Something very unusual happened at the Securities and Exchange Commission this week: The SEC accused three former bank executives of committing fraud by deliberately understating their company's loan losses during the financial crisis. Such accusations have not been made often in recent years.
Unless you happen to live in Nebraska, you probably haven't heard of Lincoln-based TierOne Corp., which had about $3 billion assets when it failed in 2010. Yet it's an important story because of what it shows about the state of securities-law enforcement in the U.S.
On Tuesday the SEC said it had reached settlements with the company's former chief executive officer and chairman, Gilbert Lundstrom, and another former senior executive, who will both pay fines. (Per the usual custom, neither admitted or denied any wrongdoing.) A third former executive is contesting the agency's claims, which include allegations of egregious accounting violations.
Several times in recent years the SEC's enforcement division has seemed to bend over backwards to avoid accusing anyone at a failed financial institution of committing accounting fraud. To name a few: When the SEC filed fraud claims against former executives of Countrywide Financial Corp., IndyMac Bancorp, Freddie Mac and Fannie Mae, it accused them of making false disclosures. But it made sure not to allege that any of the companies' books were wrong; none of them ever admitted to any accounting errors.
At Countrywide, for instance, the SEC accused former CEO Angelo Mozilo of failing to disclose known loan losses. If the SEC's allegations against him were true, then the company's financial reports by definition must have contained misstatements -- except the SEC never alleged so in its complaint against him. He committed disclosure fraud, the SEC said, not accounting fraud.
The main beneficiary of the SEC's approach in such cases has been the Big Four auditing firms, as I wrote in a column last year. They can claim their audits were fine, because there was never any official finding that the numbers were incorrect. That has helped the firms enormously in class-action litigation brought by investors.
TierOne's auditor was KPMG LLP, which also was the auditor for Countrywide. (The other Big Four firms are Ernst & Young LLP, PricewaterhouseCoopers LLP and Deloitte & Touche LLP.) Neither KPMG nor any of its personnel were named as defendants in the SEC's complaint this week. One of the allegations against the former TierOne executives was that they lied to KPMG auditors. Under the Sarbanes-Oxley Act, passed in 2002, lying to an auditor is a punishable offense.
Does this mean KPMG got a pass from the SEC? My guess is yes. An SEC spokesman, John Nester, declined to say. A spokesman for KPMG, Manuel Goncalves, declined to comment.
There is somebody out there, however, who believes KPMG should be held liable for failing to catch TierOne's accounting chicanery. TierOne's Chapter 7 bankruptcy trustee earlier this year sued the accounting firm, accusing it of negligence and breaches of fiduciary duty. KPMG has denied the allegations and asked that the matter be resolved in arbitration proceedings rather than in court. It was TierOne's regulator, the U.S. Office of Thrift Supervision, that caught the bank's accounting manipulations -- not KPMG, which continually blessed TierOne's financial statements and resigned as auditor in 2010 only weeks before the bank failed.
The financial crisis was in large part about financial institutions' cooked books. A big reason that companies such as Lehman Brothers, Fannie Mae and Freddie Mac failed was that investors could tell from the outside looking in that their balance sheets were bogus. Even Hank Paulson, the former Treasury secretary, said as much in his memoir. (The SEC never brought a single enforcement action against a former Lehman executive.)
That's why it's so disappointing to look at the SEC's own highlights of the various lawsuits it has brought in connection with the financial crisis -- and to realize that not one of those lawsuits has been against an auditor. The government didn't just bail out the big banks back in 2008 and 2009. It bailed out their accounting firms, too. This can't be good for investors' confidence in the long run.
(Jonathan Weil is a Bloomberg View columnist. Follow him on Twitter.)
Read more breaking commentary from Bloomberg View at the Ticker.