Goldman Sachs Needs a New Audit Committee: Jonathan Weil

Goldman Sachs Group Inc.’s reputation sustained a body blow last year when the firm paid $550 million to settle a fraud claim by the Securities and Exchange Commission over its sales of a mortgage-bond deal called Abacus. The integrity of its financial statements, however, has never come under serious challenge.

Maybe investors should think twice, though, considering the backgrounds of some of the directors responsible for ensuring the sanctity of Goldman’s numbers.

Take James Schiro, who joined Goldman’s board in 2009 and is the chairman of its audit committee. One of his jobs is to make sure Goldman and its outside auditor, PricewaterhouseCoopers LLP, remain "independent" of each other and have no compromising mutual interests. You might even say his qualifications for the role are unique, although this wouldn’t be a compliment.

Schiro was PwC’s chief executive officer from 1998 to 2002. During his tenure, an SEC investigation found more than 8,000 violations of auditor-independence rules by the Big Four accounting firm, mostly related to partners who owned stock in PwC audit clients.

In one instance, Schiro himself owned stock in an audit client called Emcore Corp. After the SEC’s staff told Emcore in 1999 to drop PwC and get its books re-audited by another firm, the company sued Schiro personally. Emcore dropped its suit, which also named the firm and several other PwC partners as defendants, after reaching a settlement in 2001. The terms weren’t disclosed.

Gupta Accused

That history has added relevance because of the recent travails of one man: Rajat Gupta, a former Goldman audit-committee member who left the company’s board last year. If there was ever a moment when Goldman needed its audit panel’s members to be unassailably clean, this would be it.

Gupta stands accused by the SEC’s enforcement division of leaking confidential information from Goldman’s boardroom meetings to Raj Rajaratnam, the former Galleon Group hedge-fund manager convicted this month on insider-trading charges. (Gupta denies the claims.) The question that naturally follows is how many people on Goldman’s eight-member audit committee have track records that should give investors pause.

James Johnson, a Goldman director since 1999, was CEO of Fannie Mae from 1991 to 1998. An internal Fannie probe in 2006 led by former U.S. Senator Warren Rudman identified several accounting violations that occurred on Johnson’s watch. Johnson wasn’t accused by regulators of misconduct.

Lead Director

Goldman’s lead director, John Bryan, was on General Motors Corp.’s board from 1993 to 2009 and served on its audit committee from 1996 to 2001. The SEC accused GM of misstating its financial results for several years, including 2000 and 2001, as part of a complaint settled in 2009; no individuals were named as defendants.

Stephen Friedman, who remained on Goldman’s audit committee after Schiro succeeded him last September as its chairman, drew harsh criticism in 2009 following disclosures he had bought Goldman shares while serving as chairman of the Federal Reserve Bank of New York, one of Goldman’s regulators. While his trades broke no rules, they were widely panned as unseemly, and he from the New York Fed under pressure.

Friedman also is a former chairman of Goldman; he retired from the firm in 1994 when it was still a private partnership. Technically he qualifies under the rules as an independent member of Goldman’s board, allowing him to serve on its audit committee. In substance, though, to say the guy who used to run Goldman is independent of Goldman seems a bit much. (Goldman’s audit committee is unusual in that all of the company’s non-executive directors serve on it.)

Trading Scandals

Ideally Goldman’s audit committee wouldn’t have any members with questionable independence credentials or ties to past accounting or trading scandals. Yet half of them do. All four either declined to comment or didn’t return phone calls. A Goldman spokesman, Lucas van Praag, declined to comment. So did a PwC spokeswoman, Caroline Nolan.

As for Schiro, who was CEO of Zurich Financial Services AG from 2002 to 2009, the years he was at the helm of PwC were some of the most troubled in its history.

Among the firm’s audit clients were Tyco International Ltd., Raytheon Co., Warnaco Group Inc., and Take-Two Interactive Software Inc., all of which settled accounting-fraud complaints with the SEC, without admitting or denying the allegations. Tyco’s former CEO, Dennis Kozlowski, went to jail for looting the company. The PwC audit partner who signed off on Tyco’s books settled fraud accusations by the SEC, which permanently barred him from auditing public companies.

SEC Reprimand

In 1999, the SEC censured the firm over the rash of independence violations involving partners who owned shares of PwC audit clients. It fined PwC $5 million in 2002 for a separate batch of independence violations and faulty audits covering 14 companies.

The SEC reprimanded PwC yet again in 2003 for professional misconduct related to its 1998 audit work for a company called SmarTalk TeleServices Inc. The next year, PwC paid $2.4 million to settle SEC claims that it aided securities-law violations at Warnaco in 1999. I could keep going, but you get the point.

(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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