Question: Are the Big Four and national audit firms better off with regard to reputation and public trust than they were eight years ago at the height of the Enron and WorldCom debacles?
Overall, I would say the answer would merit an overwhelming "Yes," since it would be hard to fathom how the perception of the profession in general and the larger firms in particular could plunge lower than they had circa 2001-2002. But through a concerted effort on a lot of fronts, and a rather large foot planted on the backside of auditors in the form of Sarbanes-Oxley and the creation of the Public Company Accounting Oversight Board, the profession figuratively thumbed its nose at one of F. Scott Fitzgerald's revered maxims, and returned for a strong second act.
In a sort of a strange parallel of resurrection, Andrew Cuomo rebounded from a disastrous gubernatorial campaign in 2002 to re-invent himself as New York's crusading attorney general in 2006. Four short years later, he crushed his Tea Party opponent in the New York governor's race to assume the office his father had held from 1983 to 1994. Before moving his family into the governor's mansion, Cuomo had one last piece of business as AG, to file suit against Big Four firm Ernst & Young for allegedly helping its former client Lehman Brothers engage in accounting fraud prior to the investment bank's collapse in 2008.
E&Y's role as Lehman's auditor had apparently been in the crosshairs of prosecutors since the March 2010 release of a 2,200-page report by a bankruptcy examiner detailing the bank's implosion. The report charged that Lehman's C-level executives had, among other things, used creative accounting to inflate the value of its real estate holdings through what are known asRepo 105 transactions, and, more important, stated that there was evidence to support several claims against E&Y for poor supervision over Lehman's accounting practices. Cuomo's 32-page complaint alleged that Lehman ramped up its use of Repo 105 transactions the year before it collapsed. The increased use stemmed most likely from the fact that its portfolio was burdened with billions in bad mortgage and real estate assets. Repo 105 cleared a path for Lehman to burnish its balance sheet.
But enough history.
Going forward, Cuomo's decision to file suit against E&Y will leave his successor, Eric Schneiderman, with a complex case that doesn't come with a gift-wrapped guarantee of a successful prosecution. Ernst & Young has argued that the bankruptcy report singled out two quarters in which the firm did not audit Lehman's financial statements. The prosecution will have be convincing in its arguments that E&Y's audit opinion, which was predicated on several of the Financial Accounting Standards Board's old rules under U.S. GAAP, was in violation of the law.
In fact, as a result of the bankruptcy report, FASB is now in the process of converging those rules with IFRS, whose principles don't provide for repurchase transactions like Repo 105.
As an aside, I'm also a bit puzzled as to why no charges at press time have been leveled against Lehman execs, such as chief executive Richard Fuld. Or why the Securities and Exchange Commission hasn't stepped in at any point against the failed investment bank.
Whatever. There's an excellent chance E&Y will agree to a settlement before Schneiderman can even begin voir dire. Nor do I think whatever happens will set the profession back to the spiral of eight years ago. Remember, a lot of positives can happen in that time.
Just ask some of the big audit firms - or Andrew Cuomo.
Bill Carlino
Editor-in-Chief
