As Caleb Newquist notes, most financial reporters cover the accountancy industry “once in a lunar eclipse on the winter solstice.” So it’s fantastic to see Bloomberg’s Jonathan Weil coming out with two incisive, hard-hitting columns in succession on the subject.
Last week, Weil drew a bead on PricewaterhouseCoopers, which has signed off on a $2.2 billion accounting benefit at MBIA. That number represents “estimated recoveries,” most of which are due to come from Bank of America; they’re essentially bonds which MBIA is allowed to put back to the lender because they didn’t conform to the lender’s own representations and warranties.
At the same time, however, PricewaterhouseCoopers is also happy signing off on Bank of America’s accounts, which include no liabilities to MBIA at all.
Weil concludes:
The job of an independent auditor should be to ensure that the numbers make sense.
At MBIA and Bank of America, they don’t.
Is this illegal? Probably not. But this week, Weil comes out swinging at Ernst & Young, dismissing its defense against Cuomo’s charges as “insane” and “nonsense,” and placing it in the broader context of E&Y’s corporate culture:
Allegations of misconduct at E&Y have become such a routine part of the firm’s business that they’ve come to be expected…
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.
(Note Weil’s mastery of the hyperlink: would that all journalists were as good.)
Weil effortlessly dismantles E&Y’s statement that “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,” by pointing out that Cuomo’s whole case is based on the assertion that the transaction was not in accordance with GAAP:
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.
As any freshman accounting major can tell you, it’s a violation of GAAP for a company to tell investors it’s using one type of accounting treatment when it’s actually using another, especially when the method it’s secretly employing makes its balance sheet look stronger.
Meanwhile, Francine McKenna is doing sterling work on this case as well, pointing to the parts of the Valukas report where E&Y comes off as particularly obstructionist:
I think the NY AG’s investigators questioned EY and its partners first as part of building a case against Lehman executives. When EY was as difficult and non-cooperative as they seem to have been with Valukas, the NY AG decided to redirect their energies to the auditors. They had the Lehman Bankruptcy Examiner’s report as a road map, an almost-ready for prime-time template for a complaint against the auditors.
McKenna singles out this passage from Valukas:
Prior to this invitation and during [E&Y partner William] Schlich’s four‐day interview as an Ernst & Young representative, the Examiner invited Ernst & Young to opine on why Repo 105 transactions were proper and did not result in Lehman filing materially misleading financial statements…Schlich replied that the transactions were proper if they complied with Lehman’s self‐defined Accounting Policy. Despite an additional invitation from the Examiner, Ernst & Young has not offered any further explanation.
There are echoes, here, of the way in which Cuomo decided to file suit against Steve Rattner after being angered by his incomplete responses to initial questioning. It’s natural for individuals and companies not to want to incriminate themselves when being questioned by the attorney general. But when dealing with Cuomo, it seems that being as cooperative as possible as early as possible is the way to go. He hates being given incomplete information.
Felix Salmon is a financial writer, editor, and podcaster. A former finance blogger for Reuters and Condé Nast Portfolio, his work can be found at publications including Slate and Wired, as well as his own Substack newsletter.