Accounting vs. Technology - Who's At Fault

Accounting vs. Technology - Who's At Fault

Summary: Did technology play a role in the financial services meltdown?A columnist for a major IT publication documented his positions on the role of IT in the current financial services meltdown.

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TOPICS: Banking
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Did technology play a role in the financial services meltdown?

A columnist for a major IT publication documented his positions on the role of IT in the current financial services meltdown. He asked questions such as “Were the internal IT groups in these firms working on projects that were misaligned with the financial services firms’ business strategy?” The article attempted to place blame where it does not belong.

At the heart of a these spectacular business failures rests a complex and intentionally opaque maze of documents that were designed to obscure anyone's understanding of the true risk involved in the financial instruments being sold. These instruments wrapped up a mix of high, medium and low risk mortgages into prepackaged bundles that few people could understand. Fewer still understood that these mortgage portfolios would be so vulnerable to a drop in housing values nationwide. Over time, we will probably learn that this obfuscation was absolutely intentional. The firms that created these documents and the financial instruments that went with them were built them in a way that few people could ever understand.

Several months ago, I had a conversation with the head of the school of accounting at a major United States university. We spoke at length about the recent Bear Stearns collapse. I told him that I had read their most recent annual report and wondered if he had an opinion of it as well. The company had used a number of special purpose entities (SPEs) much like Enron. These are off-balance-sheet tools used to contain specific assets or liabilities. While some companies have successfully used these to smooth out the effect of erratic or highly variable business transactions on their own books, the lack of transparency into these transactions is unfortunate and subject to abuse. I know I couldn't follow the financial structures in the Bear Stearn's annual report and I doubt most shareholders could either.

After Enron, the United States Congress enacted the Sarbanes-Oxley legislation. While this legislation was heralded as a means of preventing future financial blowups, it hasn't. Bear Stearns, Washington Mutual, Lehman Brothers, etc. are great examples of how Sarbanes-Oxley does not work. Specifically, Sarbanes-Oxley fails because it forces firms to document procedures and controls but it doesn't address the root problems of these fiascoes:

• Special purpose entities (SPEs) are off-balance-sheet legal entities and are not subject to auditor oversight or review from the Securities Exchange Commission. Shareholders, the actual owners of these corporations, can't even get information about these SPE's. No one can get an accurate read of the financial health of the company that utilizes these instruments unless that company voluntarily provides detailed financial records of those special purpose entities. Unless the AICPA, SEC and other entities get tough on the use and reporting around special purpose entities, these financial failures will continue.

• Wall Street hires some of the best and brightest graduates of business schools and law firms. They hire aggressive individuals who seek out ways to get a few basis points and/or circumvent legislation/regulators in order to craft new financial instruments for the financial services industry. Instruments like the CDOs that are at the heart of the current financial collapse. These ‘best and brightest’ people run circles around the leaders of the accounting industry. The Wall Street types are more cunning, clever and quicker than the accountants. Today, we can say that they created a $700+ billion mess that the accounting industry could not or did not understand or contain. The accounting industry must move at the speed of Wall Street not with the speed of the tectonic plates of the earth.

Washington needs to start over. Sarbanes-Oxley needs to be repealed and replaced with legislation that deals with the opaque financial instruments, special-purpose entities and other off-balance-sheet shenanigans that companies utilize. Washington must make companies produce financial statements that are transparent not opaque, complete not limited and fully aware of the business risks that special transactions put upon the firm and shareholders.

Accounting firms just don't get it. Their industry has become ever more irrelevant because of their inability to provide timely insights into business deals and operations. Every accountancy with a Wall Street audit client should publicly apologize for their firm and their industry's inability to understand or clearly report the true financial situation each of these failed businesses faced. It is a damning embarrassment to the accounting industry that so many giant firms have failed in such short order and yet these companies received pretty clean audits just last year.

I am virtually certain that lawsuits will emanate from these spectacular failures and aggrieved litigants and shareholders alike will seek redress from the accounting industry. While I would like to be sympathetic, I cannot be. Auditing has to come back to its roots. It has to be about presenting the total picture of a company's financial situation, warts and all. This selective inclusion or exclusion of multi-billion-dollar transactions is unacceptable and should have never been permitted in the first place.

Did IT have a material hand in all of this mess? I really don’t think so. I believe a host of others did and this time IT deserves a pass.

Topic: Banking

About

Brian is currently CEO of TechVentive, a strategy consultancy serving technology providers and other firms. He is also a research analyst with Vital Analysis.

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9 comments
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  • Actually two people are responsible for the mess...

    ...and it involves the repeal of Glass-Steagall in 1999.

    Sen. Phil Gramm for sponsoring it in the first place...and President Bill Clinton for signing it into law.
    IT_Guy_z
    • Fuzzy math...

      Two people eh? How about the other 451 people in either the House or Senate that also voted for it? Compare that to the 65 who voted against it and the 16 who didn't even care enough to vote, you still want to lay this at the feet of just two people?
      jasonp@...
  • RE: Accounting vs. Technology - Who's At Fault

    Brian - this is something that some of us have been foreboding for a while now. It will almost certainly lead to a collapse of one of the Big 4 and with it bring a catac;lysmic change in the way audits are undertaken.
    dahowlett@...
    • I wouldn't bet on the auditors

      From the article:

      "At the heart of a these spectacular business failures rests
      a complex and intentionally opaque maze of documents
      that were designed to obscure anyone?s understanding of
      the true risk involved in the financial instruments being
      sold."

      The obscuring should have been enough to highlight risk.

      The reality is people were making plenty of money out of
      these instruments and choose not to rock the boat. This
      included the major auditing firms. It'll be interesting to see
      what charges come out of it all (I'm not expecting much).

      In two decades I've seen literally hundreds of audits, most
      of the work is conducted by juniors fresh out of university
      with no idea what they're looking for. The people these juniors report to are sucking on the teat of big business.

      In December I had a discussions with a director of a major
      financial company. I said I can't understand how they make
      the money they claim for clients, I was told I simply didn't
      have their knowledge. 6 months later the company went
      into administration owing over a billion dollars. This was supposedly an audited and heavily regulated entity.

      Being the third boom I've experienced, the same cons will
      be repackaged to a gullible market of overpaid
      "professional" in the not to distant future.
      Richard Flude
  • They always pull this crap then they get regulated, then they complain...

    about the regulation. Its a rather vicious circle.

    The problem is that people are human. We do stuff based on greed when it comes to financial markets. On top of greed, the markets are also geared to profitability.. thus placing more enphasis on greed. I am not saying this is a bad thing, it just requires the regulators to keep a closer eye on things AND more importantly get as many details as possible when it comes to funny looking securities.

    Just like the FDA, EPA, etc.. they need to keep a closer eye on things. Cursory no longer cuts it. People thought we were over-regulated before... The EU has more regulation than us now... which means we have fallen behind.
    Been_Done_Before
  • How many dumb-asses will believe this?

    Technology at fault... ROFL... what absolute hor5e-5hit.. its called naked greed: IT has got zero to do with it. But, no-one ever got fired for stringing the great unwashed (public) with a bit of hookum as long as it takes the heat off the real culprits for a while...
    muzza2005
  • RE: Accounting vs. Technology - Who's At Fault

    I haven't heard anyone say that 'main street'(I have begun to hate that phrase for its ubiquity) should take responsibility for believing The Secret. If I sit around on my a## for long enough believing something will come true then it will become reality. My dreams can come true because I can believe the banks when they tell me that my $35,000 salary can service a $300,000 loan. I am going to be rich because that is the american dream(tm) and we can all be rich and drive hummers and watch espn on wide screen plasmas whilst deciding which console to play games on and which designer shirts I can throw away later...
    Credit has made suckers of everyone. No-one seems to understand caveat emptor any more. Or caveat creditor.
    Everyone wants something for nothing. Bankers, blue collar workers, mom and pop, retirees, everyone. And we did it by living in this hallucinogenic dream, smoking credit like it was crack and thinking that the money actually existed. And that we actually owned the stuff we 'bought' on credit. Because we were told that if we believed hard enough then it would become true. And we bought it all. Is everyone awake yet? Because it is time to start paying.
    talukdar_m@...
  • Totally Rubbish!

    It simply proves Brian Sommer knows nothing about accounting or auditing. Its better if he keeps his mouth shut and focus on technology alone.

    Accounting / Auditing had no role in this financial crisis. The crisis is purely due to sudden fall in market value of mortgage properties and the subsequent credit crunch. The financial firms were overleveraged and EVERY TOM, DICK AND HARRY KNEW HOW LEVERAGED THEY WERE.

    More disclosures will not solve this problem. Goldman Sachs' leverage ratio is still above 20. Is Buffet a fool?
    praveen307
  • RE: Accounting vs. Technology - Who's At Fault

    its an accountant fault since he operate the computer and in put the figure
    elijahakinjide@...