regulatory compliance, tone at the top and internal audit – entity level controls – they have to report likely illegal acts to SEC per Section 10A of the Exchange Act.
You may want to review this Appendix published by the PCAOB this past November. It was attached for private reading to a discussion document distributed at the last PCAOB Standing Advisory Group meeting and describes in full every law, standard and rule related to the auditors obligations to assess and manage the risk of illegal acts during the audit throughout the engagement lifecycle.
SAC is toast. It is an investment advisor and subject to the custody surprise audit requirement. Are investors’ funds safe? Where’s the custody review?
It doesn’t look like it would have been too tough for PwC to see that the SAC regulatory compliance outfit was a sham.
Methinks that Henry and Anonymous are ‘PART OF THE PROBLEM’ in their criticisms of your article.
Obviously the are defenders of SEC inaction and DOJ inaction.
To some extent , I can see their point of view because the burden of proof in these fraud cases is EXTREMELY heavy.
On the other hand, there is systemic lack of enforcement in these agencies. What would happen to Henry and Anonymous
if, like Jon Corzine, they LOST— as in, could not locate—$2 billion of someone’s money. Kids who hold up a Seven Eleven
for $100 do hard time in jail
Charlie Q
You seem to forget the scope of an audit of financial statements and the GAAS requirements regarding illegal acts. Auditors are not responsible for illegal acts unless they have a material direct effect on financial statements.
I’m sure the profession enjoys your consistent stretching of their responsibilities. you could prove to be a great business developer for the profession.
Absolutely no question that auditors must dig deeper if they detect poor controls or risk of misstatement. And I am continually appalled by the number of audit failures due to non-adherence to these standards. HOWEVER, I would submit that insider trading (agreed — a decidedly illegal act), is close to impossible to control against. The only effective way to detect trafficking in insider information is by surveillance. It could be argued that this is a necessary evil in the securities business becuase of the risk of insider trading. And it is known to auditors that employees can have no legal expectation of privacy with respect to the computers, phones and other devices they use that belong to their employer. Yet, I don’t think Wall St. culture is quite to the point where it would endorse widespread surveillance of traders’ communications. WHile doing so would catch a lot of I/T and also DETER a lot of it, it’s not like to become institutionalized anytime soon.
The appropriate board of accountancy should immediately open up an investigation of PWC. Who will file the complaint?
@Ed Smith
Funny thing…This is one scope expansion the audit firms want nothing to do with. The excuses for avoiding it are legion but boil down to liability management. If the industry admits defeat and publicly accepts its obligations under laws and the standards, the game is lost.
Actually, the exact words of Section 10A say that reporting by the auditor to the SEC is required “when, during the course of a financial audit, an auditor detects likely illegal acts that have a material impact on the financial statements and appropriate remedial action is not being taken by management or the board of directors.”
In addition, the auditor has to have processes in place to detect likely illegal acts and address them with management and the board in the first place. PW India did not. Although they were not sanctioned for non-reporting, that was because the firm was either so incompetent, so corrupt or both that they didn’t even bother trying to detect Satyam’s fraud and the weaknesses in the PW Indian audit practice were said by the regulators to be pervasive, that is not limited to the Satyam engagement. The SEC, and the PCAOB which filed a simultaneous enforcement action, chose to believe at that time that PW India was ignorant of the illegal acts. The jury is still out, literally, in India, on whether the Price Waterhouse India auditors were aware of the illegal act, complicit in the fraud with executives, and did not report them or were simply incompetent as the SEC would lead us to believe.
In the case of KPMG’s role in Xerox’s fraud, the SEC said in its complaint: “Section 10Aof the Exchange Act requires a public accountant conducting an audit of a public company such as Xerox to: (i) determine whether it is likely that an illegal act occurred and, if so; (ii) determine what the possible effect of the illegal act
is on the financial statements of the issuer; and (iii) if the illegal act is not clearly inconsequential, inform the appropriate level of management and assure that the Audit Committee of the client is adequately informed about the illegal act detected. If neither management nor the Audit Committee takes timely and appropriate remedial action in response to the auditor’s report, the auditor is obliged to take further steps, including reporting the likely illegal act to the Commission.”
Management has a responsibility to tell the auditor about any illegal acts, such as the violation of insider trading rules that DOJ says SAC never reported outside the firm. Not to communicate promptly to the independent auditors any potential illegal act that might have a direct and material effect of financial statement amounts risks violating Sarbanes-Oxley Section 303 and the SEC’s final rule on “Improper Influence on Conduct of Audits. As stated in Section 10A, such illegal acts must be considered by the independent auditor “whether or not perceived to have a material effect on the financial statements;” and the auditor’s response of investigation and reporting to management (and assuring that the audit committee or board of directors also is adequately informed) is required by Section 10A,“unless the illegal act is clearly inconsequential. The terms “whether or not perceived to have a material effect,” and “unless clearly inconsequential” work in tandem to make it virtually impossible not to communicate any information regarding a potential illegal act to the independent auditors without violating Section 10A and Sarbanes-Oxley Section 303.
Given how often the auditors claim they have been “duped” by management, I’m surprised we don’t see more Section 303 prosecutions of management. In fact, I have never seen a Section 303 prosecution. Maybe “duped” is just PR and the SEC does not take it seriously enough to bring charges. The SEC and often private litigators, need the auditor more to make a case against executives and directors.
http://www.law.yale.edu/documents/pdf/SEA-Section_10A_Audit_Requirements-A_Play_in_Five_Acts.pdf
“Materiality (or immateriality) now is viewed through the lens of SEC Staff Accounting Bulletin (“SAB”) No. 99,Materiality, and no longer (if ever) depends solely on quantitative measures. the SEC staff provides non-exhaustive list of factors that should be considered in assessing materiality, and states: “Among the considerations that may well render material a quantitatively small misstatement of a financial statement item are –whether the misstatement affects the registrant’s compliance with regulatory requirements…or whether the material misstatement involves concealment of an unlawful transaction [emphasis added].” In practice, the amounts need not be material if the circumstances involve violations of laws or regulations.”
You can read more about all of this in this post.
https://francinemckenna.com/2012/02/22/are-auditors-reporting-fraud-and-illegal-acts-the-sec-knows-but-isnt-telling/
But how does an audit DETECT signs of I/T?
@Peter Goldmann
You don’t audit for insider trading. Audit for tone at the top, internal audit and legal and regulatory compliance effectiveness. External auditors opinion of finacial statements is worthless if tone at the top is a culture of illegality, as Bharara described SAC, and there is no effective controls framework including legal/regulatory.
@Francine
With respect, that is a quib response to a fair question from Peter Goldman. “Tone at the top” is as vague and wide-open a topic as any – senior management can be machiavellian , written information readily available to auditors is rarely a manifestation of corporate culture and the auditor doesn’t just whizz around a company gauging “tone” to form a view of before deciding if more needs to be done.
I do agree with your perspective around laws and regs. But here is the practial conundrum. In the case of insider trading, most companies will have a policy that prohibits it, they will show you examples of comms around expectations and illegal acts, evidence of training to staff and clean correspondence with regulators. Added to that, the risk and compliance team who are considered ethical and competent, when directly asked about fraud, illegal acts and suspicious activity, reply in the negative. None of these raise flags of likely illegal acts relating to insider trading. So the auditor concludes that the risk of material misstatement has been addressed. However, these events will still happen.
The reality is that insider trading is complex, often involves outside parties and is best discovered through effective market supervision. Yes, there should be appropriate regulatory compliance frameworks in place, and these should be assessed, but in all reality, this is unlikely to detect such acts.
Finally, I would like to highlight one perspective often not fully contemplated. Insider trading does not result in assets that do no exist (cash out, security in, or vice-versa) for that particular entity. However, until such time as such acts are identified AND there is a liability arising from actions from regulators or third parties, there is no further impact on the financial statements. Even if you could somehow mount an argument for constructive obligation, recognition of liabilities would be almost incalculable. So, let’s just keep the risk of material misstatement due to insider trading in full GAAP context.
I dont dispute the need for something better here – but let’s accept that within the scope of a financial statements audit, this is just reaching one too far.
@Anon
I’m afraid you and others insist on speaking to the specifics of insider trading when I’m speaking about the auditors obligations with regard to assessment of the risk of illegal acts and what to do if they find them. The arguments about whether insider trading are something we should prosecute or not are not my concern here. Suffice to say insider trading is illegal and the SEC and DOJ are getting very good at prosecuting it. They have a template and it’s easy to use over and over again, in particular if a member of the watchdog set, such as an audit partner, violates the laws.
I don’t think “tone at the top” is so hard to gauge. Bharara articulated it very clearly with regard to SAC. Why didn’t PwC see the same thing at SAC or MF Global, for example? It would be much easier if lead audit partners considered it before, during and after accepting an engagement. We’re in the trust business. If a lead partner can’t look client management in the eye, face to face, on premise, and say “I trust this person to follow the law, regulations and the policies of this company” then the battle is already lost. I would argue that for many of these companies, that assessment is pretty easy. They are recidivists and known scoundrels. Audit services should be withheld and they’d be forced to tow the lien. But that’s not how it works. Take any bad company, repeat offender, obvious problem child and there’s always an audit firm who will do the audit – for the money. Fannie Mae, Koss, LVS, Overstock, Navistar, Herbalife, Siemens, GE, Xerox, Barclays, etc.
The materiality of an insider trading conviction is quite clear from a qualitative perspective, if not a from a quantitative perspective. (It’s not required for illegal acts to be judged on a quantitative basis as I have explained in my previous comment.) Criminal indictments of the firm, of significant numbers of employees, will put SAC out of business, like it put Galleon’s Raj Rajaratnam out of business. I think that’s a risk to the integrity of the financial statements the an audit firm has to consider.
@Anon
“and the auditor doesn’t just whizz around a company gauging “tone” to form a view of before deciding if more needs to be done.”
That’s what the lead partner is supposed to do, at the beginning of the engagement, during the planning phase. Do I need to cite the standards?
I have to agree with Anon that Tone at the TOp is a vague and intangible “thing”. No doubt, a conspicuously poor tone at the top should give even the most fraud-ignorant auditor reason to look harder. But as anon points out, insider trading is a complex and almost by definition, elusive, crime. I don;t know if there are any stats to prove it, but my guess would be that more cases of I/T got discovered by someone blowing the whistle than by a sharp auditor going after a hunch that something was wrong. BTW, most of the companies you mentioned above were not I/T cases. Koss, for example, was your basic big-dollar embezzlement by a financial manager operating in the absence of controls. Michael Koss could not be accused of setting a poor Tone at the Top. Yet Grant Thornton didn’t get a whiff of the $34m scheme until someone clerk ta AMEX questioned a corporate check
@ Peter Goldman
“Tone at the Top” is not elusive except for amoral, sellout auditors.
You are right that auditors are rarely whistleblowers or the party-stoppers. Whistleblowers that are not auditors usually the reason why fraud is exposed. But what does that say about the audit process, auditors ethics, skepticism, and lack of professionalism?
“Michael Koss could not be accused of setting a poor Tone at the Top.” Michael Koss is an idiot and is not qualified to run a public company. I wrote about that here.
https://francinemckenna.com/2010/01/16/defending-koss-and-their-auditors-just-loopy-distorted-feedback/
GT was a patsy, brought in because they would do the audit without insisting on a 404 review.
So we disagree here. Not sure we will find a happy medium on these issues.
@Francine
My observations around illegal acts vis-a-vis insider trading are pretty much the same.
My comment about ‘whizzing around the company’ was more about the fact that its not easy to pass the trust test as you describe it in anything other than a normal human interactions over a period of time. How many people do you meet in life generally that come across as ethical and moral, but as time goes on you start to see signs that maybe things are not as they seem. This doesn’t happen quickly. You notice it slowly but you gradually start to distance yourself. It’s not like a light switch.
The same is true for audit. It can take years before such signs become observable. Humans are just not that transparent. Perhaps you are suggesting psychology should become part of the auditors repertoire. Maybe that’s a good idea. But I am not a sell out immoral auditor just because I don’t happen to agree that ‘tone at the top’ is a straightforward and effective way to assess the issue at hand.
@Anon
I actually take a read on folks pretty quickly. Professional skepticism is a required part of the auditors’ toolkit. If you are a “pleaser” you don’t belong in the business at a leadership level.
@ Francine
Being quick to judge is not the same thing as Professional Skepticism.
@Anon
I don’t think I said “quick to judge”. I said take a read quickly. Being able to assess quickly based on available info and long experience is, I think, a very valuable skill. Skeptical should be the natural state for an auditor and, as AU Section 230 says, “In exercising professional skepticism, the auditor should not be satisfied with less than persuasive evidence because of a belief that management is honest.”
@ Francine
It is interesting that was your response as it is exactly what I was trying to show. What one intends to convey and how it is received are two different things.
In relation to ‘tone at the top’ this is precisely one of the problems when things are not obviously ‘wrong’. What leaders convey and their intentions behind are not self-evident a lot of the top. It is simplistic, and dangerous, to assume one has a ‘natural’ ability to do draw conclusions in such an environment.
I have experienced rather bizarre interactions with senior leaders only to find that staff execute with exacting moral standards.
On the other hand, I have seen leaders communicate and set expectations consistently around behavioural appropriateness only to observe underhanded and Machiavellian behavioural at the coal face.
Hence my suggestion that psychology form part of the repertoire. But finding deep accounting acumen alongside such skills is rare.
So whilst we wait in earnest for such types to magically make their way through the profession, we need a better answer to auditor expectations around illegal acts.
@Anon
I accept your doubt that many can’t live up to the laws and standards. But they are laws and standards. And nowadays, as opposed to the post-SOX bonanza period, fewer professionals rise to the top as lead partners on engagements because the audit business is low growth. I think we can be more selective. I also thing that the firms are not nearly doing enough to be selective, to mentor, to monitor and to discipline partners that don’t tow the line. That’s how we end up with “rogues” like Flanagan and Gansman and London who had so much responsibility for key clients and for others.
The problem is the firms try to rationalize obligations away or argue them to death in court when they are standards that have been in place for a long long time. The basic concepts of independence and public duty are old. They are not new based on SOx. They are the foundation of our profession, such as it is. Either step up or acknowledge it’s not a profession anymore and pull the government-mandate, subsidy, monopolistic ticket to profits the firms now enjoy. We’re getting a poor return on our investment.
@ Francine
I don’t think anyone would, or could, disagree with that sentiment.
The big concern I have for the profession is that it is increasingly less risky and financially more appealing to join the corporate sector. The very best and brightest young partners and aspiring partners are now put off by the prospects of being in the profession. Why? Interestingly, at least at one Big 4 firm, because there are fines and other financial penalties for ANY detected findings by either internal practice review or regulatory review.
A punitive culture may get technical compliance up, but I can assure you that this will not improve the substance of audit quality in the long term. Humans rarely perform well in such environments – ask any workplace psychologist or expert.
It’s about time all stakeholders took a step back and thought long and hard about how to truly improve all elements of audit quality.
@Anon
It would be a good start if firm professionals, investors and the regulators could agree on how audit quality is defined. They don’t right now.
http://pcaobus.org/News/Events/Documents/05152013_SAGMeeting/Audit_Quality_Indicators.pdf
As the Head of Operational Due Diligence for a major Investment Advisor this is something that is near and dear to my heart. I love to throw the Auditors over the cliff whenver I get a chance as if I have to hear from our Investment staff “where was the Auditors” one more time when we run into these things Im going to retire.
Having said that this is not one of those times as there is no way….i repeat…no way you can expect the Auditors to capture something like this nor is it in their jurisdiction anyways so i fail to see why you think PWC should be held accountable here at all.
Why in the world would they be taking a look at Research controls way up fron in the investment process when they are soley just looking at the Accounting controls to ensure the AFS’s are being built properly?
And you do know that SAC does not require a custody surprise audit due to the fact that they get their Funds audited within 90 days of year end (which is one of the exemptions you can use to be excluded from surprise audits)
Finally the AFS are for the Cayman Fund itself and the “Tone at the Top” comes from the Board of Directors who oversee the Fund (which contracts with the IA – SAC to trade on behalf of the Fund) so who you should really be looking at is the Auditors for the IA itself if you want this article to be accurate…ill give you a hint…its not PWC….
Fund Auditing is a completely different animal than Public Company Auditing and im afraid this article is so off base (although the intent as admirable) that it does the Audit industry a diservice as the Investment Due Diligence community is already infurated enough with it that it doesnt need more fire.
Signed,
– An Investor that redeemed from SAC 4 years ago due to our own independent analysis
@JJG
I am aware that PwC is not the auditor for the IA but for the private fund. That is stated in the article. It’s also stated in the article that IAs don’t have to have an independent auditor.
SAC”s Form ADV indicate that it does have custody of customer funds. I do not see anything to indicate that they have an exemption. The rules for surprise audits are pretty clear now.
http://www.sec.gov/rules/final/2009/ia-2968.pdf
If you have further insight or think I got something wrong, please email me and let me know. fmckenna2010@gmail.com
Otherwise, you are the first to suggest any corrections.
From Form ADV:
In this Item, we ask you whether you or a related person has custody of client (other than clients that are investment companies registered under the Investment Company Act of 1940) assets and about your custodial practices.
A. (1) Do you have custody of any advisory clients’: Yes No
(a) cash or bank accounts?
(b) securities?
If you are registering or registered with the SEC, answer “No” to Item 9.A.(1)(a) and (b) if you have custody solely because (i) you deduct your advisory fees directly from your clients’ accounts, or (ii) a related person has custody of client assets in connection with advisory services you provide to clients, but you have overcome the presumption that you are not operationally independent (pursuant to Advisers Act rule 206(4)-(2)(d)(5)) from the related person.
(2) If you checked “yes” to Item 9.A.(1)(a) or (b), what is the approximate amount of client funds and securities and total number of clients for which you have custody:
U.S. Dollar Amount Total Number of Clients
(a) $ 50,885,688,000 (b) 31
I find this thread to be all over the place. I think it says the puplic would be better served if accounting firms behaved more independenty from the companies they serve. I think there is truth to this and the bigger the profitability of the client (not just fee) the bigger the problem. But what’s the solution? Mandatory audit rotation? More governmant oversight? Although failures may look spectacular it would be interesting to see data on the percentage of audit failures. I suspect overall the profession does pretty well. But as with any profession, there are going to be people in powerful positions that lack the proper ethics or competence to completely avoid failures.
The other key issue appears to be the auditor’s responsibility to detect fraud. Detectiing financial statement fraud is difficult enough – I can’t imagine holding financial statement aditors accountable for detecting insider trading fraud. Also, independent auditors are experts in accounting not regulatory compliance. What procedures would we have them apply to audit regulatory compliance and how would the firm justify the cost to management and the audit committee who will certainly question how these procedures relate to signing off on the financial statements.
Re: Francine’s opinion on the scope and role of an auditor’s duty to investigate: http://www.youtube.com/watch?v=5hfYJsQAhl0