Captured: Financial Regulator at Risk

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By David S. Hilzenrath, Project on Government Oversight

When the board that regulates corporate auditors announced the appointment of a top official in 2018, it said her experience made her “an excellent fit for the role.”

The role—“chief auditor”—involves setting and interpreting rules that auditors of publicly traded companies must follow. The appointee, Megan Zietsman, was at the time of the announcement a partner at Deloitte & Touche, one of the largest audit firms. According to her LinkedIn profile, she had worked there for more than 18 years. According to the announcement, she began her career with Deloitte in 1989.

Alumni of the Big Four dominate the quasi-governmental organization that regulates the Big Four.

As chief auditor at the Public Company Accounting Oversight Board (PCAOB), Zietsman succeeded Martin Baumann, who had “a 33-year career at PricewaterhouseCoopers,” according to a news release announcing his appointment to the board. Baumann succeeded Thomas Ray, who had worked at audit firm KPMG before joining the oversight board. When Ray left the PCAOB, he returned to KPMG, according to his LinkedIn profile.

“Am I the only one who thinks this is another slap in the face of the taxpayers, the shareholders, the professionals?” Francine McKenna, who writes about the auditing industry, blogged in 2009, when Ray rejoined KPMG.

Deloitte, PricewaterhouseCoopers (PwC), KPMG, and Ernst & Young (EY) are known as auditing’s “Big Four” and dominate the industry.

As it turns out, alumni of the Big Four dominate the quasi-governmental organization that regulates the Big Four.

Drawing on original data compiled by the Project On Government Oversight (POGO) and intimate details revealed in a court case related to KPMG, the accompanying story documents cozy connections between the regulators and the regulated. This story illustrates variations on the theme.

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Ray did not respond to questions for this story. Neither did PCAOB spokesperson Torrie Matous.

“In the rare instances when we hire professionals with regulatory experience for our Audit practice, our goal is to ensure that our firm and our clients are up to speed on the latest professional standards and regulations so that we can continue to deliver high quality audits that the capital markets can rely upon,” KPMG spokesman Andrew Wilson said in a statement to POGO.

In an interview with POGO, Baumann said “it’s sort of obvious” why the oversight board hires people with auditing backgrounds.

“Who else would you hire but people who were trained in accounting and trained in auditing and then performed both as auditors?” he asked.

The PCAOB staff’s May 2019 pronouncement on “auditor independence” shows where that can lead.

body of so-called auditor independence rules restricts relationships between auditors and their clients. To be sure, audit firms are independent in name only. They are hired and paid by the companies they are responsible for auditing. That gives them incentives to curry favor with those companies and compromise their responsibilities as protectors of the investing public. However, the auditor independence rules are meant to mitigate the dangers. For example, with few exceptions, if auditors are auditing a bank, they aren’t supposed to borrow money from the bank.

In May 2019, after a series of cases in which auditors were found to have broken the rules, the PCAOB issued “staff guidance” on how to deal with violations. The guidance says that, under certain circumstances, if the audit firm and directors of the company involved agree that the audit firm remains objective and impartial, the audit firm that violated independence rules can publicly present itself as independent.

“The faulty interpretation of the rules contained in this staff guidance would both undermine auditor independence and deceive the investing public.”

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The guidance would paper over problems and mislead the public, several groups that advocate for investors have said.

“The faulty interpretation of the rules contained in this staff guidance would both undermine auditor independence and deceive the investing public,” the groups argued in a letter.

The letter was signed by representatives of Consumer Federation of America, AFL-CIO, Better Markets, Center for American Progress, and Americans for Financial Reform.

“This guidance ‘guts’ the auditor independence rules,” Lynn Turner, a former chief accountant at the Securities and Exchange Commission (SEC) and former Big Four auditor, said in an email to POGO.

Reserved Seats

A revolving door was built into the oversight board.

The law that created the PCAOB reserved two of the five seats on the governing board of the PCAOB for accountants.

In an April 2019 interview with the Project On Government Oversight, former PCAOB Chairman James R. Doty said that should be changed.

“Why should the accounting profession have two seats?” Doty asked rhetorically. “That puts them one vote away from domination.”

For accounting expertise, governing board members have the PCAOB staff, Doty said.

Traditionally, each member hires a personal staff, and many of those people previously worked for the big audit firms.

Current Chairman William D. Duhnke has two senior aides listed on the PCAOB website, both of whom have worked at Ernst & Young. Board member James G. Kaiser spent 38 years at PwC. One of his aides worked at Deloitte. Board member Duane M. DesParte worked at Deloitte and the now-defunct Arthur Andersen. One of his aides worked at KPMG. Another worked at Ernst & Young and Deloitte.

The PCAOB answers to the Securities and Exchange Commission—chiefly, to the SEC’s chief accountant.

The SEC’s chief accountants historically come from the Big Four.

In 2015, Reuters reported that the chief accountant at the time, a now-deceased veteran of Deloitte, fought then-chairman of the PCAOB Doty’s efforts to institute reforms that would make auditors more accountable.

The current SEC chief accountant, Sagar Teotia, was also a partner at Deloitte.

Teotia’s predecessor as chief accountant, Wes Bricker, joined the SEC from PwC. After Bricker left the SEC in May 2019, he rejoined PwC—as vice chair of the firm.

That was Bricker’s second trip through the revolving door. Earlier in his career, he left PwC to serve as a professional accounting fellow at the SEC and then went back to the firm.

In other words, Bricker went from PwC to the SEC to PwC to the SEC to PwC.

The SEC’s office of the chief accountant is partly staffed by such fellows, who often come from big accounting firms and spend a couple of years at the agency. The SEC says fellows must “sever all ties” with their employer before becoming a fellow, but there’s a history of fellows returning to the same firms they came from when their fellowships are over.

In for a Spin

One accountant who apparently followed that path is James Wesley “Wes” Kelly. According to a LinkedIn profile, Kelly spent about 15 years at PwC, then about two years at the SEC, and then returned to PwC.

As a fellow at the SEC, he was “primarily responsible for providing oversight of the Public Company Accounting Oversight Board (PCAOB) on auditing policy related matters,” according to a different online profile that apparently dated to his time at the SEC.

Earlier, while employed at the audit firm, Kelly “served as a liaison between PwC and the PCAOB” assisting audit teams “that were undergoing inspection by the PCAOB,” the profile said.

During that same chapter of his career, before he was hired by the SEC, Kelly was involved in an auditing debacle. As POGO has reported, Kelly worked on PwC’s audits of Colonial BancGroup, parent of Colonial Bank, for about 10 years and according to his own testimony rose to be manager and senior manager of those audits. In 2009, the bank imploded after falling victim to a massive mortgage loan fraud.

In part, the bank had purchased interests in mortgages that had already been sold to others.

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The debacle spawned litigation against PwC that played out over the ensuing years. Though none of the individual PwC auditors were named as defendants, the litigation challenged the work of the firm’s audit team.

In 2017, when Kelly was back at PwC, a federal judge ruled that PwC had performed Colonial audits negligently and ordered PwC to pay the Federal Deposit Insurance Corporation, which backstops failed banks like Colonial, hundreds of millions of dollars of damages.

In a withering critique of PwC’s auditing, the judge wrote that PwC never inspected or asked to inspect a single one of the loan documents for mortgages that served as collateral for hundreds of millions of dollars of funding advanced by the bank. The judge wrote that one of the key participants in the fraud “testified that if PWC had asked to see even just ten loan files ‘[t]he jig would be up.’”

PwC and Kelly did not respond to requests for comment on these issues for this story.

As POGO reported in September, there is no public record of PCAOB enforcement action against Kelly, PwC, or other PwC auditors over the Colonial BancGroup audits, and the SEC has taken no such action.

Investigating a Former Employer

Should a regulator investigate his former employer?

How much confidence would such an investigation inspire?

Those are questions POGO put recently to Mauro Botta, a former PricewaterhouseCoopers auditor who has tried to expose what he described as auditing misconduct.

The questions weren’t hypothetical.

As a PwC auditor in Silicon Valley, Botta claimed to have seen a pattern of bad auditing. He said he resisted pressure to go along with it. As POGO reported previously, in 2016, he filed a confidential whistleblower complaint with the SEC in effect urging the agency to investigate. He told the SEC he was concerned about “the risk of collusion” between auditors and the companies they were responsible for auditing. Essentially, he alleged PwC auditors were pulling punches to keep clients happy.

Then, after the SEC began inquiring, PwC fired Botta. Botta sued the firm, alleging that it fired him in retaliation for standing up to “fraudulent,” “deceptive,” and “negligent” practices at PwC and for reporting that conduct to the SEC.

A magnifying glass examines the PwC logo surrounded by auditing documents

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PwC has been fighting Botta’s lawsuit and has tried unsuccessfully to get it dismissed.

In a statement to POGO in 2018, PwC spokesperson Sarah Tropiano said the claims in Botta’s lawsuit were false. “PwC maintains the highest ethical standards around our business and a robust code of conduct that protects whistleblowers,” she said. “Mr. Botta’s employment was terminated for legitimate business reasons, and we will demonstrate that in court.”

POGO published a story spotlighting Botta’s allegations in May 2018, and they subsequently received international media attention.

For this examination of the PCAOB’s revolving door, POGO revisited Botta’s case. We found that it drew the attention of the oversight board. And, we found that one of the PCAOB investigators looking into Botta’s allegations against PwC was himself a veteran of PwC.

Court records show that, in September 2018, members of the enforcement staff at the oversight board contacted Botta. Documents filed in connection with Botta’s lawsuit against PwC include emails between Botta and the PCAOB officials.

“Your lawyer … said that we could contact you directly to arrange a time to discuss your complaint against PwC,” Craig L. Siegel, senior counsel in the PCAOB’s Division of Enforcement and Investigations, wrote in the first of the emails. “Are you interested in speaking with us?”

Siegel cc’d his PCAOB colleague Stephen D’Angelo, a forensic accountant and assistant director in the enforcement division.

Botta confirmed to POGO that Siegel and D’Angelo interviewed him, that they spoke with him repeatedly, and that they were looking into his allegations together.

In a September 28, 2018, email, after Botta asked the men from the PCAOB follow-up questions, Siegel wrote: “We cannot comment on the specifics of the Division’s inquiry, including next steps and timing, but we will contact you if we need further information.”

Siegel cc’d D’Angelo on that message, too.

According to D’Angelo’s LinkedIn profile, before joining the PCAOB enforcement division in 2010, he spent 10 years and one month working for PwC.

“How is that possible?” Botta asked in disbelief when informed of that history. “I mean, my God.”

What if anything will come of the PCAOB’s inquiry remains unclear.

D’Angelo, Siegel, and oversight board spokesperson Torrie Matous did not respond to questions for this story.

The PCAOB ethics code apparently allows an investigator like D’Angelo to investigate his former employer. The restriction on participating in matters that could affect a former employer is narrowly worded, and it expires after the PCAOB staff member has been at the oversight board for 12 months.

For Botta, that’s part of the problem.

Botta said the fact that a PCAOB investigator assigned to his complaint came from PwC shook his faith in the board and his hopes for an impartial investigation.

“I’m so disheartened,” he said.

Originally posted here.

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