SEC’s ex-chief accountant: Is agency a lapdog or watchdog?

Introduction

A former top Securities and Exchange Commission official today urged the regulator “to get serious about enforcement” and questioned why senior Wall Street and accounting firm executives have gone unpunished for their role in the financial crisis.

“Is the SEC a lapdog or a watchdog?” asked Lynn Turner, a former SEC chief accountant who left in 2001, in testimony before a Senate panel examining the role of accounting firms in the financial crisis.

Turner also criticized the Financial Accounting Standards Board (FASB), which sets rules and standards that guide auditor actions, for failing to issue “timely standards” on off-balance sheet transactions like Repo 105. That was the accounting trick Lehman Brothers used to park as much as $50 billion a quarter overseas to fool investors about its true leverage.

“The FASB has a very diluted mission and objective of trying to serve all auditors, financial management who prepares financial statements, as well as investors,” Turner said in his prepared testimony. “When one is tasked to serve all, it often results in none being served.”

The SEC has brought dozens of market crisis-related cases since 2008, which have yielded some big settlements, including the record $550 million that Goldman Sachs agreed to pay last year after the investment bank was charged with lying to investors about a subprime security. But regulators have yet to pursue any civil or criminal actions against the firms or audit partners who signed off on financial statements of the dozens of banks that later went bankrupt or required a government bailout.

Why no warnings from auditors?

Democrat Jack Reed of Rhode Island, head of the Senate subcommittee that held the hearing, said “auditors have a special responsibility” to the public, one that in the run-up to the 2008-09 financial crisis they didn’t keep.

“Why were there no timely warnings about companies that failed within months of an unqualified (financial audit) report?” Reed asked.

James Doty, chairman of the Public Company Accounting Oversight Board (PCAOB), said that its inspection reports, beginning in 2006, showed “defects and failures” in audits performed by the accountants. “[The auditors] should have delved more deeply into valuation issues,” he told the lawmakers.

The PCAOB is conducting several investigations related to bank audits, Doty said, but those proceedings, and any disciplinary actions that may result, are confidential under the 2002 Sarbanes-Oxley Act. The confidentiality requirement means that the PCAOB rarely makes public any details of its enforcement actions. Doty has asked Congress to amend Sarbanes-Oxley to allow the agency to make enforcement actions public, like the SEC.

One accounting issue likely under investigation is Lehman’s Repo 105, which was uncovered by Anton Valukas, the court-appointed bankruptcy examiner of the Lehman estate. The complicated Repo 105 scheme was explained in a Financial Reform Watch story last September.

Valukas, who also testified at the Senate hearing, said he found evidence to support a civil lawsuit against former Lehman executives and auditors at Ernst & Young for their role in manipulating the balance sheets. He said that the public is entitled to believe that a “clean” report from an auditor stands for something.

“The public has every right to conclude that auditors who hold themselves out as independent will stand up to management and not succumb to pressure to avoid rocking the boat,” Valukas said.

The current chief accountant at the SEC, James Kroeker, who also testified, said that while he could not comment on pending investigations, the examiner’s report about Lehman is “detailed and chilling.” The SEC has not filed any charges related to the report, which was released one year ago.

Cuomo filed only Repo 105 lawsuit

So far, the only law enforcement official to take action against Repo 105 is former New York Attorney General Andrew Cuomo. Last December before becoming governor, Cuomo sued Ernst & Young for its role in hiding Repo 105 from the investing public.

Leslie Seidman, chairman of the private-sector Financial Accounting Standards Board (FASB), said the group is revising the standard for determining when a repurchase agreement like Repo 105 should be accounted for as a sale—as Lehman did—or a financing.

Turner, the most outspoken critic among those testifying, said that the SEC should get more funding, and that the PCAOB should conduct an in-depth investigation of the role of the accounting firms. But he also seemed the most pessimistic about the prospects of meaningful change.

“We never seem to get the problems fixed,” he said. “Twenty-five years ago, you heard the same testimony. What is wrong with this system?”