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Two To Go

There are two sub-groups in the financial services industry that have yet to face the music. But I wouldn't be a bit surprised if executives in these groups are experiencing bouts of panic in the night.

One sub-set is the auditing firms of which Ernst & Young, Peat Marwick, KPMG and Deloitte are the top four. Then there are perhaps a half dozen below them and another ten below them. Many of these accounting combines are in trouble with various legal agencies for giving tax advice to companies and executives on how actually to break or evade the laws. Some partners will ultimately find themselves in the clink for performing a function that was not essential to being a CPA. But given the larger fees charged for consulting than for auditing the incentive to maneuver and fabricate investment-and-tax strategies was clearly there. Raw greed did the rest. Sarbanes-Oxley has turned out to be an extremely expensive, time-consuming and burdensome set of regulations, especially for small public corporations, that prevent virtually nothing that violates the law.

The two issues that face the auditing partnerships are:



1. that their personnel audited each of the banks that went belly-up or nearly belly-up, and that these audits included examining the sub-prime lending practices which common wisdom tells us constitute the basic cause of the present financial calamity.

2. that the thousands of accounts held with the Madoff empire or what was in reality the Merkin subsidiary of Madoff and the other accomplices to his crookery all had auditors, many of them with the big four or secondary groups. None of them found any thing strange in the accounting, which means that they did not actually look.  They were also committing fraud of a high order.

The other sub-set is comprised of the three major rating agencies: Moody's, Standard and Poor's, and Fitch. Readers may remember my blog posts about these once haughty firms, especially during the early days of the market collapse.

The big news is that the nations largest public pension fund, California Public Employees Retirement System (CALPERS) is now suing these three enterprises for what is basically fraud. Leslie Wayne has a detailed and readily understandable report in Wednesday's Times ("Calpers Sues Over Ratings Of Securities") about what Calpers described as the "wildly inaccurate" credit assessments given by the three leading agencies in the business. Among these were packages of investment paper, including sub-prime mortgages, which somehow in the estimation of the big three warranted Triple A ratings.

Near the end of 2007, Calpers had nearly $261 billion worth of investment assets. In December 2008, it had just under $180 billion, a decline of almost one third. Not better than the average and not worse. This is a disaster to its pension holders.

Dishonesty and avarice are at the foundations of the rating system. Ratings are paid for by the rated. If the rater does not satisfy the rated the latter goes next door.

Moody's is public company. S & P is owned by McGraw Hill which has problems of its own and is now selling its flagship, BusinessWeek, for $1. No, not a million dollars; one dollar. Fitch is privately held. The Times had another story, this one by David Gillen on June 5, ("In Rating Industry, Investors Still Trust"). Investors also believed in Citi.