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EDITOR’S NOTE: 4 years ago, I spoke with some people in the big SEC auditing firms that give “clean” letters to public companies stating that the financial statements are a fair representation of the financial condition and operations during the period covered by the statements. Those of us who studied auditing, or like me who have taught auditing, know that those clean statements have not been true for decades, including most notably the absence of a caveat regarding the viability of the companies that were engaged in questionable and in some cases unfathomable transactions involving exotic financial instruments. If Alan Greenspan couldn’t understand it, then how could the auditor write a letter like that for JPM, Citi, BOA, Wells Fargo, Chase, et al?

Like the false appraisals by a rating agencies for these exotic instruments, and like the false appraisals coming from lenders who hired appraisers to “come in” at the necessary fair market value of the underlying property in order to close the deal so they could quickly take their fees and toss the risk onto investors and homeowners, the absence of the auditors screams out for justice. What would have happened if the auditors said flat out that the viability of these megabanks was in question in the event these exotic instruments imploded,, and that there was no way for them to accurately confirm the value that management had placed on them nor anyway to confirm that they were tier 1, 2 or 3 assets?

The question answers itself. Without a clean letter, the companies would have been forced into a policy of reporting that was transparent which, after all, is the reason for the audit — so the investors, prospective investors and customers and vendors of the company can accurately assess their risk in doing business with these megabanks. What would have happened? We all know. If the statements showed what we know today to have been the truth all along, the entire securitization illusion would have collapsed even as it began, and the Great Recession would never have occurred, the housing market would never have gone thorough the gyration that now effect virtually 100% of all Americans, directly or indirectly, and the life-styles and in some cases the lives of depressed people who took the lives of their families and then themselves would never have in the history books or on the media — because they would have been non-existent.


Troubled Audit Opinions


On one side is an assessment of a company with a clean audit opinion from the Toronto office of Ernst & Young, and with bonds rated just below investment grade by Standard & Poor’s and Moody’s. It has raised billions in capital markets.

On the other is an investment research firm using the name Muddy Waters Research. It says the company, the Sino-Forest Corporation, is a fraud, and that its shares are worthless.

As this is written, there is no definitive answer as to who is right. But the initial reaction of the markets seemed to be that they had more trust in the short-seller — a company whose Web site gives no address — than in the auditor’s opinion.

The shares, traded in Toronto, lost more than 70 percent of their value in two days, shaving $3 billion off its valuation. Bond prices also plunged. Prices had to fall sharply before speculators could be found who were willing to bet that the financial statements really did, in the boilerplate words of the auditor’s letter, “present fairly, in all material respects, the financial position of Sino-Forest Corporation.”

If there was a fraud, there is no doubt that Ernst & Young will be sued, and there is even less doubt that it will deny responsibility. After all, its letter did make clear that management was responsible for the internal controls needed to assure the statements are “free from material misstatement, whether due to fraud or error.”

To the auditing industry, the fact that investors tend to blame auditors when frauds go undetected reflects unrealistic expectations, not bad work by the auditors. The rules say auditors are supposed to have a “healthy degree of skepticism,” but not to detect all frauds.

“There is a significant expectations gap between what various stakeholders believe auditors do or should do in detecting fraud, and what audit networks are actually capable of doing, at the prices that companies or investors are willing to pay for audits,” stated a position paper issued in 2006 by the chief executives of the six largest audit networks.

Note that last part. They suggested that if investors were really worried about fraud, they should consider paying more for a “forensic audit” that would have a better — but not guaranteed — chance of spotting fraud. Don’t like our work? Pay us more.

There is no doubt that some companies are easier to audit than others, and that Sino-Forest falls on the harder side. While it has headquarters in Toronto and Hong Kong, its operations are — or at least are claimed to be — spread out over much of China. The company says it manages nearly two million acres in forest plantations across China. Muddy Waters says that is a lie, and that its actual operations are much smaller.

Investors trying to decide whether to believe the Muddy Waters report, with its detailed assertion that the company’s claims are contradicted by Chinese records, would love to know just what Ernst did to check. What records did it inspect? Which tree plantations did it visit? Who did the work? Was it people from Ernst’s Toronto office, which signed the report, or people from a Chinese affiliate? How many auditors did the work, over what period of time?

Ernst’s audit opinion does not say, which is no surprise. Virtually every audit opinion in the world says almost the same thing, with no details about the company being audited. Auditors are paid millions of dollars to produce a report that no one thinks is worth reading.

On June 21, the Public Company Accounting Oversight Board, which regulates auditors in the United States, plans to ask for public comments on whether to require auditors to do more and say more.

One idea the board is expected to consider is requiring auditors to disclose more about what they did, and did not, do. Ideally, auditors would point to things that they could not audit. There are a lot of them now, and sometimes they are crucial.

“The foundation” of the Sino-Forest fraud, stated the Muddy Waters report, “is its convoluted structure whereby it runs much of its revenues through ‘authorized intermediaries.’ ” Those organizations supposedly process tax payments owed to China on wood production, the report said, thereby assuring the company “leaves its auditors far less of a paper trail.”

Auditors could be called upon to specify where they thought fraud was most likely in a given company or industry, and what they did to confront the risk. Investors could have a chance then of comparing the work of differing audit firms, as one firm disclosed it had checked something other auditors did not mention.

If an audit was expected to call attention to possibly critical information that was not available to the auditors, perhaps there might be pressure from investors on companies to make that information available. In any case, investors could better understand what the auditors knew — and did not know — in reaching their conclusions.

The problems with audits now go well beyond questions of fraud. A critical element for many banks is the valuation of securities that trade infrequently, if at all. There may be a wide range of possible estimates, and the auditor now must simply conclude the estimates are within that range. If so, it signs off.

To make things worse, the estimates may have come not from the company being audited, whose work the auditor can examine, but from a pricing service that views its models as proprietary, making them virtually impossible to audit. That fact is something investors should know, but now do not.

Nor do auditors disclose information about how reasonable an estimate is. In some cases, a wide range might be defensible, and investors have no way to know whether a company was particularly conservative or aggressive in its estimates. The oversight board may consider asking that companies disclose what they deem to be the range of reasonable estimates, and why they chose the one they did. Then the auditors could comment on that.

If auditors enforced some consistency on ranges, then financial statements of different companies might be more comparable, even though they chose different estimates.

The accounting oversight board is also expected to ask if it is time to end the “one grade fits all” audit model, in which every company is deemed to “fairly” present its results. Perhaps a second grade could be added, like “presents adequately,” for companies that push the envelope but do not violate the rules.

In addition, auditors could be called upon to discuss the risks the company was taking. They could also be asked to call attention to some of the most critical disclosures in the footnotes, something that French auditors already do.

If much of that happened, audit opinions could become a lot more interesting to read. Investors might actually learn something, and they might be able to form opinions about differences in audit firms.

Another long-overdue change would be to have the lead partner on an audit sign the opinion in the annual report. Now, the firm signs, and investors have no way of knowing who was responsible. If an audit signed by a certain partner later blew up, that could be devastating to his or her career if investors shied away from any companies whose audits he later signed. Would that make auditors more careful? Perhaps.

This week, as the controversy over Sino-Forest raged, Canadian regulators began an investigation and the company indignantly defended itself. “I have spent 17 years building Sino-Forest and I can promise investors we are not guilty of the charges levied against us,” said Allen Chan, the chairman. “Our financial statements have been audited by Ernst & Young a leading international audit firm….”

Its board appointed a special committee of three directors, all Canadians who served on the company’s audit committee and including a former Ernst partner, to investigate. The committee hired PricewaterhouseCoopers, another member of the Big Four.

Investors seemed confused. After the plunge of last week, the shares bounced around on extremely heavy volume this week. They rose a bit on Thursday to 5.15 Canadian dollars ($5.26), but were still down 72 percent from the price of 18.21 Canadian dollars just before the charges were aired last week.

Moody’s said it will review its ratings and “seek to assess the veracity of the claims” made by Muddy Waters. It gave details of what it would check.

But Ernst was mute, unwilling to either defend its work or discuss how it had reached its now-questioned conclusion that the financial statements “present fairly” the company’s condition. Investors who relied on the audit will just have to wait.

“It would be inappropriate to make any comment while the work of the special committee is ongoing,” said Amanda Olliver, a spokeswoman for the audit firm in Toronto. “In any event,” she added, “our professional obligations prevent us from speaking about client matters.”

13 Responses

    David – This forces investigations overseen by the outside auditors and can alter company behavior —if newspapers CCd then if its really nasty it may get wider attention. Document the facts–attach proofs such as you would in court

    I agree and good point. I was reading the opposition in 2007 – 2008 to merging the FASB into IASB. It was excerpts from reports provided the government submitted by British academia, legal experts and economic authorities.

    I was a little shocked ….wow.

    Nothing more or less to scale than on point rhetoric consisting of
    – American business cannot be trusted
    – Americans do not report straight
    – American business is based on a hyper shortened horizon
    – High litigious business environment

    Read on – example :

    3 November 2008 Ev 12 Treasury Committee:

    Evidence to have a major impact on the development of IFRS. Any future proposal would have to be tested against what would be acceptable to the litigious US environment.

    Although the IASB model requires public consultation for accounting standards, there was no constitutional requirement for public consultation on this fundamental convergence decision.

    Furthermore, there are indications that that more concessions have been made on the IASB side than the US side. FASB Chair Bob Herz has suggested “the IASB has amended many of its standards, and, to a lesser extent, we in FASB have modified some of our own” (Herz, 2005). The IASB may to an extent be insulated from political influence at individual state and EU level.

    The US FASB is overseen by the US Securities and Exchange Commission which is itself subject to US political influence. Not to be trusted


  2. @sao

    Well guess what—I’m a entity living in an entity and I’m NOT going to let some other illegal entity have my entity—NEVER!!!

  3. INVESTORS don’t do business unless ‘Title Corporation’ insures ‘Pooling of Assets’, ‘Pooling of Receivables’, ‘Credit Increase on an existing title policy’… so whose audits ? Chicken and Egg situation.

  4. We are dealing with apples and banana’s

    Any ‘audit’ over SEC is by MEMBER ONLY in accordance with rules and regulations of a private membership.

    SEC ‘Members are entities.

    ‘Exclusive’ membership to exchange currency over private financial exchange.

    When entity hires firm they do audit as firm with no person’s name.

    Anyone ever wonder why?

    You can’t put in jail the entity.

  5. This is HUGH!

    National mortgage fraud scandal spreads to the judiciary

    Judges caught with their hand in the cookie jar?

    Continue reading on National mortgage fraud scandal spreads to the judiciary – National Architecture & Design |

    While the U. S. Department of Justice is actively prosecuting mortgage and foreclosure fraud, a national organization that helps homeowners avoid foreclosure has evidence that certain state judges appear to be protecting lawbreakers. Billions of dollars have been received by corporations in the foreclosure industry since the Great Recession began. Are these vast sums of money finding their way to elected state judges and politicians?

    CHOESTOE, GA – June 11, 2011 ( – Amid the splendor of pristine mountains, waterfalls and springtime flowers in one of America’s favorite vacationlands, a passionate lady-with-a-cause, presented evidence yesterday that could shake the judicial system to its foundation. While helping families facing foreclosure, her non-profit organization has recently stumbled upon very questionable judicial actions in several states. The evidence is overwhelming that the powerful foreclosure industry not only has inappropriate influence over state court systems, but is using threats and economic pressure to stymie investigative efforts and legislative regulation.

    On first appearance one would expect to see Anne Batte as the hostess of a chic cocktail party in Chevy Chase, MD, welcoming a National Geographic explorer back home, or perhaps chatting away at the grand opening of an art museum’s new wing in Denver. The college coed figure, youthful looks and sophisticated vocabulary of the blonde Southern Belle disguise her total dedication to an effort to help the victims of America’s Great Recession. She is an Evangelical Christian and the founder of Operation Restoration, Inc..

    Anne Batte grew up in Richmond, VA. She is the daughter of the late, John Batte, a prominent Virginia attorney and real estate developer. Her inherited position in Richmond society would have never predicted her current lifestyle. Among many experiences in her past, she also has been the successful developer of large real estate projects and has lived in several regions, including Costa Rica. After returning to live in Atlanta in March 2008, she became aware of the mass suffering in the United States caused by the Great Recession and the apparent indifference of those in power to this suffering. She stated yesterday that she has taken Jesus’s Sermon on the Mount, literally and trusts in God to provide her earthly needs as she carries out her mission.

    Operation Restoration describes itself as “a free, non-profit mission of healing and restoration that is dedicated to foreclosure prevention.” It currently is helping homeowners in 39 states, but as more donations become available, it plans to provide services nationwide. The organization has published educational information and self-help tools online. It provides trained case managers to guide borrowers and realtors. It also assists law enforcement agencies when team members become aware of possible crimes being committed.

    The staff and volunteers of Operation Restoration come from a broad range of professions in the finance, real estate and construction communities. Bankers and attorneys have been extremely helpful in developing the programs of the organization. Ms. Batte stated that she hoped the national media would help the public understand that the entire financial and legal community should not be condemned for the illegal or greedy actions of some members of their professions.

    Evidence of judicial corruption

    Under the shade of a giant weeping willow tree in the North Georgia Mountains, Batte presented a cardboard box full of photocopied legal documents. These copies were obtained from court cases and foreclosure actions from around the nation. However, the questionable legal actions seem concentrated in the Lower Southeast, where the Great Recession began.

    Within the mounds of paperwork, the most obvious violations of federal and state laws involved forged signatures of attorneys, corporate officers and notary publics. The names on these documents can not be released to the public at this time because such information would interfere with active criminal investigations or are evidence for civil cases in progress.

    There were 12 different signatures on legal documents supposedly reviewed and signed by one attorney. All of them contrasted starkly with the signature within his own mortgage! In some of the court cases he was involved with, sloppy and apparently illegal work allowed official court documents to be forged for both parties representing sellers and buyers, or plaintiffs and defendants. Ms. Batte stated that this particular case was thoroughly exposed in November 2010 by one of the nation’s oldest broadcast news teams, WSB-TV. However, since then, the ABC local affiliate has ceased investigating cases of foreclosure fraud. No action has been taken by law enforcement agencies against the attorney.

    Other forged documents claimed that corporations held deeds to real estate properties that they didn’t own. A major national bank foreclosed on a property which the occupants owned free and clear, and didn’t even have a mortgage. More common cases involved attorneys signing documents claiming that mortgages were in default that actually were current in payments. Certain women signed official court documents as registered notary publics when in fact they were NOT notary publics at that time.

    Continue reading on National mortgage fraud scandal spreads to the judiciary – National Architecture & Design |

    The next level of fraud presented by Ms. Batte involved how state courts had dealt with obvious cases of fraud, forgery and perjury. In a typical case, attorneys for the plaintiff challenged the legality of court documents witnessed and signed by a person pretending to be a notary public. Several months after the illegal act, she had become a notary public. She was employed by a large law firm, which persuaded several attorneys and notary publics to sign sworn affidavits that she was a notary public at the time when they originally submitted documents to the court. All of these affidavits were acts of perjury, which should have resulted in disbarment, criminal fines and potentially, prison sentences. So far the judge has done nothing.

    In case after case, official court documents identified certain judges in state courts, who were consistently blocking cases involving forgery of deeds, legal documents and foreclosure actions from being brought to trial. In some cases, district attorneys refused to present evidence of illegality to the courts. In other cases, district attorneys or civil attorneys tried to present evidence of illegality, but were quickly censured by certain judges. In one case, in Fulton County, GA, a judge threatened a crime victim with contempt of court if she ever was in his courtroom again. Her complaint was that forged signatures were utilized by a mortgage service company to foreclose on her home, when in Georgia mortgage service companies can not legally foreclose on residential real estate.

    State banking committee stalls mortgage fraud legislation.

    Ms. Batte stated that while legislators in many states have publicly announced their opposition to shady mortgage procedures and fraudulent foreclosures, there has been little state level legislation that addresses the problems. She explained that most states have public records of large sums of money being spent by lobbyists to persuade legislators to maintain the status quo.

    A good example of the contrast between public statements made by politicians and their actual behind-the-scenes activities can be found in Georgia. Georgia State Senator Jack S. Murphy was named chairman of the GA. Senate Banking Committee in January 2011. GA Senate Bill 123, amending the laws on mortgage fraud, was sent to his committee for review. There it has sat since then. In the meantime, Murphy along with seven other former officers of the failed Integrity National Bank of Alpharetta, GA have been charged by FDIC regulators with gross negligence and various breaches of fiduciary duty associated with its issuance of mortgage loans. The FDIC is seeking damages of over $70 million. Murphy refuses to resign from the Banking Committee.

    The Georgia House of Representatives passed its version of the mortgage fraud bill in April 2011. However, since the Senate version never came out of committee, the House version was introduced into the Senate shortly before midnight on the General Assembly’s last day of this session. It was tabled to the 2012 session.

    What are state criminal justice agencies doing?

    Anne Batte was asked why state agencies were not taking a more active role in the investigation of forgeries, mortgage fraud and illegal foreclosures. She responded that the involvement of state attorney generals varies from state to state. Some have shown great concern when shown evidence that judges in their state were not enforcing the law. Others claimed that they had no jurisdiction or that it was improper for them to question the findings of standing judges.

    Ms. Batte stated that Samuel Olens, a highly respected attorney and former Cobb County, GA Commission Chairman, made prosecution of mortgage and foreclosure fraud a major platform of his campaign last fall. However, after becoming Georgia’s new Attorney General, he has not prosecuted any cases of these types of fraud, nor investigated charges of judges showing inappropriate favoritism to the foreclosure industry.

    At the end of her interview, Ms. Batte was asked if she felt any concern for her personal safety since providing incriminating evidence to criminal justice agencies about judiciary impropriety. She said that members of their organization have received some threats. At times their office phones have appeared to be illegally tapped. The dynamic civic leader ended her response with this statement of her faith, “I have placed my life in God’s hands and in him, I will always trust.”

  6. Accredited investments under the Generakl business trust structure

  7. To the auditing industry, the fact that investors tend to blame auditors when frauds go undetected reflects unrealistic expectations, not bad work by the auditors. The rules say auditors are supposed to have a “healthy degree of skepticism,” but not to detect all frauds.

    This loose standard dovetails with Sarbannes Oxley such that you in the public who encounter irregularities as customers—observers, employees, whatever perspective can FORCE the audit firms and company audit committee to face the issues—stuck in their faces and documented by CCs to various agencies and/or fed state legislators. The agencies and legislators do little or nothing perhaps but the warning is documented and the audit firm and officers become liable for non-disclosure. This forces investigations overssen by the outside auditors and can alter company behavior —if newspapers CCd then if its really nasty it may get wider attention. Document the facts–attach proofs such as you would in court—-its not perfect but it is a way to attempt to correct things. Most people do not understand that SA exists and how it is to be used civilly.

    It would be a great boon to people, if this SA piece were more widely discussed and its tools placed into the hands of the readers.

  8. Here is a petition I fround from this website

    Spread the word thru social media and Blogs like etc….

  9. “Three Strikes and You Are OUT”, law was started by a small grass-roots group of people in Washington State, Ida Ballisoites and Helen Harlow, and it would never be if it were not for public petition that unanimously we accomplished being signed by a record amount of signatures. It was grueling like this mortgage fraud when the internet was not so available in those days. It is an unconscionable crime and no politician would help. They all mocked us for our efforts.

  10. Consistent public protest in front of their firms would be a good idea as well. Does anyone know of an attorney who would be able and willing to put a petition together for us Americans that would be put into law -laws protecting the homeowners and jobs we can pass by the people in every state by petitioning on line by the peoples vote, instead of waiting for these politicians to do their job. That has not got us very far. A petition like that would receive priority attention from Americans.

  11. The auditors need to be audited that’s simple. Where is the transparency that was promised in 08? Why isn’t any of this information transparent like was promised? We have a corrupted system to the core and like any other malignate disease, u must attack it at the core. The world needs an enema. That’s a good start. Debi. 5613899339

  12. These hired gun bean counters need to be held accountable,
    Ernest & Young, needs to learn that like Author Anderson. cooking the books for your clients, instead of following strict accounting rules, can and will result in ruin.

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