Oversight board investigates lack of warnings by auditors before financial crisis

By David S. Hilzenrath
Thursday, March 17, 2011; 1:06 AM

The financial crisis has left some observers wondering why audit firms did not prevent or warn investors about problems that ultimately had a devastating effect on the U.S. economy.

Now the nation's top audit cop is asking the same question.

The Public Company Accounting Oversight Board is conducting investigations that may lead to disciplinary action against audit firms or individual auditors, the board's chairman, James R. Doty said in a statement he prepared for a meeting Wednesday.

"In several cases - including audits involving substantial financial institutions - PCAOB inspection teams identified what they determined to be audit failures," Doty said.

The oversight board's investigations are unlikely to shed light on the issue anytime soon. Under federal law, unless the board gets a waiver from the subject of the investigation, it must keep disciplinary proceedings confidential until they are concluded.

"This will take a long time," Doty said.

Revelations of systemic problems in the mortgage industry, including shoddy documentation of loans, have raised additional questions about auditors.

Under a post-Enron law, auditors have been responsible for auditing not just a company's financial statements but also its internal controls.

In December, New York's attorney general filed a lawsuit against Ernst & Young, alleging that it helped Lehman Brothers hide billions of dollars of liabilities by temporarily removing them from its books at the end of fiscal quarters. The "Repo 105" transactions, which came to light after Lehman collapsed at the height of the financial crisis in 2008, were explicitly approved by Ernst & Young, alleged Andrew Cuomo, who was then attorney general and is now governor of New York.

Ernst & Young vowed to fight the lawsuit, saying, "Lehman's audited financial statements clearly portrayed Lehman as a highly leveraged entity operating in a risky and volatile industry."

While its own investigations play out, the oversight board is studying how to make audits more informative for investors.

In general, after an annual audit, the auditors write a boilerplate letter essentially saying whether the company passed or failed. The vast majority of companies pass. Some investors are urging the board to require auditors to describe potential trouble spots in a company's accounting.

CONTINUED     1        >

© 2011 The Washington Post Company