July 17, 2018

Jonathan Weil

Nobody Seems to Care About Williams Companies’ $497 Million Accounting Error

Bloomberg's Jonathan Weil likes digging through dirty laundry. If you're an auditor, the PCAOB, a TBTF bank or in today's case, a natural gas producer, playing games that just so happen to cross his radar and it insults his intelligence, you can expect JW to open up your ringer of dirty undies for all of […]

PwC Japanese Affiliate Has Two of Its Ugly Audits Exposed

Today, Bloomberg's Jonathan Weil wrote his fourth column exposing clients of a Big 4 audit firm whose PCAOB inspection report reveals that the audit performed was less than stellar. This time around, JW exposes two clients of PwC's Japanese Affiliate Kyoto Audit Corp.: The report [in full, below] said the board’s staff reviewed the firm’s audits for […]

Pondering Bank of America’s Balance Sheet

As far as the market is concerned, more than half of the company’s book value is bogus, due to overstated assets, understated liabilities, or some combination of the two. [Jonathan Weil/Bloomberg]

(UDPATE) KPMG-Bermuda’s PCAOB Inspection Gets a Little Unwanted Attention

Most of you are acutely aware that PCAOB inspection reports, while chock full of interesting tidbits, are a little anti-climactic since we never learn who the auditees are. Oh sure, we can speculate until our heart’s content but the PCAOB says they took a vow of silence after 43 struck his signature on Sarbanes-Oxley.

The secrecy is frustrating (read: bor-ing) so it was especially cool to see Jonathan Weil let the cat out of the bag on at least one Big 4 client:

Two weeks ago,Accounting Oversight Board released its triennial inspection report on the Hamilton, Bermuda-based affiliate of KPMG, the Big Four accounting firm. And it was an ugly one. In one of the audits performed by KPMG- Bermuda, the board said its inspection staff had identified an audit deficiency so significant that it appeared “the firm did not obtain sufficient competent evidential matter to support its opinion on the issuer’s financial statements.”

This being the hopelessly timid PCAOB, however, the report didn’t say whose audit KPMG-Bermuda had blown. That’s because the agency, as a matter of policy, refuses to name companies where its inspectors have found botched audits. It just goes to show that the PCAOB’s first priority isn’t “to protect the interests of investors,” as the board’s motto goes. Rather, it is to protect the dirty little secrets of the accounting firms and their corporate audit clients.

That’s why it gives me great pleasure to be able to break the following bit of news: The unnamed company cited in KPMG- Bermuda’s inspection report was Alterra Capital Holdings Ltd. (ALTE), a Hamilton-based insurance company with a $2.3 billion stock- market value, which used to be known as Max Capital Group Ltd.

Using his detective skills, Weil pieced together the number clients KPMG Bermuda had inspected, the timing of said inspections and the details of the audit deficiency (“the failure to perform sufficient procedures to test the estimated fair value of certain available-for-sale securities”) to come up with Alterra. Of course no one – the PCAOB, KPMG Bermuda or Alterra – would comment/confirm for Weil’s column but you probably knew that was coming. Nevertheless, JW gets into the how bad of an audit this really was:

It’s when you look at Alterra’s financial statements that the magnitude of KPMG-Bermuda’s screw-up becomes apparent. Available-for-sale securities are the single biggest line item on Alterra’s balance sheet. They represented almost half of the company’s $7.3 billion of total assets as of Dec. 31, 2008, and a little more than half of its $9.9 billion of total assets at the end of last year.

This sort of screw-up, some might argue, falls somewhere in the range of “horrendously bad” and “really fucking bad” and Weil wonders if Alterra shareholders will have the stones to throw the bums out at the shareholders meeting on May 2. We can’t say where any of the shareholders stand on the usefulness (or lack thereof) of the audit report, so maybe this revelation is NBD to them. But if that is the case, it seems to make an even stronger case for the irrelevancy of auditors.

Weil’s larger point is that the PCAOB continues to hide behind their policies that are supposed to protect investors but in reality come off as talking points, not so unlike the firms they regulate. The PCAOB says they’re working on that but we’ll have to wait until summer to find out how crazy things get and whether it will be enough to shove auditors back into some respectability.

Dirty Little Secret Outed in Bermuda Blunder [Jonathan Weil/Bloomberg]

UPDATE:
Alterra cops to it with an 8-K that was filed about 90 minutes ago:

Alterra is aware of a recently issued report by the Public Company Accounting Oversight Board (the “PCAOB”) related to the PCAOB’s review of KPMG Bermuda’s 2008 audit files of a public company client located Bermuda, as well as an article posted on Bloomberg that indicates that the public company client is Alterra (formerly Max Capital Group Ltd.). Alterra confirms that it is the client referenced in the PCAOB’s report.

The PCAOB report findings question the sufficiency of procedures performed by KPMG Bermuda in its audit of Alterra’s estimated fair value of certain available-for-sale securities as promulgated by generally accepted audit standards (“GAAS”). The PCAOB report questioned whether the audit procedures used by KPMG Bermuda in 2008 to verify such values were sufficient. The PCAOB report does not question the appropriateness of the values that Alterra attributed to assets available-for-sale in 2008.

Alterra notes that the PCAOB made substantially similar findings in a number of inspections of 2008 and 2009 audits performed by the larger accounting firms and, since 2008, we understand the firms have issued additional guidance to clarify the work to be completed on the audit of fair value investments.

KPMG Bermuda has represented to Alterra and its Audit Committee that it believes it properly and appropriately followed GAAS as defined at the time of the audit. KPMG Bermuda confirmed in its response to the PCAOB report that “none of the matters identified by the PCAOB required the reissuance of any of our previously issued reports.” Alterra reaffirms its belief that the asset values ascribed to its available-for-sale securities in 2008 and subsequent periods remain appropriate.

KPMG Bermuda issued an unqualified opinion for Alterra’s year end financial statements for each of 2008, 2009 and 2010.

Making Sense of the Ernst & Young Defense

Over at Bloomberg, Jonathan Weil (who has the tendency to let the dust settle before chiming in) takes Ernst & Young to task for their lack of willingness to take responsibility for the Lehman Brothers bankruptcy and digs up a bunch of old bodies in the process.

E&Y had established itself as a repeat offender long before Governor-Elect Cuomo filed his suit. In recent years we’ve seen four former E&Y partners sentenced to prison for selling illegal tax shelters, while other partners have been disciplined by the SEC for blessing fraudulent financial statements at a variety of companies, including Cendant Corp. and Bally Total Fitness Holding Corp.

In the Bally case, E&Y last year paid an $8.5 million fine, without admitting or denying the SEC’s professional-misconduct claims. The SEC also has imposed sanctions against E&Y three times since 2004 for violating its auditor-independence rules.

After that friendly reminder (which certainly makes some people wince), JW takes a look at the E&Y’s response to the suit, specifically the part where they more or less say that Cuomo is off his rocker, “There is no factual or legal basis for a claim to be brought against an auditor in this context where the accounting for the underlying transaction is in accordance with the Generally Accepted Accounting Principles (GAAP).”

Weil says E&Y is missing the point entirely:

That isn’t an accurate depiction of the claims Cuomo brought, though. Cuomo’s suit unambiguously took the position that Lehman violated GAAP. What’s more, it’s not credible for E&Y to say that Lehman didn’t. (An E&Y spokesman, Charles Perkins, said he “can’t comment beyond our statement.”)

In the footnotes to its audited financial statements, Lehman said it accounted for all its repurchase agreements as financings. This was false, because Lehman accounted for its Repo 105 transactions as sales, a point the Valukas report chronicled in exhaustive detail.

The question is, of course, if this all adds up to fraud on E&Y’s part. Cuomo says it does. Weil says that E&Y needs to come up with a better story. Colin Barr, on the other hand, writes that E&Y could easily turn the tables:

The Ernst & Young statement suggests the firm will argue that it can’t be prosecuted under the Martin Act because Lehman, not E&Y, was the outfit actually producing the financial reports, and because it was Lehman, not E&Y, that was peddling billions of dollars of securities just months before its implosion.

In this view, E&Y was just a gatekeeper hired to vouch for Lehman’s books, something it will claim it did well within the confines of the law. This strikes lawyers who are familiar with the law as an eminently reasonable approach, if not exactly a surefire recipe for success.

“If I were Ernst & Young, I would assert I was not a primary actor,” said Margaret Bancroft, a partner at Dechert LLP and author of a 2004 memo that explained the Martin Act soon after Spitzer began brandishing it against Wall Street. “You can say that with more than a straight face.”

“Just gatekeepers,” and not “fraudsters,” is obviously the preferred view but the catch is, E&Y would be admitting that they are really shitty gatekeepers.

Accounting News Roundup: Congress Delay on Taxes Could Hit January Paychecks; KPMG Settles with Hollinger; PwC Asking Clients to Share Internal Info | 10.07.10

Republicans See a Political Motive in I.R.S. Audits [NYT]
“Leading Republicans are suggesting that a senior official in the Obama administration may have improperly accessed the tax records of Koch Industries, an oil company whose owners are major conservative donors.

And the Republicans are also upset about an I.R.S. review requested by Senator Max Baucus, the Montana Democrat who leads the Finance Committee, into the political activities of tax-exempt groups. Such a review threatens to “chill the legitimate exercise of First Amendment rights,” wrote two Republican senators, Orrin G. Hatch of Utah and Jon Kyl of Arizona, in a letter sent to the I.R.S. on Wednesday.
ick to point out that the I.R.S. was put under tight restrictions about access to Americans’ tax returns as a result of political shenanigans by the Nixon administration involving tax audits.”

AIG’s Real Numbers Still Shrouded in Secrecy [Jonathan Weil/Bloomberg]
“Two years ago when the government seized control of AIG, the Treasury in effect took a 79.9 percent ownership stake in the company, through preferred shares and warrants it received as part of AIG’s $182 billion bailout package. By keeping its stake below 80 percent, the government ensured that a financial-reporting method known as push-down accounting wouldn’t be permitted under U.S. accounting rules.

The reason that was so important? Had AIG chosen to implement push-down accounting, it would have had to undergo a complete re-assessment of all its assets and liabilities. And, with a few possible exceptions, the company would have been required to begin showing them on its balance sheet at their fair market values, which may have left AIG’s books looking a lot worse.”

Delays to Tax Tables May Dent Paychecks [WSJ]
“Lack of congressional action on 2011 income taxes may force the Treasury Department to make unprecedented moves to prevent U.S. workers from seeing large tax increases in their January paychecks.

The issue: 2011 tax-withholding tables. Treasury officials usually release the tables, which determine the take-home pay of millions of wage-earners, by mid-November because it takes payroll processors weeks to adjust their systems before Jan. 1.”

Steven Bandolik Joins Deloitte’s Distressed Debt & Asset Practice [PR Newswire]
“Deloitte announced today that Steven Bandolik has joined its distressed debt and asset practice. Bandolik’s hire marks the latest in a series of strategic growth initiatives executed over the last 18 months to expand Deloitte’s distressed debt and asset practice.

‘Challenges need to become opportunities in order for borrowers, lenders and investors to move forward, and get back to their core business of making positive returns on investments. Despite lower interest rates, obtaining new financing regardless of loan performance continues to be an issue unless properties and financial positions are extremely strong,’ said Bandolik. ‘In this environment, clients require intellectual capital to re-structure transactions, and design sensible underwriting, due diligence and risk management procedures. Their debt may need to be structured more conservatively, requiring higher equity levels that could withstand future stress, with a focus on deleveraging over the holding period.’ ”

Hollinger Inc.: Settlement of Claims Against KPMG LLP [Marketwire]
“The Litigation Trustee of Hollinger Inc. (“Hollinger”) announced today that he has entered into a settlement agreement with KPMG LLP to resolve all claims against Hollinger’s former advisor advanced by the Litigation Trustee on behalf of Hollinger. The settlement entails no admission of liability on the part of KPMG LLP. The terms of the settlement include releases in favour of KPMG LLP from Hollinger and its subsidiaries, as well as from third parties involved in related Hollinger litigation. The settlement and the releases are subject to court approval, which will be sought on notice to other affected parties. The rest of the terms of the settlement agreement are confidential.”


CAQ Reports on Fraud Best Practices, Launches New Effort [Compliance Week]
“The CAQ conducted five roundtables and 20 in-depth interviews to develop consensus on how companies can best create a financial reporting environment where fraud has little potential to seed or take root. The CAQ published the findings as a cornerstone to further collaborative efforts with other professional groups to share ideas and best practices on how to derail fraudulent financial reporting.”

PwC audit clients asked to give up internal information [Accountancy Age]
“Ian Powell, chairman of PwC told an audience of 300 business professionals, the audit model needed reform, and believed some internal discussions, now privately held between an auditor and company, needed to be made public.

‘It may well be that by making more of those discussions public, the value of an audit can be collectively improved,’ he said.

‘I have asked our lead audit partners to discuss this idea with audit committee chairs of PwC clients to see if we can work together on a voluntary basis to improve the disclosure of such matters over the next reporting cycle.’

The comments come as the European Commission prepares to release a green paper on audit competition, due later this month, and the House of Lords prepares to hear evidence on the issue, next week.”

Greenspan: Financial overhaul to have ‘significant impact’ on economic growth [On the Money/The Hill]
Some people are still listening to this man.

Madoff clan denies fraud role, seek suit dismissal [Reuters]
A consistent message may actually convince someone, some day.

Some People Would Like to Know Why PwC Is Mum on The Alleged Morgan Keegan Fraud

Last week, the SEC continued its “Bustin’ Up Fraud” tour by charging Memphis-based Morgan Keegan & Company, Morgan Asset Management, and two employees, James C. Kelsoe, Jr. and Joseph Thompson Weller with “fraudulently overstating the value of securities backed by subprime mortgages.”

The long/short of it is that SEC’s Enforcement Divish alleges that Kelsoe “arbitrarily instructed the firm’s Fund Accounting department to make ‘price adjustments’ that increased the fair values of certain portfolio securities.” Weller didn’t do a damn thing to remedy this, Morgan published fraudulent net asset values (NAVs) based on these valuations and investors ended up losing something like $2 billion. Typical stuff in this day and age.


While Khuzhami and Co. gave the usual spiel about “lies” and whatnot, Jonathan Weil over at Bloomberg is wondering why PricewaterhouseCoopers is being totally left out of this ordeal (our emphasis):

Now that the Securities and Exchange Commission has accused Morgan Keegan & Co. of fraudulently overvaluing subprime-mortgage bonds in several of its mutual funds, there’s still one major player in this saga that hasn’t uttered a peep.

That would be PricewaterhouseCoopers LLP, the Big Four auditor that blessed the funds’ year-end financial statements for fiscal 2007. Funny thing is, officially at least, PwC is still clinging to its position that there wasn’t anything wrong with the funds’ numbers. That’s a lot harder to believe now than it might have been before last week.

Not to take issue with Jonathan Weil (who we think is great, btw) but we aren’t surprised at all that PwC is standing by their audited numbers. “Deny ’til you die” is Big 4 101, even if that denial is through complete and utter silence. They’re better at holding out on guilt than Pete Rose.

JW ends up addressing his own inquiry saying, “Perhaps PwC is awaiting the final outcome of the SEC’s case, which might take years to litigate. While the SEC didn’t name PwC as a defendant, the firm is being sued in court by fund investors. So PwC has a clear incentive to avoid acknowledging that any of its audit conclusions may have been wrong.” Jackpot! And if there’s one advantage that PwC and the rest of the Big 4 have on the road to failure, it’s time.

Ultimately, this detecting fraud. The public want auditors to find it. Auditors claim that’s not their job. The “expectations gap” as the leadership likes to say. And while Big 4 leaders cling to this “gap” like a security blanket, Weil brings up the question that more people have been asking lately, “if auditors can’t detect fraud, what good are they?”

Bond-Fund Fraud Suits Leave Auditor Speechless [Bloomberg/Jonathan Weil]
SEC Charges Morgan Keegan and Two Employees With Fraud Related to Subprime Mortgages [SEC Press Release]
SEC Complaint