New Audit Integrity Watchlist: Which Firms "Made The Grade"


As we await the fate of Washington Mutual, the pipeline of troubled institutions is filling up.

I mentioned Audit Integrity earlier this week in a post on Downey Financial, and later the firm reached out to me to explain that it considers Downey very risky from an accounting and governance perspective.

I just received Audit Integrity's September Watchlist. Washington Mutualisn't on it. Neither is Lehman Brothers. I asked why, and was told that the watchlist looks for future problems--WaMu and Lehman shares have already been hammered and we already know they're in trouble.

So which companies are on the new watchlist? In first place for having the highest accounting and governance risk is State Street. On the bright side, Audit Integrity says State Street is less likely than its peers to be sued over the next year. But it's regulatory and litigation issues over the PAST year weigh heavily on Audit Integrity's ranking.

Other red flags include: 1) a high level of incentive compensation for top management, which may lead to too much focus on short-term gains; 2) the fact that the CEO is also the Chairman; 3) the high number of divestitures; 4) a greater than average executive turnover during the last year. But the biggest red flag, according to Audit Integrity, is the ratio between State Street's "interest receivable" or interest it claims it's earned, over the actual "interest income". "Comparably large interest receivables indicate overvalued assets and possible revenue recognition issues.

Interest Receivable is subject to manipulation through a number of schemes such as: recording fictitious loans or investments, premature revenue recognition, erroneous journal entries, or extending credit to poor risk customers."

Interestingly, other companies with a high degree of accounting and governance risk include Ebay . Audit Integrity has changed the way it measures risk, adding to its previous metrics a new one--dividing the number of shorted shares by average daily volume. Both State Street and Ebay fare pretty well by that standard, with ratios of only one percent.

The new changes has led to a lot of companies being added to the watchlist this month, including Transocean, Wachovia,Juniper Networks,Wells Fargo, General Mills, and McDonald's. McDonald's?? Well, the point is to be foward-thinking!


The company says, "Effectively, the Watchlist now represents companies which, in our judgment, have not been recognized by the larger marketplace as still having the potential for further deterioration in price."

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