I never want to make excuses for the excesses of Wall Street or the horrific judgment exercised by iBank management — you cannot, its inexcusable — but it long past time we begin holding the Street’s grand enabler’s responsible for their actions.

Which brings me to the accountants.

The New York attorney general may be bringing a civil fraud lawsuit against Ernst & Young, “accusing the accounting firm of helping Lehman mislead investors,” according to the WSJ.

The accountants were the pushers to the Street’s junkies. They allowed all manner of shenanigans to go on, under their imprimatur of legitimacy. From WorldCom to Tyco to Enron and now to Lehman Brothers, most of these frauds would not have been possible without the loving assistance of large and credible accounting firms.

And they did it for the money. Ernst & Young earned approximately $100 million in fees for its auditing work from 2001 through 2008 for Lehman Brothers.

Some people assumed that the death penalty for Arthur Anderson would have kept the industry in line. But such restraint was not to be. Thanks to yet another piece of radical deregulation, the accounting industry was given carte blanche to run wild. The Securities Litigation Reform Act of 1995 had created a civil liability out for the accountants. It allowed them to legally become Wall Street’s pushers, no longer answerable to Investors who were defrauded due to their accounting audits. It practically decriminalized accounting fraud.

Here is a piece of trivia about this ruinous legislation: Prior to becoming SEC Chair, Christopher Cox was one of the authors of the Securities Litigation Reform Act. When a radical deregulator becomes Wall Street’s chief cop, what could possibly go wrong?

Here is what I wrote in Bailout Nation about the Securities Litigation Reform Act of 1995:

“This legislation was supposed to be a way to eliminate class action lawsuits that were the bane of public companies’ existence. Buried in the legislation was a little-noticed clause that eliminated “joint and several liability” for those who contribute to securities fraud. The consequences of the change were significant. It removed liability for fraud from the accountants who audited quarterly statements for public companies.

What do you think happened once accountants were no longer liable? An explosion of accounting fraud! The accounting scandals of the late 1990s and early 2000s were directly attributable to this small legal change. So too was the collapse of Enron, which led to the corporate death penalty for Arthur Andersen. We can probably pin the subsequent enactment of Sarbanes-Oxley, which is undoubtedly having all sorts of its own unintended consequences, on that same clause. These all trace back to what the industry itself had requested.

As the saying goes: Be careful what you wish for; you may get it.

We are left to wonder: Who else has questionable accounting . . .?

>

See Also:
Auditors Face Fraud Charge
LIZ RAPPAPORT And MICHAEL RAPOPORT
WSJ, December 20, 2010  
http://online.wsj.com/article/SB10001424052748704138604576029991727769366.html

A Lehman Case Emerges More Than 2 Years After Collapse
PETER LATTMAN
NYT, December 20, 2010
http://dealbook.nytimes.com/2010/12/20/after-ernst-young-who-may-be-next/

Ernst & Young Said to Face Fraud Suit Over Lehman
Karen Freifeld and Linda Sandler
Bloomberg, December 20, 2010
http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=a.FUd6bUfTvo

Category: Bailout Nation, Legal, Really, really bad calls, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

42 Responses to “Blame the Accountants — and Deregulation”

  1. wunsacon says:

    >> a way to eliminate class action lawsuits

    Gee, which “team” hates lawyers and class action lawsuits especially? Which team fielded the POTUS who must’ve signed this in 1995?

    More of that great bipartisanship!

  2. Pure-Water says:

    BR, Help me here…if this act removed liability how did Arthur Anderson go down and why is E & Y facing charges?

  3. Sechel says:

    I’ve been rather shocked(yes really) at the number of Wall Street apologists on the issue of end of quarter window dressing. Arent’ the auditors supposed to be a form of adult supervision on this, providing a “good housekeeping” seel of aproval?

  4. Wes Schott says:

    …repeal of Glass-Steagal

    …the CFMA

    …the Securities Litigation Reform Act

    the enablers of the party – “Wall Street got drunk”

    …all seemed to have occurred under the watch of who? just took a while for the party to get into full swing.

    it is kind of amusing that many of my friends blame it on the Red team, when it was the Blue team, trying to impress the bidness class, that set in all in motion…

    i guess you can’t bend the boundaries of the rules, until the rules are in place…and bend they did…

    …now, too big to fail means, too big to prosecute since shares would go to zero if prosecuted…so sue the facilitators – accountants – Lehman is gone already (and, apparently, they weren’t TBTF) – it is all a show, a shame, kinda like the WWF…

  5. michael-D says:

    wes shott … you left out yet another massive gift from the very same administration: GATT

    whats terribly frustrating and frightening about this sort of thing is that we still have [otherwise] intelligent folks who will shout out that our problem isn’t deregulation; rather its an excess of increasing and obstructive regulation. i presume they just listen to the talking heads on fox or to the party blow-hards or something.

    you have to hand it to those pushing the MotD … they have the sheeple screaming out their mantra for them and in true bush fashion, don’t want to be confused by any facts or data.

  6. Wes Schott says:

    The General Agreement on Tariffs and Trade (typically abbreviated GATT) was negotiated during the UN Conference on Trade and Employment and was the outcome of the failure of negotiating governments to create the International Trade Organization (ITO). GATT was formed in 1949 and lasted until 1993, when it was replaced by the World Trade Organization in 1995. The original GATT text (GATT 1947) is still in effect under the WTO framework, subject to the modifications of GATT 1994.[1]

  7. Oops, there is a typo –

    It should read FOR LEMAN BROTHERS:

    “And they did it for the money. Ernst & Young earned approximately $100 million in fees for its auditing work from 2001 through 2008 for Lehman Brothers.”

  8. Transor Z says:

    Andersen epilogue: Huron Consulting, an Arthur Andersen spinoff, under investigation for material misstatements in annual financials:

    http://www.forbes.com/feeds/afx/2009/08/04/afx6737705.html

    (Reuters) – A global consulting company that rose from the ashes of the destroyed accounting firm Arthur Andersen is now facing a scandal of its own.

    The problems at Huron Consulting Group Inc (HURN) may reflect a corporate culture that carried over from Arthur Andersen, the firm that collapsed in connection with the Enron Corp scandal in 2002, legal and corporate governance experts say.

    Chicago-based Huron was founded by two dozen Andersen partners. Gary Holdren, once a senior Andersen partner and a member of its executive committee, on Friday resigned as Huron’s chairman and CEO after Huron said it would restate more than three years of earnings because of misreported costs related to acquisitions.

    The chief financial officer and chief accounting officer are also departing.

  9. Moss says:

    I don’t agree with the depiction of red vs. blue or pointing to a specific administration. The financial folly transcended party affiliation. Dereg of the FIRE industry became the consensus policy strategy and simply gained momentum and legitimacy until the collapse. We should all hope that some ‘justice’ be served because the next crisis will be far worse.

  10. Sechel says:

    B.R. If they did it “for the money” how is that different than what the rating agencies did?

    ~~~

    BR: Very good young grasshopper — its not different at all!

  11. Wes Schott says:

    @moss-

    could not agree more

    …it is not about red v blue at all..it is about the corporations v you

    …and, not sure about legitimacy (unless you or of the mindset of Bubbles Greenspan) – justice is not being served because once you take TBTF as a given, justice can only be served on the periphery…and, yes, indeed the next wave will be larger than the last wave…

  12. Its complex. The PSFLMA was vetoed by Clinton, but overridden by nearly every GOP member (McCain was a notable exception) and a handful of liberals — a weird coalition fer sure.

  13. Petey Wheatstraw says:

    Representative government at work. Unfortunately, it only represents the corporate citizen.

    I am constantly re-amazed at the depth of the stupidity and self-loathing of the American electorate.

  14. michael-D says:

    “In 1993, the GATT was updated (GATT 1994) to include new obligations upon its signatories. One of the most significant changes was the creation of the World Trade Organization (WTO). The 75 existing GATT members and the European Communities became the founding members of the WTO on 1 January 1995. The other 52 GATT members rejoined the WTO in the following two years (the last being Congo in 1997). Since the founding of the WTO, 21 new non-GATT members have joined and 29 are currently negotiating membership. There are a total of 153 member countries in the WTO.”

    my only point is that while GATT seems to be a living breathing virus it appears to have been the ’94 changes which mad a really huge difference. of course, events out of the uruguay round [reagan admin] weren’t esp well-intentioned.

    and wes and moss … i couldn’t agree more even more than you … if that makes any grammatical sense whatsoever.

    cheers

  15. Petey Wheatstraw says:

    Make no mistake: (R) and/or (D) are empty labels, as are liberal/conservative. We are ruled by corporate power, accountable to no law. Fascism will emerge from this. Hopefully, the result will be the same for our corporate masters and their pseudo-governmental minions, as it was for Il Duce and his.

  16. Petey Wheatstraw says:

    Oh yeah:

    Everything we’re choking on is a result of right-wing policies, regardless of the use of the labels mentioned, above.

  17. DeDude says:

    Sad to say but the accounting firms are just like the payola rating firms. Nothing they say can be trusted because they have huge incentives to lie and no incentive to tell the truth. It is all about the incentives.

  18. rktbrkr says:

    Rating agencies,RE appraisers,AIG “insurance”, bond insurers and now CPA firms all rubber crutches for American investors and consumers.

    I thought the creation of convenient accounting for the banks (MTM & reserves) (and powder puff stress tests) was sufficient – guess not!

    If the regulators won’t regulate how can you expect the CPAs to fall on their swords?

    Might as well end the charade and go to cash basis accounting. Eventually the diminished cash flow of unpaid mortgages at the big banks will become apparent and Turbo Timmy will be cutting them another Sunday night special to deal with “unimaginable circumstances”

  19. Sechel says:

    I’ve given up on looking at reported earnings and just look at EBBS(earnings before bad stuff)

  20. curbyourrisk says:

    Barry: I agree, BUT I think the better question is — (you said, “We are left to wonder: Who else has questionable accounting . . .?”)

    WHO DOES NOT HAVE QUESTIONABLE ACCOUNTING. Persoanlly I would like to see SIV and ALL Off-Balance-Sheet crap forcibly brought back on the balance sheet. After Enron…..we were told to do away with Pro-forma accounting (assumption accounting). Why is that we need to report non-GAAP and GAAP earnings. What is the difference between non-GAAP and pro-forma. When I review companies, I always include the charges…and make note of them in my write ups later. I always let the numbers speak for themselves.

    ~~~

    BR: heh heh Sad, but true . . .

  21. Jessica6 says:

    My understanding was that formerly, each individual partner at an accounting firm was responsible for the misconduct of the other partners at a firm, but by the mid-90s the LLP structure was instead permitted.

    @Wes Schott: throw in the Commodities Modernization Act while you’re at it :)

  22. gloppie says:

    “a weird coalition fer sure.”

    not weird to me; on one side there’s the haves, which include politicians of both aisles, bankers, lawyers, captains of industry, and the enabling support industry (accounting, auditing, ratings, lobbying, fancy dining, fast driving hi flying etc…etc…)
    and the other side is the have-nots.

    The only real historical struggle is between vested interests & social justice, according to Arnold Toynbee. It is not weird that there would be a coalescence of apparently opposing actors around an issue that is now shown (after it blew up) to be what it really is; self interest, plain ‘ol “good for yer Capitalism” selfishness, me first me first……

    HA.

    Wake up.

  23. constantnormal says:

    One finds this in all sorts of “consultants”. Pretty much any trade that is paid to satisfy the customer’s every whim will descend to behavior that is barred by whatever standards held by that profession or society in general when the policing of those standards is lax and the rewards to misbehave are sufficiently high.

    And the policing of professional standards is usually not rigorously enforced by law — after all, are the police really equipped to even determine violations in most specialties? It is really up to the guild/trade to police itself, and to report those members who are guilty of “malpractice” (it seemed the best word, and applies far beyond the medical realm) to their governing bodies, and to act in accordance with their standards in keeping their profession honest and trustworthy.

    The only role of the government is to limit the practicing of licensed trades to the legitimate members as determined by the governing bodies of that trade. Not that the AMA does a particularly good job at this — it usually takes a lengthy string of bodies before they will act to against one of their members, and if I understand this correctly, an organization of the state determines the ability of doctors to practice in that state, much as the bar association (which is *not* an arm of government) does for doctors. It would be better if the state medical review boards were an arm of the AMA, which would be charged with upholding doctor quality and professionalism, rather than an arm of the state — IMHO. BTW, I am speaking here at the limits of my knowledge, and am likely wrong about some details. Please feel free (which I know that you all will) to correct me, if you have actual knowledge in these areas. I’m always willing to learn.

    This is why the bar association strips lawyers of their ability to practice law, and not a judge and jury. I’m not sure about how an accountant’s credentials/certification are removed, or even if there is any sort of rigorous standard that allows one to be a practicing accountant, or if any moron can be hired and placed in that role.

    There are certainly a lot of professions (engineers, computer programmers, people in the construction trades) where there is little or nothing in the way of professional certification that enables the recipient to practice that trade (don’t wave the PE certification for engineers at me, 99% of practicing engineers are not PEs, it is just something to allow higher fees to be charged, with some assurance of competency on the part of the holder of that certification — I know of no way for a Professional Engineer certification to be removed by any sort of professional governing body for anything other than the failure to pass a qualifying exam).

    If you do not want professionals to be swayed by monetary rewards, you had better have some uniform standards and mechanisms in place to control their ability to practice their trade. This will set the minimalist government folks a-howling, as this would amount to that evil “regulation”, and rules imposed by bureaucracies. Quite right. And the opposite of rules and regulations is chaos.

    It is fine to object to inefficient/ineffective/nonsensical regulations, and to change them for the better. Even desirable, HIGHLY desirable. But to undertake an exercise like removing all controls leads to nothing but horrors.

    And so we move from the unbearable to the horrific. No stops along the way.

    ————————————————————-
    Butch Cassidy: No, no, not yet. Not until me and Harvey get the rules straightened out.

    Harvey Logan: Rules? In a knife fight? No rules.

  24. carleric says:

    The funniest part of the comments is the unending (by some) search for blame to one political stripe or other….don’t you get it?….they are all paid off scum…was Chris Cox the worst SEC Chairmen ever? I seem to remember someone named Harvey Pitt and a series of fools and theives before him. The idea that the SEC or Congress or some other group of morons is looking out for our interets is simply laughable on its face.

  25. AHodge says:

    Who else….?
    Pension funds, life insurance cos, “credit” hedge funds, pretty much everyone with “asset backed” on their books.

    Did i mention the Fed?

    they are all still refusing to take losses and mark their books, because current accounting systematically avoids their marking.
    They are still whining like pussies about fire sale pricing making market prices unreliable 3 years later? and spending massive amounts suborning congress, SEC, FASB etc
    via groups like the Fair Value Coalition, an Orwellian name if ever i heard one.
    finance will remain broken as long as each side of a derivative deal or complex product can carry THE SAME THING at massively different prices. The Herz FASB initiative to to accounting two ways including something approaching the right way is out there. but now SHAPIRO fired Herz i am betting it dies a quiet death.

    even convicting E&Y of their over the top laxity
    will not move this massively flawed valuation,
    which is absolutely central to Wall sts trillions dollar scam.

  26. ashpelham2 says:

    Let’s look at what accounting firms are really charged to do.

    They are paid high fees to show that an organization has complied with regulations by whatever industry or governing body says those regs are. Simply put, it’s their interest to not disagree with what management asserts is true, even if it is not. There have been situations where some of the big accounting firms have resigned from an arrangement because they couldn’t agree with management, or had doubts about their “independence” to that relationship. I would dare say that these are the less profitable relationships, because no one in the accounting biz wants to give up on that big cash cow client unless someone might go to jail because of it. That’s about the only way E&Y or PwC or Deloitte or anyone else is going to willingly quit a client.

    As someone stated above, it’s the same deal with the ratings agencies; they are paid to agree with management as to how great that company is.

    In the interest of full disclosure, I had a brief stint working for PricewaterhouseCoopers in the tax department of the office responsible for the tax returns of a certain very large Bank here in America. until they fired us and then hired all of us inhouse. My wife worked at Arthur Anderson from 2000 until they crumbled to the ground. It wasn’t her fault. :D

  27. mathman says:

    To all you commenting “regulars” here who would like to see justice done, a little inspiration for the holidays:

    http://www.youtube.com/watch?v=RNqv85coyTw

  28. DeDude says:

    Wes @ 7:39

    I have no problem admitting that 30% of the Dems (so called blue dogs, but they are actually just lab dogs) are obedient servants of Wall Street, but so is 90% of the GOPsters. So you have a heck of a lot more to answer for in your party than I have in mine. The “they are all equally bad” meme may fly on Fox but it doesn’t check out with reality.

    Clinton was way to far to the right for my personal taste. Just as with Obama I often wished that he would have chosen to go down in flames, rather than to compromise. But the minute something is passed in congress with a veto busting majority, you can no longer blame it on the president. Then it is the responsibility of congress (and you can check out what percentage of each party voted for or against, to find the political party to be blamed for each piece of legislation).

  29. Wes Schott says:

    Dedude@7:39

    “So you have a heck of a lot more to answer for in your party than I have in mine”

    …assuming that comment is directed at me, i have no idea what you are referring to, i don’t have a party, i am apolitical…and please spell it correctly, that’s Faux News…

  30. DeDude says:

    Anybody who spawns the meme that the two parties are both (equally) responsible is serving the GOPsters (whether they call them their party or not). Yes our corporate masters have influence in both parties (and will get a lot more since they were granted personhood), but there is only one party that at least has attempted to pass legislation to protect regular people against corporate exploitation and tyranny. With the K street project corporations took complete control of all but a handful of GOPsters in congress, there is still a majority among congress Dems that are fighting for the people. But those Dems are a minority of congress as a whole, so they are often forced to accept amputated and ineffective legislations as the “better than nothing” best they can get done. They should be applauded and supported rather than lumped together with the corporate scumbags that have taken total control of the house.

  31. DeDude says:

    Wes; to take your exact quote that I object to:

    “it is kind of amusing that many of my friends blame it on the Red team, when it was the Blue team, trying to impress the bidness class, that set in all in motion”

    Reality is quite different from that Faux narrative. The real deal (as pointed out by Barry) was that it was the Red team roping in a few blue stragglers who passed PSFLMA over the objections of the blue team and its leader in the White House.

    I agree that on certain other legislations the blue team leader should have taken a show down (and likely got over-ruled) rather than negotiated and compromised with the red team. On free trade both teams (except for a minority of blue team members) unfortunately supported this destructive concept.

  32. rfullem says:

    anyone seen a study on the economics of white collar crime? Oh I forgot. there was no crime. just questionable activity, lax standards, and no due diligence. How does a expert fail due diligence yet still not be negligent? wow. Clearly in the wrong “business.”

  33. VennData says:

    If you make the legislators liable for their legislation… VennData, you may be on to something! Make Christopher Cox the example. That should keep them in line for at least one cycle.

    … is that why McConnell and Boehner are crying all the time?

    http://www.thedailybeast.com/video/item/mitch-mcconnell-has-a-good-cry

  34. rfullem says:

    OCC, SEC, Fed Regs, DOJ? Not a peep. Not even willing to offer a good explanation of why they are not doing anything. yet still collecting a paycheck .

  35. bobk says:

    Thanks for the reminder Barry. The PSFLMA wasn’t called the “License to Lie” for nothing.

  36. jritzema says:

    “It removed liability for fraud from the accountants who audited quarterly statements for public companies.”

    Accountants do not audit quarterly statements, just annual statements. Pull up anybody’s 10Q and it says at the top of the statements “unaudited.” Auditors do some quarterly work of public companies but it is usually just matching up the numbers to the client’s system outputs.

  37. [...] Ritholtz, “The accountants were the pushers to the Street’s junkies.”  (Big Picture also Street [...]

  38. abcd_act says:

    I find it terribly ironic that a firm like E&Y with probably 100K employees is a target of fraud rather than the key financial officers at the firm well, you know, that actually committed fraud. Why can’t the SEC, and other initials led agencies actually walk one CFO/CEO down a phalanx of reporters in hand cuffs?

    The outcome of Enron was silly in my opinion, Arthur Anderson was forced out of business, and later acquitted, but 100ks employees were forced to look elsewhere for new jobs. Public companies were saddled with SOX controls/testing which really didn’t clean anything up, but created a bonanza of cash for the remaining audit firms. Forcing another big CPA firm out of business without cleaning up the mess is just asking for this to keep happening.

  39. philipat says:

    The Managements SHOULD BE already indicted under the terms of SarbOx compliance statements, signed quarterly by the CFO and CEO. For some reason ;-), this seems to have been overlooked by the Regulators.

    If, however, E&Y can be convicted, does this finallymake it difficult for even the Regulators to ignore the culpability of Managements?

  40. tradeking13 says:

    “We are left to wonder: Who else has questionable accounting . . .?”

    They all do, especially after the abrogation of accounting standards in Mar. ’09.

  41. kmcgrew says:

    My first job out of college was as an auditor in a national public accounting firm. That was in 1979. By the early 1980′s, you could already see that the audit function was being commoditized in favor of more profitable consulting. A Big 8 firm would low-ball the audit to get in the door and start the consulting process. There was never really enough time in the budget to do the right job with regard to the audit function. So, this issue has been with us for almost 30 years, well before 1995. I have always been of the opinion that each company subject to an audit pays a fee into a pool and that is how auditors are paid. How objective is an audit opinion when the CFO has been playing golf with the audit partner for 20 years? I have been a financial advisor since 1987, and have always advised clients, as shareholders of a company, to vote against the CPAs. To politicize this issue is missing the point – it isn’t red vs. blue, it is just green.