The Real Reason Accounting Firms Are Unaccountable

Just because PricewaterhouseCoopers, as defunct Alabama-based Colonial Bank's outside auditor, missed a massive fraud at the bank that sank it in 2009 and cost the FDIC $2.5 billion doesn't mean PwC did anything wrong...

Just because the fraud PwC missed was engineered between a top Colonial executive's mortgage department and the bank's biggest mortgage banking client, and PwC never looked into the legitimacy of any of the mortgages that were put up as collateral, doesn't mean PwC did anything wrong...

According to PwC, they didn't do anything wrong because they're not responsible for not knowing what they didn't know or what was hidden from them.

And that's a good defense, though it's not what you want to hear from an institution entrusted with high-level auditing.

Even though a judge at the U.S. District Court for the Western District of Washington ruled last week that the FDIC could sue PwC doesn't mean that they are in any danger of being held accountable for rubber-stamping the audit reports that were relied on by investors and regulators.

So, the FDIC's lawsuit will be settled out of court and sealed. We'll never know how negligent PwC was or how negligent they will continue to be.

That's just the way it goes in the protected world of the "Big Four" accounting firms - the same way it still goes at the big rating agencies.

They're all protected by the same regulator who oversees both industries: the U.S. Securities and Exchange Commission.

Here's why that's a problem...

The Big Four's Chokehold on the System

I've spilled enough ink on how corrupt the rating agencies were and how the SEC protected them.

I haven't shared what I know about how the Big Four accounting giants (Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers) are also protected by the SEC, the regulator they captured years ago.

Now, with the prospect of the FDIC suing PwC over their failure to catch what they should have caught in their normal course of auditing, it's time to shine the light on the same old SEC - again.

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The story starts with the Public Company Accounting Oversight Board, the PCAOB.

After some terrific accounting scandals came to light in 2001 (most infamously the implosion of Enron), Congress enacted the Sarbanes Oxley Act of 2002, or SOX for short.

SOX was about accounting accountability. While the SOX Act is long and complicated and calls for lots of regulations and checks and balances, including provisions for whistleblowers, the meat of it is about CEOs and CFOs being legally liable for signing off on accounting paperwork and audits.

In establishing SOX, Congress established the Public Company Accounting Oversight Board to set standards and to lead the charge against wrongdoers.

PCAOB is technically a "private" company funded by the fees it collects from the accounting firms, broker-dealers, and others it has jurisdiction over.

The chairman and board of the PCAOB are picked by the five-member board of the SEC. Most of the time, the chair of the PCAOB and its small board come from some connections to Congress and an administration, are lawyers who've served in other government-associated positions, or come from private practice but have solid government credentials and friends in high places.

For the most part, the PCAOB tries to fulfill its mandate. That isn't the problem.

The problem is the SEC - and within the SEC, the office of the chief accountant has the chief accountant himself. The chief accountant essentially has direct responsibility over the PCAOB.

That is the problem.

Wolves Guarding Hen Houses

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Most of the chief accountants, who oversee and dictate policy at the PCAOB, come from the Big Four accounting firms.

The SEC's new chief accountant, Wesley Bricker (blessed by Mary Jo White, the former chair of the SEC who anointed Bricker in November 2016), was a partner responsible for banking, capital markets, financial technology, and investment management at PricewaterhouseCoopers LLP.

We'll see the effects of Mr. Bricker's influence as accounting rules and regulations get a good looking over in the near future.

We already know that Mr. Bricker's predecessor, Chief Accountant James Schnurr, was friendly with the accounting industry he oversaw.

Schnurr, anointed by SEC Chair Mary Jo White in 2014, was deputy managing partner at the world's largest accounting firm, Deloitte & Touche, prior to his regulatory service.

While Mr. Schnurr was deputy managing partner at Deloitte, the accounting giant audited and rubber-stamped the books of Bear Stearns, Washington Mutual, and Fannie Mae. Each went bust soon after, costing investors over $115 billion in losses.

Besides Mr. Schnurr's deep ties to Deloitte, Mary Jo White represented Deloitte while she was a partner at law firm Debevoise & Plimpton. And Chair White's husband, John White, is a partner at law firm Cravath Swaine & Moore, which counts Deloitte among its clients.

But none of that is out of the ordinary.

Each of Mr. Schnurr's predecessors, going back to 1992, came from senior partnerships at one of the Big Four accounting firms.

Most returned to their firms when their stint as chief accountant ended.

In reality, "the very people the PCAOB is regulating are the ones that are overseeing them," according to Lynn E. Turner, a former Big Four accounting executive who served as chief accountant of the SEC from 1998 to 2001.

Ever wonder why there aren't thousands of executives prosecuted under the SOX rules that were supposed to bring them to justice? Now you know.

PwC will settle with the FDIC, maybe get a slap on the wrist, and move on with their business of charging clients hefty fees to rubber-stamp their books and records. They, like the other giant accounting firms, are protected by the regulators whose strings they pull.

Keep that in mind the next time you hear one of these giants claim they had no idea what was being hidden from them in their audits.

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About the Author

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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