Wednesday, February 20, 2008

PWC On Guard

"American International Group Inc., which has struggled to recover from an accounting scandal, will be forced to write down the value of financial instruments tied to mortgages after its auditors said they found 'material weakness,' in its accounting systems, a signal that accounting firms may get tough on already battered financial giants. ... Bond rating firm Fitch Ratings announced yesterday that it is putting AIG's issuer default rating on 'negative' watch. ... Kathleen Shanley said ... 'But the latest disclosures about a "material weakness" in the internal controls related to the company's credit default swap portfolio undermines credibility with investors.' ... PricewaterhouseCooper's finding that there was a material weakness in the internal controls used to value the insurance contracts is one of the first of its kind involving a major company since the financial crisis erupted last August, said [Mark] Cheffers. ... The accounting firm's actions are in line with a push by auditors to force companies to use market values for securities they hold even if there is little trading going on. ... Not everyone gives the auditors, or even [PWC] in this case such high marks, though. The finding of a material weakness by [PWC] was 'absolutely' a step in the right direction said Janet Tavakoli, president of Tavakoli Structured Finance Inc., a Chicago research firm. But she said that disclosures were still insufficient in regard to the way AIG and others are coming up with values for such complex securities", my emphasis, Liam Pleven and David Reilly (LP&DR) at the WSJ, 12 February 2008.

"Many big Wall Street firms were asleep at the switch in the years leading up to the credit crisis. At least another group--the auditors--seems to be minding the store. They fell down badly during the tech-stock bubble, but their standards seem to be pretty tight these days. The most recent evidence: The apprently hard line taken by [AIG's] auditors [PWC], when it came to how the insurer valued credit default swaps", David Reilly (DR) at the WSJ, 13 February 2008.

"You see things; and you say, 'Why?' But I dream things that never were; and I say, 'Why not'?", George Bernard Shaw, Back to Methuselah, 1921. Similarly, I ask: why didn't PWC find this weakness before? What changed? "In valuing those swaps, AIG ... benefitted from assumed differences in value of the swaps and the securities they were insuring", LP&DR write. Assumed? What's going on here? Did PWC have an "internal inspection" team review its AIG audit workpapers and find no support for AIG's assumption? Is AIG's credit default swap valuation as well documented as Enron's valuation of long-term electric sale contracts that tripped up Arthur Andersen? Stay tuned.

Is DR serious? If PWC was so tough, it should have found this "weakness" years ago. My guess: PWC and AIG are scared and in lieu of making AIG restate prior financials, again, opening PWC and AIG up to expensive lawsuits, they "negotiated" the disclosure of a "material weakness". It seems to me that AIG changed an accounting principle, or should correct an error and has no material weakness at all. Francine McKenna's 13 February 2008 post about AIG, PWC and the WSJ at http://www.retheauditors.blogspot.com/, is definitely worth reading.

5 comments:

Buzz Saw said...

"material weakness"

Don't you just love the names they give things? I guess "$hi# $andwich" was already taken. ;P

Independent Accountant said...

Buzz Saw:
Material weakness is defined in the auditing literature. PWC did not make up the term. That said, it does not look to me like AIG has one.

Buzz Saw said...

Hello i.a.,

The whole banking and monetary system has a "material weakness", that is, they have gone completely insane with greed. They don't even count the money anymore, and they make stuff up as they go. I'd like an SIV where I can stow my bad debts, and a derivative contract for my unrealized profits too. Breeheehee!

Independent Accountant said...

The banking community has always been infused with greed. The "material weakness" in the system is its' ability to privatize profits and socialize losses. As long as we have a Federal Reserve Board, the system will be open to manipulation by politically favored insiders. This is what Andrew Jackson warned about in vetoing the recharter of the Second Bank of the United States in 1832.
Breeheehee? Is that your answer to Mogambu Guru's "hahahaha"?

Buzz Saw said...

Breeheehee? Is that your answer to Mogambu Guru's "hahahaha"?

Funny you should mention that. Even before I started reading his stuff I was fond of signing off with: "We're friggin' doomed, dooomed!". Ironic. I guess great minds think alike or else insanity commonly runs deep on the internet tubz.

Anyway, I marvel at the distribution of the money, and how capital is allocated. Watching entertainers being paid yearly salaries that exceed the GDP of small countries makes me realize that it will all fall apart some day. The level of malinvestment in the world is shocking.