Real AIG/Wall Street Solution – Shore Up Accountants
Douglas Poling, Joseph Cassano & Bernie Madoff vs. Joseph St. Denis & David Friehling
The time has come for the members of the FASB to be appointed by the Federal Reserve.
In the Wall Street Journal on Friday, March 20 the first paragraphs of an article titled, “Lawyer at Center of Troubled Unit Got Top Bonus” paints the picture of Wall Street and Washington’s (DC) failings for nearly three decades. Douglas Poling, an attorney employee for AIG sat in a meeting supposedly to bear witness as Joseph Cassano, head of AIG Financial Product Division berated an AIG internal audit person by the name of Joseph St. Dennis. St. Dennis reports that Cassano said to him, “I have deliberately excluded you because I did not want you to pollute the process”. Mr. St. Dennis resigned from AIG. Mr. Poling got the largest amount of dollars from the infamous AIG $165 million bonus pool. Mr. Cassano pocketed millions, was fired when the scandal broke in 2007 but was retained until the Congressional outrage at a million dollars per month.
Bernard Madoff had a Certified Public Accountant sign-off on his dealings or statements. This accountant, David Friehling was a small time operator who had no business attesting to the veracity of Mr. Madoff’s statements to his investors. Bernard had his shill, an individual accountant who needed to pay his mortgage. When an accountant is not financially independent from his client, the game is rigged.
Wall Street firm managements have been subverting the accounting, auditing and analyst function (I will call the AAA) for nearly two decades. The subversion techniques are new inventions or games, questionable mergers and acquisitions and through it all the power of money. Wall Street has been overpowering the AAA in the US Congress and the Securities and Exchange Commission (SEC) through lobbying. On the Street, AAA’s who do not share the enthusiasm or question Wall Street’s latest game or deal, are removed either by being reassigned or terminated.
The United States has an independent authority, called the Federal Reserve. Accounting, the first A of the AAA is governed by the Financial Accounting Standards Board, (FASB). The time has come for the members of the FASB to be appointed by the Federal Reserve. The prospective members of the Fed appointed FASB should be drawn from properly credentialed accountants, academics and analysts. Accountants should be Certified Public Accounts (CPA) and the analysts should be Chartered Financial Analysts (CFA). The first designation is licensed by States. Both are subject to rigorous exams but most of all are subject to peer review and scrutiny. The accounting profession has never been fully comfortable with many of Wall Street’s practices in the last twenty years and has rightfully sought to insulate itself from any harm. Unlike Mr. Madoff, the large Wall Street firms need the respectability of a large accounting firm. They are relegated to a list of Securities and Exchange Commission (SEC) auditors. The Madoff’s of the world need to be given a shorter list of prospective accountants.
Congress needs to empower the FASB by means of the Federal Reserve appointments. FASB needs to rule Wall Street’s financial statements. Should the FASB not be able to develop comprehensive accounting and reporting guidelines, “the rules of the game” for any existing type of business or new game such as a type of derivative, swap or any other “deal”; it is to be engaged in on a limited basis until further notice.
Joseph Cassano, a graduate of Brooklyn College as Political Science major started on Wall Street in the 1980’s under Michael Milken of Drexel, Burnham Lambert. Drexel, Burnham imploded in 1990 due to Mr. Milken inventing a new Wall Street gambling table called high yield debt or what came to know as “junk bonds”. What made junk bonds unique was that companies who could not pass the tests of creating bonds that could be traded daily on the New York or American Exchanges could now raise money without sharing ownership or equity.
Picture Wall Street as its nearby neighbor Atlantic City. In Atlantic City, so I am told there is the casino floor where everyone over the age of 18 can come to play. Upstairs there are exclusive private rooms where if you can pay the fee or ante to sit at a table you can play high stakes poker against other people. All is done under the watchful eyes of referees or floor managers with a bevy of cameras in the ceilings for additional scrutiny. This is to prevent cheating, but most of all to make sure the rules are followed so the casino and State of New Jersey are the winners in the “long run”, which to a casino is minute to minute.
Wall Street when it works correctly is set-up so the world economy and the American people benefit in the “long run”. Wall Street has many tables to play on. Some of the “hands” are millisecond to millisecond and all the way to decade to decade. The floor managers are supposed to be accountants, auditors and analysts, the AAA who continually question when and how will “this hand” settle with a fair exchange of cash. The casinos of Wall Street are supposed to pay some of the daily winnings to pay for these floor managers.
These accountants, auditors and analysts choose a disciplined field of study to qualify within their profession. They do not graduate with a social science major like Mr. Cassano and decide it does not pay enough and invent a new game. They earn designations such as Certified Public Accountant (CPA), Certified Internal Auditor and Chartered Financial Analyst. However, they have been earning less of a percentage of the Wall Street casino winnings and it has been declining for thirty years.
Michael Milken invented a new game for the casinos of Wall Street. He did not take it just upstairs but he took it all the way to Beverly Hills. He had a new “long run”, a new game. These high yield bonds or “junk” would pay off in the long run. He had to sell these bonds to someone so he kept a small table of insiders to play at his table. If the CEO of a refrigerator company came to him to raise $500 million, he said you take $750 million and use $250 million to buy junk bonds from a savings and loan. The savings and loans was the way the individual American of the late 1980’s and early 90’s was unknowingly at Mr. Milken’s gaming table.
If anyone at the firm in New York, Drexel Burnham Lambert wanted to see what Mr. Milken was doing they had to go through his brother, Lowell. Lowell was an attorney who was Michael’s “floor manager” or chief of compliance. Drexel, Burnham imploded due the Beverly Hills operation. Frank Joseph, the CEO of Drexel, Burnham, lost almost his entire net worth because he had it all invested in Drexel Burnham, a private firm. This served him right because he failed to send his auditors, accountants and analysts with firm orders to get past Mr. Milken’s brother. Mr. Joseph never said to the Milkens, “I just committed $250,000 to have auditors to examine and report to me on the propriety of your operations in accordance with Drexel, Burnham policy. If you get in their way, pack up your desks and go!”
Many of us who worked on or near Wall Street in the early 1990’s were quite surprised to see the rest of the Street’s management wanting to adopt Drexel, Burnham’s ways. “Gee, the rat jumped from the sunken ship (Drexel, Burnham), now he/she is my boss” was commonly heard back in those days. Mr. Cassano landed at AIG. Wall Street management sought the means to protect themselves from the fate of Mr. Joseph by “going public” or selling stock in their firms to share the risk with others. Most notably was Goldman Sachs going public.
Mister Cassano found a new game at AIG called “credit default swaps”. Now corporate debt or bonds could be insured against default by paying AIG a premium and the AIG casino would cover some or all of the losses. There was a small private table in London where only certain Wall Street houses and banks could play. Mr. Cassano got rich by collecting premiums for AIG. When Mr. St. Dennis, the floor manager or internal auditor was sent by management to see and quantify what risks he was taking on behalf of AIG, he had his “brother”, Mr. Poling to help him send the scrutiny away. The private American citizen ended up at Mr. Cassano’s table because he moved to swapping (insuring) residential mortgage defaults, drawing money off the casino floor onto his table.
The problem was in the process. Years ago, should Mr. Cassano wanted to invent a new game. He would have had to ask Mr. St. Dennis to help him develop a due diligence, accounting and auditing policy for his new game before starting it. Mr. St. Dennis would have learned it, typed it up and checked it with the FASB manuals and/or sought an opinion from AIG’s outside accountant. Upon approval of a policy or process, then Mr. Cassano could start. What might have been the process? Say Mr. Cassano sought to have AIG cover the first 10% of defaults on $1 billion of mortgages originated by a Wall Street firm in exchange for a premium. Mr. St. Dennis might have said that is $100 million of risk or exposure, my staff needs to personally examine or sample the randomly selected files of $10 million of those mortgages. Based on that sample we will statistically infer the level of financial exposure. We need two weeks before you get our sign-off and put our files or “work-papers” to be available for audit by the outside accounting and auditing firm. Over time, we will determine a level of default experience and until that is accomplished you, Mr. Cassano will be limited as to how much of AIG’s money you can bet. This is or was called “due diligence”.
At this point, had Mr. Cassano said to Mr. St. Dennis, “This market cannot work under those strictures”. Then AIG’s management just as a matter of policy should have said “so be it until further notice”. However, there was too much money to made or pretended to be made. When Mr. Cassano collected a premium, AIG was quick to give him bonuses, but slow to think about how much and how long was their risk. No problem, Mr. St. Dennis resigned. In the 1990’s, General Electric ended up owning a Wall Street firm named Kidder, Peabody. GE found that following the previously described rules of the game was so antithetical to Wall Street types that they sold Kidder, Peabody’s assets after losing hundreds of millions in a commercial mortgage pools and derivatives debacle.
AIG through Joseph Cassano and his firm’s credit rating provided cover at the exclusive gaming table for the sub-prime mortgage people at Lehman, Bear Stearns, Merrill Lynch, Countrywide and so on. There are allegations that AIG hid the implications of Mr. Cassano’s dealings from its outside auditors, it was easy enough without Mr. St. Dennis around anymore. Mr. David Friehling, a single or small firm CPA provided cover for Bernie Madoff. Congress through the Federal Reserve needs to empower the FASB to help Mr. St. Dennis’ of the business world protect the public from the exclusive gaming tables of the Cassano’s and the likes of Bernie Madoff. The FASB through its staff would hopefully see at a future date from a distance that a Mr. St. Dennis gets to have a rewarding career developing and executing proper controls at the likes of AIG. Should Mr. St. Dennis have a professional designation such as a Certified Public Accountant or Chartered Financial Analyst and leave a Wall Street house or an AIG for any reason, or should a Bernie Madoff fire an accounting firm for any reason, the accountant or analyst and/or firm should be summoned to the Federal Reserve in New York for a confidential interview with the FASB staff.