The Underworld of Wall Street Accounting Is Finally Coming to Light

Just recently, an indictment of five accountants became unsealed.

This isn't just any old document. It is proof of just how cozy relationships and revolving doors add to the epidemic of funky accounting practices.

The accountants named include three big shots from KPMG, one 2015 hire at KPMG who came over from the Public Company Accounting Oversight Board (the regulatory body controlled by the SEC that oversees accounting firms), and a KPMG wannabe who was working at the PCAOB.

Add that to the fact that General Electric Co.'s (NYSE: GE) outside auditor has always been KPMG, and maybe investors will start to understand that audits aren't foolproof. Sometimes even the audits that are supposed to be irreproachable are factually lacking and fraudulent.

There's a lot going on behind the scenes when it comes to GE, the PCAOB, and the Big Four of accounting (Deloitte & Touche LLP, Ernst & Young LLP, Pricewaterhouse Coopers, and KPMG).

As always, I'll be your guide...

The Call Is Coming from Inside the House

The U.S. District Court's unsealed indictment on conspiracy alleges that the group engaged in fraudulent activities to benefit KPMG.

These individuals are:

  • David Middendorf (former national managing partner at KPMG)
  • Thomas Whittle (former audit partner at KPMG)
  • David Britt (former audit partner at KPMG)
  • Cynthia Holder (former PCAOB inspector and 2015 hire at KPMG)
  • And Jeffrey Wada (former PCAOB inspector).

Brian Sweet, a former inspector at the PCAOB who was hired by KPMG, already plead guilty to conspiracy charges. It's likely he will testify against the others.

The scheme was simple enough. The PCAOB oversees supposedly independent outside accounting firms that audit public companies. Up until recently, the chairperson and board never came from the Big Four accounting firms.

The PCAOB, while technically independent, is overseen by the Office of the Chief Accountant, a position under the auspices of the SEC. For longer than most anyone can remember, the chief accountant has come from one of the Big Four accounting firms and usually returns there when they leave.

It's a revolving door into regulatory power.

Allegedly, when Cynthia Holder was at the PCAOB, she gave KPMG bigwigs a heads-up on which audits conducted by KPMG the PCAOB investigative team was going to ask to take a look at. In theory, it's to make sure KPMG wasn't deficient in doing its job. That's what the PCAOB does.

It only takes 10 minutes a week to double your way to $1 million... This strategy doesn't require any special training – yet it could potentially put $1 million in your bank account faster and easier than you ever dreamed...

For her good work at the PCAOB, Holder got a coveted job at KPMG (cough, revolving door) and allegedly enlisted Jeffrey Wada, who was still at PCAOB but wanted to join KPMG, to continue supplying KPMG with lists of audits that PCAOB inspectors were going to ask for.

Apparently the scheme was uncovered - perhaps internally, it hasn't been disclosed - and all hell broke loose. The accountants involved at KPMG and the PCAOB were fired and later indicted.

[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]

GE's Honest Auditor Deficit

Why would so many high-ranking KPMG partners risk their careers over audits of their audits if the PCAOB has no authority to fine them? They can only shame them by lowering their rankings on some scale that the public probably doesn't know even exists.

Either the Big Four accounting firms aren't that good at what they do, or they're too good because they're buddies with the firms they audit.

Of the Big Four firms - Deloitte & Touche LLP, Ernst & Young LLP, PricewaterhouseCoopers, and KPMG - it was KPMG that had the highest number of "deficiencies" (auditing issues) cited by the PCAOB in the past two years.

In 2016, 20 of KPMG's inspected audits (about 38%) were found to be deficient, and 28% of all the Big Four's audits were found to be deficient.

In 2015, 28 of KPMG's inspected audits (54%) were found to be deficient, and the comparative Big Four deficient audits totaled 35% deficient.

The Sarbanes-Oxley law that created the PCAOB effectively barred a practicing public accountant from serving as chairman. The restriction was intended to boost the regulator's independence from the accounting industry.

The new chair of the PCAOB, William Duhnke, isn't from a Big Four firm; he's a specialist in securities law and financial reporting, having worked on Senate panels for the Intelligence, Banking, and Rules committees.

But, for the first time, the PCAOB board now has two Big Four (revolving door) reps: Duane DesParte, a former audit partner at accounting firms Deloitte and Arthur Andersen; and James G. Kaiser, who had been with PwC for 38 years and held numerous leadership roles with the firm.

Now, KPMG just happens to be GE's outside auditing firm.

About that reported $15 billion black hole just discovered in GE's accounting, and whatever other accounting bogeymen lie in their basement... Why did KPMG never notice anything wrong?

It's not like they were newbies looking over GE's complex books. They'd been GE's auditor for forever, and GE loved them. In fact, GE just reappointed them, citing reasons such as "high audit quality" and "efficient fee structure."

The bottom line is that there's just no trusting anyone anymore, at least not anyone the SEC oversees. That's my takeaway.

What's sad in that realization is that the SEC is everyone's front line against all kinds of fraud by public companies, by their auditors, by their rating agencies, and this is how they roll?

There's more dirt coming. Count on it.

Understanding Wall Street's inner machinations is key to banking extraordinary returns. Shah's been on the inside, and in his free, twice-weekly Wall Street Insights & Indictments, he reveals how to trade the bigger picture for maximum returns. To get his expert insight and recommendations, just click here.

These Trade Recommendations Are CRUSHING the Market

The major indexes are driven by a few overpriced stocks. The rest of them – I'm talking thousands of stocks – are garbage.

But targeting the market's worst stocks is a great way to get rich. So long as shares are plummeting, you could be making a killing again and again.

And I'm the one person able to identify which stocks have about a 100% chance of dropping to the ground.

Since April 21, my Zenith Trading Circle recommendations have outperformed every investment on the market with average gains of 44% per day (including partial closeouts).

In fact, one of my recent plays closed out with a 955% return.

Don't cheat yourself out of the chance at thousands up for grabs here. Click here to learn more.

The post The Underworld of Wall Street Accounting Is Finally Coming to Light appeared first on Wall Street Insights & Indictments.

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.

Read full bio