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.