Bilked Investors, including the US government, are furious. 

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Spain’s two biggest bankruptcies ever, Bankia (2011-2012) and Abengoa (2015-?), share one thing in common: their auditor.

In both cases, the New York-based big-four firm Deloitte was responsible for making sure the financial statements fairly represent the financial position and performance of the companies, and that they conform to the accounting standards. Turns out, the accounts were as crooked as they come.

Both companies ran aground. Investors in the US and Spain got bilked. The US government got stiffed. And now it seems the auditor may actually end up paying a hefty price for having “seriously” infringed Spain’s account auditing laws.

Zero Independence

In the case of Bankia, Deloitte was not just the bank’s auditor, it was also the consultant responsible for formulating its accounts. As El Mundo puts it, first Deloitte built Bankia’s balances, then it audited them, in complete contravention of the basic concept of auditor independence.

Given this deeply compromising set-up, it’s hardly any surprise that Deloitte (together with Spain’s market regulators) was happy to confirm in Bankia’s IPO prospectus that the newly born franken-bank, which had been assembled from the festering corpses of seven already defunct saving banks, was in sound financial health, having made a handsome profit of €300 million just before its public launch in May 2011. It was a blatant lie: in reality Bankia was bleeding losses from every orifice.

But the lie served its purpose: 360,000 credulous investors were lured into buying shares in the soon-to-be-bankrupt bank. Another 238,000 bought “preferentes” shares or other forms of high-risk subordinate debt instruments being peddled by Bankia’s sales teams as “perfectly safe investments.”

Almost all of those people would end up losing most of their money, as the value of Bankia’s shares nose-dived spectacularly from €3.50 a piece to €0.01. Now, five years later, the bank’s duped investors are finally beginning to claw back some of the money they lost, thanks primarily to the limitless generosity of Spain’s unconsulted taxpayers, who have already stumped up tens of billions of euros to bail Bankia out.

As for Deloitte, it was found by a recent investigation to have ignored at least a dozen glaring errors in Bankia’s accounts. The company had to pay a €12 million fine for “seriously” infringing Spain’s auditing laws, but that hasn’t stopped it from continuing to audit the state-owned bank’s books. No, seriously.

Deloitte could end up facing a similar fine for failing to notice a veritable mountain of debt piling up on Spanish energy giant Abengoa’s books during the three years that it served as the firm’s auditor. Deloitte didn’t express any alarm about Abengoa’s financial health until November 13, just two weeks before Abengoa announced that it was seeking preliminary protection from creditors. By that time it was already common knowledge that there were serious problems with the finances of the firm, which is now estimated to have debt of over €8 billion and total liabilities exceeding €25 billion.

As WOLF STREET reported in December, Pepe Baltá, a 17-year old secondary school student in Barcelona who chose Abengoa as the subject of his economics project, noticed serious flaws in the company’s accounting of its mountain of debts — a full year before Deloitte’s handsomely paid auditors blew the whistle!

“The big surprise was that negative profits were being converted into positives,” he told the Spanish daily El Mundo. “I didn’t understand how they could do that.”

Such concerns did not register as important in the minds of Deloitte’s team of auditors. Or perhaps they did, but Deloitte was getting paid handsomely anyway. Why spoil a fruitful relationship?

Blowback Time?

Despite Deloitte’s front-line role in Spain’s two biggest bankruptcies, the firm has suffered little consequence of note. A €12 million fine? Come on! But that could be about to change.

Thanks to new reforms in Europe’s audit regulations, companies will soon have to put their audit work to tender every 10 years. For Deloitte, this will mean losing eight clients from among the pool of 35 companies listed on Spain’s Ibex-35 stock index. Those clients include Spain’s two biggest banks, Grupo Santander and BBVA.

Some clients did not even wait for the law to kick into effect before ditching the firm. Last summer, Santander reported that it was swapping Deloitte’s services for PricewaterhouseCooper’s, despite the fact that the banking giant has until 2023 to switch auditors. It’s a massive loss for Deloitte: in the last three years alone, it has billed Santander €260 million for its auditing and consulting services. In January BBVA announced that it, too, was calling quits on its 25-year relationship with Deloitte.

Deloitte has downplayed the bad news, placing its faith in its ability to continue attracting clients for its consulting services. Nonetheless, the toll on its reputation is being felt, with some of the firm’s partners allegedly calling for the resignation of the president of the firm’s Spanish division, Fernando Ruiz.

To rub salt in the wound, the SEC is considering launching its own investigation into Deloitte’s role in Abengoa’s downfall. The U.S. regulator’s interest in the case is perfectly justified: not only is Abengoa’s U.S. subsidiary listed on the New York Stock Exchange, its bankruptcy has left many of its stateside investors high and dry. Chief among them is the U.S. government itself, the company’s biggest creditor, which lent the firm $2.65 billion for two massive infrastructure projects, the Solana solar plant in Arizona and the Mojave Solar Project in California.

Those projects are now at risk of default, along with three other solar and wind farms owned by the company. If Abengoa ends up going into liquidation, rate-payers and/or taxpayers could be left holding the tab. The firm’s creditors and providers would also suffer a big hit.

For Deloitte this could be the beginning of a very ugly headache: by signing off on three years worth of blatantly dodgy accounts in Spain, it could end up attracting the unwanted attention of lawyers and regulators on both sides of the pond. And if Abengoa does fall, Deloitte would end up being the only party left standing that could be made to pay for the Spanish firm’s creative book-keeping. By Don Quijones, Raging Bull-Shit.

As problems in the Spanish banking system continue to fester, there are four things that keep senior bankers awake at night. Read…  Prelude to a Nightmare

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