Subject: File No. 4-573
From: Gilbert F. Viets

November 5, 2008

RE: File No. 4-573
November 5, 2008
We can do better
Other than for convenient diversified investment vehicles such as mutual funds, mark to market thinking fails. Market envelopes badly informed momentary conjecture. Speculation is poor foundation for public financial reporting for any entity that has capital requirements or purports to pay dividends from operating cash flow. Quite a few companies are in that group. Markets can speculate all they want, but good accounting should filter contaminated facts.
Now, after years of transferring more and more command of accounting principles to political and social bodies that respond well only to wealthy organized lobbies, accounting trends toward what makes results look good (as long as it isnt taxed), rather than fact. Undisciplined CEOs retro date their stock options, revalue pension obligations (if they cant eliminate them altogether) and switch accounting whenever humor strikes. Here they move to something I would call higher of cost or market accounting.
Auditors and CFOs want relief from litigation in whatever form it can be given. Once auditors have to sign their personal names to these reports, they may also want unlisted phone numbers or pseudonyms.
The current problem arose from marking to market when market was overstated, not from having to reduce values when facts became known. Irreversible unearned bonuses and dividends were gone. (This begs for lower of cost or market accounting. We suffered through it for many years successfully.)
I recently listed from memory twelve major financial institutions that failed, or survived (so far) only with extensive government aid, assigning huge losses to investors and in some cases, depositors. It is a fractional list. Prominent, deserving names are missing. Extensive footnotes unveil reporting based on good for the day Wall Street Journal valuations. Big 4 audit firms had freshly issued clean opinion audit reports on the financial statements.
NEW CENTURY 3/15/2006
BEAR STEARNS 2/12/2007
NOVASTAR 2/28/2007
WACHOVIA 2/25/2008
FANNIE MAE 2/26/2008
FREDDIE MAC 2/27/2008
INDY MAC 2/28/2008

(Note: For AIG, the auditor noted a material weakness on lack of control of credit default swaps, but rendered a clean opinion on the financial statements. All others had clean internal control reports.)

Professional standards purportedly require auditors to consider the ability of companies to continue normal operation for at least a year following the audited financial statements. If there is a concern, auditors must warn investors. None of the audit reports expressed a going concern warning. None pass the hindsight test.
Each of the big 4 audited at least two of the twelve companies. One audited six.
Not to dwell on the past, but historically: bad loans provide no cash flow credit default swaps produce real obligations poor controls set facts adrift How can objective auditors and CFOs miss the problem?
Heres how: Mark to market accounting provides a nook to miss clear problems of asset existence and quality, unrecorded liabilities and sustainable cash flow. Want proof? Watch the bankruptcy examinations and litigation discovery.
As I think about imponderables, I imagine CFOs of two companies, each with portfolios including the others securities, sequentially writing up their portfolio values based on the effect of the write up the counterpart just recorded. Is there no limit? Can someone assure us it has not happened?
The U. S. Treasury Advisory Committee on the Auditing Profession report, issued on October 6, 2008, is introduced by comments that seem nave:
the Committee heard of many positive developments within the auditing profession in recent years and of a generally positive impact the Public Company Accounting Oversight Board (PCAOB) has had on audits


the effectiveness of a companys system of internal control now seems to be working generally as intended and is a watershed event that has improved and will continue to improve financial reporting

Truth is too vast. Audits failed. Internal controls failed. My random, unscientific, partial list of companies represents a colossal failure to discover and inform. But, experienced researchers are invited to test it.

The Advisory Committee proceedings actually disclosed the designed, defensive financial fragility of the audit firms for whom some want a safe harbor. The big 4 firms operate an oligopolistic business model of limited liability partnerships, having no capital and no insurance they have existing litigation exposure into the hundreds of billions of dollars before considering litigation to come from the recent huge failures they are sustained by large cash flow from industry, being rapidly passed through empty vessels, providing average protected partner income approaching $1 million. Independent thought and attitude is, at best, challenged. (Also, history is not a training requirement.)

Safe harbor? These battleships were beached and stripped several years ago. The ships officers stand on dry land. Its hard to be effective from a safe harbor. The global free market needs seaworthy battleships with courageous captains.

We can do better

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