Auditors' contribution to the fiscal crisis

Floyd Norris has written in today's New York Times that the Public Company Accounting Oversight Board was harshly critical of 27 of 61 of the Deloitte & Touche's audits that it inspected, over three years ago.

They should have drilled into allowances for loan losses, and they should have been especially alert for signs that the banks were playing games when they sold loans. Auditors should have carefully reviewed how the banks were valuing their mortgage-backed securities and loans that they planned to sell.

So, why are we learning it only now?

The Sarbanes-Oxley law that established the board included provisions to protect the public images of audit firms. If a board inspection found problems with the quality control systems, that was to be kept confidential unless the firm did not move to fix the problems over the following year. Then the release could be delayed while the firm tried to persuade the board to keep the information private. If that effort failed, the firm could appeal to the Securities and Exchange Commission.

Only then could the report be made public. So in this case, it took 41 months from the issuance of the report — more than three years — for Deloitte’s clients to learn of the problem.

Another problem:

In theory, the board can put a firm out of business, but since the demise of Arthur Andersen reduced the Big Five to what some call the Final Four, there is general agreement that going to three would be unacceptable. So while the board can credibly threaten to close down a small firm that does a dozen or two audits each year, no such threat would be credible for Deloitte or one of the other three major accounting firms.

Contempt for regulators is nothing new in the auditing world....