auditors photo cartoonThe credit rating agencies played a large role in the financial crisis. They are now going in reverse to make sure they downgrade any Government, or corporation, lest they get blamed for further incompetence. Irionically they have been downgrading right before a company or Government is about to go bust-see Greece.

However the rating agencies have got their fair share of blame. There are other groups that rightfully got blamed: the GSEs, AIG, the investment banks, subprime lenders and borrowers, the Government, The Federal Reserve etc. One group that played a huge role in enabling the financial crisis has gotten almost no media attention, and that is the focus of this article; the auditors.

‘The Blame Game’, an article published in the Institute of Chartered Accountants of England and Wales (ICAEW) sometime after the financial crisis, presented a rather unfair argument of how auditors are not responsible for the financial meltdown. According to the article, the auditors are simply required to give their view on whether the figures are accurate and are not responsible for commenting on the riskiness of the business model. Therefore, the auditors did an ‘outstanding job’ regardless of the criticism.

However, the criticism which primarily directed at the Big Four auditors – Deloitte, Ernst & Young, KPMG and PwC – still proves to be considerably justified. The main job of the external auditors is to understand and assess the business processes, document internal controls and verify compliance. Basically, they are there to check and comment on the risks of the business model. The inability on their part to detect the warning signs and report these on time is never a job well done.

Not that these Big Four auditors are responsible for actually causing the financial meltdown, because clearly they are not there to stop their client companies from making bad financial decisions, but they are responsible to the extent of not properly disclosing these detrimental financial decisions. The method or process of auditing has evolved in the audit industry such as the valuation methods for companies’ assets. However, the primary job of the auditors is to provide reliable information based on subjective valuation of the company. Therefore, as long as the definition of auditors has not changed, they are liable for the financial meltdown to a certain extent.

Ernst & Young’s ‘negligent’ professional practice of signing off on Lehman Brother’s book has long been the case referred to persistently in order to illustrate role of auditors in the financial crisis. However, the remaining three auditors of the Big Four also had clients that had to be bailed out by the government, contributed to the financial crisis or simply blew up. KPMG audits Citigroup, Deloitte & Touche audits Fannie Mae and was the auditor for Bear Stearns, and PricewaterhouseCoopers is the auditor for American Internal Group and Goldman Sachs Group.

During the time of financial crisis, AIG and Goldman Sachs, despite being audited by PricewaterhouseCoopers, valued their credit-default-swap differently. PwC did assert identification of ‘material weakness’ in AIG’s internal controls, however, that is not enough to ascertain them doing their job flawlessly. PwC were also accused by shareholders of AIG for not detected fraud at AIG. Generally, Auditors are responsible for supervising the internal controls of the company it is auditing for, which means they are required to prevent misstatements and frauds. The recent foreclosure sandals and the securitization of mortgages go against the claims of these auditors performing dutifully. The legal battles which have been filed recently indicate how some banks did not properly transfer the mortgages which were sold to investors due to lack of controls. This pretty much means the auditors wrongly or negligently signed off on sales, which added up to transfer of billions of dollars of mortgages from banks to investors, without making sure there were sufficient internal controls.

Even though the auditors were not responsible for inefficient lending and investing of banks and the flaws of the credit-rating system, they are still accountable for not properly or more evidently elucidating the warning signs which led to the financial crisis.