8/3/2019 On Misplaced Confidence in Auditors

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Misplaced confidence in Auditors

My name is Matt Berry and I have a short position with GMCR. I will be posting my reasons for

my short and rebuttals to those promoting the long position. Everyone, it should go without saying,

is responsible for their own research and risk analysis.

First let’s deal with Price Waterhouse Coopers (PWC) as the auditor of Green Mountain Coffee Roasters,

Inc (GMCR). A repeated comment found on Yahoo Message board goes something like this one, 

Did you see that Price Waterhouse Coopers has now blessed the company's improved financial

controls (see the recently file 10-K). … etc. ( Search Yahoo Message Board for "Blessing"),

"Waterhouse", or "PWC") 

But no one is really saying that an auditor’s “blessing” guarantees the safety of an investment.

For example, PWC themselves qualify their signatures with the following reminder.

"Because of its inherent limitations, internal control over financial reporting may not prevent or

detect misstatements. " ~ PWC for GMCR's 2011 10-K

The “objection” to this reminder was put to me as … “ that language is in the annual report of every

company since Sarbanes Oxley became effective.” But this repetition is out there for a good reason. It

may lose its power over us by use, just as crying wolf very soon fails to put the town on alert ‒ but just

as the failure to draw a response leaves the population vulnerable to the real danger, so is this

conclusion not trivial simply because it is repeated. Repetition of a warning does not eliminate the

danger; on the contrary, the repetition usually increases the danger by leaving us less vigilant ‒ but what

can we do? ‒ that’s how we’re built. Consider the following:

AIG and PWC … 

"Where were the auditors? Now that American International Group Inc. has admitted to a clutch

of accounting improprieties and is mulling whether to restate its past results, an all-too-familiar

question is emerging: Why didn't the auditor catch what was going on? Were misdoings hidden

from AIG's longtime auditing firm, PricewaterhouseCoopers, or did the firm turn a blind eye to

problems it should have seen?" ~ http://www.businessweek.com/magazine/con... 

http://www.businessweek.com/bwdaily/dnfl... 

Here is the settlement: http://www.aigsecuritieslitigationpwcset... 

This does not isolate PWC from other auditors and say that they are necessarily bad or that I should avoid

stocks audited by them. For example, I would never avoid a city because it had a lot of police to protect

me. Of course not. But I wouldn't drop my guard either. Just because there are police in the city does

not mean that I will never get robbed, or that I should leave my door unlocked and my money on the

kitchen table. A working judicial system is no reason for reckless disregard.

8/3/2019 On Misplaced Confidence in Auditors

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There are inherent vulnerabilities in an auditor’s line of work, not to mention the fact that many of the

incentives are aligned with a company's continuation and not with an exposure of its problems. Auditors

are not exactly happy or eager to find fraud; they have a financial interest in keeping their clients and are

not in the habit of biting the hand that feeds them. As a consequence their work does not necessarily

protect investors (or themselves) from human blind spots.

It's a minefield out there, PWC's problems with Tyco:

"The suit, filed in New Hampshire federal court, alleged that as Tyco’s auditor 

PricewaterhouseCoopers failed in its auditing duties." http://blogs.wsj.com/law/2007/07/06/pwc-

... 

PWC's Indian affiliate & Satyam:

"The Indian affiliate of PricewaterhouseCoopers routinely failed to follow the most basic audit

procedures, the United States Securities and Exchange Commission said Tuesday as it

penalized the firm for its failed audits of Satyam Computer Services, the Indian company that

falsely reported more than $1 billion in profits. "~ http://www.nytimes.com/2011/04/06/busine... See also: http://www.law.com/jsp/law/international... 

The issue for us here is not whether or not an auditor is guilty or innocent, or better or worse than other

auditors, but whether or not an auditor's signature serves as sufficient "protection" for investors. It does

not. Although it is comforting to have that signature, mental comfort is not safety. No auditor can fully

substitute an investor's need for due diligence. Of course I would indeed feel more comfortable with their

"blessing" than with their criticism, but I do not confuse this comfort with either safety or my

responsibility for study. My point is simply that even the best of them cannot fully protect us, that even

an auditor can be fooled, and that it is dangerous to think that an auditor's signature relieves us of a duty

to study the evidence on our own. Here's a more recent case … with MF Global:

http://www.forbes.com/sites/francinemcke... 

As for the argument, “PWC has integrity and therefore …” Integrity of the auditor can hurt you as much

as its dishonesty. It will all get sorted out eventually -- but that begs the question of which way the

evidence is leaning. If PWC has the integrity that its reputation, size, and age suggest, then the evidence

itself should be our guide ...since that is the direction that integrity will take the issue. (If you did not trust

PWC, then of course you would rely on the evidence even more.)

Evaluating the evidence is the key task for every investor, not blindly following someone else's

"blessing." If you haven't gone over it yet, here is Einhorn's presentation. (If you are pressed for time,scroll forward to the latter half and start with Confidential Witness #1.)

http://blogs.wsj.com/deals/2011/10/19/he... 

Buyer Beware: The market is strewn with signed yet worthless 10-ks.

Matt Berry, Short GMCR