Investors question audit committee knowledge

Wal Street faces an inquisition into the credit crunch

The risks in off-balance sheet vehicles were misunderstood by audit committees, a huge US shareholder activist group has said.

CtW Investment Group, a governance organisation, which represents shareholders with $1.5trillion (£750bn) in funds, is holding a quasi-inquisition into what went wrong in the major US investment banks’ control processes, interviewing audit and risk oversight committee chiefs.

The opaque structures disguised the risks that the US banks were facing, leading to the huge losses and writedowns that have damaged the global economy. ‘We have two questions that we’re asking relating to whether the directors understood whether a company had exposures and what these exposures were, and whether they understood the underlying risks of the mortgage-backed securities,’ said Michael Garland, CtW’s director of value strategies.

‘Some of the meetings have re-enforced our skepticism, especially in relation to the balance sheets and accounts. We are mindful that directors are not responsible for managing risk but overseeing risk… we’re questioning what management were doing to address that. So far they’re all trying to make a case that this [the sub-prime write-downs] was an industry collapse,’ Garland said.

The pressure on bank directors, especially those on audit committees, has been intense as investors look for someone to blame for writedowns.

The questions come during the US AGM season, and directors could lose their jobs if investors feel their work has not been up to scratch.

Earlier this year Peter Montagnon, director of investment affairs at the Association of British Insurers, said he thought committees had not understood the risks. Some investor groups have even called for special audits of risk management and control systems.

CtW has requested meetings with directors of six banks, which account for 88% of the $87bn in total sub-prime-related writedowns and credit losses. The organisation has already met with directors of Morgan Stanley, Citigroup and Wachovia Bank, and is set to meet with Merrill Lynch next week.

In letters to the directors, CtW point to red flags raised by reports and economists concerned with relaxed lending practices and unsustainable pricing of property as early as 2005.

Citigroup said its audit committee had carried out its responsibilities. Other banks had not responded at the time of going to press.