Wednesday, 22 December 2010

Spotlight falls on Big 4 role in banking crisis

With the annoucement that the New York State Attorney-General, Andrew Cuomo, could press charges against Ernst & Young relating to an accounting practice which allowed the Lehman Brothers to hide tens of billions of dollars in debts from investors, the spotlight is beginning to fall on the role of auditors in the banking crisis. With the levels of fees that the Big 4 receive for auditing the banks measured in hundreds of millions, yet again questions have to be asked as to whether they are commercially conflicted from calling out where they find questionable practices when the loss of a contract to audit can have such a large financial impact on a firm.

An argument put forward by some from the Big 4 is that many of the reasons for the financial crisis were too complex to have been spotted by the auditors. One of the reasons for this may be that, whilst the Big 4 charge millions to conducts audits, they flood the audits with new graduates and junior staff, thus maximising their profits. Carrying out audits, which is openly acknowledged as not the most interesting work that the Big 4 do, is seen very much as part of the rites of passage, part of the apprenticeship that is required to be done by those wishing to progress through the firm. Questions need to be asked as to whether the right calibre of staff are put onto audits and whether the culture of Big 4 prevents those on audits from asking the difficult questions.

A critical part of the Attorney-General's case will be that both middle ranking managers at Lehman Brothers and Ernst & Young flagged up concerns about the use of 'Repo 105'  to Ernst & Young, but that this was not raised with the Lehman Brothers board. This raises a serious question about the culture within the Big 4, where Partners are treated as demi-gods who's judgements cannot be questioned, certainly if the employee wishes to remain in the firm or on a career upward trajectory. In the case of Matt Lee, the Lehman's employee who raised the issue, within weeks he was laid off.

The issue of the auditors raising issues is not limited to Lehman Brothers, but also the other banks that failed during the crisis such as Countrywide, Northern Rock and Anglo Irish Bank.

With all the focus on bankers and their bonuses, it should not be forgotten that many of the partners of the Big 4 are paid significantly higher than the majority of the investment bankers and rather than their pay being reduced as a result of the financial crisis, which they could potentially have helped prevent, all the Big 4 have announced significant growth in their profits and their partners' take home pay.

History can teach us many lessons and the partners of the Big 4 should very conscious of the impact of Enron on the once mighty Andersen and its partners.

1 comment:

  1. Christopher Hanks3 January 2013 at 09:47

    When Big 4 auditing firms are named as co-defendants in big securities class-action lawsuits, as is now happening in the Lehman Bros/Ernst&Young and Bear Stearns/Deloitte-Touche cases, three things always happen: First, the Big 4 firm will always claim that the financial audits were all done properly, that the case is "meritless," and that they look forward to defending themselves in court. Second, as the suit progresses, the firm will settle out of court for an amount substantially less than what the suit calls for (and without admitting any wrongdoing), thereby enabling the good life to go on for Big 4 auditors everywhere. Third, two years or so later after everyone has forgotten about the case, the Public Company Accounting Oversight Board will issue a generalized "inspection report" stating that the firm did indeed fail to perform a "quality audit," and the firm in question will issue a release assuring everyone that it is working closely with the PCAOB to make sure failures never happen again. Great system, isn't it?

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