Many wonder why the Securities and Exchange Commission and U.S. Department of Justice are seemingly unable to prosecute Lehman Brothers and its auditor Ernst & Young for the massive over-valuations of the investment bank’s sub-prime mortgage-backed “assets” and other misleading (and, possibly, fraudulent) information published in ﬁnancial statements in the years and quarters leading to the systemic ﬁnancial meltdown that Lehman’s own bankruptcy helped fuel. Are Lehman’s auditors above the law? Regrettably, for a number of reasons, auditors are becoming increasingly immune from challenge by prosecutors, regulators and investors.
The ﬁrst reason is that money talks in Washington. Although most citizens know of the overwhelming donations to federal political candidates by banks and other ﬁnancial services ﬁrms, it may surprise some that accountants are also a very generous source of funding for both Republican and Democratic candidates. In the election cycle of 2009-2010, alone, the “big four” accounting ﬁrms and their association contributed more than $8 million to federal candidates, according to the Center for Responsive Politics. In the same period, fraud defendant Ernst & Young contributed
in excess of $1.6 million to politicians.
“When the Rich Break Laws, Prosecutors Find Themselves on Trial”
Certainly, it is not unknown for Members of Congress to make their views known when favored companies or industries are under investigation. In a recent column applauding the documentary Inside Job
, Paul Krugman, the Nobel laureate in economics, provided just one of many examples of recent political intrusion into prosecutors’ work:
The . . . proposed [legal] settlement between state attorneys general and the mortgage servicing industry . . . is a ‘shakedown’,” says Senator Richard Shelby of Alabama. The money banks would be required to allot to mortgage modiﬁcation would be ‘extorted,’ declares The Wall Street Journal. And the bankers themselves warn that any action against them would place economic recovery at risk. All of which goes to conﬁrm that the rich are different from you and me: when they break the law, it’s the prosecutors who ﬁnd themselves on trial. Source
Why Can’t SEC Pursue Big White Collar Criminals?
Aside from Congressional interference with prosecutors, why can’t the SEC bring big accountants and banks to heel? Again, Congress runs interference. With the new majority in the House of Representatives now cutting millions from the SEC’s budget at the same time the Commission’s responsibilities have ballooned, the agency must place on-hold desperately needed technology up-grades and new hires. For years, experts have warned that regulators could not and cannot keep up with the explosive growth in securities markets and the new exotic computer-driven ﬁnancial instruments that played a starring role in the 2008 ﬁnancial meltdown.
Consider these comments by regulatory authorities:
– “State regulators and the SEC ﬁled numerous cases against corporations and secondary actors [the lawyers, accountants, investment bankers and other advisers that enable complex modern frauds] in the recent decade. However, many more cases of fraud were not pursued by regulators due to their limited resources.” — September 17, 2009 Testimony before the U.S. Senate Judiciary Committee’s subcommittee on crime and drugs by Tanya Solov, Director, Illinois Securities Department on behalf of the North American Securities Administrators Association, the representative organization of the regulators within each of the 50 states. The state administrators testiﬁed in favor restoring private liability for fraud aiders and abettors.
– “Quite frankly, our enforcement and examination resources have been seriously constrained in recent years,” — Mary Schapiro, Chairman, Securities and Exchange Commission, in speech to the Council of Institutional Investors, April 6, 2009.
– “Investors’ rights of private action have been seriously eroded in the past decade. Investors should not have to suffer the type of conduct that contributed to Enron and other scandals. And the SEC does not, and will not have the resources to enforce the securities laws in all instances.” — Mr. Lynn Turner, CPA and former SEC Chief Accountant in March 10, 2009 testimony before Senate Banking Committee hearing.
Can Investors Take Action Against Auditors?
Aside from their seeming immunity from serious criminal or government civil actions, the auditors upon whom investors and the public rely when researching a company have also won near immunity from private investor actions — a major deterrent to accounting fraud and other wrongdoing — thanks to a pro-fraud defendant law Congress enacted in 1995 over President Clinton’s veto and radical decisions by an increasingly politicized Supreme Court (which Congress is unwilling to override).
As explained by Philadelphia attorney and Roosevelt Institute “Braintruster” Daniel Berger, accountant-driven securities “reform” legislation in 1995 and two Supreme Court decisions (Central Bank in 1994 and Stoneridge in 2008) eliminated accountability to investors for those who knowingly aid and abet securities fraud, such as the accountants who allegedly helped Lehman “cook the books”:
Bi-partisan legislation in the 1990s [during the de-regulatory binge] and two major Supreme Court decisions in 1994 and 2008 have effectively eliminated liability for aiding and abetting securities fraud. [In a column, economist Robert] Kuttner noted that ‘You can be sure if this right were still available, Ernst and Young would have thought twice about giving Lehman a clean bill of health.’ Source
In January, 2010, testimony before the United States Financial Crisis Inquiry Commission, Denise Voigt Crawford, the president of the North American Securities Administrators Association and Commissioner of Texas State Securities Board explained how investors’ ability to pursue private actions, a major deterrent to Wall Street and corporate accounting fraud and other wrongdoing, have been limited:
[O]ver the last 15 years, Congressional actions and Supreme Court decisions have restricted the ability of private plaintiffs to seek redress in court for securities fraud. These restrictions have not only reduced the compensation available to those who have been the victims of securities fraud, they have also weakened a powerful deterrent against misconduct in our ﬁnancial markets. (See Commissioner Crawford’s full testimony
Will Auditors Remain Above the Law?
The climate might be changing in Washington and in Europe. The Washington Post recently reported that the Public Company Accounting Oversight Board is asking why auditors didn’t warn the public and investors about the shaky condition of America’s ﬁnancial services industry before the 2008 meltdown:
The Public Company Accounting Oversight Board is conducting investigations that may lead to disciplinary action against audit ﬁrms or individual auditors, board chairman James Doty said in a statement he prepared for a meeting [March16] Source
Regulatory authorities in Europe and the United Kingdom are also investigating the role of auditors in the worldwide ﬁnancial meltdown
made in the USA, according to Reuters.
With continued media scrutiny of the causes of the great ﬁnancial debacle, and Wall Street spawned recession that followed it, public opinion might trump campaign contributions and lead Congress to restore to U.S. citizens lost legal rights, fully fund regulators and law enforcement agencies and even butt out of state and federal prosecutions. And, regulatory and possible criminal actions by the less conﬂicted European Union might also help shame U.S. law makers into taking action.
Some day soon, auditors may again become subject to the same laws as us little people.
More articles by Jeff McCord about investors and securities fraud and the need to improve investor protection can be read at The Investor Advocate
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