SACRAMENTO — Experts are urging California lawmakers to aggressively scrutinize major accounting firms, under fire for their part in the collapse of financial institutions around the country.
They called for stricter penalties for firms that turn in fraudulent audits that favor their clients over the public — including banning them from practicing in California.
The trail of financial deception — from Bernie Madoff's so-called Ponzi scheme that ripped off investors of $50 billion to alleged fraudulent accounting by KPMG in its handling of failed California subprime mortgage lender New Century — "can lead one to believe the public can't rely on the accuracy of financial documents of publicly traded companies," said Assemblyman Pedro Nava, D-Santa Barbara, the chairman of the Assembly Banking and Finance committee.
"If this is so, our entire free enterprise economy is at risk," he said earlier this week at a hearing he held. "I'm concerned that if we don't carefully study what occurred at New Century and elsewhere, we may find ourselves never solving this calamity."
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Nava said he plans to hold a series of hearings looking into the collapse of the mortgage lending industry — and the role the accounting industry played in it — with the hope of producing legislation that could provide more backing to the California Accountancy Board, the industry's watchdog agency.
Accounting firms Advertisementhave an inherent conflict, experts said: they're required to uphold the trust of the public but they're paid by the same companies whose financial figures they audit.
"Especially in this period of deregulation, accountants have been there to justify what management wants them to do, which has led to disastrous consequences," said Barry Broad, lobbyist for the California Teamsters. "And you don't read about these accountants going to jail or the Board of Accountancy putting them out of business because frequently these regulatory bodies view their role as protecting the industry's reputation than being cops."
More resources — for staffing and investigations — are needed if the enforcement wing of the state's accountancy board can effectively monitor major accounting firms, which have billions of dollars in revenues at their disposal, said Ed Howard, chief counsel at the Center of Public Interest Law.
"You can't have a cop without laws, or laws enforced without adequately resourced cop," Howard said.
Even after the federal government and California strengthened regulatory laws in 2002 in the wake of Enron, very few actions were brought forward by the California Accountancy Board, said Mark Molumphy, an attorney with Cotchett, Pitre & McCarthy, a Burlingam-based law firm that represents San Mateo and Monterey counties in a lawsuit against Lehman Brothers and Washington Mutual over $200 million in losses after the collapse of the two banking companies last fall. The counties are also asking for federal bailout money.
"There's no effective enforcement procedures to make sure the auditors are doing a good job," Molumphy said.
A major problem is that since 1992, private investors have not been able to sue accounting firms over fraud.
"It's not a coincidence that we've had so many financial scandals," Molumphy said. "These hearings are a perfect opportunity to take a look at that."
Fines and lawsuits typically don't have the desired impact, said Steve Thomas, an attorney whose firm, Thomas, Alexander & Forrester sued KPMG International on behalf of a New Century trustee.
"I do believe private lawsuits can make a difference, but they take a long time," Thomas said. "And when you fine KPMG $1 million for initialing false tax shelters, and they're making $22 billion, it doesn't alter behavior.
"States have an important role," Thomas added. "The states are the gatekeepers of the gatekeepers. The state decides whether KPMG is going to be able to keep doing business in California. It's a central role, and we believe that has been the missing piece."
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KPMG International, the fourth-largest U.S. accounting firm, is accused of performing negligent audits that triggered the collapse last fall of New Century, once the nation's second largest subprime mortgage lender, according to the lawsuit that Thomas' firm filed last month. The lawsuit seeks $1 billion in damages.
Former lawmaker Joe Dunn, who led the state's investigation into Enron earlier this decade, recommended using subpoena and contempt powers — and requiring witnesses to testify under oath — to force accounting firms to explain questionable auditing practices.
"You really won't get exactly where you want to until you get representatives of companies involved — whether voluntarily or by subpoena — to testify under oath," said Dunn, now the CEO of the California Medical Association.
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