In 2017 my Website was migrated to the clouds and reduced in size.
Hence some links below are broken.
One thing to try if a “www” link is broken is to substitute “faculty” for “www”
For example a broken link
can be changed to corrected link
However in some cases files had to be removed to reduce the size of my Website
Contact me at if you really need to file that is missing


Bob Jensen's Bottom Line Conclusions on the Accounting Frauds and Scandals

Bob Jensen at Trinity University  


Good News Highlights
Globally Networked Databases and Online Financial Reporting

Enterprise Resource Planning (ERP) Installations for Smaller Enterprises

Dawning of the Age of XBRL

Dawning of the Age of Continuous Auditing and Auditbots

Dawning of Age of Customized Reporting and Aggregations

Dawning of the Age of P2P File Sharing

Harmonization of Accounting Standards Is Finally Becoming a More Serious Goal

New Spirit of Reform and Ethics Awareness

Expansion of the Accounting Profession into Assurance Services 

Some Things Do Get Better Under Threatening Litigation Storm Clouds 
(There are signs that the Sarbanes Oxley legislation is working)

Lifelong Learning Alternatives in the Age of Distance Education and Training 


Independence Rules

Corporate Reform: The New SEC Auditor Independence Rules (from Ernst & Young) ---$file/CorporateReformSECAuditorIndependenceRules.pdf 



Bad News Highlights
Systemic Accounting Problems That Cannot ( or Otherwise Will Not Likely) Be Solved
  • Systemic Problem:  All Aggregations Are Arbitrary
  • Systemic Problem:  All Aggregations Combine Different Measurements With Varying Accuracies
  • Systemic Problem:  All Aggregations Leave Out Important Components
  • Systemic Problem:  All Aggregations Ignore Complex & Synergistic Interactions of Value and Risk
  • Systemic Problem:  Disaggregating of Value or Cost is Generally Arbitrary
  • Systemic Problem:  Systems Are Too Fragile
  • Systemic Problem:  More Rules Do Not Necessarily Make Accounting for Performance More Transparent
  • Systemic Problem:  Economies of Scale vs. Consulting Red Herrings in Auditing
  • Systemic Problem:  Intangibles Are Intractable

White Collar Crime Pays Big Even If You Get Caught

Profitable Looting in the Capital Markets:  Crime Keeps on Paying

Debate Topic:  Punishing the Many for Crimes of a Few  
(The above link contains a module on the rise in class action lawsuits resulting from Sarbanes-Oxley reforms)

Accounting Education Shares Some of the Blame --- 

Accounting Tricks and Creative Accounting  

Outrageous Executive Compensation Schemes That Reward Failure and Fraud

Corporate Boards and the SEC Will Not Solve Corporate Governance the Crisis

Incompetent and Corrupt Audits are Routine

Whistle Blowing is Often Not Rewarded But Times Are Changing  

Cost Cutting Pressures Create Moral Hazards

Computer Security is Becoming More Fragile in the Age of Electronic Warfare

Collision of Security and Privacy and Freedom Criteria

Investment Banking and Security Analysis Professions Are Rotten to the Core

Dawning of the Age of Unaccountable Contracting

Failed Education Systems In the Early Years Leave Weak Foundations to Build Upon

Media Coverage is Very, Very Good and Very, Very Bad
From Enron to Earnings Reports, How Reliable is the Media's Coverage?  

CPA = Career Passed Away   

The Three Cs of Fraudulent Financial Reporting (Warning Signs)

Will public accounting audit services survive?  Insurance Versus Assurance?

The Most Criminal Class Writes the Laws ---

Rotten to the Core ---

Take the Enron Quiz ---

More on Accounting Theory and All Its Problems ---



Background Links on Accounting and Business Fraud

I'm giving thanks for many things this Thanksgiving Day on November 22, 2012, including our good friends who invited us over to share in their family Thanksgiving dinner. Among the many things for which I'm grateful, I give thanks for accounting fraud. Otherwise there were be a whole lot less for me to study and write about at my Website ---

Main Document on the accounting, finance, and business scandals --- 

Bob Jensen's Enron Quiz (and answers) ---

Bob Jensen's threads on professionalism and independence are at

Bob Jensen's threads on special purpose (variable interest) entities are at

Bob Jensen's threads on ethics and accounting education are at

The Saga of Auditor Professionalism and Independence ---  

Incompetent and Corrupt Audits are Routine ---

Bob Jensen's threads on accounting theory are at 

Bob Jensen’s threads on the future of auditing

Bob Jensen’s threads on the weaknesses of risk-based auditing are at

Bob Jensen's threads on pro forma frauds are at 

Bob Jensen's threads on accounting theory are at 

Bob Jensen's threads on options accounting scandals are at

Accounting Scandals
The funny thing is that I never looked up this item before now. Jim Mahar noted that it is a good link.

Summary of Major Accounting Scandals ---

Bob Jensen's threads on such scandals:

Bob Jensen's threads on audit firm litigation and negligence ---

Current and past editions of my newsletter called Fraud Updates ---

Bob Jensen's fraud conclusions ---

Bob Jensen's threads on auditor professionalism and independence are at

Bob Jensen's threads on corporate governance are at 

Enron ---

Rotten to the Core ---

Fraud Updates ---

American History of Fraud ---

Fraud in General ---

Future of Auditing --- Click Here

AICPA Fraud Resource Center --- Click Here

Forensic Accounting Course Materials

November 3, 2009 message from Eileen Taylor [eileen_taylor@NCSU.EDU]

Need advice on choosing a textbook for an MBA class on fraud (to be taken mostly by Master of Accounting students).

I am deciding between Albrecht's Fraud Examination and Hopwood's Forensic Accounting. I also plan to have students read Cynthia Cooper's book, Journey of a Corporate Whistleblower.

I will be teaching a three-week version of the course this summer as a study abroad, but also will be converting it into a 16 week semester-long 3 hour course.

Any suggestions would be helpful -

Thank you,

November 3, 2009 reply from Bob Jensen

Hi Eileen,

I'm really not able to give you an opinion on either choice for a textbook. But before making a decision I always compared the end-of-chapter material and the solutions manual to accompany that material. If the publisher did not pay for good end-of-chapter material I always view the textbook to be a cheap shot. The end-of-chapter material is much harder to write than the chapter material itself.

I also look for real world cases and illustrations.

Don't forget the wealth of material, some free, at the site of the Association of Certified Fraud Examiners ---
I would most certainly consider using some of this material on homework and examinations.

Instead of a textbook you might use the ACFE online self-study materials ($79)  ---
Click Here

There is a wonderful range of topics covered ---      [eweb_acfe_com]

Accounting and Auditing

Computers and Technology

Criminology and Ethics

Fraud Investigation

Fraud Schemes

Interviewing and Reporting

Legal Elements of Fraud

Spanish Titles

Bob Jensen

"A Model Curriculum for Education in Fraud and Forensic Accounting," by Mary-Jo Kranacher, Bonnie W. Morris, Timothy A. Pearson, and Richard A. Riley, Jr., Issues in Accounting Education, November 2008. pp. 505-518  (Not Free) --- Click Here

There are other articles on fraud and forensic accounting in this November edition of IAE:

Incorporating Forensic Accounting and Litigation Advisory Services Into the Classroom Lester E. Heitger and Dan L. Heitger, Issues in Accounting Education 23(4), 561 (2008) (12 pages)]

West Virginia University: Forensic Accounting and Fraud Investigation (FAFI) A. Scott Fleming, Timothy A. Pearson, and Richard A. Riley, Jr., Issues in Accounting Education 23(4), 573 (2008) (8 pages)

The Model Curriculum in Fraud and Forensic Accounting and Economic Crime Programs at Utica College George E. Curtis, Issues in Accounting Education 23(4), 581 (2008) (12 pages)

Forensic Accounting and FAU: An Executive Graduate Program George R. Young, Issues in Accounting Education 23(4), 593 (2008) (7 pages)

The Saint Xavier University Graduate Program in Financial Fraud Examination and Management William J. Kresse, Issues in Accounting Education 23(4), 601 (2008) (8 pages)

Also see
"Strain, Differential Association, and Coercion: Insights from the Criminology Literature on Causes of Accountant's Misconduct," by James J. Donegan and Michele W. Ganon, Accounting and the Public Interest 8(1), 1 (2008) (20 pages)

Bob Jensen's Fraud Updates ---
Bob Jensen's threads on fraud ---

FBI Corporate Fraud Chart in August 2008 ---

A great blog on securities and accounting fraud ---

Bob Jensen's threads on fraud and forensic accounting ---




The Consumer Fraud Portion of this Document Was Moved to 



Good News Highlights
Globally Networked Databases and Online Financial Reporting

Enterprise Resource Planning (ERP) Installations for Smaller Enterprises

Dawning of the Age of XBRL

Dawning of the Age of Continuous Auditing and Auditbots

Dawning of Age of Customized Reporting and Aggregations

Dawning of the Age of P2P File Sharing

Harmonization of Accounting Standards Is Finally Becoming a More Serious Goal

New Spirit of Reform and Ethics Awareness

Expansion of the Accounting Profession into Assurance Services 

Some Things Do Get Better Under Threatening Litigation Storm Clouds 
(There are signs that the Sarbanes Oxley legislation is working)

Lifelong Learning Alternatives in the Age of Distance Education and Training 


Independence Rules

Corporate Reform: The New SEC Auditor Independence Rules (from Ernst & Young) ---$file/CorporateReformSECAuditorIndependenceRules.pdf 



Bad News Highlights
Systemic Accounting Problems That Cannot ( or Otherwise Will Not Likely) Be Solved
  • Systemic Problem:  All Aggregations Are Arbitrary
  • Systemic Problem:  All Aggregations Combine Different Measurements With Varying Accuracies
  • Systemic Problem:  All Aggregations Leave Out Important Components
  • Systemic Problem:  All Aggregations Ignore Complex & Synergistic Interactions of Value and Risk
  • Systemic Problem:  Disaggregating of Value or Cost is Generally Arbitrary
  • Systemic Problem:  Systems Are Too Fragile
  • Systemic Problem:  More Rules Do Not Necessarily Make Accounting for Performance More Transparent
  • Systemic Problem:  Economies of Scale vs. Consulting Red Herrings in Auditing
  • Systemic Problem:  Intangibles Are Intractable

White Collar Crime Pays Big Even If You Get Caught

Profitable Looting in the Capital Markets:  Crime Keeps on Paying

Debate Topic:  Punishing the Many for Crimes of a Few  
(The above link contains a module on the rise in class action lawsuits resulting from Sarbanes-Oxley reforms)

Accounting Education Shares Some of the Blame --- 

Accounting Tricks and Creative Accounting  

Outrageous Executive Compensation Schemes That Reward Failure and Fraud

Corporate Boards and the SEC Will Not Solve Corporate Governance the Crisis

Incompetent and Corrupt Audits are Routine

Whistle Blowing is Not Rewarded  

Cost Cutting Pressures Create Moral Hazards

Computer Security is Becoming More Fragile in the Age of Electronic Warfare

Collision of Security and Privacy and Freedom Criteria

Investment Banking and Security Analysis Professions Are Rotten to the Core

Dawning of the Age of Unaccountable Contracting

Failed Education Systems In the Early Years Leave Weak Foundations to Build Upon

Media Coverage is Very, Very Good and Very, Very Bad
From Enron to Earnings Reports, How Reliable is the Media's Coverage?  

CPA = Career Passed Away   

The Three Cs of Fraudulent Financial Reporting (Warning Signs)

Will public accounting audit services survive?  Insurance Versus Assurance?

The Most Criminal Class Writes the Laws ---

Rotten to the Core ---

Take the Enron Quiz ---

More on Accounting Theory and All Its Problems ---


First the Good News


Globally Networked Databases and Online Financial Reporting
Internet reporting of financial statements is now commonplace among virtually all major companies around the world.   Even companies that do not have financial reporting documents at their own Websites generally have their financial reports available from some provider such as the immensely popular EDGAR database of the SEC.

At first, governments and companies supplied reports online that were also available in hard copy.  In this respect, the Internet simply became a more convenient, faster, and less-costly way of distributing hard copy reports.  However, digitized versions have some added advantages that are not feasible in hard copy reports, the most notable of which is the ability to search for words and pictures.  Another advantage is the ability for analysts to slice and dice reports and combine components in to more useful combinations.

Some innovative companies have moved even further in Internet Reporting.  One of the most innovative companies in this regard is Microsoft Corporation.  Microsoft allows users to generate alternate financial reports under different sets of foreign accounting standards, including Japanese standards, French standards, etc.  In addition, Microsoft provides two types of databases in Excel:

  1. Pivot tables that allow very simple and interactive slicing, dicing, and reformation of data by the user.

  2. Forecast spreadsheets that allow users to make their own economic and growth assumptions to easily generate financial forecasts under alternative assumptions.

For details regarding Microsoft's financial analysis tools, go to 

The FEI has a new 16-page fraud checklist that can be downloaded for $50. Access to an online database is $129 --- Click Here

"New research provides resources on fraud prevention and financial reporting," AccountingWeb, January 18, 2008 ---

Financial Executives Research Foundation (FERF), the research affiliate of Financial Executives International (FEI), has announced the release of two important new pieces of research designed to aid public company management and corporate boards in the efficient evaluation of their assessment of reporting issues and internal controls. A new FERF Study, entitled "What's New in Financial Reporting: Financial Statement Notes from Annual Reports," examines disclosures from 2006 annual reports for the 100 largest publicly-traded companies which used particularly innovative techniques to clearly address difficult accounting issues. The study identifies and analyzes recent reporting trends and common practices in financial statements.

The report illustrates how companies addressed specific accounting issues recently promulgated by the Financial Accounting Standards Board (FASB), and by the Securities and Exchange Commission (SEC), and in doing so, uncovered a number of trends, which included:
  • Most of the disclosures selected appear to have been developed specifically for a company's own operations and industry standards, rather than "boilerplate" disclosures.
  • Four accounting areas identified with a considerable variation in disclosures. The examples cited in these areas used innovative techniques to clearly address difficult accounting issues.
    1. Commitments and contingencies
    2. Derivatives and financial instruments
    3. Goodwill and intangibles
    4. Revenue recognition
  • Twenty-five out of 100 filers in the 2006 reporting season reported tangible asset impairments as a critical accounting policy.
  • Many companies report condensed consolidating cash flows statements as part of their segment disclosures, although not required by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information.

    To further facilitate use of this report as a reference tool, all of the financial statement footnotes gathered for the study are available to members on the Financial Executives International Web site.

    "FERF undertook this study to provide our members with an illustration of how companies have used innovative techniques to clearly address difficult accounting concerns," said Cheryl Graziano, vice president, research and operations for FERF. "Recent accounting issues publicized by the FASB and the SEC have had a direct impact on members of the financial community, and the report shows that many companies are taking action."

    "We hope that all financial executives can utilize the report as both a quick update to summarize recent trends in the most annual reporting season, as well as a reference to address common accounting issues. The convenience of the online database will provide executives with a readily handy tool when drafting their own annual reports," said Graziano.

    A second piece of research by FEI, entitled the "FERF Fraud Risk Checklist," provides boards of directors and management with a series of questions to help in assessing the potential risk factors associated with fraudulent financial reporting and the misappropriation of assets. These questions were developed from a number of key sources on financial fraud and offer executives a single framework in which to evaluate their company's reporting, while providing a sample structure for management to use in documenting its thought process and conclusions.

    "Making improvements to compliance with Sarbanes Oxley is a daily practice for financial executives, and the first step in efficient evaluation of internal controls is the proper assessment of potential exposures or risks associated with fraud," said Michael Cangemi, president and CEO, Financial Executives International. "Through conversations with members of the financial community, we learned that, while this type of risk assessment is a routine skill for auditors, many members of management are not always familiar with this concept. This checklist combines knowledge from the leading resources on fraud to help financial management take a proactive step in evaluating their company's practices and identifying areas for improvement."

    The annual report study, including the full report and access to the online database, and the fraud checklist, are available for purchase on the FEI Web site

    Bob Jensen's threads on fraud are at

    Until recently, giant databases both within and between firms either did not communicate with one another or they did so only after expensive "back door" software was custom developed for each instance. 

    Deconstructing Babel:  eXtensible Markup Language (XML)
    XML and application integration XML may not yet be a true "silver bullet," but it can be used to great effect in integration projects if IT managers create a detailed plan that can overpower its weaknesses. 
    "Deconstructing Babel: XML and application integration," By Henry Balen, Application Development Trends, December 2000 --- 


    XML has become the lingua franca for inter-application communication. Using XML, all messages sent between applications consist of self-describing text. This makes the messages easily understandable by both humans and machines, although it does not supply an efficient packaging of the message. (XML messages can be considerably larger than a binary representation of the same information.)

    There are three aspects of inter-application communication:

    Transport—how to get information across the wire; Protocol—how to package the information sent across the wire; and Message—the information itself. The transport is usually a lower level network standard such as TCP/IP. Inter-process communications standards, such as CORBA, DCE and DCOM, have their own protocols that sit on top of such transports.

    The protocol used depends on the communication mechanism. Standards may use different protocols to communicate: CORBA uses IIOP, while electronic mail uses SMTP. Each of these protocols allows you to package a message, specify a destination and get the message to the designated location. In protocols that support remote method invocation (RMI), the destination can consist of an object reference and method.

    With each of these protocols, the user defines the message that is sent across the wire. In the case of CORBA, DCE, DCOM and so on, the message is defined using an Interface Definition Language (IDL). In E-mail and message-oriented middleware (MOM) it can be more fluid. No matter what you use, there is an agreement between the sender and receiver about the meaning of the message. The meaning is not transferred with the message.

    So why use XML? In XML, documents contain meta-information about the information being transmitted, and can be extended easily. However, XML is less efficient than transmitting the information using a binary protocol. One advantage, though, is that humans and computers can both read the document.

    To overcome the communication problem, the application can be enabled to send and receive information in the form of XML. This can be done independent of protocol, and if the meaning is agreed upon between the applications or organizations, then you just need to get the package to its intended destination. How it gets there is up to you. Of course, in these days of the Internet, the HTTP protocol is a natural choice. There are business domain-specific XML vocabularies under development.

    Application integration 

    From the point of view of an application, there are various points of integration: data store, APIs or components, and protocol. The point of integration used depends on the nature of the application. If integration means the ability to speak XML, then you will need to acquire or build adapters for the point of integration. These adapters are responsible for getting information in and out of the application, and performing any necessary transformations along the way.

    If the integration involves the sharing of information, you may want to integrate at the level of the data store. Assuming you have an existing database containing the information you want to share, your integration adapter is responsible for translating from a query's result set to an XML document. Conversely, when the application receives information in the form of XML, the adapter performs a reverse translation and maps the document elements to the appropriate database entities.

    Additional Reading

    XML, VoiceXML, XLink, XHTML, XBRL, XForm, XSLT, RDF and Semantic Web Watch --- 

    "Financial Reporting on the Internet – Instant, Economical, Global Communication," by Glen Gray, Information Technology, May 20021 --- 

    "Financial reporting on the Internet and the external audit," by Roger Debreceny and Glen Gray, The European Accounting Review, Volume 8, Number 2, 1999 --- 

    "Electronic Based Financial Reporting, by Hasri Bin Mustafa and Nor Azman Bin Shaari --- 

    Electronic Corporate Reporting Website --- 


    Enterprise Resource Planning (ERP) Installations for Smaller Enterprises
    In the past, it was not only troublesome to get different accounting databases within a firm to communicate with one another, but it was virtually impossible to get databases in all disciplines such as marketing, engineering, human resources, finance, legal services, manufacturing, purchasing, etc. to communicate with each other.  This made planning a costly and highly difficult process.  Enterprise Resource Planning (ERP) software has changed all this for firms who have been willing to invest in a costly startup program.   Initially, the ERP software entailed an enormous investment that only large firms could afford.  The trend now is to make this software more affordable to smaller firms.

    "Spotlight on Midlevel ERP Software," by Roberta Ann Jones, Journal of Accountancy, May 2002 --- 

    Years ago, when the personal computer was just coming into its own, accounting software was relatively simple: Its single function was to automate the task of double-entry accounting and produce a straightforward balance sheet. As computers became more robust and integrated databases standardized, accounting software developers added more functions—including cost accounting, manufacturing resource planning (MRP), customer resource management (CRM), human resources (HR) and payroll. To differentiate these superproducts from the simple accounting programs, marketing-minded vendors christened the new packages enterprise resource planning (ERP) software.

    Additional Reading

    ERP Overview and Email Messages from Teachers of ERP --- 


    Dawning of the Age of XBRL
    In the early days of the Web, we were very grateful for the tremendous advantage digitization provided for word and picture searching.  But there remained enormous problems such as the following:
    1. Missing information due to not choosing the proper word or phrase.  For example, a search for "Financial Reporting on the Internet" missed documents that instead used a phrase like "Financial Reporting on the Web."

    2. Being overwhelmed with hits that are only indirectly related to what is being sought or they are not related at all.  For example, when searching for academic papers on a given topic, a searcher may not be able to separate the wheat from the chaff of thousands of advertisements that use the keyword or documents that use the keyword in a different context.  For example, the term "derivatives" will generate thousands of documents on financial derivates and thousands more on mathematics derivatives.

    Deconstructing Babel:  eXtensible Business Reporting Language (XBRL)

    XML was designed to overcome both of the above two problems.  However, XML provides only a general framework that cannot be used to drill down into the specialized vocabulary of each discipline until that discipline develops its own standardized taxonomy.  For business reporting, a consortium of major corporations, investment firms, accounting firms, security analysts, and others came together under the leadership of the American Institute of CPAs to develop an "under-the-hood" taxonomy and framework that extended XML to the varied and complex terminologies of accounting and business.

    XBRL specifications have at last been completed for U.S. GAAP and will soon be widely employed in electronic financial statements.


    XBRL is:

    • A standards-based method with which users can prepare, publish (in a variety of formats), exchange, and analyze financial statements and the information they contain.
    • Freely licensed, which permits the automatic exchange and reliable extraction of financial information across all software formats and technologies, including the Internet.
    • Ultimately benefits all users of the financial information supply chain: public and private companies, the accounting profession, regulators, analysts, the investment community, capital markets and lenders, as well as key third parties such as software developers and data aggregators.
    • Does not require a company to disclose any additional information beyond that which they normally disclose under existing accounting standards. Does not require a change to existing accounting standards.
    • Improves access to financial information/speeds up access.
    • Reduces need to enter financial information more than one time, reducing the risk of data entry error and eliminating the need to manually key information for various formats, (printed financial statement, an HTML document for a company’s Web site, an EDGAR filing document, a raw XML file or other specialized reporting formats such as credit reports and loan documents) thereby lowering a company's cost to prepare and distribute its financial statements while improving investor or analyst access to information.
    • Leverages efficiencies of the Internet as today’s primary source of financial information by making Web browser searches more accurate and relevant. (More than 80% of major US public companies provide some type of financial disclosure on the Internet.)
    • XBRL meets the needs of today's investors and other users of financial information by providing accurate and reliable information to help them make informed financial decisions.

    June 6, 2002 message from Neal Hannon

    Here is a list of companies that have joined XBRL-Germany. Good luck in Deutschland!

    Additional Reading

    XBRL Home Page ---

     XML, VoiceXML, XLink, XHTML, XBRL, XForm, XSLT, RDF and Semantic Web Watch --- 



    Dawning of the Age of Continuous Auditing and Auditbots
    In April 2002, the Securities and Exchange Commission approved the release for public comment of proposed rules that would modernize and improve the timeliness of its system of corporate disclosures. The proposed changes recognize the importance of the Internet and move companies closer to real-time reporting. Some see these changes as long overdue. Despite widespread improvements in information technology, the shorter filing deadlines proposed by the Commission would represent the first change in more than 30 years
    I guess the SEC did not read about Ebenezer at 

    Audited financial statements seriously lag most investment decisions in the market place.  In most instances, they appear only once a year and refer to a point in time that is at best three months behind the date of the statements.  The information is too infrequent and too delayed.

    In the past, it was just too costly for auditors to monitor each transaction in real time as it transpired and to follow the course of this transaction through various phases such as the transformation of raw material into work in process and then into finished goods and cost of goods sold.   Computing and networking technologies have eliminated most of those cost barriers.   We are approaching an age where it may be more costly to monitor a transaction after the fact than to monitor it in real time as it is happening.

    Many CEOs receive financial statements at least one per day.  There is no reason why upgraded auditing processes cannot attest to these statements for external users.   These upgrades are termed "continuous" or "real-time" audits.   In the future, encapsulated software that can be accessed only by the auditors might accompany each and every transaction of a firm.  These might be called "auditbots" or "audit robots" that detect, trace, verify, aggregate, and report to auditors as transactions take place.  Sampling errors will be reduced since it becomes possible to monitor every transaction rather than a post-event sampling of transactions.

    Continuous auditing shifts the entire focus from auditing on verification of processes as opposed to mere verification of outputs.  This type of auditing is especially important for XBRL reporting since the semantic demands of XBRL require a verification of the basic underlying transactions prior to being aggregated into outputs.  One of the major obstacles is that auditing standards will one day have to be entirely revamped for continuous auditing.  See Lymer and Debreceny (2002).

    Information becomes more accurate, more timely, and more relevant to managers, creditors, and investors.  Long-time advocate of continuous auditing, Professor Miklos Vasasarhelyi at Rutgers University contends that continuous auditing may have prevented the excess swelling and ultimate collapse of Enron.

    "Auditors in Search of the Future," June 14, 2002 --- 

    Swinney is a partner with KPMG. He heads a team of 10 at an inhouse think tank KPMG calls its Assurance and Advisory Services Center. The task: Establish what financial reporting will look like three, five, 10 years from now.

    The sorts of reforms Swinney and others envision would have a dramatic impact on accounting firms, their clients and investors. "Auditing standards, systems, our own business model, all would clearly change," Swinney says.

    KPMG isn't alone in its quest. Other firms have similar teams doing similar work. "It all connects back to improving the effectiveness of the audit," says John Fogarty, who directs Deloitte & Touche LLP's "third generation audit" project, from the firm's headquarters in Wilton, Conn.

    For auditors, these are trying times. Andersen, of course, is unraveling. High-profile corporate disasters continue to explode. Restated accounts appear almost daily. Practitioners are being maligned. Methods are being questioned. Critics question the extent external auditors have cozied up with their corporate clients and how this impugns credibility.

    "What society needs are accurate, believable reports," says Ira Solomon, who heads the accounting department at the University of Illinois. For more than 10 years, Solomon has been investigating the growing gap between businesses -- especially their assets and their value determinants -- and the financial statements that are issued. "There's a long, long way to go" to get an audit that accurately reflects these changes, he says.

    For example, Solomon continues, auditors traditionally have engaged in "vouching and tracing." But that is based on tangible assets. What happens, he asks, when the assets of large corporations are no longer tangible, as is the case in many companies today? The whole definition of value changes. An audit must reflect this.

    Swinney, for one, maintains the rash of negative publicity that began with Enron Corp. is neither the driver of nor the distraction for his project. "Things that we're doing, things that we're thinking about, aren't affected by Enron," says the veteran accountant, who is due to return to his New York-based media practice sometime this summer.

    While Fogarty agrees Enron hasn't dictated direction, he believes next-generation audit techniques would militate against the kind of renegade corporate bookkeeping that Enron has come to symbolize. "All this is aimed at helping improve our ability to detect fraud or things that are like fraud," he says.

    The changes envisioned by accounting's futurists are about content and mindset, says Fogarty. Technology, however, has provided the impetus. It enables the availability of more information more quickly than conceivable even a few years ago. "The whole world's changed," says Solomon.

    Auditors want to tap into that technological potential. Investors and other interested parties outside the corporation clamor for access. "We believe marketplace demand will drive the acceleration of the reporting as well as the depth of reporting," says Swinney.

    What will encompass the next-generation audit is far from settled. Planners agree that changes will be evolutionary. The degree of change may differ greatly from country to country and even from company to company. Here, however, are some of the likely elements.

    *Continuous reporting. Audit planners believe within the next few years they will have the technological means to monitor the financial complexities of a corporation in real time. From an auditing viewpoint, that will render the fiscal quarter or year pretty much meaningless. "Today, we're very periodic oriented, but in the future, I believe it will become more continuous," says Fogarty.

    *The virtual close. The time gap already is shrinking between when books are closed, an audit is completed and the results are made public. Technology should allow that to disappear almost completely. When combined with continuous reporting, this gives outsiders the theoretical ability to monitor financial results as fast as company executives. However, that kind of real-time reporting could make stock markets horribly unstable and stock prices volatile. "I don't see it ever coming, at least in my professional lifetime," says Fogarty, who is 47.

    *Web-based audits. In the future, a company's financial accounts and data will be completely digitized. The Web will act as host. That will allow auditors to sit in one location and access all necessary corporate information and transactions. While the technology for this exists and while there are small-scale experiments under way, Swinney believes widespread Web-based audits are "realistically six, seven years down the road."

    *Non-financial audits. Now, audits are restricted to transactions, accounts and balance sheets. In the future, auditors could be called on to verify non-financial indicators such as environmental performance, health and safety records or comparisons with competing companies. They might weigh industry risks. Some European and Canadian companies voluntarily submit themselves to this non-financial reporting today. Already, there are moves afoot within the Securities and Exchange Commission for auditors to verify the management discussion and analysis section of quarterly reports.

    *Embedded agents and data mining. Accounting firms believe they could do a better job if they were allowed access to client systems and used software not only to collect data, but to alert auditors about possible anomalies. An auditor could open his or her laptop each morning and receive any warnings about potential problems. Swinney describes it as a kind of warning light system on a dashboard.

    Not that corporations can be expected to embrace all this willingly. As the Financial Accounting Standards Board can attest, corporate lobbyists have tried their best to kill accounting reforms of the past several decades. Many of these ideas, while now mostly theoretical, would likely run into significant opposition should regulators try to make them mandatory. Corporate technology departments would resist opening any systems to outsiders.

    Auditors counter that they need the kind of access that technology offers to do their job properly. An audit "will never be perfect," says Fogarty. But he believes "the more auditors are involved in processes, the more discipline is brought to bear. The more discipline is brought, the more the chances of information being incorrect or misleading or left out can be reduced."

    "Embedded Audit Modules in Enterprise Resource Planning Systems: Implementation and Functionality," by Roger S. Debreceny, Glen L. Gray, Joeson Jun-Jin Ng, Kevin Siow-Ping Lee, and Woon-Foong Yau, Journal of Information Systems, Fall 2005, pp. 7-28 ---

    Embedded Audit Modules (EAMs) are a potentially efficient and effective compliance and substantive audit-testing tool. Early examples of EAMs were implemented in proprietary accounting information systems and production systems. Over the last decade, there has been widespread deployment of Enterprise Resource Planning (ERP) systems that provide common business process functionality across the enterprise. These application systems are based upon a common foundation provided by large-scale relational database-management systems. No published research addresses the potential for exploiting the perceived benefits of EAMs in an ERP environment. This exploratory paper seeks to partially close this gap in the research literature by assessing the level and nature of support for EAMs by ERP providers.

    We present five model EAM-use scenarios within a fraud-prevention and detection environment. We provided the scenarios to six representative ERP solution providers, whose products support "small," "medium," and "large" scale clients. The providers then assessed how they would implement the scenarios in their ERP solution. Concurrent in-depth interviews with representatives of the ERP providers address the issue of implementing EAMs in ERP solutions.

    The research revealed limited support for EAMs within the selected ERP systems. Interviews revealed that the limited support for EAMs was primarily a function of lack of demand from the user community. Vendors were consistent in their view that EAMs were technically feasible. These results have a number of implications for both practice and future research. These include a need to understand the barriers to client adoption of EAMs and to build a framework for integrating EAMs into firm risk-management environment.

    Bob Jensen's threads on ERP education are at
    Also see  

    Additional Reading

    Canadian Continuous Disclosure Obligations:  OSC Rule 51-801

    "AICPA Top 5 Emerging Impacts on You!" by Roman H. Kepczyk, CPA (Published in Accounting Today - April 25, 1999) --- 

    "Non-stop Auditing," by Greg Shields, CA Magazine, September 1998, --- 

    Texas A&M Center for Continuous Auditing --- 

    S. Michael Groomer and Uday S. Murthy, Accounting Information Systems:  A Database Approach --- 

    ISACA/IIA Los Angeles, March 25, 2002 --- 


    Dawning of Age of Customized Reporting and Aggregations
    "Customized Financial Reporting, Networked Databases, and Distributed File Sharing," by Robert E. Jensen and Jason Zezhong Xiao, Accounting Horizons, September 2001 --- 

    We analyze the relation between customization and standardization in corporate financial reporting. We argue that “Customization Around a Standard Report” (CASR) is a promising approach to financial reporting. Under this approach, the prevailing general purpose report serves as a benchmark, upholds information credibility, maintains information comparability, and satisfies users’ common information needs while the added customization meets users’ different information and presentation requirements. CASR will be less effective if implemented by the reporting company alone. To be more effective, CASR should be undertaken jointly by the reporting company, the information intermediary, and the end user. Such joint CASR could be implemented in a peer-to-peer networking environment where data-bases from primary financial data sources, such as reporting companies, and secondary reports from certified financial analysts are networked and shared. Such an environment will create an enormous demand for both customization and standardization. We predict that networking and file sharing in this way will greatly enhance opportunities for assurance services to add legitimacy and selectivity to an over-whelming menu of customization options that will one day be available online.


    Additional Reading

    "The impact of cognitive styles on information systems design," by Benbast, I., and R. N. Taylor, MIS Quarterly, June 1978, pp. 43–54.

    Building Database-Driven Web Catalogues, by Danish, S., and P. Gannon (New York, NY: McGraw-Hill, 1998)



    Dawning of the Age of P2P File Sharing
    "Customized Financial Reporting, Networked Databases, and Distributed File Sharing," by Robert E. Jensen and Jason Zezhong Xiao, Accounting Horizons, September 2001 --- 

    Peer-to-Peer Networking (P2P) Technology and CASR This joint CASR could be implemented in an environment of networked databases and distributed file sharing. Such an environment is emerging with the advent of a group of Internet-based peer-to-peer distributed software alternatives such as Napster ( ), Gnutella (, InfoSearch ( ), Freenet  ( ), and Pointera ( ). Peer-to-peer file distribution technology allows users to search for data on other people’s computers. Although these software products are not the same, the technology’s main features are its ability to facilitate distributed file sharing, ad hoc networking, and distributed search. These features make the location of files irrelevant; data belong to the entire network rather than to a particular computer (Oram 2000). The importance of peer-to-peer file sharing in the future is nicely summarized by Waters (2001). This type of technology has enormous implications for CASR. In the world of peer-to- peer networking, companies and analysts can earmark the data for access by numerous networked users and any user can access numerous interpretations of a business report and share financial analyses of Company XYZ by Analyst A, Analyst B, and Company XYZ itself.


    Additional Reading 
    Threads on the P2P, PDE, Collaboration, and the Napster/Wrapster/Gnutella/Pointera/FreeNet/BearShare/ Paradigm Shift in Web Serving and Searching ---



    Harmonization of Accounting Standards Is Finally Becoming a More Serious Goal
    In 2002, significant new funding and structural changes accompanied the name change of the International Accounting Standards Committee (IASC) to the International Accounting Standards Board (IASB).   At the same time, there is serious momentum in IOSCO (major stock exchanges) to replace national standards (e.g., those of the U.S. FASB) that are not harmonized with harmonized IASB standards.  Much depends upon the ability of the IASB to cope with the complexities of global finance and accounting and the willingness of national governments, particularly the U.S., to allow IASB standards to take the place of national standards.  This will not transpire for many years until many differences are worked out, but the momentum is shifting in favor of the IASB.

    Standard setting entails a constant power struggle between corporations seeking more discretion in earnings management and off-balance sheet financing versus investors and standard setters seeking more uniformity in reporting, reduced managerial discretion in reporting, and more extensive booking of debt and extensive disclosures.  Since IASB standards in the past have not been "required," there has never been a true test of whether the IASB can withstand the financial and political power moves by corporations.  Auditing firms are often caught in the middle between their clients and standard setters.  This has often led to hypocrisy and inconsistencies where auditing firms preach virtue but silently side with major clients in the political arena to constrain standard setters.  See 

    Additional Reading

    Paul Pacter's great site at 

    IASB Home Page --- 

    IAS Around the World ---{C5C71BC5-9A76-4D41-92C9-DA31D6B20319}&sd=395693802 

    Europe Moves to International Accounting Standards 
    The European Union has adopted a regulation requiring public companies to prepare their consolidated accounts in accordance with international accounting standards starting January 1, 2005. The U.S. reaction to an international GAAP has been rather ho-hum, but key figures in the U.S. are starting to rally behind the cause. 

    PwC Chief Recommends Adoption of Global Accounting Standards
    PricewaterhouseCoopers' CEO Samuel DiPiazza is becoming a very vocal proponent of disbanding U.S. GAAP in favor of moving towards more global accounting standards. Mr. DiPiazza is recommending the adoption of a global GAAP that moves away from rules-based reporting to principles-based reporting, and has outlined a system to accomplish this. 


    New Spirit of Reform and Ethics Awareness
    Pull your SOX up boss (remember Marlon Brando in Teahouse of the August Moon)
    More than 500 public companies have reported deficiencies with their internal accounting controls under a controversial new federal rule -- a figure sure to feed the continuing debate about the cost and usefulness of recent efforts to strengthen corporate governance.  To backers, the volume of disclosures demonstrates that the new rule, part of the 2002 Sarbanes-Oxley corporate-accountability law, is pushing a lot of U.S. companies into line. But business groups complain that it's costing them a lot of money and effort to turn up deficiencies that in most cases are inconsequential.
    Deborah Solomon, "Accounting Rule Exposes Problems But Draws Complaints About Costs," The Wall Street Journal,  March 2, 2005; Page A1 ---,,SB110971840422767575,00.html?mod=home_whats_news_us 

    The Enron/Andersen scandals have sickened investors, academics, courts, security analysts,  government leaders, and the world in general to a point where the future of capital markets and capitalism itself rests heavily upon restoring confidence in integrity of the information systems that underlie the functioning of free markets. 

    The world is growing weary of constantly reading (monthly) where leading auditing firms have been fined and/or have lost civil suits due to incompetent or fraudulent auditing and consulting.  It appears that in the U.S., auditing firms and the AICPA have survived the current threat of government takeover of auditing, but continued scandals like the one that led to the demise and fragmentation of the Andersen accounting firm will renew this threatened takeover that will put auditing controls in the public rather than private sector.

    In testimony given before the US Senate Committee on Banking, Housing, and Urban Affairs on September 9, 2004, Ernst & Young Chairman and CEO Jim Turley discussed the changes in the accounting profession in the two years since the Sarbanes-Oxley Act of 2002. He emphasized the value of the PCAOB, the reviews and changes we've implemented in our organization, strengthened corporate governance and accountability, and increasing investor confidence. --- 

    The Big Five Firm CEOs Join Hands (in Prayer?)
    Facing up to a raft of negative publicity for the accounting profession in light of Big Five firm Andersen's association with failed energy giant Enron, members of all of the Big Five firms joined hands (in prayer?) on December 4, 2001 and vowed to uphold higher standards in the future. 

    The American Institute of Certified Public Accountants released a statement by James G. Castellano, AICPA Chair, and Barry Melancon, AICPA President and CEO, in response to a letter published by the Big Five firms last week that insures the public they will "maintain the confidence of investors." --- 

    Additional Reading

    Bob Jensen's Threads on Accounting Fraud, Forensic Accounting, Securities Fraud, and White Collar Crime --- 

    Proposed Accounting and Auditing Reforms in the Wake of the Enron Scandal --- 

    Teaching Ethics -- Bill Christie once helped bust Nasdaq price fixers. Now, he's Vanderbilt's B-school dean -- and bringing those lessons to MBAs 


    Expansion of the Accounting Profession into Assurance Services

    "Deloitte & Touche Launches DTect Financial Fraud Investigation Service," SmartPros, September 7, 2004 --- 

    The Financial Advisory Services practice of Deloitte & Touche LLP has launched DTect, a proprietary fraud investigation service designed to help companies identify, track and analyze electronic and financial fraud indicators by sifting through large amounts of electronic data in a fraction of the time expended by using existing conventional methods.

    “We involved forensic technology practitioners and forensic accountants from around the world in the development of the service. Many of these professionals are former law enforcement technologists with significant experience in the use of computers in economic crime investigations,” said Peter McLaughlin, DTect National Product Line Leader.

    DTect is a procedural-driven service created to analyze mountains of historical financial transactional data such as sales, accounts payable, inventories and employee compensation. It is designed to utilize hundreds of analytical test algorithms, resulting in profiles that help identify anomalies that could indicate financial fraud. These test algorithms are executed against client-supplied data, which result in a series of profiles that are scored and ranked according to client-specific risk measurements. The higher ranking scores indicate the most probable occurrences of potential fraud, abuse, or collusion of employees and vendors.

    The DTect service does not rely solely on traditional sampling techniques but enables comprehensive testing of multiple aspects of financial transactions. Anomalies and trends are identified through DTect’s unique scoring methodology, which is used to focus efforts on the highest risk transactions and entities. Other differentiators that set DTect apart from traditional software technology include the incorporation of third-party data sources, analysis of the total population of records rather than only a sampling and the ability to customize test scenarios to conform to specific client needs.

    In developing DTect, Deloitte & Touche forensic professionals analyzed all types of fraud to identify distinguishing attributes. The investigators then created the tests, which can be applied to business processes such as vendor, payroll and expense disbursements, to detect the presence of fraud characteristics. Each test generates a risk score, which is assigned to each vendor, employee or job category, invoice, or transaction that fails a test. High risk scores indicate anomalies in vendors and transactions. Deloitte & Touche investigators then work with their clients to interpret and explain results, to investigate and resolve anomalies, and to identify potential incidents of fraud.

    Continued in the article

    AICPA formed the Special Committee on Assurance Services (SCAS) in 1994.  After a careful analysis of demographic and other trends, this committee concluded the following:

    Your marketplace is changing.  Multibillion-dollar markets for new CPA services are being created.  Investors, creditors, and business managers are swamped with information, yet frustrated about not having the information they need and uncertain about the relevance and reliability of what they use.  CPA firms of all sizes--from small practitioners to very large firms--can help these decision makers by delivering new assurance services.  (AICPA Web site, "Assurance Services,"

    The Elliott Committee (named after its chair, Robert K. Elliott) identified six new service areas considered to have high potential for revenue growth for assurance providers:

    1. Risk Assessment

    2. Business Performance Measurement

    3. Information Systems Reliability

    4. Electronic Commerce

    5. Health Care Performance Measurement

    6. ElderCare

    The work of the Elliott Committee was followed by the appointment of the ongoing Assurance Services Executive Committee, chaired by Ronald Cohen.  This committee is charged with the ongoing development of new assurance services and the provision of guidance to practicing CPAs on implementing the services developed.

    • Information Systems Reliability Assurance 

    • Electronic Commerce Assurance. 

    Business-To-Consumer Assurance

    • CPA/CA WebTrust (Joint Venture of AICPA and CICA)
      • Business Practices and Disclosure--The entity discloses its business and information privacy practices for e-business transactions and executes transactions in accordance with its disclosed practices.

      • Transaction Integrity--The entity maintains effective controls to provide reasonable assurance that customers' transactions using e-business are completed and billed as agreed.

      • Information Protection and Privacy--The entity maintains effective controls to provide reasonable assurance that private customer information obtained as a result of e-business is protected from uses not related to the entity's business.

    • Proprietary E-Business Audits

    • Privacy Audits

    Business-to-Business Assurance

    • Assurances against service disruptions and product shipments

    • CPA/CA SysTrust (Joint Venture of AICPA and CICA)
      • Availability--The system is available during times specified by the entity.

      • Security--Adequate protection is provided against unwanted logical or physical entrance into the system.

      • Integrity--Processes within the system are executed in a complete, accurate, timely and authorized manner.

      • Maintainability--Updates (upgrades) to the system can be performed when needed without disabling the other three principles.

    • SAS 70 Reviews of Service Organizations (extended to B2B Risks)

    SAS 70, Reports on the Processing of Transactions by Service Organizations, was issued to provide assistance in the auditing of entities that obtain either or both of the following services from an external third party entity.

    • Executing transactions and maintaining related accountability

    • Recording transactions and processing data

    • Internal Controls Risk

      • The financial statement assertions that are either directly or indirectly affected by the service organization's internal control policies and procedures.

      • The extent to which the service organization's policies and procedures interact with the user organization's internal control structure.

      • The degree of standardization of the services provided by the third-party to individual clients.  In the case of highly standardized services, the service auditor may be best suited to provide assurance: however, when the third-party offers many customized services, the third-party auditor may be unable to provide sufficient assurance regarding a specific client.

    SAS 70 provides for two reports the service auditor can provide to the user auditor concerning the policies and procedures of the service organization:

    • Reports on policies and procedures placed in operation.

    • Reports on policies and procedures placed in operation and tests of operating effectiveness.

    Other Potential New Services to Facilitate E-Business

    • Value-Added Network (VAN) Service Provider Assurance

    • Evaluation of Electronic Commerce Software Packages

    • Trusted Key and Signature Provider Assurance

    • Criteria Establishment

    • Counseling Services

    The AICPA's Assurance Services Website is at 


    Some Things Do Get Better Under Threatening Litigation Storm Clouds
    In 1950, automobile firms could have made safer and more reliable vehicles.  Instead they cut corners on safety, had very limited warranties, and programmed in obsolescence to encourage drivers to buy new vehicles more often rather than maintain older vehicles.  They either ignored or actively resisted pressures from consumer groups for such safety devices such as seat belts, sturdier seats, etc.

    Billions of dollars of lawsuit settlements have, in retrospect, changed the entire focus of the automobile industry toward passenger safety.  Millions upon millions of dollars lost in court battles really do change priorities.  Although the price of added quality and safety is reflected in prices, we now have safer products and better warranties in most instances.

    The same thing is true in any industry that has lost lawsuits to consumers, patients, employees, and investors.  Powerful lobbying efforts combined with free-wheeling spending in state and federal legislatures have often been successful in fending off restraining legislation, but corporations have been much less successful in fending off lawsuits from injured parties, including investors who lost their savings and creditors who lost the money loaned to industry.

    The Andersen accounting firm exploded into bits and pieces due to the pile up of past and pending civil litigation for incompetence and alleged fraud.  It was not the SEC or the Justice Department that sent Andersen's partners scurrying to remove themselves from Andersen.  Rather, it was the burden of past and pending lawsuits.  Remaining public accounting firms are going to be much more aware that lawsuit after lawsuit can sink the largest ships in the industry if greater care is not taken to prevent such litigations from taking place.

    It's a change in philosophy for an agency that has spent the last couple of years chasing after wrongdoing uncovered by New York Attorney General Eliot Spitzer. Throughout the spate of corporate scandals, the SEC has been conducting investigations after the fact, levying fines on companies long after the abuse has occurred, and failing to spot questionable practices, such as mutual fund trading abuses.   Donaldson (SEC Chairman) wants to change that by taking a cue from Spitzer. Spitzer's strategy was to narrow his focus and concentrate on areas where small investors were being harmed. The SEC will do the same through a newly formed office of Risk Assessment, the Washington Post reported.
    SEC Chairman: Find Solutions Before Problems Explode," AccountingWeb, September 30, 2004 --- 

    The European Commission on Monday rejected a plea from the "Big Four" accounting firms for a monetary limit on the amount that auditors can be sued for. Frits Bolkestein, European commissioner responsible for financial services, said unlimited liability was a "quality driver" because auditors who did their job properly had no exposure to litigation.
    Andrew Parker, The New York Times, March 24, 2003

    SOX is Deemed a Success by Deloitte's CEO 

    "D&T Chief Tells Congress Sarbanes Is Working," SmartPros, July 23, 2004 --- 

    New corporate reform regulations are working as intended, according to James Quigley, chief executive officer of Deloitte & Touche USA.

    In testimony before the House Committee on Financial Services Thursday, Quigley called on stakeholders in the capital markets to continue to work constructively to fully implement the Sarbanes-Oxley Act of 2002 (SOX) to realize its objectives.

    "The signing of the Sarbanes-Oxley Act represented a landmark event for investors," he said. "the act is already having a significant impact and, over time, it should help in fulfilling its intended purpose of restoring investor confidence."

    Citing the results of a Deloitte survey of Fortune 1000 Deloitte clients, Quigley said progress has been made in several key areas, including the focus and commitment of audit committees and corporations to transparent financial reporting. The survey found that the number of audit committee meetings held has increased by more than 50 percent since SOX was signed.

    Quigley said that he has been impressed with the degree to which audit committees are meeting the new expectations that have been placed on them, saying that committee members have responded by increasing their time commitment to their responsibilities.

    On the topic of tax services, he recommended that the authority of the audit committee to make decisions with respect to tax scope of services should be supported, and that further scope of services regulations were not warranted. He noted, however, that structured tax strategies with no business purpose should not be marketed by any service provider.

    Continued in the testimony.

    Additional Reading

    "The Costs of Ordinary Litigation," by David M. Trubek, et al., UCLA Law Review, October 1983 --- 

    Law & Economics Class Notes of Professor William M. Landes, March 29, 2000, University of Chicago --- 




    Lifelong Learning Alternatives in the Age of Distance Education and Training
    Although many startup ventures in colleges and corporations in distance education have failed and the hype has faded somewhat, the fact is that distance education remains a tidal wave that will shake the very foundations of brick and mortar campuses.  Campuses catering to the 18-year old first year students will not fade from the scene, because these students have unique socialization and maturation needs served by residency on a campus.

    The fact of the matter is that thousands upon thousands of distance education courses are available worldwide.  The University of Wisconsin alone has over 5,000 such courses.  The University of Massachusetts system in provided over 700 online summer school courses in 2002.  Army University (comprised of 24 major colleges providing training and education courses to soldiers) had over 12,000 students in its first year and will have over 22,000 by the end of 2002.

    One of the signs of changing times is when venerable Harvard University modified its residency requirement for "mid-career" students.  Harvard now has a significant number on online courses.  Prestigious universities like Stanford, Columbia, Carnegie-Mellon, and Columbia are looking an tens of millions of dollars from online tuition.

    In accounting, as in other disciplines, the knowledge needed has become too complex to lead to chance or to haphazard continuing education systems of the past, especially those that give CPE credit for attendance alone rather than tested comprehension.  Increasingly, accountants will have newer specialties accompanied by certifications that can be obtained from online training and education programs.  Distance education is too powerful and too convenient to hold back in spite of the efforts of some traditional educators and teachers' unions to do so.

    Additional Reading

    Bob Jensen's Review Documents at 

    Bob Jensen's Threads on Cross-Border (Transnational) Training and Education --- 





    Now for the Bad News


    Systemic Accounting Problems That Cannot or Otherwise Will Not Be Solved
    Accounting for Business Firms Versus Accounting for Vegetables

    Take a look at how your favorite greens stack up in the chart below:

    Green (Raw - per 100 g serving) Vitamin A Vitamin C Fiber Folate Calories
    Arugula 2,373 IU 15 mg 1 g 97 mcg 25
    Chicory 4,000 IU 24 mg 4 g 109.5 mg 23
    Collards 3,824 IU 35.3 mg 3 g 166 mcg 30
    Endive 2,050 IU 6.5 mg 3 g 142 mcg 17
    Kale 8,900 IU 120 mg 2 g 29.3 mcg 50
    Butterhead (includes Boston and Bibb) 970 IU 8 mg 1 g 73.3 mcg 13
    Romaine 2,600 IU 24 mg 1 g 135.7 mcg 14
    Iceberg 330 IU 3.9 mg 1 g 56 mcg 12
    Loose leaf (red, green) 1,900 IU 18 mg 1 g 49.8 mcg 18
    Radicchio 27 IU 8 mg 0 g 60 mcg 23
    Spinach 6,715 IU 28.1 mg 2 g 194.4 mcg 22
    Source: U.S. Department of Agriculture, 1999

    Also see
    Examination of Front-of-Package Nutrition Rating Systems and Symbols ---

    Systemic Problem:  All Aggregations Are Arbitrary
    Systemic Problem:  All Aggregations Combine Different Measurements With Varying Accuracies
    Systemic Problem:  All Aggregations Leave Out Important Components
    Systemic Problem:  All Aggregations Ignore Complex & Synergistic Interactions of Value and Risk
    Systemic Problem:  Disaggregating of Value or Cost is Generally Arbitrary

    While looking at the following diet guides, it dawned on me that perhaps accounting reports should be more like food labeling and comparison tables/charts rather than the traditional bottom line reporting.  The problem with accounting is bottom-line reporting of selective and ill-conceived aggregates such as earnings-per-share or debt/equity.  Suppose spinach has an e.p.s. of 4.67 in comparison to 5.62 for Kale.  The aggregations all depend upon how components are measured, how they are weighted (e.g., Vitamin A versus Folate weighting coefficients), and what components are included/excluded (e.g., Vitamin A is included below, but Vitamin B components are ignored).  The same is true of e.p.s. in financial reporting.   The "bottom line" depends in a complex way upon how components are measured and weighted as well as upon what components are included/excluded.  

    In a similar manner, accounting aggregations all depend upon how components are measured, weighted, and included/excluded.  Cash is measured with great accuracy whereas goodwill impairment is highly inaccurate, thereby causing greater error range when cash and goodwill are added together in balance sheets.   Similarly, in the "New Economy" where intangible intellectual capital is soaring in value relative to traditional tangible assets, the intangibles left off the balance sheet may be far more important that the combined value of everything included in the balance sheet.

    An even larger problem is that the value and risk of diet components depend heavily upon complex and synergistic relationships.  For example, research shows that after the body hits its maximum threshold of Vitamin C, it simply throws off the excess.  Kale far surpasses endive in Vitamin C content, but this is irrelevant in a diet overflowing in Vitamin C from other sources such as citrus fruits.  Some persons may be allergic to components that are of greater value to other persons.

    In a similar manner accounting valuations are greatly complicated by synergistic complexities.  A patent in the hands of one company may be all but useless in the hands of another company.  Indeed some companies buy up patents just to squelch newer technology that threatens existing products.  Similarly, financial risk is not a fixed thing.  It is a very dynamic threat that is based upon all sorts of contingencies such as world events and media coverage that can interact heavily with the level of risk at any point in time.

    For similar reasons disaggregating of values/costs is generally arbitrary.  Firstly there is the famous problem of joint production cost allocation arbitrariness noted in the early writings of John Stuart Mill (The Principles of Political Economy) and Alfred Marshall (The Principles of Economics).  Then there is the problem of synergistic complexities noted above.  For example, suppose spinach sells for $5 per bunch.  Any attempt to disaggregate that $5 into additive values of nutrients will be arbitrary, because nutrients in combination may be worth more or less than the sum of disaggregated values of each nutrient.  This gives rise to the systemic problem of consolidation goodwill when two or more companies are combined into one whole.

    "The True Science of Spinach: What the Popeye Mythology Teaches Us about How Error Spreads," by Maria Popova, Brain Pickings, July 2, 2013 ---

    35 Science 'Facts' That Are Totally Wrong ---

    Teaching Case
    "The Gatekeepers: A Case on Allocations and Justifications," by David Hurtt, Bradley E. Lail, Michael A. Robinson, and Martin T. Stuebs, SSRN, August 18, 2014 ---

    This case provides an opportunity for you to make accounting allocation choices, justify those choices, and subsequently consider the ramifications of those choices. Two different scenarios – one in the academic setting and one in the business setting – examine the incentives and reporting issues faced by managers and accountants – the gatekeepers in these reporting environments. For each scenario, you will read the case materials, related tables, and then answer the Questions for Analysis. Each scenario presents you with an allocation task. In the first scenario, you will need to assess group members’ contributions to a project and allocate points across the group. These point allocations contribute to the determination of individual group members’ grades. The second scenario is also an allocation task but in a business setting, specifically the segment reporting environment. Here the task is to allocate common costs across reporting segments. For advanced reading, you will want to consider Accounting Standards Codification (ASC) topic 820 which addresses segment reporting, as this can help guide you in the degree of flexibility, if any, allowed in determining how to allocate costs.

    Bob Jensen's threads on accounting theory ---

    Bob Jensen's threads on case writing and teaching ---

    Bloomberg's 2015 Ranking of the Top MBA Programs ---

    Jensen Comment
    This is nicely presented in a table that lets you compare how rankings differ under the component criteria. For example, the Booth Business School at the University of Chicago comes in at an overall Rank 2. It 's Number 1 in terms of employer ranking and in job placement. However, it came in at Rank 29 in terms of the alumni survey. Stanford is at Rank 1 in terms of alumni but is Rank 21 in terms of job placement.

    The US News rankings of Top MBA programs can be found at
    I think US News relies more on rankings submitted by business school deans. Accordingly we would expect US News to be more influenced by the reputations of faculty, especially research reputations.

    The Bloomberg rankings illustrate what I call a systemic vegetable nourishment problem of rankings on the basis of multiple criteria (scroll up).

    "Best Colleges for Return on Investment (by state)." Bloomberg Business Week, April 2012 ---

    Jensen Comment on these Rankings by Garbage Aggregations
    Two things to note at the beginning: Firstly, this is a slide show of states in alphabetical order. Secondly this ranking is not based on business school education ROI. Some private universities high in the rankings like Bates and Princeton do not even have business education programs.

    In some states the rankings are based on schools having noted engineering programs. For example, the Colorado School of Mines is rated by BBW as having the best ROI in Colorado. Nearly all CSM graduates are engineers such that comparing them with other colleges having no engineering programs is like comparing automobiles to airplanes. The same can be said for claiming that the Florida Institute of Technology has the best ROI among all the colleges and universities in Florida. And the same can be said for the winning Georgia Tech in Georgia.

    It's meaningless to aggregate "returns" for universities that have a great number of disciplines within those universities such as the University of Colorado, the University of Florida, and the University of Georgia. Premed graduates from those huge universities get a lot of return for investment whereas for elementary education graduates the returns from those same universities aren't so great. If those huge universities are compared with specialized universities like the Colorado School of Mines and the Florida Institute of Technology, the aggregated "return" calculations for huge universities are nonsense. This is yet another example of the vegetable nutrition systemic aggregation problem that I illustrated above.

    In some states, not all, the rankings are based on prestige irrespective of cost. For example, I doubt that Princeton would be the best ROI school in New Jersey if Princeton's graduates were cut off by only degrees given to them by Princeton. Instead a majority of Princeton's graduates go on to other graduate schools (including medicine, business, and law) such that the numerator "return"  in the ROI calculation is confounded by non-Princeton variables relative to the denominator (primarily Princeton's undergraduate tuition rate).

    There are some surprising outcomes that I just do not understand. For example, Drake University according to BBW has the highest ROI in Iowa. In contrast, Grinnell has much larger endowment and more prestige in terms of media rankings of private universities. Having grown up in Iowa I considered Drake to be way below Iowa University, Iowa State University (the engineering school), Grinnell, and many other Iowa colleges and universities. Having lived in Maine for ten years I would never choose Bates College as leading in anything in academics relative to the University of Maine and Bowdoin College There are other anomalies. I have a hard time rating Washington and Lee above the University of Virginia on most any scale..

    As far as I'm concerned this is just another set of misleading rankings by the money grubbing media.

    Bob Jensen's threads on controversial rankings of colleges and universities (including distance education programs) are at


    More on Accounting Theory and All Its Problems ---

    Systemic Problem:  Systems Are Too Fragile
    Too many business firms and their subsystems have become fragile in their dependence upon highly aggregated and poorly conceived indices, notably bottom-line net income and total liabilities.  Employee compensation in the form of profit sharing, bonus, stock option, and salary plans are almost perfectly correlated with net income.  Cost of capital and credit availability are directly tied to income and booked debt.  Financial analysts and investment bankers almost totally rely upon a firm's reported earnings and debt coupled with corporate management's own forecasts of earnings and debt.  Enron was at the extreme in terms of total dependence upon top executives' management of  earnings and keeping debt off the balance sheet.  However, many other firms walk on similar egg shells.   Far greater disasters than the collapse of Enron have transpired, most notably the overnight implosion of a firm called Long Term Capital --- 

    Auditing firms have accordingly become paranoid about yelling "Fire" in crowded theatres.  I sympathize greatly with Andersen's dilemma on August 20, 2001 when Sherron Watkins, a high-level employee at Enron, blew the whistle to Andersen's national office and to Enron's CEO.  With extreme competence, she described how Enron's accounting was almost a total hoax.  Whether or not top executives of Andersen knew this before August 20 is beside the point.  The fact that the whistle was blown forced Andersen to scurry to its attorneys in search of advice on what to do.  Andersen's dilemma on August 20 became how to fix the problem without yelling "Fire" among investors, employees, creditors, and regulators.  If Andersen moved quickly to force Enron to restate earnings on August 21, Enron's implosion would have occurred in late August.  I am certain that Andersen bided its time while desperately seeking a way out.

    In the case of Enron, there appears to be no saving solutions that Andersen could have recommended to the Audit Committee and the Board of Directors.  Enron was already in too deep.  The only way to save Enron was to place Enron's creditors, investors, and employees at unsuspecting higher levels of risk in higher-stake gambles that, if successful, would recoup earlier losses.  See 

    Andersen's silence in allowing Enron to further borrow, gamble, and carry on an accounting hoax was risky and placed Andersen at an even higher level of risk for its own future knowing that, after August 20, it was a warned party to further deception.  When do you yell "Fire" in a crowd?

    Most corporations are not as fragile as Enron, although thousands became abandoned hulks following the demise of companies.   Most accounting firms are not as fragile as Andersen following the firm's recent big hits for really bad audits (e.g., Waste Management and Sunbeam) that cost hundreds of millions in litigation losses.  

    Most corporations manage earnings as if reported losses will be ruinous, because in most instances the bottom-line reported outcomes can make or break the team of top executives even if the firm survives bad times.


    From The Wall Street Journal's Accounting Educator Reviews on January 24, 2002

    TITLE: Too Gray for Its Own Good 
    REPORTER: Baruch Lev 
    DATE: Jan 22, 2002 
    PAGE: A20 
    TOPICS: Audit Quality, Accounting, Auditing, Auditing Services

    SUMMARY: Baruch Lev, Professor of Accounting and Finance at New York University Stern School of Business, discusses the institutional factors that have contributed to low quality audits and makes suggestions for improvement.

    1.) What markets have high quality products? List three ways that the auditing profession differs from these markets.

    2.) What are the typical characteristics of markets with high quality products? Are these characteristics present in the auditing profession? Support your answer. How do auditing firms distinguish themselves from competitors?

    3.) List three ways that Lev suggests improving the quality of auditing. List two advantages and two disadvantages of each suggestion.

    4.) List two things that you think will improve audit quality. How will your suggestions improve audit quality?

    Reviewed By: Judy Beckman, University of Rhode Island 
    Reviewed By: Benson Wier, Virginia Commonwealth University 
    Reviewed By: Kimberly Dunn, Florida Atlantic University


    Take the Enron Quiz ---



    Systemic Problem:  More Rules Do Not Necessarily Make 
    Accounting for Performance More Transparent
    By adding such accounting rules as requiring related party disclosures in financial statements, we end up with incomprehensible footnotes such as Footnote 16 of the Enron's Year 2000 annual report.  So many roads to hell are paved with good intentions.  See

    By taking on more fair value reporting of assets and liabilities, we create, in many instances, fictional movements in earnings, assets, and liabilities that wash out over time but create huge and often misleading jumps in amount during interim periods.  Many changes in value are little more than wild guesses that are combined with relatively accurate components of bottom-line numbers.  As a result, bottom-line numbers are more easily managed.  This was demonstrated in the way Enron kept managing its fictional steady rise in earnings and still staying within the GAAP constraints.

    One of the problems is that by adding more and more to be accounted for and requiring more and more fair value adjustments, we have greatly complicated the ever-popular bottom line ratios as earnings-per-share and debt/equity.  Correlations between earnings and cash flows become even more obscured.  We end up with messes like that described by Sherron Watkins at 

    New rules that appear to book losses and to put debt on balance sheets tend to be thwarted by innovative and more complex contracting to hide losses and keep debt off balance sheet.  

    I guess I am still in favor of more disclosure, but the disclosures must be understandable to readers who have had no more than four courses in accounting.  And new ways must be invented to portray risk other than in time tracks of earnings and debt levels.


    Systemic Problem:  Economies of Scale vs. Consulting Red Herrings in Auditing
    Academics and some investors are clamoring for auditing firms to shed off their consulting practices.  I think fears that consultancy destroys auditor independence are red herrings.  In most instances, the distinctions between internal auditing versus external auditing are matters of semantics as long as both types of auditing are intended to protect investors either directly or indirectly.

    The root problem is that serious economies of scale in consulting and auditing destroyed price and service competition.  This is the major reason why there are currently only five international firms that have the capacity to audit large corporations, especially global corporations.  For example, all the Big Five firms have invested countless millions on knowledge bases for auditing and tax.  Any smaller firm trying to duplicate these investments just does not have the money or the talented systems experts to build and daily maintain such computerized networked databases of knowledge.

    Economies of scale have led to an oligopoly of auditing where there is virtually no difference in fees or services between the Big Five international firms.  And if fee differences do arise, chances are that the cheaper audit may be less rigorous to save on expenses.  Clients seriously question the skills and experiences of young auditors sent out on missions that are way over their heads.

    Bob Elliott stressed, in a January 15 nationwide television broadcast on CSPAN, that the approximate $1 million per week that Andersen received in the past year was less than 0.5% of Andersen revenues.  Ostensibly, the Enron audit's quality would not be compromised by such a relatively small proportion of total revenue juxtaposed against billions at stake in a loss of face worldwide.  However, it we take this a little further, it is the case that most local offices are profit centers within each of the Big Five accounting firms.  Losing a client like Enron that brought in over $1 million per week into Houston's Office of Andersen would be devastating to any local office in the world.  The local office may, as a result, bend over backward to keep such a client from switching auditors even though the national office may not be so inclined to take such risks.  In huge firms, the top ramrod of the outfit is not usually aware of what all the straw bosses and cowhands are doing day to day.

    I may be the last professor in the world who terribly regrets the recent decisions of large CPA firms to divorce themselves from their consultancy practices in the wake of the Enron scandal. This may be a disaster for our profession.

    Although my thoughts regarding what I will speak about on this panel are still in the embryo stage, I am considering comments related to the following: 

    • Will the auditing profession become a railroad in the jet age?

    • Does CPA Mean Career Passed Away?   This is an older document that has suddenly become more relevant to the future of our profession. 


    Systemic Problem:  Intangibles Are Intractable
    In this era of technological change, unbooked intangibles such as knowledge capital and reputation are overtaking tangibles in terms of total value and total risk of a firm.  Accounting rules traditionally focus on tangible assets, expenses, revenues, and liabilities.  Intangibles have become so immense in value and most of their value never gets booked in financial statements.  In some cases the value of intangibles may be far greater than the current values of all booked assets.

    To complicate matters more, the value of intangible assets may be much more volatile.  Thousands of dot.coms that were immensely valuable from 1990-1998 became valueless almost overnight in the late 1990s.  The fact of the matter is that we just have not yet invented a good way to account for intangibles other than long and probably incomprehensible disclosures in this regard.  To actually book numbers for intangibles value and risk is still viewed as foolhardy.  Further details are provided in the following two documents:

    Brief Summary of Accounting Theory

    Return on Business Valuation, Business Combinations, 
    Investment (ROI), and Pro Forma Financial Reporting



    Robert K. Elliott
    Challenge and Achievement in Accounting During the Twentieth Century
    , edited by Daniel L. Jensen (The Ohio State University and the University of Florida's Fisher College of Business, 2002, pp. 22-23)


    If I could just respond to one point.  No one says that GAAP isn't important or that it doesn't give important information about value realization.  But in the marketplace there's an increasing gap between value creation, about which we have no good models, and value realization, the later realization of the value that's created.  If we look back to the Industrial Era, the gap between when value was created and when it was realized wasn't so  great, and we could live with it.  But now there is a huge gap, and we never claimed as accountants that the net worth on the balance sheet was supposed to equal the value of the company.  But 10 or 20 years ago, the ratio of market value to book value was about 2 to 1.  Today it's about 6 to 1.  And for some companies over 100 to 1.  What that tells us, I think, is that what's measured in the balance sheet is seriously lagging what's happening in the marketplace.  Yes, we have to be concerned with value realization.  In the end we have to make profits and have cash.   But our GAAP measures are really not diagnostic for investors to figure out which companies are actually creating value.  In the absence of disciplined information about those areas, assured information about those areas, the marketplace runs on rumors.  Those rumors tend to be wrong and that expresses itself in the marketplace in terms of huge volatility.  That volatility then leads to higher cost of capital, as investors demand to be compensated for that volatility.

    Now, I'm not recommending that these assets necessarily be reduced to debits and credits and put on the balance sheet.  I'm not talking about the necessity to incorporate them all into the existing GAAP model.  What I am saying is that there is objective information that could be developed about these things, that this could be done in a way that's similar across enterprises in the same industry, and that assurance could be given about such information which would make the market estimates in value creation better than they are today.  Perfect?  No.  I'm not looking for perfection.  I'm looking for better than today.

    These are enormous and complex systemic problems.   Nothing imaginable will solve all of them. 

    Additional Reading

    Bob Jensen's threads on accounting theory --- 

    Baruch Lev's Home Page --- 

    Measuring the Business Value of Stakeholder Relationships – all about social capital and how high-trust relationships affect the bottom line. Plus a new measurement tool for benchmarking the quality of stakeholder relationships --- 

    Trust, shared values and strong relationships aren't typical financial indicators but perhaps they should be. A joint study by CIM and the Schulich School of Business is examining the link between high trust stakeholder relationships and business value creation. The study is sponsored by the Canadian Institute of Chartered Accountants (CICA).

    The research team is looking at how social capital can be applied to business. The aim of this project is to better understand corporate social capital, measure the quality of relationships, and provide the business community with ways to improve those relationships and in turn improve their bottom line.

    Because stakeholder relationships all have common features, direct comparisons of the quality of relationships can be made across diverse stakeholder groups, companies and industries.

    Social capital is “the stock of active connections among people; the trust, mutual understanding, and shared values and behaviors that bind the members of human networks and communities and make cooperative action possible” (Cohen and Prusak, 2000).

    So far the research suggests that trust, a cooperative spirit and shared understanding between a company and its stakeholders creates greater coherence of action, better knowledge sharing, lower transaction costs, lower turnover rates and organizational stability. In the bigger picture, social capital appears to minimize shareholder risk, promote innovation, enhance reputation and deepen brand loyalty.

    Preliminary results show that high levels of social capital in a relationship can build upon themselves. For example, as a company builds reputation among its peers for fair dealing and reliability in keeping promises, that reputation itself becomes a prized asset useful for sustaining its current alliances and forming future ones.

    The first phase of the research is now complete and the study moves into its second phase involving detailed case studies with six companies that have earned a competitive business advantage through their stakeholder relationships. Click here for a full report


    More on Accounting Theory and All Its Problems ---


    White Collar Crime Pays Big Even If You Get Caught

    The law does not pretend to punish everything that is dishonest. That would seriously interfere with business.
    Clarence Darrow --- Click Here  

    Why white collar crime pays for Chief Financial Officer: 
    Andy Fastow's fine for filing false Enron financial statements:  $30,000,000
    Andy Fastow's stock sales benefiting from the false reports:     $33,675,004
    Andy Fastow's estimated looting of Enron cash:                          $60,000,000
    That averages out to winnings, after his court fines, of $10,612,500 per year for each of the six years he spent in prison.
    You can read what others got at 
    Nice work if you can get it:  Club Fed's not so bad if you earn $29,075 per day plus all the accrued interest over the past 15 years (includes years where he got away with it).

    Club Fed Why the government goes easy on corporate crime.---

    Rotten to the Core ---

    Yet Another Illustration of How Lightly White Collar Crime is Punished
    Navy Commander Sent To Jail For 18 Months Over Service’s Largest Fraud Scheme ---

    How profitable is insider trading?

    Insanely profitable ---

    "Corrupt — and Set for Life In New York, officials convicted of fraud continue to draw taxpayer-funded pensions," by Jillian Kay Melchior, National Review, September 24, 2013 ---

    A corruption conviction doesn’t necessarily stop elected officials from profiting at the taxpayers’ expense. But a new effort led by U.S. Attorney Preet Bharara aims to go after politicians’ public pensions when the courts find them guilty.

    “Our primary mission is to address and to undo injustice, and, in the public-corruption context, a galling injustice that sticks in the craw of every thinking New Yorker is the almost inviolable right of even the most corrupt elected official — even after being convicted by a jury and jailed by a judge — to draw a publicly funded pension until his dying day,” Bharara, attorney for the Southern District of New York, testified on September 17 at the Moreland Commission to Investigate Public Corruption. He added that “convicted politicians should not grow old comfortably cushioned by a pension paid for by the very people they betrayed in office.”

    National Review Online has found that since 2008, at least four convicted politicians in New York have drawn pensions, all in excess of $3,000 per month.

    Continued in article

    How profitable is insider trading?

    Insanely profitable ---

    White collar crime pays even if you know you're going to get caught ---

    "Inside the Mind of the White-Collar Criminal," by Bill Barrett, AccountingWeb, August 19, 2013 ---

    Jensen Comment
    Bill has written a nice summary of what motivates white collar crime, although the article could use a few more footnotes and references to both case studies and empirical research that investigated white collar criminals.

    The really hard part of predicting who will commit white collar crime arises when some of of the major factors leading to such crime are in place (e.g., personal debt, addictions, infidelity, feelings of resentment, etc.) are in place for those who commit white collar crime versus those who do not commit white collar crime on the job. The problem is the phrase "on the job." For some, fear of loss of a job just seems to outweigh all the other temptations to steal. For example, for every employee who wants a bigger house or better horses enough to steal from employers, there are more employees who really want bigger houses and better horses who will not steal for such things. There are some who steal millions for such things, especially a particular woman accountant from Dixon, Illinois who stole $30 million for faster horses and more money.

    Whereas it's pretty easy to understand why an unemployed drug addict in dire need of a fix robs a convenience store, it's far more complicated to understand multimillionaires like CFO like Andy Fastow or hedge fund manager Bernie Madoff want to stack millions more to their piles of loot. In some instances it's more than the money, but I think more often than not its still primarily the money. But what stops a really greedy CFO or hedge fund manager from committing a crime while others become criminals like Andy and Bernie? I don't think we know enough to fine tune our predictions about who will and who won't steal.

    White collar crime is often very complicated. For example, some shoplifters really want the merchandise they steal. But the wife of one of my low-income coaches in school was known in my small Iowa home town to be a shoplifter who really didn't much want the high-end clothing and fancies she stole. I lived in town during high school, and the coach and his wife also happened to be our neighbors. They were good neighbors, although unlike most of our other neighbors in this small town they had no children. Perhaps this shoplifter was a bit more bored without having a job and children to occupy her time. But certainly most spouses who have no jobs and children do not become shoplifters.

    My coach visited each of retail merchants on Main Street and explained beforehand that his wife had a mental problem that nobody seemed to understand. He asked them to report to him rather than the police when they detected her shoplifting. He promised to return the merchandise and pay for any damages and inconvenience. Of course this is not an ideal solution since there could be and probably were instances where her shoplifting was not detected. It also presented a moral hazard in that an unscrupulous merchant might have taken advantage by extorting extra money from the coach as an incentive not to report her crime.

    I suspect that in private my coach pleaded over and over with his wife to stop shoplifting. This couple eventually moved to New Mexico, and I don't know how her "addiction to shoplifting" was eventually resolved.

    What bothers me most about white collar crime is that more often than not it pays even when you know you are most likely going to get caught ---
    It can be very lucrative since sentences are relatively light for such crimes. Bernie Madoff's life sentence is an exceptionally rare, very rare event. But then he stole more than anybody else.

    August 21, 2013 reply from Bill Barrett

    Thanks for the kind words, Bob. The article, like many I write, was more for practitioner mass consumption.

    I like your dialogue on white-collar criminal motivation (as well as your postings on forensic accounting: . Yes, I have found that many W-C Cs have socked away funds to “retire” after they get out; serving their time as model prisoners eligible for early release.

    You may be aware of behavioral consistency theory which postulates that the same criminal will behave in relatively the same way across offenses (i.e. Barry Minkow of ZZZZ Best Carpet Cleaning Services).  

    On another note is Andrew Fastow, whom your cite in closing, and the difference between ‘occupational’ and ‘organizational’ fraud. Fastow turned state’s evidence, enjoying pretrial federal prison (i.e. conjugal visits, but only a 9-hole golf course …). However, he was not a good witness until he was put in solitary confinement for three to six months. It was during this time that he came to truly realized how fraudulent and destructive his, and Enron’s, business activities actually were.

    Oh, well. I claim I will never be out of work.



    What Affects Our Trust in Government?

    Jensen Comment
    One thing that affects are trust in government is lenient prison sentences for enormous white-collar  fraudsters in both the public and private sectors --- i
    Crime pays as long as the crime is massive in rewards.

    Another thing that affects our trust in government is the coziness of the private and public sector such as when government bureaucrats are given fabulous incentives to bail out of government jobs into high paying jobs in the industries they preciously regulated. Generals hope to become defense contractor executives. FDA regulators hope to become executives in the pharmaceutical industry. SEC, FBI, and Department of Justice employees hope to get plush jobs and offices in big accounting and law firms. It did take long before industries eventually owned the government agencies that regulated and investigated those industries. What government agency is truly independent and highly respected?

    Another thing that affects our trust in government is when current or former bureaucrats and legislators are given $250,000 or more for a short speech. That must be some inspirational/informative speech! Yeah right!

    Our legislators are not trusted by the public for good reason. They are trusted even less when they leave office to become high-paid lobbyists.

    How many mayors and governors went to prison when the loot they stashed can't be found? Three recent governors of Illinois, for example, went to prison.  Don't expect them to be clerking at convenience stores when they're released.

    Can you become a mayor of most of the USA's major cities without doing under-the-table business with corrupt municipal labor unions?

    The bigger the government program the bigger the piñata for fraud! Exhibit A is the Department of Defense. Exhibit B is Medicare. Exhibit C is Medicaid. And on and on and on.

    Private sector fraud goes hand-in-hand with public sector fraud.

    Name some of our government servants who became multimillionaires even though they were always on the public payroll? LBJ is not an exception. He's the rule.

    The real world is not a Disney movie victory of of goodness over evil.

    Bob Jensen's Rotten to the Core threads ---

    "CEO in fraud case needs more than seven days prison: court," by Jonathan Stempel, Reuters, February 15, 2013 ---

    A former chief executive who pleaded guilty to wrongdoing in a scheme that ultimately helped drive his company into bankruptcy could have been sent to prison for 10 years. The trial judge thought seven days was fair.

    Not long enough, a federal appeals court said on Friday.

    The 6th U.S. Circuit Court of Appeals said Michael Peppel, the former chief executive of the audio-visual technology company MCSi Inc, must be resentenced for his 2010 guilty plea to charges of conspiracy to commit fraud, false certification of a financial report, and money laundering.

    U.S. District Judge Sandra Beckwith in Cincinnati abused her discretion in sentencing Peppel to an "unreasonably low" week behind bars based almost solely on her belief that the defendant was "a remarkably good man," the appeals court said.

    Prosecutors had charged Peppel in December 2006 over an alleged fraud they said had begun six years earlier, amid financial difficulties at his publicly traded, Dayton, Ohio-based company.

    Peppel was accused of working with his chief financial officer to inflate results through sham transactions with a firm called Mercatum Ltd, and companies such as FedEx Corp (FDX.N) that were not implicated in wrongdoing. Prosecutors said he also sold $6.8 million of MCSi stock during this time.

    By the end of 2003, MSCI was bankrupt, and a reported 1,300 people had lost their jobs.

    Citing the need to punish Peppel and deter others, the government asked Beckwith at his October 2011 sentencing to impose a 97- to 121-month prison term. This was the length recommended, but not required, under federal guidelines.

    But the judge said the five years since the indictment had been "punishing, literally and figuratively" for Peppel, who had begun working for an online pharmacy to support his five children. He also had a brother with multiple sclerosis.

    "Michael's mistakes do not define him," Beckwith said. "I see it to be wasteful for the government to spend taxpayers' money to incarcerate someone that has the ability to create so much for this country and economy."

    She also imposed a $5 million fine and the maximum three years of supervised release.

    Circuit Judge Karen Nelson Moore, however, wrote for a unanimous three-judge appeals court panel that Beckwith was wrong to rely on "unremarkable aspects" of Peppel's life in imposing a "99.9975% reduction" to the recommended prison term.

    "There is nothing to indicate that the support provided by Peppel to his family, friends, business associates, and community is in any way unique or more substantial than any other defendant who faces a custodial sentence," Moore wrote.

    Beckwith was not immediately available for comment.

    Ralph Kohnen, a lawyer for Peppel, on Friday said: "We expect that the judge will exercise the same common sense and fairness in imposing a similar sentence on remand."

    Continued in article

    Bob Jensen's threads on how White Collar Crime Pays Even if You Know You're Going to Get Caught ---


    The following is from Kurt Eichenwald's, Conspiracy of Fools (Broadway Books, 2005, pp. 671-672) --- 

    Prosecutors informed Fastow that they would shelve plans to charge Lea (Fastow's wife)  if he would plead guilty.  Fastow refused and Lea was indicted.  Suddenly, the Fastows faced the prospect that their two young sons would have to be raised by others while they served lengthy prison terms.  The time had come for Fastow to admit the truth.

    "All rise."

    At 2:05 on the afternoon of January 14, 2004, U.S. District Judge Kenneth Hoyt walked past a marble slab on the wall as he made his way to the bench of courtroom 2025 in Houston's Federal District Courthouse.  Scores of spectators attended, seated in rows of benches.  In front of the bar, Leslie Caldwell, the head of the Enron Task Force, sat quietly watching the proceedings as members of her team readied themselves at the prosecutors' table.

    Judge Hoyt looked out into the room.  To his right sat an array of defense lawyers surrounding their client, Andy Fastow, who was there to change his pleas.  Fastow, whose hair had grown markedly grayer in the past year and a half, sat in silence as he waited for the proceedings to begin.

    Minutes later, under the high, regal ceiling of the courtroom, Fastow stepped before the bench, standing alongside his lawyers.

    "I understand that you will be entering a plea of guilty this afternoon," Judge Hoyt asked.

    "Yes, your honor," Fastow replied.

    He began answering questions from the judge, giving his age as forty-two and saying that he had a graduate degree in business.  When he said the last word, he whistled slightly on the s, as he often did when his nerves were frayed.  He was taking medication for anxiety, Fastow said; it left him better equipped to deal with the proceedings.

    Matt Friedrich, the prosecutor handling the hearing, spelled out the deal.  There were two conspiracy counts, involving wire fraud and securities fraud.  Under the deal, he said, Fastow had agreed to cooperate, serve ten years in prison, and surrender $23.8 million worth of assets.  Lea would be allowed to enter a plea and would eventually be sentenced to a year in prison on a misdemeanor tax charge.

    Fastow stayed silent as another prosecutor, John Hemann, described the crimes he was confessing.  In a statement to prosecutors, Fastow acknowledged his roles in the Southampton and Raptor frauds and provided details of the secret Global Galactic agreement that illegally protected his LJM funds against losses in their biggest dealings with Enron.

    Hemann finished the summary, and Hoyt looked at Fastow.  "Are those facts true?"

    "Yes, your honor," Fastow said, his voice even.

    "Did you in fact engage in the conspiratorious conduct as alleged?"

    "Yes, your honor."

    Fastow was asked for his plea.  Twice he said guilty.

    "Based on your pleas," Hoyt said, "the court finds you guilty."

    The hearing soon ended.  Fastow returned to his seat at the defense table.  He reached for a paper cup of water and took a sip.  Sitting in silence, he stared off at nothing, suddenly looking very frail.

    "Gangster Bankers: Too Big to Jail:  How HSBC hooked up with drug traffickers and terrorists. And got away with it," by Matt Taibbi, Rolling Stone, February 14, 2013 ---

    The deal was announced quietly, just before the holidays, almost like the government was hoping people were too busy hanging stockings by the fireplace to notice. Flooring politicians, lawyers and investigators all over the world, the U.S. Justice Department granted a total walk to executives of the British-based bank HSBC for the largest drug-and-terrorism money-laundering case ever. Yes, they issued a fine – $1.9 billion, or about five weeks' profit – but they didn't extract so much as one dollar or one day in jail from any individual, despite a decade of stupefying abuses.

    People may have outrage fatigue about Wall Street, and more stories about billionaire greedheads getting away with more stealing often cease to amaze. But the HSBC case went miles beyond the usual paper-pushing, keypad-punching­ sort-of crime, committed by geeks in ties, normally associated­ with Wall Street. In this case, the bank literally got away with murder – well, aiding and abetting it, anyway.

    Daily Beast: HSBC Report Should Result in Prosecutions, Not Just Fines, Say Critics

    For at least half a decade, the storied British colonial banking power helped to wash hundreds of millions of dollars for drug mobs, including Mexico's Sinaloa drug cartel, suspected in tens of thousands of murders just in the past 10 years – people so totally evil, jokes former New York Attorney General Eliot Spitzer, that "they make the guys on Wall Street look good." The bank also moved money for organizations linked to Al Qaeda and Hezbollah, and for Russian gangsters; helped countries like Iran, the Sudan and North Korea evade sanctions; and, in between helping murderers and terrorists and rogue states, aided countless common tax cheats in hiding their cash.

    "They violated every goddamn law in the book," says Jack Blum, an attorney and former Senate investigator who headed a major bribery investigation against Lockheed in the 1970s that led to the passage of the Foreign Corrupt Practices Act. "They took every imaginable form of illegal and illicit business."

    That nobody from the bank went to jail or paid a dollar in individual fines is nothing new in this era of financial crisis. What is different about this settlement is that the Justice Department, for the first time, admitted why it decided to go soft on this particular kind of criminal. It was worried that anything more than a wrist slap for HSBC might undermine the world economy. "Had the U.S. authorities decided to press criminal charges," said Assistant Attorney General Lanny Breuer at a press conference to announce the settlement, "HSBC would almost certainly have lost its banking license in the U.S., the future of the institution would have been under threat and the entire banking system would have been destabilized."

    It was the dawn of a new era. In the years just after 9/11, even being breathed on by a suspected terrorist could land you in extralegal detention for the rest of your life. But now, when you're Too Big to Jail, you can cop to laundering terrorist cash and violating the Trading With the Enemy Act, and not only will you not be prosecuted for it, but the government will go out of its way to make sure you won't lose your license. Some on the Hill put it to me this way: OK, fine, no jail time, but they can't even pull their charter? Are you kidding?

    But the Justice Department wasn't finished handing out Christmas goodies. A little over a week later, Breuer was back in front of the press, giving a cushy deal to another huge international firm, the Swiss bank UBS, which had just admitted to a key role in perhaps the biggest antitrust/price-fixing case in history, the so-called LIBOR scandal, a massive interest-rate­rigging conspiracy involving hundreds of trillions ("trillions," with a "t") of dollars in financial products. While two minor players did face charges, Breuer and the Justice Department worried aloud about global stability as they explained why no criminal charges were being filed against the parent company.

    "Our goal here," Breuer said, "is not to destroy a major financial institution."

    A reporter at the UBS presser pointed out to Breuer that UBS had already been busted in 2009 in a major tax-evasion case, and asked a sensible question. "This is a bank that has broken the law before," the reporter said. "So why not be tougher?"

    "I don't know what tougher means," answered the assistant attorney general.

    Also known as the Hong Kong and Shanghai Banking Corporation, HSBC has always been associated with drugs. Founded in 1865, HSBC became the major commercial bank in colonial China after the conclusion of the Second Opium War. If you're rusty in your history of Britain's various wars of Imperial Rape, the Second Opium War was the one where Britain and other European powers basically slaughtered lots of Chinese people until they agreed to legalize the dope trade (much like they had done in the First Opium War, which ended in 1842).

    A century and a half later, it appears not much has changed. With its strong on-the-ground presence in many of the various ex-colonial territories in Asia and Africa, and its rich history of cross-cultural moral flexibility, HSBC has a very different international footprint than other Too Big to Fail banks like Wells Fargo or Bank of America. While the American banking behemoths mainly gorged themselves on the toxic residential-mortgage trade that caused the 2008 financial bubble, HSBC took a slightly different path, turning itself into the destination bank for domestic and international scoundrels of every possible persuasion.

    Three-time losers doing life in California prisons for street felonies might be surprised to learn that the no-jail settlement Lanny Breuer worked out for HSBC was already the bank's third strike. In fact, as a mortifying 334-page report issued by the Senate Permanent Subcommittee on Investigations last summer made plain, HSBC ignored a truly awesome quantity of official warnings.

    In April 2003, with 9/11 still fresh in the minds of American regulators, the Federal Reserve sent HSBC's American subsidiary a cease-and-desist­ letter, ordering it to clean up its act and make a better effort to keep criminals and terrorists from opening accounts at its bank. One of the bank's bigger customers, for instance, was Saudi Arabia's Al Rajhi bank, which had been linked by the CIA and other government agencies to terrorism. According to a document cited in a Senate report, one of the bank's founders, Sulaiman bin Abdul Aziz Al Rajhi, was among 20 early financiers of Al Qaeda, a member of what Osama bin Laden himself apparently called the "Golden Chain." In 2003, the CIA wrote a confidential report about the bank, describing Al Rajhi as a "conduit for extremist finance." In the report, details of which leaked to the public by 2007, the agency noted that Sulaiman Al Rajhi consciously worked to help Islamic "charities" hide their true nature, ordering the bank's board to "explore financial instruments that would allow the bank's charitable contributions to avoid official Saudi scrutiny." (The bank has denied any role in financing extremists.)

    Continued in a long article

    Bob Jensen's Rotten to the Core threads---

    Bob Jensen's Fraud Updates ---


    Can You Train Business School Students To Be Ethical?
    The way we’re doing it now doesn’t work. We need a new way

    What is the main temptation of white collar criminals?

    Answer from
    Jane Bryant Quinn once said something to the effect that, when corporate executives and bankers see billions of loose dollars swirling above there heads, it's just too tempting to hold up both hands and pocket a few millions, especially when colleagues around them have their hands in the air.  I tell my students that it's possible to buy an "A" grade in my courses but none of them can possibly afford it.  The point is that, being human, most of us are vulnerable to some temptations in a weak moment.  Fortunately, none of you reading this have oak barrels of highly-aged whiskey in your cellars, the world's most beautiful women/men lined up outside your bedroom door, and billions of loose dollars swirling about like autumn leaves in a tornado.  Most corporate criminals that regret their actions later confess that the temptations went beyond what they could resist.  What amazes me in this era, however, is how they want to steal more and more after they already have $100 million stashed.  Why do they want more than they could possibly need?

    "Can You Train Business School Students To Be Ethical? The way we’re doing it now doesn’t work. We need a new way," by Ray Fisman and Adam Galinsky, Slate, September 4, 2012 ---

    A few years ago, Israeli game theorist Ariel Rubinstein got the idea of examining how the tools of economic science affected the judgment and empathy of his undergraduate students at Tel Aviv University. He made each student the CEO of a struggling hypothetical company, and tasked them with deciding how many employees to lay off. Some students were given an algebraic equation that expressed profits as a function of the number of employees on the payroll. Others were given a table listing the number of employees in one column and corresponding profits in the other. Simply presenting the layoff/profits data in a different format had a surprisingly strong effect on students’ choices—fewer than half of the “table” students chose to fire as many workers as was necessary to maximize profits, whereas three quarters of the “equation” students chose the profit-maximizing level of pink slips. Why? The “equation” group simply “solved” the company’s problem of profit maximization, without thinking about the consequences for the employees they were firing.


    Rubinstein’s classroom experiment serves as one lesson in the pitfalls of the scientific method: It often seems to distract us from considering the full implications of our calculations. The point isn’t that it’s necessarily immoral to fire an employee—Milton Friedman famously claimed that the sole purpose of a company is indeed to maximize profits—but rather that the students who were encouraged to think of the decision to fire someone as an algebra problem didn’t seem to think about the employees at all.


    The experiment is indicative of the challenge faced by business schools, which devote themselves to teaching management as a science, without always acknowledging that every business decision has societal repercussions. A new generation of psychologists is now thinking about how to create ethical leaders in business and in other professions, based on the notion that good people often do bad things unconsciously. It may transform not just education in the professions, but the way we think about encouraging people to do the right thing in general.


    At present, the ethics curriculum at business schools can best be described as an unsuccessful work-in-progress. It’s not that business schools are turning Mother Teresas into Jeffrey Skillings (Harvard Business School, class of ’79), despite some claims to that effect. It’s easy to come up with examples of rogue MBA graduates who have lied, cheated, and stolen their ways to fortunes (recently convicted Raj Rajaratnam is a graduate of the University of Pennsylvania’s Wharton School of Business; his partner in crime, Rajat Gupta, is a Harvard Business School alum). But a huge number of companies are run by business school grads, and for every Gupta and Rajaratnam there are scores of others who run their companies in perfectly legal anonymity. And of course, there are the many ethical missteps by non-MBA business leaders—Bernie Madoff was educated as a lawyer; Enron’s Ken Lay had a Ph.D. in economics.


    In actuality, the picture suggested by the data is that business schools have no impact whatsoever on the likelihood that someone will cook the books or otherwise commit fraud. MBA programs are thus damned by faint praise: “We do not turn our students into criminals,” would hardly make for an effective recruiting slogan.


    If it’s too much to expect MBA programs to turn out Mother Teresas, is there anything that business schools can do to make tomorrow’s business leaders more likely to do the right thing? If so, it’s probably not by trying to teach them right from wrong—moral epiphanies are a scarce commodity by age 25, when most students start enrolling in MBA programs. Yet this is how business schools have taught ethics for most of their histories. They’ve often quarantined ethics into the beginning or end of the MBA education. When Ray began his MBA classes at Harvard Business School in 1994, the ethics course took place before the instruction in the “science of management” in disciplines like statistics, accounting, and marketing. The idea was to provide an ethical foundation that would allow students to integrate the information and lessons from the practical courses with a broader societal perspective. Students in these classes read philosophical treatises, tackle moral dilemmas, and study moral exemplars such as Johnson & Johnson CEO James Burke, who took responsibility for and provided a quick response to the series of deaths from tampered Tylenol pills in the 1980s.
    It’s a mistake to assume that MBA students only seek to maximize profits—there may be eye-rolling at some of the content of ethics curricula, but not at the idea that ethics has a place in business. Yet once the pre-term ethics instruction is out of the way, it is forgotten, replaced by more tangible and easier to grasp matters like balance sheets and factory design.  Students get too distracted by the numbers to think very much about the social reverberations—and in some cases legal consequences—of employing accounting conventions to minimize tax burden or firing workers in the process of reorganizing the factory floor.


    Business schools are starting to recognize that ethics can’t be cordoned off from the rest of a business student’s education. The most promising approach, in our view, doesn’t even try to give students a deeper personal sense of mission or social purpose – it’s likely that no amount of indoctrination could have kept Jeff Skilling from blowing up Enron. Instead, it helps students to appreciate the unconscious ethical lapses that we commit every day without even realizing it and to think about how to minimize them.  If finance and marketing can be taught as a science, then perhaps so too can ethics.


    These ethical failures don’t occur at random – countless experiments in psychology and economics labs and out in the world have documented the circumstances that make us most likely to ignore moral concerns – what social psychologists Max Bazerman and Ann Tenbrusel call our moral blind spots.  These result from numerous biases that exacerbate the sort of distraction from ethical consequences illustrated by the Rubinstein experiment. A classic sequence of studies illustrate how readily these blind spots can occur in something as seemingly straightforward as flipping a fair coin to determine rewards. Imagine that you are in charge of splitting a pair of tasks between yourself and another person. One job is fun and with a potential payoff of $30; the other tedious and without financial reward. Presumably, you’d agree that flipping a coin is a fair way of deciding—most subjects do. However, when sent off to flip the coin in private, about 90 percent of subjects come back claiming that their coin flip came up assigning them to the fun task, rather than the 50 percent that one would expect with a fair coin. Some people end up ignoring the coin; more interestingly, others respond to an unfavorable first flip by seeing it as “just practice” or deciding to make it two out of three. That is, they find a way of temporarily adjusting their sense of fairness to obtain a favorable outcome.


    Jensen Comment
    I've always thought that the most important factors affecting ethics were early home life (past) and behavior others in the work place (current). I'm a believer in relative ethics where bad behavior is affected by need (such as being swamped in debt) and opportunity (weak internal controls at work).  I've never been a believer in the effectiveness of teaching ethics in college, although this is no reason not to teach ethics in college. It's just that the ethics mindset was deeply affected before coming to college (e.g. being street smart in high school) and after coming to college (where pressures and temptations to cheat become realities).

    An example of the follow-the-herd ethics mentality.
    If Coach C of the New Orleans Saints NFL football team offered Player X serious money to intentionally and permanently injure Quarterback Q of an opposing team, Player X might've refused until he witnessed Players W, Y, and Z being paid to do the same thing.  I think this is exactly what happened when several players on the defensive team of the New Orleans Saints intentionally injured quarterbacks for money.

    New Orleans Saints bounty scandal ---


    What is the main temptation of white collar criminals?

    Answer from
    Jane Bryant Quinn once said something to the effect that, when corporate executives and bankers see billions of loose dollars swirling above there heads, it's just too tempting to hold up both hands and pocket a few millions, especially when colleagues around them have their hands in the air.  I tell my students that it's possible to buy an "A" grade in my courses but none of them can possibly afford it.  The point is that, being human, most of us are vulnerable to some temptations in a weak moment.  Fortunately, none of you reading this have oak barrels of highly-aged whiskey in your cellars, the world's most beautiful women/men lined up outside your bedroom door, and billions of loose dollars swirling about like autumn leaves in a tornado.  Most corporate criminals that regret their actions later confess that the temptations went beyond what they could resist.  What amazes me in this era, however, is how they want to steal more and more after they already have $100 million stashed.  Why do they want more than they could possibly need?

    See Bob Jensen's "Rotten to the Core" document at
    The exact quotation from Jane Bryant Quinn at

    Bob Jensen's threads on professionalism and ethics ---

    Bob Jensen's Rotten to the Core threads ---

    September 5, 2012 reply from Paul Williams


    This is the wrong question because business schools across all disciplines contained therein are trapped in the intellectual box of "methodological individualism." In every business discipline we take as a given that the "business" is not a construction of human law and, thus of human foible, but is a construction of nature that can be reduced to the actions of individual persons. Vivian Walsh (Rationality Allocation, and Reproduction) critiques the neoclassical economic premise that agent = person. Thus far we have failed in our reductionist enterprise to reduce the corporation to the actions of other entities -- persons (in spite of principal/agent theorists claims). Ontologically corporations don't exist -- the world is comprised only of individual human beings. But a classic study of the corporation (Diane Rothbard Margolis, The Managers: Corporate Life in America) shows the conflicted nature of people embedded in a corporate environment where the values they must subscribe to in their jobs are at variance with their values as independent persons. The corporate "being" has values of its own. Business school faculty, particularly accountics "scientists," commit the same error as the neoclassical economists, which Walsh describes thusly:

    "...if neo-classical theory is to invest its concept of rational agent with the penumbra of moral seriousness derivable from links to the Scottish moral philosophers and, beyond them, to the concept of rationality which forms part of the conceptual scheme underlying our ordinary language, then it must finally abandon its claim to be a 'value-free` science in the sense of logical empiricism (p. 15)." Business, as an intellectual enterprise conducted within business schools, neglects entirely "ethics" as a serious topic of study and as a problem of institutional design. It is only a problem of unethical persons (which, at sometime or another, includes every human being on earth). If one takes seriously the Kantian proposition that, to be rationally ethical beings, humans must conduct themselves so as to treat always other humans not merely as means, but also always as ends in themselves, then business organization is, by design, unethical. Thus, when the Israeli students had to confront employees "face-to-face" rather than as variables in a profit equation, it was much harder for them to treat those employees as simply disposable means to an end for a being that is merely a legal fiction. One thing we simply do not treat seriously enough as a worthy intellectual activity is the serious scrutiny of the values that lay conveniently hidden beneath the equations we produce. What thoughtful person could possibly subscribe to the notion that the purpose of life is to relentlessly increase shareholder wealth? Increasing shareholder value is a value judgment, pure and simple. And it may not be a particularly good one. Why would we be surprised that some individuals conclude that "stealing" from them (they, like the employees without names in the employment experiment, are ciphers) is not something that one need be wracked with guilt about. If the best we can do is prattle endlessly on about the "tone at the top" (do people who take ethics seriously get to the top?), then the intellectual seriousness which ethics is afforded within business schools is extremely low. Until we start to appreciate that the business narrative is essentially an ethical one, not a technical one, then we will continue to rue the bad apples and ignore how we might built a better barrel.


    September 5, 2012 reply from Bob Jensen

    Hi Paul,

    Do you think the ethics in government is in better shape, especially given the much longer and more widespread history of global government corruption throughout time? I don't think ethics in government is better than ethics in business from a historical perspective or a current perspective where business manipulates government toward its own ends with bribes, campaign contributions, and promises of windfall enormous job benefits for government officials who retire and join industry?

    Government corruption is the name of the game in nearly all nations, beginning with Russia, China, Africa, South America, and down the list.

    Political corruption in the U.S. is relatively low from a global perspective.
    See the attached graph from



    Bob Jensen

    "Federal Tax Crimes, 2013," by John A. Townsend, SSRN, February 5, 2013 ---

    This is the 2013 01 edition of the Federal Tax Crimes book that I started many years ago for use in a Tax Fraud and Money Laundering course at the University of Houston Law School. With some colleagues, we substantially revised that earlier version into a separately targeted book, titled Tax Crimes published by LEXIS-NEXIS. The full title of the LEXIS-NEXIS book is John Townsend, Larry Campagna, Steve Johnson and Scott Schumacher, Tax Crimes (LEXIS-NEXIS Graduate Tax Series 2008).

    This pdf text offered here is a self-published version of my original text that I have kept up since publication of the LEXIS-NEXIS book. The LEXIS-NEXIS book is more suitable for students in a classroom setting and is targeted specifically for graduate tax students. This pdf book I make available here is not suitable for students in a class setting, but is more suitable for lawyers in practice, covering far more topics and with far more detail and footnotes that may be helpful to the busy practitioner. It cannot be used fruitfully for the target audience of the LEXIS-NEXIS book.

    Bob Jensen's Fraud Updates ---


    "RESTORING CRIMINAL LIABILITY FOR FINANCIAL FRAUD," by Anthony H. Catanach and J. Edward Ketz, Grumpy Old Accountants, October 1, 2012 --- 

    The 2008 financial crisis was brought about by bank managers who finagled various transactions, primarily in the mortgage markets or the market for their securitizations, and obfuscated with accounting cover-ups and opaque disclosures.  Our governments have prosecuted very few of the criminals and have meted out fines at a fraction of the amounts that managers fraudulently.  Furthermore, as Jonathan Weil recently pointed out in his article titled “When Will the SEC Finally Go After Auditors?”, our governments have not brought a single action against an auditor for their involvement in the financial crisis.  What has happened to our institutions?  Is justice dead in America?  Does the current administration care, or is it just incompetent?

    An interesting paper came our way recently that addresses these topics.  “Restoring Criminal Liability for Financial Fraud in the United States: A Moral and Legal Imperative” written by Catharyn Baird, CEO of EthicsGame; Don Mayer, University of Denver; and Anita Cava, University of Miami.  They presented the paper at the 2012 Academy of Legal Studies in Business conference and won the “Virginia Maurer Best Ethics Paper” award.  One may obtain a copy of the paper by emailing Kathi Quinn at

    “Too big to fail” has become a mantra for our times, but frankly the phrase does not capture the essence of this story.  Matt Taibbi has referred to the era as “too crooked to fail,” and this seems more apropos.  Even better in our minds is the slogan “too in bed with government to fail.”  That, at least, provides an explanation for the impotence of our so-called watchdogs.  As Baird, Mayer, and Cava suggest, “Government may have gradually become the chief enabler of ‘too big to fail’ as well as ‘too big to jail.’”

    This injustice has to end.  “Some high-level criminal prosecutions for fraud are essential to restore balance in the financial system, a balance that would come from a healthy fear of individual indictment rather than fines paid by the firm [i.e., shareholders].”

    The authors of this paper explore the deficiency of various assumptions and theories, such as that of self-interest.  They point to Alan Greenspan’s confession that he relied on the self-interests of corporations to protect themselves and their shareholders.  We disagree with this point.  The real errors by Greenspan are his reification of the firm, thinking it can maximize utility, and that maximization of shareholder wealth is an application of the self-interest principle.  The truth is that CEOs and CFOs are maximizing their own utility and they care about shareholder wealth only to the extent that it coincides with their interests.  Greenspan should have known that managers do not maximize the wealth of shareholders.

    We do however appreciate the authors’ discussion about ethical “blind spots,” applying a concept of bounded ethicality.  Business decision-making often must be quick, preventing a deeper analysis of ethical issues.  Individuals often put their ethical principles aside, complying with superiors or trying to win promotions or bonuses based on successful business transactions.  And individuals seldom pay attention to the conflicts of interest that frequently intersect their lives.  The authors illustrate these blind spots in their analysis of the crimes at Ameriquest, Countrywide, Lehman Brothers, Goldman Sachs, and Wells Fargo.

    Sam Antar, former CFO at Crazy Eddie, would add the blind spots of auditors.  He says that many young accountants tell him about reprimands received from their superiors for actually “auditing”—even when they are just reading questions from a firm checklist.  They are not allowed to demonstrate any skepticism of their “client.”

    Baird, Mayer, and Cava mention that too much faith has been put into self-regulation.  They point to reliance on the efficient market hypothesis instead of government oversight, the repeal of the Glass-Steagall Act, and the inertia that impedes the regulation of derivatives.  We would add that in our experience self-regulation always drifts into no regulation.  We need look no further than the accounting and auditing profession for a current example.

    The best part of the paper is the analysis of “why current laws [and regulations] are either inadequate or under-enforced.”  Baird, Mayer, and Cava posit nine possible reasons for this state of affairs:

    • “Some deception is accepted as part of marketplace behavior.  Caveat emptor is still a practical ‘default’ position.…the duty to favor the firm becomes almost automatic.”
    • “Juries are mystified by the complexities of financial transactions.”
    • The hurdle of the reasonable doubt standard is too high as “jurors are generally likely to find ‘reasonable doubt’” which masquerades for their ignorance.
    • “Financial wrong-doing at the highest levels often has the protection of corporate attorneys representing the alleged wrong-doers.”  Ironically, these fees are paid by the shareholders who have been injured by the fraud.
    • “The FBI’s resources are limited, and the Department of Justice can only prosecute the files that the FBI prepares; in addition, agents are promoted within the ranks based on successful convictions…”  The number of employees at the FBI and the SEC is simply too small to confront these demons.
    • “There is the appearance that major civil lawsuits and government-sponsored settlements create sufficient accountability, but individuals are not held accountable as criminal laws would, and the firms themselves often pay just a portion of the monies they ‘earned’ as a result of deceptive practices.”
    • “Neither political party has the nerve to alienate the major banks as potential funders of their political campaigns.”
    • “Financial fraud detection requires a whole different type of training.  Creating these types of specialized agents takes significant time and money.”
    • “It is possible that new criminal statutes need to be crafted that will meet the due process and vagueness concerns of” recent court cases.

    Continued in article

    Another CBS Sixty Minutes Blockbuster (December 4, 2011)
    "Prosecuting Wall Street"
    Free download for a short while;stories
    Note that this episode features my hero Frank Partnoy

    Sarbanes–Oxley Act (Sarbox, SOX) ---

     Key provisions of Sarbox with respect to the Sixty Minutes revelations:

    The act also covers issues such as auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure.

    Sarbanes–Oxley Section 404: Assessment of internal control ---

    Both the corporate CEO and the external auditing firm are to explicitly sign off on the following and are subject (turns out to be a ha, ha joke)  to huge fines and jail time for egregious failure to do so:

    • Assess both the design and operating effectiveness of selected internal controls related to significant accounts and relevant assertions, in the context of material misstatement risks;
    • Understand the flow of transactions, including IT aspects, in sufficient detail to identify points at which a misstatement could arise;
    • Evaluate company-level (entity-level) controls, which correspond to the components of the COSO framework;
    • Perform a fraud risk assessment;
    • Evaluate controls designed to prevent or detect fraud, including management override of controls;
    • Evaluate controls over the period-end financial reporting process;
    • Scale the assessment based on the size and complexity of the company;
    • Rely on management's work based on factors such as competency, objectivity, and risk;
    • Conclude on the adequacy of internal control over financial reporting.

    Most importantly as far as the CPA auditing firms are concerned is that Sarbox gave those firms both a responsibility to verify that internal controls were effective and the authority to charge more (possibly twice as much) for each audit. Whereas in the 1990s auditing was becoming less and less profitable, Sarbox made the auditing industry quite prosperous after 2002.

    There's a great gap between the theory of Sarbox and its enforcement

    In theory, the U.S. Justice Department (including the FBI) is to enforce the provisions of Section 404 and subject top corporate executives and audit firm partners to huge fines (personal fines beyond corporate fines) and jail time for signing off on Section 404 provisions that they know to be false. But to date, there has not been one indictment in enormous frauds where the Justice Department knows that executives signed off on Section 404 with intentional lies.

    In theory the SEC is to also enforce Section 404, but the SEC in Frank Partnoy's words is toothless. The SEC cannot send anybody to jail. And the SEC has established what seems to be a policy of fining white collar criminals less than 20% of the haul, thereby making white collar crime profitable even if you get caught. Thus, white collar criminals willingly pay their SEC fines and ride off into the sunset with a life of luxury awaiting.

    And thus we come to the December 4 Sixty Minutes module that features two of the most egregious failures to enforce Section 404:
    The astonishing case of CitiBank
    The astonishing case of Countrywide (now part of Bank of America)

    The Astonishing Case of CitiBank
    What makes the Sixty Minutes show most interesting are the whistle blowing  revelations by a former Citi Vice President in Charge of Fraud Investigations

    • What has to make the CitiBank revelations the most embarrassing revelations on the Sixty Minutes blockbuster emphasis that top CItiBank executives were not only informed by a Vice President in Charge of Fraud Investigation of huge internal control inadequacies, the outside U.S. government top accountant, the U.S. Comptroller General, sent an official letter to CitiBank executives notifying them of their Section 404 internal control failures.
    • Eight days after receiving the official warning from the government, the CEO of CitiBank flipped his middle finger at the U.S. Comptroller General and signed off on Section 404 provisions that he'd also been informed by his Vice President of Fraud and his Internal Auditing Department were being violated.
    • What the Sixty Minutes show failed to mention is that the external auditing firm of KPMG also flipped a bird at the U.S. Comptroller General and signed off on the adequacy of its client's internal controls.
    • A few months thereafter CitiBank begged for and got hundreds of billions in bailout money from the U.S. Government to say afloat.
    • The implication is that CitiBank and the other Wall Street corporations are just to0 big to prosecute by the Justice Department. The Justice Department official interviewed on the Sixty Minutes show sounded like hollow brass wimpy taking hands off orders from higher authorities in the Justice Department.
    • The SEC worked out a settlement with CitiBank, but the fine is such a joke that the judge in the case has to date refused to accept the settlement. This is so typical of SEC hand slapping settlements --- and the hand slaps are with a feather.

    The astonishing case of Countrywide (now part of Bank of America)

    • Countrywide Financial before 2007 was the largest issuer of mortgages on Main Streets throughout the nation and by estimates of one of its own whistle blowing executives in charge of internal fraud investigations over 60% of those mortgages were fraudulent.
    • After Bank of America purchased the bankrupt Countrywide, BofA top executives tried to buy off the Countrywide executive in charge of fraud investigations to keep him from testifying. When he refused BofA fired him.
    • Whereas the Justice Department has not even attempted to indict Countrywide executives and the Countrywide auditing firm of Grant Thornton  (later replaced by KPMG) to bring indictments for Section 404 violations, the FTC did work out an absurdly low settlement of $108 million for 450,000 borrowers paying "excessive fees" and the attorneys for those borrowers ---
      This had nothing to do with the massive mortgage frauds committed by Countrywide.
    • Former Countrywide CEO Angelo Mozilo settled the SEC’s Largest-Ever Financial Penalty ($22.5 million) Against a Public Company's Senior Executive
      The CBS Sixty Minutes show estimated that this is less than 20% of what he stole and leaves us with the impression that Mozilo deserves jail time but will probably never be charged by the Justice Department.

    I was disappointed in the CBS Sixty Minutes show in that it completely ignored the complicity of the auditing firms to sign off on the Section 404 violations of the big Wall Street banks and other huge banks that failed. Washington Mutual was the largest bank in the world to ever go bankrupt. Its auditor, Deloitte, settled with the SEC for Washington Mutual for $18.5 million. This isn't even a hand slap relative to the billions lost by WaMu's investors and creditors.

     No jail time is expected for any partners of the negligent auditing firms. .KPMG settled for peanuts with Countrywide for $24 million of negligence and New Century for $45 million of negligence costing investors billions.

    Bob Jensen's Rotten to the Core threads ---

    Bob Jensen's threads on how white collar crime pays even if you get caught ---

    "Should Some Bankers Be Prosecuted?" by Jeff Madrick and Frank Partnoy, New York Review of Books, November 10, 2011 ---
    Thank you Robert Walker for the heads up!

    More than three years have passed since the old-line investment bank Lehman Brothers stunned the financial markets by filing for bankruptcy. Several federal government programs have since tried to rescue the financial system: the $700 billion Troubled Asset Relief Program, the Federal Reserve’s aggressive expansion of credit, and President Obama’s additional $800 billion stimulus in 2009. But it is now apparent that these programs were not sufficient to create the conditions for a full economic recovery. Today, the unemployment rate remains above 9 percent, and the annual rate of economic growth has slipped to roughly 1 percent during the last six months. New crises afflict world markets while the American economy may again slide into recession after only a tepid recovery from the worst recession since the Great Depression.

    n our article in the last issue,1 we showed that, contrary to the claims of some analysts, the federally regulated mortgage agencies, Fannie Mae and Freddie Mac, were not central causes of the crisis. Rather, private financial firms on Wall Street and around the country unambiguously and overwhelmingly created the conditions that led to catastrophe. The risk of losses from the loans and mortgages these firms routinely bought and sold, particularly the subprime mortgages sold to low-income borrowers with poor credit, was significantly greater than regulators realized and was often hidden from investors. Wall Street bankers made personal fortunes all the while, in substantial part based on profits from selling the same subprime mortgages in repackaged securities to investors throughout the world.

    Yet thus far, federal agencies have launched few serious lawsuits against the major financial firms that participated in the collapse, and not a single criminal charge has been filed against anyone at a major bank. The federal government has been far more active in rescuing bankers than prosecuting them.

    In September 2011, the Securities and Exchange Commission asserted that overall it had charged seventy-three persons and entities with misconduct that led to or arose from the financial crisis, including misleading investors and concealing risks. But even the SEC’s highest- profile cases have let the defendants off lightly, and did not lead to criminal prosecutions. In 2010, Angelo Mozilo, the head of Countrywide Financial, the nation’s largest subprime mortgage underwriter, settled SEC charges that he misled mortgage buyers by paying a $22.5 million penalty and giving up $45 million of his gains. But Mozilo had made $129 million the year before the crisis began, and nearly another $300 million in the years before that. He did not have to admit to any guilt.

    The biggest SEC settlement thus far, alleging that Goldman Sachs misled investors about a complex mortgage product—telling investors to buy what had been conceived by some as a losing proposition—was for $550 million, a record of which the SEC boasted. But Goldman Sachs earned nearly $8.5 billion in 2010, the year of the settlement. No high-level executives at Goldman were sued or fined, and only one junior banker at Goldman was charged with fraud, in a civil case. A similar suit against JPMorgan resulted in a $153.6 million fine, but no criminal charges.

    Although both the SEC and the Financial Crisis Inquiry Commission, which investigated the financial crisis, have referred their own investigations to the Department of Justice, federal prosecutors have yet to bring a single case based on the private decisions that were at the core of the financial crisis. In fact, the Justice Department recently dropped the one broad criminal investigation it was undertaking against the executives who ran Washington Mutual, one of the nation’s largest and most aggressive mortgage originators. After hundreds of interviews, the US attorney concluded that the evidence “does not meet the exacting standards for criminal charges.” These standards require that evidence of guilt is “beyond a reasonable doubt.”

    This August, at last, a federal regulator launched sweeping lawsuits alleging fraud by major participants in the mortgage crisis. The Federal Housing Finance Agency sued seventeen institutions, including major Wall Street and European banks, over nearly $200 billion of allegedly deceitful sales of mortgage securities to Fannie Mae and Freddie Mac, which it oversees. The banks will argue that Fannie and Freddie were sophisticated investors who could hardly be fooled, and it is unclear at this early stage how successful these suits will be.

    Meanwhile, several state attorneys general are demanding a settlement for abuses by the businesses that administer mortgages and collect and distribute mortgage payments. Negotiations are under way for what may turn out to be moderate settlements, which would enable the defendants to avoid admitting guilt. But others, particularly Eric Schneiderman, the New York State attorney general, are more aggressively pursuing cases against Wall Street, including Goldman Sachs and Morgan Stanley, and they may yet bring criminal charges.

    Successful prosecutions of individuals as well as their firms would surely have a deterrent effect on Wall Street’s deceptive activities; they often carry jail terms as well as financial penalties. Perhaps as important, the failure to bring strong criminal cases also makes it difficult for most Americans to understand how these crises occurred. Are they simply to conclude that Wall Street made well- meaning if very big errors of judgment, as bankers claim, that were rarely if ever illegal or even knowingly deceptive?

    What is stopping prosecution? Apparently not public opinion. A Pew Research Opinion survey back in 2010 found that three quarters of Americans said that government policies helped banks and financial institutions while two thirds said the middle class and poor received little help. In mid-2011, half of those surveyed by Pew said that Wall Street hurts the economy more than it helps it.

    Many argue that the reluctance of prosecutors derives from the power and importance of bankers, who remain significant political contributors and have built substantial lobbying operations. Only 5 percent of congressional bills designed to tighten financial regulations between 2000 and 2006 passed, while 16 percent of those that loosened such regulations were approved, according to a study by the International Monetary Fund.2 The IMF economists found that a major reason was lobbying efforts. In 2009 and early 2010, financial firms spent $1.3 billion to lobby Congress during the passage of the Dodd-Frank Act. The financial reregulation legislation was weakened in such areas as derivatives trading and shareholder rights, and is being further watered down.

    Others claim federal officials fear that punishing the banks too much will undermine the fragile economic recovery. As one former Fannie official, now a private financial consultant, recently told The New York Times, “I am afraid that we risk pushing these guys off of a cliff and we’re going to have to bail out the banks again.”

    The responsibility for reluctance, however, also lies with the prosecutors and the law itself. A central problem is that proving financial fraud is much more difficult than proving most other crimes, and prosecutors are often unwilling to try it. Congress could fix this by amending federal fraud statutes to require, for example, that prosecutors merely prove that bankers should have known rather than actually did know they were deceiving their clients.

    But even if Congress does not, it is not too late for bold federal prosecutors to try to bring a few successful cases. A handful of wins could create new precedents and common law that would set a higher and clearer standard for Wall Street, encourage more ethical practices, deter fraud—and arguably prevent future crises.

    Continued in article

    Watch the video! (a bit slow loading)
     Lynn Turner is Partnoy's co-author of the white paper."Make Markets Be Markets"
     "Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy, Roosevelt Institute, March 2010 ---
     Watch the video!

    The greatest swindle in the history of the world ---

    Bob Jensen's threads on how the banking system is rotten to the core ---

    View from the Left
    "Barclays and the Limits of Financial Reform," by Alexander Cockburn, The Nation, July 30, 2012 ---

    White Collar Crime Pays Big Even If You Get Caught ---

    Bob Jensen's Threads on Accounting Fraud, Forensic Accounting, Securities Fraud, and White Collar Crime --- 

    Corporate Executives Just Do Not Learn From Past Disasters

    "Execs to Cash In Despite Market Woes: Even companies whose investors received a negative return this year expect to fund at least 100% of formula-based annual bonus plans," David McCann,, December 9, 2011 ---

    Are companies in denial when it comes to executives' annual bonuses for 2011? Judge for yourself.

    Among 265 companies that participated in a newly released Towers Watson survey, 42% said their shareholders' total returns were lower this year than in 2010. No surprise there, given the stock markets' flat performance in 2011.

    Yet among those that reported declining shareholder value, a majority (54%) said they expected their bonus plan to be at least 100% funded, based on the plan's funding formula. That wasn't much behind the 58% of all companies that expected full or greater funding (see chart).

    "It boggles the mind. How do you articulate that to your investors?" asks Eric Larre, consulting director and senior executive pay consultant at Towers Watson. Noting that stocks performed excellently in 2010 while corporate earnings stagnated — the opposite of what has happened this year — he adds, "How are you going to say to them, 'We made more money than we did last year, but you didn't'?"

    In particular, companies would have to convincingly explain that annual bonus plans are intended to motivate executives to achieve targets for short-term, internal financial metrics such as EBITDA, operating margin, or earnings per share, and that long-term incentive programs — which generally rest on stock-option or restricted-stock awards, giving executives, like investors, an ownership stake in the company — are more germane to investors.

    But such arguments may hold little sway with the average investor, who "doesn't bifurcate compensation that discretely," says Larre. Rather, investors simply look at the pay packages as displayed in the proxy statement to see how much top executives were paid overall, and at how the stock performed.

    Larre attributes much of the current, seeming generosity to executives to complacence within corporate boards. This year, the first in which public companies were required to give shareholders an advisory ("say on pay") vote on executive-compensation plans, 89% received a thumbs-up. But that came on the heels of 2010, when the S&P 500 gained some 13% and investors were relatively content with their returns. "They may not be as content now," Larre observes. "I think the number of 'no' say-on-pay votes will be larger during the 2012 proxy season."

    Continued in article

    Bob Jensen's threads on corporate governance are at

    Would Foster do it all over again if he knew he was certain to get caught?

    "Former Citigroup Accountant Accused of Embezzling $19.2 Million," by Eric Dash, The New York Times, June 27, 2011 ---

    Gary Foster toiled away as a midlevel accountant in Citigroup’s Long Island City back office, collecting around a $100,000 paycheck last year.

    But federal prosecutors claim Mr. Foster gave himself a bonus fit for a star investment banker by embezzling more than $19.2 million from Citi before its auditors picked up on the scheme.

    Mr. Foster, a 35-year-old former assistant vice president in Citi’s internal treasury finance department, was arrested by Federal Bureau of Investigation agents at Kennedy Airport Sunday morning after returning from a trip to Europe and Asia.

    On Monday afternoon, he pleaded not guilty to charges of bank fraud at a hearing in Federal District Court in Brooklyn and was expected to be set free on $800,000 bond.

    Mr. Foster, who is divorced and has two children, had been enjoying the high life. He owned six properties, including an apartment in Midtown Manhattan; two luxury apartments in Jersey City; a $1.35 million house in Tenafly, N.J.; and a $3 million home in Englewood Cliffs, N.J., that had a $500,000 entertainment system and bathroom mirrors that turned to video screens when touched, according to a law enforcement official.

    He also owned a Maserati GranTurismo and BMW 550xi. A Ferrari was on order, said the official, who was not authorized to speak about the investigation.

    Mr. Foster’s lawyer, Isabelle A. Kirshner, said that she had spoken only briefly with her client and had just started to review the allegations.

    “We will investigate the matter thoroughly,” she said. She would not comment on her client’s personal assets.

    The fraud charges are the latest effort by the Justice Department to crack down on white-collar crime at a time when the agency is under increasing pressure to hold Wall Street bankers accountable. This case is against a relatively junior Citigroup executive, and appears to have little to do with the financial crisis.

    Still, it is yet another embarrassment for a bank that once made its entire work force take an ethics pledge and uses “responsible finance” as a corporate slogan.

    It also raises new questions about Citi’s internal controls, nearly two years after regulators forced it to strengthen its risk management and compliance practices upon losing tens of billions of dollars during the financial crisis.

    Earlier this month, the bank came under fire from lawmakers after taking more than a month to disclose that hackers stole data from more 360,000 Citi credit card accounts.

    In this case, it took nearly a year after the claimed embezzlement began before Citigroup’s internal auditors uncovered that millions of dollars were missing.

    According to the complaint, Mr. Foster transferred the money from various Citigroup corporate accounts to his own bank account at JPMorgan Chase late last year. From July to December 2010, he moved about $900,000 from Citigroup’s interest expense account and about $14.4 million from Citigroup’s debt adjustment account to the bank’s main cash account. Then, on eight separate occasions, he wired the money to a personal account at Chase.

    To conceal some of the transactions, the complaint contended that Mr. Foster used a false contract or deal number to be placed in the reference line of the wire transfer. Mr. Foster voluntarily quit Citigroup in January, according to a person briefed on his employment. His reasons for leaving are not known.

    “The defendant allegedly used his knowledge of bank operations to commit the ultimate inside job,” said Loretta E. Lynch, the United States attorney for the Eastern District of New York in Brooklyn.

    Citigroup detected the fraud a couple of weeks ago during an internal audit of the treasury department, where Mr. Foster worked, according to the complaint and a person briefed on the situation. The bank said it immediately contacted law enforcement officers after discovering the suspicious transactions and has put in additional safeguards and internal controls.

    “We are outraged by the actions of this former employee,” said Shannon Bell, a Citigroup spokeswoman. “In light of the ongoing investigation, we cannot comment any further at this time.”

    Mr. Foster joined Citigroup in 1999, shortly after graduating from Rutgers University with an accounting degree, according to his profile on LinkedIn. He rose to become an assistant vice president, supervising the derivatives unit in the bank’s treasury finance department.

    Since leaving Citigroup, he has billed himself as a part-time hedge fund consultant, according to his profile. On Facebook, he counts “traveling the world” as a favorite activity.

    Continued in article

    Would Foster do it all over again if he knew he was certain to get caught.

    Possibly since white collar crime generally pays even if you know you're going to be caught since prison terms are generally short-term for non-violent white collar crime and the loot can generally be hidden with friends or in off-shore banks.

    But Foster made the mistake of investing most of the loot in such things as U.S. real estate instead of hoarding it offshore. This was dumb!

    See How White Collar Crime Pays Even If You Get Caught ---

    "Ernst & Young — Cuomo Initiates Settlement Talks With Filing," by Walter Pavlo, Forbes, December 24, 2010 ---
    Thanks to David Albrecht for the heads up.

    Andrew Cuomo, New York’s attorney general, filed a civil complaint again Ernst & Young claiming that the accounting firm helped Lehman Brothers mislead investors by using transactions called Repo 105s (aka Cooking The Books).  Anyone who thinks that E&Y and the state of New York are going to make it to a courtroom to settle this in front of a jury has got to be kidding.  Last time I checked, there were four major accounting firms (The Big 4) and there have been numerous calls that a fifth is needed to take the place of the ill-fated Arthur Andersen.  A guilty verdict for E&Y would mean we would have “The Big 3” (look how well that number worked out for the automotive industry).  A settlement is imminent.

    We have all seen this type of theater play out before.  A prosecutor calls out a company for some “massive wrongdoing” then settles within a year for a new record dollar figure (Goldman Sachs, Bank of America, AIG, etc.).  This filing by Cuomo simply gets the negotiations started with E&Y.  But are these types of settlements effective?

    Corporate Counsel’s Sue Reisinger did an in-depth piece as to whether these large settlements work in deterring future bad behavior.  Her conclusion…THEY DON’T.  A look at BP alone provides plenty of evidence of this.  Back in 2005, a BP facility was cited for over 300 safety violations at a plant that had an explosion killing 15 and injuring 270.  To correct this bad behavior, BP got a $21 million fine as a deterrent.  This past April that same BP facility released thousands of pounds of cancer-causing chemicals into the air for 40 days…another fine.  Then the BP oil spill in the Gulf of Mexico, killing 11 and impacting lives all along America’s Gulf Coast.  So how do you punish the company to correct the behavior?  My son was even perplexed when we bought gas at the local BP station, “should we purchase gas elsewhere to protest the oil spill or purchase it here to help pay for the cleanup?”  I didn’t have an answer, but I do know this, put someone in jail that was responsible and these questions go away.

    So what should be done?  Start locking people up and here’s why:

    1)    We need people as examples, not companies.  Shareholders are shouldering most of the financial penalty, not the individuals responsible.

    2)    Prison is effective punishment.  While I will argue that prison sentences for some are too long, the experience does get your mind right.  White-Collar recidivism is negligible for a reason….the punishment works.

    3)    Hold People Accountable.  I would rather see the CEO of a company go to jail saying he was sorry, than see one more commercial about how sorry the company is about the wrong they did (a la BP).

    4)    Arresting one person will lead you to the real person responsible.  Once someone is arrested they will start talking, and so on, and so on.

    The corporate veil has a place in business but it should not protect those that are guilty of crimes…and it seems to me that more than a few bad guys have gotten away.  Civil litigation has become too easy for both the prosecutors and the defense, so let’s up the game and put some butts on the line.  I’m speaking from experience, prison hurts, is a great deterrent and will go a long way to clean things up in corporate wrongdoing.

    Bob Jensen's threads on white collar crime are at

    Bob Jensen's threads on the Lehman/Ernst Repo 105 scandal are at

    Why white collar crime pays for Chief Enron Accountant: 
    Rick Causey's fine for filing false Enron financial statements:    $1,250,000
    Rick Causey's stock sales benefiting from the false reports:     $13,386,896
    That averages out to winnings of $2,427,379 per year for each of the five years he's expected to be in prison
    You can read what others got at 
    Nice work if you can get it:  Club Fed's not so bad if you earn $6,650 per day plus all the accrued interest over the past 15 years.

    "Ex-Enron Accountant Pleads Guilty to Fraud," Kristen Hays, Yahoo News, December 28, 2005 ---

    A former top accountant at Enron Corp. sealed his plea deal with prosecutors Wednesday, becoming a key potential witness in the upcoming fraud trial of former CEOs Kenneth Lay and Jeffrey Skilling.

    Lay and Skilling were granted two extra weeks to adjust to the setback before their much anticipated trial, the last and biggest of a string of corporate scandal cases, starts at the end of January.

    The accountant, Richard Causey, pleaded guilty to securities fraud Wednesday in return for a seven-year prison term — which could be shortened to five years if prosecutors are satisfied with his cooperation in the trial. He also must forfeit $1.25 million to the government, according to the plea deal.

    Causey's arrangement included a five-page statement of fact in which he admitted that he and other senior Enron managers made various false public filings and statements.

    "Did you intend in these false public filings and false public statements, intend to deceive the investing public?" U.S. District Judge Sim Lake asked.

    "Yes, your honor," replied Causey, who said little during the short hearing, appearing calm, whispering to his attorneys and answering questions politely.

    Continued in article

    Jensen Comment
    I forgot to mention the millions that Fastow and Causey will probably make on the lecture circuit after they are released from prison.  Scott alludes to this below:

    January 3, 2005 reply from Scott Bonacker [aecm@BONACKER.US]

    Was someone asking about ZZZZ Best?

    "Morze created 10,000+ phony documents, and no one caught it. He teaches his course Fraud: Taught by the Perpetrator many times each year for the Federal Reserve, bar associations, Institute of Internal Auditors, CPA and law firms.

    Public speaking does seem to benefit the speakers. Guys in Gary's group are dealing better than other white-collar criminals, says Mark Morze, one of Mr. Zeune's speakers, who served more than four years in jail for his role in ZZZZ Best Co., the carpet-cleaning enterprise that bilked banks and investors for some $100 million back in the 1980s. Guys who are in denial pay the price forever, Mr. Morze says. Source: The Wall Street Journal, May 25, 1999"


    Scott Bonacker, CPA
    Springfield, Missouri

    Jensen Comment
    The message below is from another convicted felon trying to make a business on selling ethics on the lecture circuit.  This is what probably happens to smaller crooks who, unlike Fastow and Kowalski, do not have enough of the loot stashed away to avoid having to make a living after prison.  Every now and then he needs publicity to re-energize his lecturing.

    Walter Pavlo Jr., a former senior finance manager at MCI, who served more than a year and a half in prison for money laundering, wire fraud and obstruction of justice, says that he started out by manipulating accounting at the telecom company with management's tacit approval back in 1995. Then he developed his own scheme to bilk customers out of roughly $5 million. Today, Mr. Pavlo, 40, presents himself as a cautionary tale to corporate audiences, as he waits for an employer willing to accept his past and hire him as a consultant. "After a while, I want to stop being an example of what not to do," says Mr. Pavlo.
    Kris Maher, “'A Ticking Bomb':  Don't Let Workplace Wrongdoing Destroy Your Career,” The Wall Street Journal Classroom Edition, November 2003 ---  

     From: Walt Pavlo []
    Sent: Tuesday, January 10, 2006 2:38 PM
    To: Jensen, Robert
    Subject: Walt Pavlo - A New Year, A New Website and A New E-mail


     Happy New Year.

     This past year has been most rewarding for me as I expanded my reach to audiences all across the country.  I have been most fortunate to work with some of the top companies in the country as well as lecture at some of the top business schools.  In addition, the coverage that I received for my work in USA Today (November 16, 2005) was a reflection of the level of trust that many have placed in me by allowing me to address their employees and students.  I am truly grateful.

     In an effort to continue my outreach, I have launched my new website and have established Etika, LLC as a vehicle to continue to get my message out about the importance of ethical behavior in the work place.  I feel that we are making a significant contribution to business education and I have always felt that my lectures only work best when I am part of a solution and not “the” solution.  I understand and embrace that my contribution is just a part of a larger movement to make our workplaces more ethical and our workforce more aware of their responsibility to act ethically at all times.

     Please take note of my new website and e-mail address and feel free to contact me with any questions.

    All the best in 2006.
    Walt Pavlo

    Etika LLC
    2780 East Fowler Avenue
    Suite 411
    Tampa, FL 33612

    Tel: 201 362 1208

    Email :


    "The Difficulty of Proving Financial Crimes," by Peter J. Henning, DealBook, December 13, 2010 ---

    The prosecution revolved around the recognition of revenue from Network Associates’ sales of computer security products to a distributor through what is called “sell-in” accounting rather than the “sell-through” method. Leaving aside the accounting minutiae, prosecutors asserted that Mr. Goyal chose “sell-in” accounting as a means to overstate revenue from the sales and did not disclose complete information to the company’s auditors about agreements with the distributor that could affect the amount of revenue generated from the transactions.

    The line between aggressive accounting and fraud is a thin one, involving the application of unclear rules that require judgment calls that may turn out to be incorrect in hindsight. While Mr. Goyal was responsible as the chief financial officer for adopting an accounting method that likely enhanced Network Associates’ revenue, the problem with the securities fraud theory was that prosecutors did not introduce evidence that the “sell-in” method was improper under Generally Accepted Accounting Principles. And even if it was, the court pointed out lack of evidence that that this accounting method had a “material” impact on Network Associates’ revenue, which must be shown to prove fraud.

    A more significant problem for prosecutors was the absence of concrete proof that Mr. Goyal intended to defraud or that he sought to mislead the auditors. The Court of Appeals for the Ninth Circuit found that the “government’s failure to offer any evidence supporting even an inference of willful and knowing deception undermines its case.”

    The court rejected the proposition that an executive’s knowledge of accounting and desire to meet corporate revenue targets can be sufficient to establish the intent to commit a crime. The court stated, “If simply understanding accounting rules or optimizing a company’s performance were enough to establish scienter, then any action by a company’s chief financial officer that a juror could conclude in hindsight was false or misleading could subject him to fraud liability without regard to intent to deceive. That cannot be.”

    The court further explained that an executive’s compensation tied to the company’s performance does not prove fraud, stating that such “a general financial incentive merely reinforces Goyal’s preexisting duty to maximize NAI’s performance, and his seeking to meet expectations cannot be inherently probative of fraud.”

    Don’t be surprised to see the court’s statements about the limitations on corporate expertise and financial incentives as proof of intent quoted with regularity by defense lawyers for corporate executives being investigated for their conduct related to the financial meltdown. The opinion makes the point that just being at the scene of financial problems alone is not enough to show criminal intent.

    If the Justice Department decides to try to hold senior corporate executives responsible for suspected financial chicanery or misleading statements that contributed to the financial meltdown, the charges are likely to be similar to those brought against Mr. Goyal, requiring proof of intent to defraud and to mislead investors, auditors, or the S.E.C.

    The intent element of the crime is usually a matter of piecing together different tidbits of evidence, such as e-mails, internal memorandums, public statements and the recollection of participants who attended meetings. Connecting all those dots is not an easy task, as prosecutors learned in the case against two former Bear Stearns hedge fund managers when e-mails proved to be at best equivocal evidence of their intent to mislead investors, resulting in an acquittal on all counts.

    The collapse of Lehman Brothers raises issues about whether prosecutors could show criminal conduct by its executives. The bankruptcy examiner’s report highlighted the firm’s use of the so-called “Repo 105” transactions to make its balance sheet look healthier than it was each quarter, which could be the basis for criminal charges. But the appeals court opinion highlights how great the challenge would be to establish a Lehman executive’s knowledge of improper accounting or the falsity of statements because just arguing that a chief executive or chief financial officer had to be aware of the impact of the transactions would not be enough to prove the case.

    The same problems with proving a criminal case apply to other companies brought down during the financial crisis, like Fannie Mae, Freddie Mac and American International Group. Many of the decisions that led to these companies’ downfall were at least arguably judgment calls made with no intent to defraud, short-sighted as they might have been. Disclosures to regulators and auditors, and public statements to shareholders, are rarely couched in definitive terms, so proving that a statement was in fact false can be difficult, and then showing knowledge of its falsity even more daunting.

    In a concurring opinion in the Goyal case, Chief Judge Alex Kozinski bemoaned the use of the criminal law for this type of conduct, stating that this prosecution was “one of a string of recent cases in which courts have found that federal prosecutors overreached by trying to stretch criminal law beyond its proper bounds.”

    Despite the public’s desire to see some corporate executives sent to jail for their role in the financial meltdown, the courts will hold the government to the requirement of proof beyond a reasonable doubt and not simply allow the cry for retribution to lead to convictions based on high compensation and presiding over a company that sustained significant losses.

    Continued in article

    Bob Jensen's Fraud Updates ---

    "Commissioner slams SEC settlement," SmartPros, July 13, 2011 ---

    One of the SEC's five commissioners has taken the extraordinary step of publicly dissenting from an enforcement action on the grounds that it was too weak.

    Commissioner Luis A. Aguilar said the Securities and Exchange Commission should have charged a former Morgan Stanley trader with fraud in view of what he called "the intentional nature of her conduct."

    The dissent comes weeks after the SEC took flak for negotiating a $153.6 million fine from J.P. Morgan Chase in another enforcement case but taking no action against any of the firm's employees or executives.

    Under a settlement announced Tuesday, the SEC alleged that former Morgan Stanley trader Jennifer Kim and a colleague who previously settled with the agency had executed at least 32 sham trades to mask the amount of risk they had been incurring and to get around an internal restriction.

    Their trading contributed to millions of dollars of losses at the investment firm, the SEC said.

    Without admitting or denying the SEC's findings, Kim agreed to pay a fine of $25,000.

    Aguilar said the settlement was "inadequate" and "fails to address what is in my view the intentional nature of her conduct."

    "The settlement should have included charging Kim with violations of the antifraud provisions," Aguilar wrote.

    Continued in article

    Jensen Comment
    Maybe Jennifer also did porn. SEC enforcers like porn (daily).---

    Bob Jensen's Fraud Updates ---

    "The 11 Most Shocking Insider Trading Scandals Of The Past 25 Years," Business Insider, November 4, 2010 ---

    1986: Ivan Boesky, Dennis Levine and the fall of Drexel Burnham Lambert

    2001: Martha Stewart and ImClone (I think this is less about what she did than who she was)

    2001: Art Samberg's Illegal Microsoft Trades

    2001: Rene Rivkin Convicted For Insider Trading That Netted Him Only $346

    2005: Joseph Nacchio and Qwest Communications

    2006: Livedoor and Murakami, The Enron Of Japan

    2007: Mitchel Guttenberg, David Tavdy and Erik Franklin

    2007: Randi and Christopher Collotta

    2009: The Galleon Mess

    2010: Some Very Wily Brothers - Charles and Sam Wyly And An Alleged $550 M Scheme

    2010: Insider Trading By French Doc Might Have Helped FrontPoint Avoid Huge Losses

    "Giuliani Asks Congress to Define Insider Trading," by Nathaniel C. Nash, The New York Times, April 23, 1987 --- Click Here Topics/People/G/Giuliani, Rudolph W.

    The United States Attorney in Manhattan, Rudolph W. Giuliani, asked Congress today to pass legislation that would define illegal insider trading, saying it would help him in prosecuting criminal cases.

    Such a definition would ''end the debate'' over what are legal and illegal practices, said Mr. Giuliani, whose office has brought almost a dozen criminal insider trading cases against participants in the current Wall Street scandal.

    Mr. Giuliani's prominence in the investigations led the White House to offer to appoint him chairman of the Securities and Exchange Commission, succeeding John S. R. Shad, who is retiring. But Mr. Giuliani declined the appointment.

    Mr. Giuliani told the Senate Banking Committee in hearings today that his office and the S.E.C. were investigating at least one case that involved criminal collusion by various investors or firms on Wall Street. He declined to provide any specifics about the case, citing his policy of not commenting on continuing investigations. An Investigation Confirmed

    ''Are you finding problems with such issues as collusion, say among arbitrage firms or other investors, in your investigations?'' asked Senator Donald W. Riegle Jr., Democrat of Michigan, who is chairman of the Banking Committee's securities subcommittee.

    After consulting with Gary G. Lynch, the head of the S.E.C.'s enforcement division, who was also testifying, Mr. Giuliani said such an investigation was being conducted by both agencies and that a public development in the case might ''be coming fairly soon.''

    Since the insider-trading scandal began last year, there has been much debate over what should be done to stop what some in Congress say is a ''systemic'' problem of insider trading and other abuses of the takeover process. Several Proposals Put Forward

    Mr. Giuliani had several recommendations:

    * In addition to increasing the size of the S.E.C. enforcement staff and that of the Justice Department to handle the growing caseload, he recommended that the penalties for insider trading be increased from the current five-year maximum to eight or 10 years.

    * He suggested that Congress send a message to the judiciary that ''prison sentences should be given in most of these cases,'' saying he strongly believed that the likelihood of spending time in prison would be the single largest deterrent to traders, ''as opposed to the organized-crime figure who factors a six-year prison term into his strategy.''

    * He recommended that a mandatory prison sentence of one to two years be given anyone convicted of obstruction of justice or perjury in an insider-trading investigation and that firms be subject to penalties for the illegal actions of their employees if the firms are found to be negligent on self-policing.

    Mr. Giuliani's call for a clear definition of insider trading comes amid considerable debate over whether such a statute would restrict, rather than preserve, the S.E.C.'s current enforcement reach.

    For years, S.E.C. officials have opposed such a definition, but Mr. Lynch said he would not oppose a definition provided it was sufficiently broad and ''neither narrows the current case law, discards the misappropriate theory or increases the evidentiary burdens on the S.E.C.''

    Both Mr. Lynch and Mr. Giuliani said they were surprised at the pervasiveness of insider trading they had discovered on Wall Street. Mr. Lynch said 20 of the 100 professionals on his staff were working on cases that have come out of current scandal; Mr. Giuliani said as much as 20 percent of his staff was involved in insider-trading cases.

    Bob Jensen's threads on greater sinners ---

    American History of Fraud ---



    Ex-Merrill Lynch Analyst Sentenced for Insider Trading
    A former Merrill Lynch analyst caught in a sprawling $7 million insider trading scheme must serve more than three years in prison to show Wall Street that sharing inside secrets will not be met with leniency, a judge said yesterday. The judge, Kenneth M. Karas of United States District Court in New York, said he was sending the former trader, Stanislav Shpigelman, to prison because he did not want those entrusted to protect secrets about stocks to think stellar academic backgrounds and great families would protect them from punishment for financial crimes.

    "Ex-Merrill Lynch Analyst Sentenced for Insider Trading," The New York Times, January 6, 2007 ---
    Jensen Comment
    This is only the first round. Generally scum bags like this get greatly reduced or suspended sentences on appeal. It's far worse to be poor and steal a loaf of bread.


    Bob Jensen's "Rotten to the Core" threads are at

    Bob Jensen's threads on the Enron/Andersen frauds ---



    The Sad State of Professional Discipline in Public Accountancy

    White Collar Crime Pays Even If You Get Caught
    (It's similar to arresting a Mafia boss in Italy)

    "Despite convictions, Rigases live in the lap of luxury," by Jerry Zremski, Buffalo News, December 3, 2006 ---

    Instead of facing immediate prison time, experts say Rigases might win a new trial.

    Nearly two and a half years after being convicted of bank fraud and other corporate crimes, former Buffalo Sabres owner John J. Rigas and his son Timothy remain comfortably at home in Coudersport, Pa., awaiting the results of their appeal.

    Meanwhile, many other executives who found themselves on the government's rap sheet in recent years - Andrew Fastow of Enron, Bernard Ebbers of WorldCom, Dennis Kozlowski of Tyco are all behind bars.

    What's more, lawyers close to the Rigas case and independent experts are now entertaining a possibility that, to trial-watchers, seemed laughable at the time of the Rigases' conviction in July 2004: that they could win their appeal and thus face a retrial.

    While it's rare for a federal appeals court to reverse a criminal conviction, it's also rare for a court to take nearly six months to decide such a matter. Yet that's how long ago a three-judge appellate panel in New York City heard the Rigas appeal, and some lawyers think the long wait for a decision is indication that the court is taking the appeal very seriously.

    "Usually, you expect a decision in a case like this in about a month and a half," said Mark Mahoney, the Buffalo attorney who won freedom for one of the Adelphia Communications Corp. defendants, Michael Mulcahey. "The delay means they are taking more time because the issues here are somewhat knotty."

    Of course, the elaborate frauds concocted at Enron, WorldCom and Tyco are inherently knotty, but courts were able to unravel them sufficiently to make sure that the convicts in each case went to prison comparatively quickly.

    Ebbers was convicted in March 2005, lost an appeal and was sent to a federal prison in Louisiana in September.

    Fastow was sentenced in September and joined Ebbers in Oakdale Federal Detention Facility this month.

    And Kozlowski was sent to Mid-State Correctional Facility in Marcy within weeks after his 2005 conviction and even before he appealed.

    There's one thing that separates all those cases from the one that ensnared the Rigases, who ran Adelphia, a huge cable company based in Coudersport. Their appeal raises a serious legal question that even the judge in their trial agreed ought to be heard.

    At a little-noticed court hearing in July 2005, a month after he sentenced John Rigas to 15 years and Timothy Rigas to 20 years in prison, Judge Leonard B. Sand allowed them to go free on bail pending their appeal.

    He said he did so because the defense raised a novel argument: the government persuaded the jury to convict the Rigases of fraud and conspiracy based on their violations of generally accepted accounting principles but never called an expert witness to explain what those principles are.

    At the hearing, Sand said he didn't necessarily buy that argument, but added it "is something that I can't call frivolous."

    Mahoney said "a lot of people felt it was generous" when Sand let the Rigases out on bail, because it's rare that people convicted in the federal courts win that sort of freedom.

    Denise O'Donnell, a former U.S. attorney in the Western District of New York, agreed.

    "There is a presumption against bail in the federal system, so the Rigases had a very high hurdle to overcome just to get released pending the appeal," she said.

    The fact that they were released shows that they "raised a substantive question of law" that could lead to the reversal of their conviction, O'Donnell added.

    Attorneys for the Rigases spelled out that question at a hearing before a three-judge federal appeals panel on June 13.

    Without an expert witness explaining accounting rules, "the jury was never put in a position to decide whether the Rigases' conduct was proper or improper," argued John Nields, the lawyer for Timothy Rigas.

    Richard Owens, the prosecutor in the case, countered by saying the government didn't want to prolong an already lengthy trial by starting "a battle of the experts."

    Three federal judges are still pondering that argument, and independent legal experts agreed with the Rigas attorneys that the appeal needs to be taken seriously.

    "I was surprised" that such an expert witness wasn't called, said Eugene O'Connor, a former federal prosecutor who now teaches law and accounting at Canisius College. "The question I have is: How is the jury to assess with some certainty that these men violated the accounting standards?"

    Then again, the prosecution laid out a case that, in the court of public opinion at least, might be seen as difficult to refute.

    Arguing that the Rigases treated Adelphia as their "private piggy bank," Owens showed that John Rigas billed the company for his Columbia House record club and used the corporate jet to send Christmas trees to his daughter in New York City.

    Timothy Rigas, meanwhile, dipped into corporate funds to purchase 100 pairs of luxury slippers and a flight meant to impress an actress friend.

    In total, prosecutors said the Rigases "looted" Adelphia of $100 million while hiding $2.3 billion in debt and misleading banks and investors about Adelphia's earnings.

    The jury convicted John and Timothy Rigas of 18 of the 23 charges against them. A mistrial was declared in the case of another Rigas son, Michael, who later pleaded guilty and was sentenced to home confinement.

    That's not entirely different than what John and Timothy Rigas are currently facing. Paul Shechtman, John Rigas' appeals lawyer, said both John and Timothy Rigas are still in Coudersport.

    "Under the circumstances, John is doing as well as can be expected," Shechtman said. "He's enjoying his grandchildren."

    Of course, those circumstances could change at any time. Lawyers close to the case said they don't know what to think about the fact that the appeals court is taking so much time to render a decision.

    "It's usually a good sign," Shechtman said. "I know they've issued opinions in cases that were heard after ours in several instances."

    However, the Second Circuit U.S. Court of Appeals is especially busy and may simply want to take its time poring over the record of the four-month trial, several lawyers said.

    One thing is for sure: if the appeals court rules for the Rigases and orders a retrial, it will be issuing an opinion that will have ramifications far beyond the borough of 2,600 that the Rigases call home.

    "It would be a huge decision with wide ramifications in financial fraud cases," O'Donnell said. "I can't think of any other similar case where this could happen."

    You can read more about the Rigas' crimes and the Adelphia accounting scandals at

    "Director Capture," The Icahn Report, January 20, 2009 ---

    Jonathan Macey is Deputy Dean and Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale Law School. He is the author most recently of Corporate Governance: Promises Made, Promises Broken (Princeton University Press, 2008) available at 

    The Icahn Report has exposed: (1) abuses in the use of golden parachute agreements; (2) many of the false premises behind the faulty assumption that corporate elections are "democratic" event that legitimize corporate boards; (3) the entrenchment effects of staggered boards of directors and, most importantly perhaps; (4) the sheer corruption of law and morality that is represented by the continued legality and adoption of poison pill defensive devices.

    In my next two blog postings I would like to bring my own, admittedly academic perspective to two topics that are, I believe, highly relevant to the agenda of this blog. The first topic is the problem of "board capture" among boards of directors of public companies. The second is the general problem with shareholder democracy caused by defects in the shareholder voting process.

    Director Capture

    In the academic world, particularly among political scientists and economists, "capture" occurs when decision-makers such as corporate directors favor certain vested interests such as incumbent management, despite the fact that they purport to be acting in the best interests of some other group, i.e. the shareholders. The problem of capture and the theories associated with the idea of capture are most closely associated with George Stigler, and the free-market Chicago School of Economic thought. Among the more interesting and important theories of Stigler and other proponents of capture theory is the idea that capture is not only possible, in many contexts it is inevitable.

    In my recent Princeton University Press book "Corporate Governance: Promises Made: Promises Broken" I apply capture theory, which is usually used to describe and model the behavior of bureaucrats in the public sector, to the directors of publicly traded companies who come to their positions through the board nominating committee.

    In my view, such directors are highly susceptible to capture… even more susceptible than bureaucrats and politicians. Capture is inevitable because management controls the machinery of the corporate election process. Management's narrow interest in having passive and supportive boards manifests itself in the appointment of docile directors who are likely to support management's initiatives and unlikely to challenge management or to demand that managers earn their compensation by maximizing value for shareholders.

    The extension of capture theory to corporate boards of directors is supported not only by foundational work in political science and economics but also by important work in social psychology. Directors participate in corporate decision-making. In doing so, these directors, as a psychological matter, come to view themselves in a very real way as the owners of the strategies and plans that the corporation pursues. And of course, these plans and strategies inevitably are proposed by incumbent management. Thus, directors inevitably risk simply becoming part of the management "team" instead of the vigorous outside monitors and evaluators that they are supposed to be. Management’s persistent support of and acquiescence in the proposals of management consistently renders directors incapable of objectively evaluating these strategies and plans later on. Of course this is not the case when the directors represent hedge funds or other large investors who have a large financial stake in making sure that the company prospers.

    Another factor leading to board capture is the fact that boards of directors have conflicting jobs. They are supposed not only to monitor management, but also to select and evaluate the performance of top management. After top managers have been selected, the boards of directors making the selection decisions are highly likely to become committed to these managers. For this reason, as board tenure lengthens, it becomes increasingly less likely that boards will remain independent.

    The theory of "escalating commitments" predicts that decision-makers such as corporate directors will come to identify strongly with management once they have endorsed the strategies and decisions made by management. Earlier board decisions supporting management, once made and defended, will affect future board decisions such that later decisions comport with earlier decisions. As the well-respected Cornell psychologist Thomas Gilovich has shown, "beliefs are like possessions" and "[w]hen someone challenges our beliefs, (for example the belief of directors that management is highly competent) it is as if someone [has] criticized our possessions."

    The cognitive bias that threatens boards of directors and other proximate monitors is a manifestation of what Daniel Kahneman and Dan Lovallo have described as the "inside view." Like parents unable to view their children objectively or in a detached manner, directors tend to reject statistical reality (such as earnings performance or stock prices) and view their firms as above average even when they are not. The first step in dealing with the problem of board capture is to recognize that the problem exists.

    Boards should be free to choose whether they wish to be trusted advisors of management or whether they want to be credible monitors of management. They can’t be both. We should stop pretending that they can.

    One policy proposal would be for companies to have two boards of directors (as they do in Germany and the Netherlands), one for monitoring and one for assisting in the management of the company. Firms that decide to retain the single board format should be required to choose whether their board should devote itself to "monitoring" (or supervising) management or to advising (or managing along with) the company’s CEO and the rest of the management team. The farce that board can do both should end.

    Boards that purport to monitor or supervise management should be held to an extremely high standard of independence. Management should not be involved in any way in the recruitment or retention of these board members. Socializing and gift-giving should be prohibited. And, of course, managers themselves should not be allowed to sit on monitoring boards. Managers should not be allowed to serve as the chairmen of monitoring boards.

    Independence standards should be relaxed for the boards of companies that elect to participate in management. Decisions that involve a conflict between the interests of shareholders and the interests of management should be subjected to close scrutiny. Such decisions include decisions about executive compensation of all kinds, particularly bonus and severance payments, as well as decisions about such things as the adoption of staggered terms for the board or the adoption of a poison pill rights plan.

    Continued in article

    Bob Jensen's threads on corporate governance are at

    Bob Jensen's threads on great minds in management are at

    "SEC Accountant Fines Largely Go Unpaid," SmartPros, June 7, 2006 ---

    The Securities and Exchange Commission has taken disciplinary action against more than 50 accountants in 2005 and 2006 for misconduct in scandals big and small. But few have paid a dime to compensate shareholders for their varying levels of neglect or complicity.

    It also turns out that nearly half of them continue to hold valid state licenses to hang out their shingles as certified public accountants, based on an examination of public records by The Associated Press.

    So while the SEC has forbidden these CPAs from preparing, auditing or reviewing financial statements for a public company, they remain free to perform those very same services for private companies and other organizations that may be unaware of their professional misdeeds.

    Some would say the accounting profession has taken its fair share of lumps, particularly with the abrupt annihilation of Arthur Andersen LLP and the jobs of thousands of auditors who had nothing to do with the firm's Enron Corp. account. Meantime, the big auditing firms are paying hundreds of millions of dollars in damages - without admitting or denying wrongdoing - to settle assorted charges of professional malpractice.

    Individual penance is another matter, however, and here the accountants aren't being held so accountable.

    Part of the trouble is that there doesn't appear to be an established system of communication by which the SEC automatically notifies state accounting regulators of federal disciplinary actions. In several instances, state accounting boards were unaware a licensee had been disciplined by the SEC until it was brought to their attention in the reporting for this column. The SEC says it refers all disciplinary actions to the relevant state boards, so the cause of any breakdowns in these communications is unclear.

    Another obstacle may be that some state boards do not have ample resources to tackle the sudden swell of financial scandals. It's not as if, for example, the Texas State Board of Public Accountancy had ever before dealt with an accounting fraud as vast as that perpetrated at Houston-based Enron.

    "We don't have the staff on board to manage the extra workload that the profession has been confronted with over the last few years," said William Treacy, executive director of the Texas board. "So we contracted with the attorney general's office to provide extra prosecutorial power."

    Treacy said his office is usually notified of SEC actions concerning Texas-licensed CPAs, but the process isn't automatic.

    With other states, communications from the SEC appear less certain. If nothing else, many boards rely upon license renewals to learn about SEC actions, but that only works if the applicants respond truthfully to questions about whether they've been disciplined by any federal or state agency. A spokeswoman for Georgia's board said one CPA recently disciplined by the SEC had renewed his license online without disclosing it.

    Ransom Jones, CPA-Investigator for the Mississippi State Board of Public Accountancy, said most of his leads come from other accountants, media reports and annual registrations.

    "The SEC doesn't necessarily notify the board," said Jones, whose agency revoked the licenses of key players in the scandal at Mississippi-based WorldCom.

    Some state boards appear more vigilant than others in policing their membership. The boards in California and Ohio have punished most of their licensees who have been disciplined by the SEC since the start of 2005.

    New York regulators haven't yet penalized any locals targeted by the SEC in that timeframe, though they have taken action against two disciplined by the SEC's new Public Company Accounting Oversight Board. It is conceivable that cases are underway but not yet disclosed, or that some individuals have been cleared despite the SEC's findings. A spokesman for the New York State Education Department said all SEC referrals are probed, but not all forms of misconduct are punishable under local statute. New rules now under consideration would strengthen those disciplinary powers, he said.

    Meanwhile, although the SEC deserves credit for de-penciling those CPAs who've breached their duties as gatekeepers of financial integrity, barely any of those individuals have been asked to make amends financially.

    No doubt, except for those elevated to CEO or CFO, most accountants are not paid as handsomely as the corporate elite. That said, partners from top accounting firms are were [sic] paid well enough to cough up more than the SEC has sought, which in most cases has been zero.

    Earlier this year, in what the SEC crowed about as a landmark settlement, three partners for KPMG LLP agreed to pay a combined $400,000 in fines regarding a $1.2 billion fraud at Xerox Corp. One of those fined still holds his license in New York.

    "The SEC has never sought serious money from errant CPAs," said David Nolte of Fulcrum Financial Inquiry LLP. "Unfortunately, the small fines in the Xerox case set a record of the amount paid, so everyone else has also gotten off easy."

    It's not that the CPAs found culpable in scandals don't deserve a right to redemption, or just to earn a living. Most of the bans against practicing before the SEC are temporary, spanning anywhere from a year to 10 years.

    But the presumed deterrent of SEC action is weakened if federal and state regulators don't work together on a consistent message so bad actors don't get a free pass at the local level.

    White collar crime punishments are a joke even if whistle blowing does make them less funny
    The main whistle-blower in the accounting fraud at HealthSouth Corp. received the longest sentence so far in the case, while another former executive received probation. U.S. District Judge Robert Propst sentenced former Chief Financial Officer Weston Smith, 45 years old, to 27 months in prison, one year of probation and ordered him to pay $1.5 million in forfeited assets. He pleaded guilty in March 2003 to conspiracy, fraud and violating the Sarbanes-Oxley corporate-reporting law. Assistant U.S. Attorney James Ingram, who asked the judge for a five-year sentence, said Mr. Smith was the first person to reveal a $2.7 billion fraud at the Birmingham, Ala., rehabilitation and medical-services chain and would deserve an even longer sentence had he not come forward when he did.
    "HealthSouth Ex-Finance Chief Is Given 27-Month Prison Term," The Wall Street Journal, September 23, 2005; Page C3 ---,,SB112741852577848939,00.html?mod=todays_us_money_and_investing

    Bob Jensen's threads on HealthSouth and Ernst & Young are at

    White Collar Crime Pays Even if You Get Caught
    For example Andy Fastow stole over $60 million from Enron and was required to pay back less than $30 million.  Where will the remainder be when he emerges a free man in a few years?

    It gets harder to get convictions for white collar crime
    In Oregon this month, a judge dismissed criminal charges against three corporate executives, saying the Justice Department unconstitutionally pursued a stealth criminal investigation under the cloak of a less-threatening civil proceeding by the SEC. And in Alabama last year, a judge dismissed charges that former HealthSouth Corp. Chief Executive Richard Scrushy lied to the SEC, ruling that he should have been warned that the Justice Department already had opened a criminal investigation when the SEC questioned him. In both cases, the judges found the line between the agencies' roles had become improperly blurred.
    Peter Lattman and Kara Scannell, "Slapping Down a Dynamic Duo: SEC and the Justice Department Fight Financial Crime Together, But Is It an Unfair Double-Team?" The Wall Street Journal, January 25, 2006; Page C1--- 

    Executive Compensation:  Here's how it works even in bankruptcy
    Last Wednesday, the judge overseeing the UAL Corporation's reorganization approved an executive pay package that would give rich salaries and at least $115 million worth of stock to the airline company's chief executive, Glenn F. Tilton, and other senior managers, when UAL emerges from Chapter 11. UAL said the executive pay was necessary to attract and retain experienced managers. But the judge's approval surprised Brian Foley, an executive pay expert in White Plains. For starters, he noted, the plan was created by Towers Perrin for the UAL board. Towers Perrin also happens to have done work for UAL management.
    "A Little Too Close for Comfort at UAL?" The New York Times, January 22, 2006 ---
    Jensen Comment
    All the pilots, flight attendants, machinists, ticket agents, baggage handlers, and other UAL employees took pay cuts.  Why not the top brass? Just goes to show you that there's no economic law of supply and demand at the CEO level. It's all a matter of back scratching where the CEO appoints the Board that in turn decide how much the CEO can loot from shareholders.

    I don't know whether to post this to my "White Collar Crime" module or my "Outrageous Executive Compensation" module.  These days both modules should probably be merged.

    White Collar Crime Pays
    This is how rich guys loot companies
    Many Private-Equity Firms Drain Out Dividends and Fees, Saddling Companies With Debt

    "Takeover Artists Quench Thirst," by Henny Sender, The Wall Street Journal, January 5, 2006; Page C1--- 

    The ink had barely dried on the sale documents about a year ago when the new private-equity owners of satellite operator Intelsat -- Apax Partners Inc., Apollo Management, Madison Dearborn Partners and Permira Advisers -- paid themselves a $350 million dividend financed with newly issued Intelsat debt.

    In a technique practically unheard of just five years ago, private-equity firms, emboldened by easy financing, are paying themselves lavish dividends and fees from the companies they acquire. Typically, private-equity firms have generated returns by acquiring companies with a mix of cash and debt, taking them private, restructuring them and then either taking them public or selling them.

    But a favorable financing environment has given rise to a high volume of dividends and fees, often paid well ahead of any operational turnaround, primarily through the aggressive issuance of debt by the acquired companies. A spokesman for Apollo, which led the Intelsat transaction, declined to comment.

    In the past two years, private-equity firms garnered more than $50 billion from so-called dividend recapitalizations, according to Standard & Poor's Corp. By contrast, there were virtually no such dividend financings just five years ago. As much as 50% of the returns that buyout firms have paid their investors in the past two years came from such dividends, financed mostly with new debt, according to calculations by some private-equity firms.

    The pace of the dividends is dizzying. Blackstone Group bought Celanese Corp. for $3.4 billion in June 2004, contributing $650 million of the purchase price. In the nine months following the closing, Celanese paid Blackstone $1.3 billion in dividends.

    Continued in article

    It pays to be an accounting cheat because you don't have to return your bonus that you got by cheating
    Hundreds of companies have restated earnings in recent years - 414 in 2004 alone, according to a recent study by the Huron Consulting Group. And in many cases, the revisions came in the wake of discoveries of questionable accounting or other possible wrongdoing that meant the numbers leading to bonuses were inaccurate. But a review of restatements by large corporations shows that companies very, very rarely - as in almost never - get that money back. The list of restatements was compiled for Sunday Business by Glass Lewis & Company, a research firm based in San Francisco.
    Jonathan D. Glater, "Sorry, I'm Keeping the Bonus Anyway," The New York Times, March 13, 2005 ---

    White collar crime still is punished lightly

    "Ex-Finance Chief At HealthSouth Gets 5 Years in Jail," by Chad Terhune, The Wall Street Journal, December 10, 2005; Page A3 ---

    A federal judge in Birmingham, Ala., sentenced former HealthSouth Corp. finance chief William T. Owens, the star witness against company founder Richard Scrushy at his criminal trial, to five years in prison.

    U.S. District Judge Sharon Blackburn expressed reservations at sending Mr. Owens, 47 years old, to prison, saying she believed Mr. Scrushy directed the $2.7 billion accounting fraud at the health-care company. Mr. Scrushy's trial ended in acquittal in June.

    Friday, the judge called it a "travesty" that Mr. Scrushy wouldn't spend any time in prison in connection with the scheme. Mr. Scrushy and his lawyers have repeatedly denied participating in the fraud, claiming that Mr. Owens was the mastermind of the plan and hid it from Mr. Scrushy. In a statement, Mr. Scrushy said Judge Blackburn's comments were "totally inappropriate given that there was not one shred of evidence or credible testimony linking me to the fraud."

    Frederick Helmsing, the lawyer for Mr. Owens, had sought probation, in light of Mr. Owens's extensive cooperation with the government investigation since 2003. Prosecutors requested an eight-year prison term.

    Continued in article

    HealthSouth's auditing firm was Ernst & Young ---

    This is absolutely unfair!  If a CEO loots his/her company, the company pays insurance for all legal costs of the CEO even if he's convicted of looting the company that pays the insurance premiums.
    A company that insured Tyco International Ltd. executives must pay legal bills for former Chief Executive L. Dennis Kozlowski, who is on trial on corporate-looting charges, an appeals court said. In a 5-0 ruling, the New York Supreme Court Appellate Division left open the possibility that Federal Insurance Co., a Chubb Corp. subsidiary, could later recover some of the costs from Mr. Kozlowski. A lower court judge had ruled that Federal Insurance, which provided liability coverage to Tyco, was required to pay Mr. Kozlowski's legal bills . . . Mr. Kozlowski and Mark H. Swartz, Tyco's former chief financial officer, are accused of stealing $170 million from the conglomerate by hiding unauthorized pay and bonuses and by abusing loan programs. They also are accused of making $430 million by inflating the value of Tyco stock by lying about the company's finances. Their retrial in Manhattan's State Supreme Court on charges of grand larceny, falsifying business records and violating state business laws is ending its second month. Their first trial ended in a mistrial in April.
    Associated Press, "Insurer to Pay Kozlowski's Costs," The Wall Street Journal, March 24, 2005; Page C3 --,,SB111161345997387951,00.html?mod=todays_us_money_and_investing

    Justice Lite:  Scott Sullivan gets five years with the possibility of earlier parole
    WorldCom Inc.'s former chief financial officer, Scott Sullivan, who engineered the $11 billion fraud at the onetime telecom titan, was sentenced to five years in prison -- a reduced term that sent a signal to white-collar criminals that it can pay to cooperate with the government. Mr. Sullivan's reduced sentence came after prosecutors credited his testimony as crucial to the conviction of his former boss and mentor, Bernard J. Ebbers, who founded the company, which is now known as MCI Inc. Last month, Mr. Ebbers was sentenced to 25 years in prison.
    Shawn Youg, Dionne Searcey, and Nathan Kopp, "Cooperation Pays: Sullivan Gets Five Years," The Wall Street Journal, August 12, 2005, Page C1 ---,,SB112376796515410853,00.html?mod=todays_us_money_and_investing

    A WSJ video is available at

    Bob Jensen's threads on the Worldcom accounting scandal are at

    Justice Lite:  Rite Aid Ex-CEO's Sentence Pared
    A federal judge on Thursday trimmed a year from the eight-year sentence of former Rite Aid Corp. Chief Executive Martin L. Grass for conspiring to obstruct justice and to defraud the nation's third-largest drugstore chain and its shareholders. U.S. District Judge Sylvia H. Rambo said she acted to reduce a disparity between Mr. Grass and other defendants sentenced for similar crimes. Mr. Grass, 51 years old, smiled and blew a kiss to family members as federal marshals led him from the courtroom.
    "Rite Aid Ex-CEO's Sentence Pared," The Wall Street Journal, August 12, 2005; Page C3 ---,,SB112379123643311147,00.html?mod=todays_us_money_and_investing

    Of all the lawsuits, one filed against Mr. Winnick last October in federal court in Manhattan holds special significance. J. P. Morgan Chase and other leading banks are seeking $1.7 billion in damages from Mr. Winnick and other Global Crossing executives, contending that the group engaged in a "massive scam" to "artificially inflate" the company's performance to secure desperately needed loans. Mr. Winnick, whose lawyers dispute the accusations, declined to be interviewed for this article.  Among other things, the suit refocuses attention on exactly what Mr. Winnick knew about his company's finances during times when it was borrowing heavily and he was selling hundreds of millions of dollars in stock. It also outlines a troubling series of meetings he held with Mr. Lay and other Enron executives just months before their company crumpled.
    Timothy O'Brian, "A New Legal Chapter for a 90's Flameout," The New York Times, August 15, 2004 --- 

    Makes You Sick to Your Stomach
    How Crooked Corporate Executives Get Away With Their Heists

    As Conseco struggles to reclaim hundreds of millions of dollars in delinquent loans, it is discovering just how adept former executives can be at hanging on to their money. And, like other companies in its place, the insurer is getting increasingly aggressive in dunning its former executives.
    "Playing Hide & Seek With Cash:  More Firms, Like Conseco, Find It's No Game Trying to Reclaim Bad Loans to Former Executives," by Joseph T. Hallinan, The Wall Street Journal,  February 9, 2005; Page C1---,,SB110790426901949318,00.html?mod=todays_us_money_and_investing 

    Some islands off New Zealand? Your spouse? A house in Florida? Where would you stash gobs of money that somebody was trying to grab?

    As Conseco Inc. struggles to reclaim hundreds of millions of dollars in delinquent loans, it is discovering just how adept former executives can be at hanging on to their money. And, like other companies in its place, the insurer is getting increasingly aggressive in dunning its former executives.

    For instance, the former WorldCom Inc. (now MCI Inc.) is zealously pursuing $400 million it says it is owed by former Chief Executive Bernard J. Ebbers, who faces a fraud trial in U.S. federal court in New York City. "The climate has changed totally," says Pearl Meyer of Pearl Meyer & Partners, an executive-compensation consultant to boards, compensation committees and management.

    In the past, she says, "companies would not even endeavor to recapture compensation." Now, though, companies routinely include "clawback provisions" in their executive employment agreements, entitling the companies to take back compensation under certain circumstances.

    "Clawback" is an apt term for what Conseco is attempting. During the 1990s, the Carmel, Ind., company arranged for its top executives and directors to borrow hundreds of millions of dollars for use in buying the company's then-soaring stock. In some cases, Conseco lent money directly to the executives; in most cases, it guaranteed their loans from banks.

    Such loans are no longer permitted under the Sarbanes-Oxley securities-reform act of 2002, says Charles M. Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. But while they were legal, Conseco made the most of them. Its loan program for directors and officers swelled to more than $600 million as officials snapped up 19 million company shares. Soon after, Conseco's fortunes crashed. Under the weight of a sagging mobile-home loan business, it was forced in 2000 to restate results. Its stock price plunged, and in 2002 Conseco filed for bankruptcy-court protection.

    It emerged from bankruptcy in 2003 and ever since has been trying to collect on those loans. The chief target these days is former Conseco Chairman and CEO Stephen C. Hilbert. In an interview, Mr. Hilbert accuses Conseco's law firm, Chicago-based Kirkland & Ellis, of having used "every below-the-belt legal tactic known to mankind. It's been pathetic."

    Reed S. Oslan, a partner with the firm, responds that Mr. Hilbert "has no one but himself to blame for the litigation Conseco was compelled to bring," adding that "a high degree of resolve on the part of the lender" is expected, given how much money is at stake.

    Conseco contends Mr. Hilbert owes it $248.2 million. During his heyday, the college dropout and former encyclopedia salesman was among the country's most highly paid executives, pulling in over $100 million a year at peak compensation.

    Today, Mr. Hilbert, 59 years old, pleads poverty. At a hearing in November in Hamilton County Circuit Court in Indiana, he said he had virtually no income and only $175 cash in his pocket, and that his wife, Tomisue Hilbert, 34, "generously" pays his bills.

    Since he was ousted from Conseco in 2000, Mr. Hilbert has transferred some $100 million in assets to his wife, according to court filings by Conseco. The sum includes $20 million in cash and an interest in a Caribbean chateau.

    Phillip Fowler, an attorney representing Mr. Hilbert, says any transfers Mr. Hilbert made to his wife were "completely proper" and that Conseco isn't entitled to recover anything from Mrs. Hilbert. "Tomisue Hilbert owes not a dime to Conseco -- period," Mr. Fowler says.

    Continued in the article

    "25 Reasons Employees Lie, Cheat, and Steal," SmartPros, September 2006 ---

    On-the-job theft goes beyond greed, according to authorities in white-collar crime (criminologists, sociologists, auditors, risk managers, etc.), who cite a large list of reasons for employee theft.

    In fact, a new edition of Fraud Auditing and Forensic Accounting lists a long list of 25 reasons -- some of which are common knowledge, but others may surprise. They include:

    • The employee believes he can get away with it.
    • No one has ever been prosecuted for stealing from the organization.
    • Employees are not encouraged to discuss personal or financial problems at work or to seek management's advice and counsel on such matters.

    Read the entire list and check out Book Corner for more details on the book.

    A Politically Divided SEC:  Why We Can't Trust Government Agencies to Protect US from Big Business

    "SEC Won't Charge, Fine Global Crossing Chairman:  Agency's Donaldson Goes Against Staff, Noting Winnick's Nonexecutive Role," by Deborah Solomon, The Wall Street Journal, December 13, 2004; Page A1 ---,,SB110290635013498159,00.html?mod=todays_us_page_one

    The Securities and Exchange Commission won't file civil securities charges against former Global Crossing Ltd. Chairman Gary Winnick over disclosure violations or impose a $1 million fine, according to people familiar with the matter.

    The action came despite objections from the SEC's two Democratic members and represents a rare reversal by the commission of its enforcement staff. It also caps a lengthy investigation of Global Crossing, the former Wall Street darling that helped set off a gold rush to capitalize on the Internet boom of the late-1990s.

    . . .

    The SEC had been expected to fine Mr. Winnick $1 million for failing to properly disclose a series of transactions undertaken by the telecom company, and he had tentatively agreed to pay that sum as part of a settlement agreement. But at a closed-door commission meeting last week, SEC Chairman William Donaldson and his two fellow Republican commissioners, Cynthia Glassman and Paul Atkins, opposed a staff recommendation to charge Mr. Winnick. Mr. Donaldson expressed concern that Mr. Winnick was a nonexecutive chairman and hadn't signed off on the inadequate disclosure, these people said.

    This is what happens when Republicans win elections (and I'm a Republican)
    The SEC is facing resistance from two Republican commissioners over the stiff fines it has been imposing on companies.
    Deborah Solomon, "As Corporate Fines Grow, SEC Debates How Much Good They Do," The Wall Street Journal, November 12, 2004 ---,,SB110021198122471832,00.html?mod=home_whats_news_us 
    Bob Jensen's threads on why white collar crime pays (even when you get caught) are at 

    It's about time.
    The SEC staff is set to propose an overhaul of rules governing how billions of shares trade each day in the U.S. The proposed plan would expand a trading rule to mandate that investors are entitled to the best price for most stock orders on both the NYSE and Nasdaq.
    Kate Kelly and Deborah Solomon, "SEC Preps 'Best-Price' Overhaulm" The Wall Street Journal, November 22, 2004 ---,,SB110108697957180493,00.html?mod=home_whats_news_us 

    Forget it!  The DC part of Washington DC means Donate Cash
    "SEC Loves NYSE," The Wall Street Journal,  December 6, 2004; Page A14

    Never underestimate the ability of a bureaucracy to wiggle backward. After many months of heavy breathing, the Securities and Exchange Commission is about to take stock trading back several decades. If you're thinking: Hmmm, this will help the New York Stock Exchange, you're right.

    Back in February, the SEC proposed an overhaul of the national market system, called Reg NMS. The idea was to modernize an increasingly laborious and inefficient structure put in place in the 1970s. The main driver for reform, especially from institutional investors who often trade on behalf of smaller investors, was the trade-through rule.

    This little bit of regulatory favoritism dictates that traders must do business with the exchange showing the "best" price for a security. It has also long given the New York Stock Exchange, with its auction system of stock specialists on the trading floor, a monopoly on a large amount of trading. Of course, having a monopoly, the NYSE had little incentive to upgrade its trading technology. And it didn't for years. Meanwhile, all sorts of swift, efficient electronic markets were created.

    Institutional investors now find that they can trade faster, with anonymity and confidence, on these electronic markets. But the trade-through rule hinders them. The NYSE argues that this rule protects small investors who otherwise might not get the "best" price. In fact, the "best" price on the NYSE is often just a "maybe" price because it can disappear during the 15-30 seconds it takes to execute an order. On electronic venues, however, the price is firm and execution is achieved as soon as the computer key is hit.

    The SEC's February proposal stopped short of abolishing the trade-through rule, but it did relax it. The proposal would have allowed traders to ignore the best price within a certain range and granted an explicit opt-out -- investors could give permission to ignore the best price on an order-by-order basis. Essentially, the proposal recognized the virtues of fast, automated markets by giving them trading priority over slow, manual markets.

    The NYSE -- the queen of slow markets -- went wild. It aggressively lobbied against the SEC proposal and, in an effort to qualify as a fast market, introduced the first real reform in decades. In a plan unveiled in August, the NYSE has proposed to make itself into a "hybrid" market by expanding its tiny automated system, called Direct Plus.

    The new Direct Plus lifts restrictions on size and timing of orders, allows orders that are not immediately executed to be canceled, and permits investors to gobble up or dump a lot of shares in one sweep at multiple prices. Specialists will, however, retain their role. The plan allows for the automatic market to switch into an auction mode if additional "liquidity" becomes necessary -- which sounds as if the NYSE is up to its old tricks. At least the threat of losing its monopoly has, finally, spurred the Big Board into some long-needed changes toward automated trading.

    But then came word that the SEC has backpedaled. In a draft scheduled to be voted on this month, the new Reg NMS has dropped the opt-out provision and extended the trade-through rule to Nasdaq. Rumors were that all markets will also be required to display their full depth-of-book -- the entire list of bids and offers -- not just their best price. Simply put, the trade-through rule would not only be retained but would reign supreme. The uproar over this news has been so loud that the SEC has now agreed to put the new rule out for comment before any final vote.

    Extending trade-through to Nasdaq is an unnecessary extension of regulatory reach. The SEC itself has admitted that, even without a trade-through rule, Nasdaq offers competitive quoting in actively traded stocks. Moreover, recent academic studies show that there is less volatility on Nasdaq and other electronic trading markets.

    The impetus for reforming the national market system was an acknowledgement that both the technology and motives for trading have changed radically in the past 30 years. The practical point was to break the monopoly strictures so that competition among markets would direct order flow to the venues that best suited investors. There is an argument that the NYSE, with its specialists, provides value for trading medium- and low-cap stocks, and no doubt the Big Board will retain its market share if that's the case. But that hardly suggests that trading in the most liquid stocks should be forced into the NYSE.

    And so after all this, the SEC has failed to grapple with the central question: Why shouldn't the markets for trading stocks be free to compete on service and innovation? Instead, it looks like the SEC is going to give investors the same-old, very old, story.

    Bob Jensen's threads on proposed reforms are at 

    Securities regulators are probing whether fund companies directed trades toward firms that lavished them with "excessive" gifts.  SEC, NASD Investigate Whether Securities Firms Gave Excessive Presents
    Deborah Solomon, "Probe Focuses on Gifts to Advisers," The Wall Street Journal, November 25, 2004, Page c19 ---,,SB110123997986182154,00.html?mod=home_whats_news_us 
    Bob Jensen's thread on securities trading frauds are at 

    So where was Levitt before Spitzer did his job?  While heading up the SEC, Levitt always seemed willing to take on the CPA firms, but he treaded lightly (really did very little) while the financial industry on Wall Street ripped off investors bigtime.  It never ceases to amaze me how Levitt capitalizes on his failures.
    Forget Enron, WorldCom or mutual funds. The crisis enveloping the insurance industry is "the scandal of the decade, without a question" and "dwarfs anything we've seen thus far."
    Arthur Levitt as quoted by SmartPros, October 25, 2004 --- 
    Bob Jensen's threads on insurance frauds are at 

    In my view Global Crossings is the pinnacle of corporate management profiteering. I cannot believe that Justice did not prosecute this obvious case of fictitious earnings manipulation and Gary Winnick is left with over $735 million when investors had an 18 billion collapse.
    Miklos A. Vasarhelyi, Rutgers University, August 15, 2004 email message

    In all, four months in a minimum-security prison seemed like a small price to pay for the millions of dollars Mozer made. In 2001, Mozer was enjoying his wealth--relaxing, and raising his eight-year-old daughter. He spent much of his time managing his own money and playing golf. Mozer's treatment raised an interesting question: what would most people have done in his situation--assuming they knew in advance they would be caught and spend four months in a low-security prison--if they also knew that, afterward, they would retire as a multimillionaire, all before their fortieth birthday? Compared to Mozer, his supervisors received mere slaps on the wrist. Gutfreund, Strauss, and Meriweather paid fines of $100,000, $75,000, and $50,000, respectively--just a few days' pay, at their salaries.
    Frank Partnoy, Infectious Greed (Henry Holt and Company, 2004, Page 109) with respect to derivatives fraud at Salomon.

    Discontent is rightfully rising over CEO pay versus performance
    In fact, the boss enjoyed a hefty raise last year. The chief executives at 179 large companies that had filed proxies by last Tuesday - and had not changed leaders since last year - were paid about $9.84 million, on average, up 12 percent from 2003, according to Pearl Meyer & Partners, the compensation consultants. Surely, chief executives must have done something spectacular to justify all that, right? Well, that's not so clear. The link between rising pay and performance remained muddy - at best. Profits and stock prices are up, but at many companies they seem to reflect an improving economy rather than managerial expertise. Regardless, the better numbers set off sizable incentive payouts for bosses. With investors still smarting from the bursting of the tech bubble, the swift rebound in executive pay is touching some nerves. "The disconnect between pay and performance keeps getting worse," said Christianna Wood, senior investment officer for global equity at Calpers, the California pension fund. "Investors were really mad when pay did not come down during the three-year bear market, and we are not happy now, when companies reward executives when the stock goes up $2."
    Claudia H. Deutsch, "My Big Fat C.E.O. Paycheck," The New York Times, April 3, 2005 ---
    Bob Jensen's threads on corporate fraud are at
    Bob Jensen's updates on fraud are at

    "Hard Time? Hardly In 1999 we wrote about some accounting bad guys who seemed to have airtight cases against them. Guess how many went to jail?"
    by Carol J. Loomis, Fortune magazine, March 18, 2002, Page 78 --- 

    Raise your hand if you think one or more Enron executives should go to jail. The yes votes on that one would surely put President Bush's approval rating to shame. We might even get past 99.99% affirmative, with only the Lay, Skilling, and Fastow families voting no.

    But the fact is that putting bigtime executives in jail for perpetrating accounting frauds has proved very hard to do. Some 2 1/2 years ago (Aug. 2, 1999) FORTUNE ran an article, Lies, Damned Lies, and Managed Earnings, that spotlighted the accounting scandals of the time. Of the big ones then generating tales of absolutely egregious behavior, none has produced jail sentences.

    Indeed, only one produced a sentence of any kind: Bruce J. Kingdon, who had run a division of Bankers Trust that did securities processing, pleaded guilty in September 2000 to conspiracy and falsifying bank records, and was ordered to perform 450 hours of community service, see a therapist once a week for three years, and pay fines of $180,500. (Bankers Trust itself had earlier paid a $63 million fine.) Kingdon's lawyer says his client's community service consisted of work for a medical cause--"cerebral palsy or muscular dystrophy or something like that."

    Jail sentences could yet come out of several other cases, including two that have actually produced indictments. The zinger is likely to be the case against two prominent CUC International executives, CEO Walter Forbes and President Kirk Shelton, who in 1997 merged their company with HFS Inc. to form Cendant. A scant four months later CUC's accounting was exposed as rotten, and Cendant's market value dropped $14 billion in one day.

    In time the U.S. Attorney for New Jersey, working with the SEC, wrung cooperating plea agreements from three former CUC financial executives, who are expected to testify against Forbes and Shelton. The two men are charged with three types of fraud--securities, mail, and wire--and with conspiracy to lie to the SEC. In their trial, scheduled to start in Newark in September, they will face a morally outraged team of prosecutors, one of whom says, "This is war." Forbes and Shelton cannot have been helped by the furor over Enron.

    The second batch of indictments emerged from another merger-related mess, arising from McKesson's acquisition of software supplier HBO & Co. in January 1999. Again, within months rot was exposed, this time in HBO's accounting. (Say, whatever happened to the due diligence that supposedly precedes mergers?) After a criminal investigation headed by San Francisco Assistant U.S. Attorney Leslie Caldwell, the two co-presidents of HBO, Albert Bergonzi and Jay Gilbertson, were charged with the fraud battery--securities, mail, and wire--and with conspiracy. No date has been set for their trial, and Caldwell won't, in any case, be apt to take part in it. She's now heading the Department of Justice task force that's investigating Enron.

    "Massive financial fraud" is what the SEC says occurred at both McKesson and Cendant. But that is also how it described the goings-on a few years ago at Sunbeam and Waste Management, and those cases have brought no criminal indictments. That means the executive everyone loves to hate, deposed Sunbeam CEO Al Dunlap, has escaped charges, and so has Waste Management's former CEO, Dean Buntrock. Other escapees: partners of Arthur Andersen & Co., which was the outside auditor at both Sunbeam and Waste Management (and, as all the world knows, at Enron).

    The weirdest accounting case around is one in which indictments have existed for years, but nothing has made it to court. Here, in early 1999, the U.S. Attorney for the Southern District of New York, Mary Jo White, charged Garth Drabinsky and Myron Gottlieb of theatrical producer Livent with 15 counts of fraud and one of conspiracy. But Drabinsky and Gottlieb had already fled to Canada, Drabinsky's homeland--and there they remain today. No wonder, since the U.S. Attorney's office has never moved to extradite them, even though it vowed from the start to do so.

    Continued at  

    "No Wonder C.E.O.'s Love Those Mergers," by Gretchen Morgenson, The New York Times, July 18, 2004 --- 

    Shareholders like it when their companies are acquired, because their stocks rise in value. Chief executives like it, too, because their severance agreements kick in. And that means they can become truly, titanically, stupefyingly rich.

    Wallace R. Barr, the chief executive of Caesars Entertainment, is the latest to line up for his barrel of bucks. Last week, Harrah's announced it would acquire Caesars for $5.2 billion. Thanks to accelerated vesting of options and stock awards, Mr. Barr stands to receive almost $20 million under so-called change-of-control provisions in his contract. And if Mr. Barr resigns from Caesars "for good reason," the contract says, he is entitled to an additional $6.6 million after the two companies merge.

    A spokesman for Caesars did not return a phone call seeking comment.

    Then there was Wachovia's proposed acquisition of the SouthTrust Corporation last month. Equilar Inc., a compensation analysis firm in San Mateo, Calif., said the terms of the deal would give Wallace D. Malone Jr., the chief executive of SouthTrust. $59 million in termination awards, stock awards and options over the next five years if he leaves the bank. He also appears to be entitled to an annual pension of about $3.8 million.

    At least Mr. Malone has said he would donate some of this bounty to charity. A spokeswoman for SouthTrust did not return a phone call seeking comment.

    "In theory, change-in-control provisions make sense," said Tim Ranzetta, the president of Equilar. "They encourage executives to act in the best interests of shareholders in transactions that they anticipate will increase shareholder value, which at the same time may harm their own careers. But empirical research seems to indicate that most companies underperform relative to the market after a merger while executives benefit from these large, one-time payouts."

    Amazingly few shareholders have carped about these giveaways. The California Public Employees' Retirement System, the big pension fund known as Calpers, voted against last month's merger of two health care companies, Anthem Inc. and WellPoint Health Networks, citing excessive pay. Executives stood to receive bonuses, severance payments and vested stock options totaling approximately $200 million in the deal. Leonard D. Schaeffer, WellPoint's chief executive, was entitled to $47 million in severance, stock options and enhanced retirement benefits, an Anthem spokesman said.

    Nobody else seemed to mind. Shareholders approved the merger on June 28.

    One reason that shareholder outrage has been muted may be that few people, beyond the executives themselves and maybe the company's compensation committee, know how costly these pay deals are. Even with all the scrutiny of corporate governance in recent years, a full tally of what executives will earn in retirement or under a change of control is simply not disclosed. Not anywhere.

    Experts say that many compensation committees do not understand the size of these pay packages because they do not routinely ask their consultants for detailed lists of the various pay components.

    And, my, how the list of goodies can go on. First comes the executives' severance pay, almost always nearly three times salary and bonus. Accelerated vesting of stock options and stock awards quickly follows; sometimes the options are granted with their full terms remaining - up to 10 years - giving them tremendous value.

    Then there are the three additional years of pension credits that get tacked on to an executive's pay, as well as the 401(k) match, years of health care benefits and the cash value of perquisites at the time of termination - such as use of the corporate jet, country-club memberships, allowances for financial planning advice, office space and secretarial services. All in one delightfully fat lump sum.

    AND don't forget that executives' pensions are often based on the unusually high severance pay, which ratchets the numbers way up.

    Of course, one downside to these enormous payments is that they generate stunning tax bills for executives. Good thing their contracts almost always require the companies to pay. And how!

    The so-called excise tax gross-up provisions can be so colossal that, according to one pay expert, a major merger was scuttled because the cost to cover executives' tax bills exceeded $100 million.

    I view these executive compensation schemes as white collar crime, and white collar crime just does not get punished severely enough to stop the epidemic.

    White collar crime pays even in the unlikely event that perpetrators get caught.  With millions of ill-gotten gains stashed away off shore or in the hands of friends and relatives, a white collar criminal looks forward to retirement in luxury after serving a few months or years in a Federal country club deceivingly called a prison.

    Related to this problem is that failure, even when it is not a crime, is rewarded with golden parachutes and immoral levels of executive compensation that do not discourage reckless management and strategies.

    The best solution is not prison except in the case of violent offenders or persons likely to flee to nations that will not extradite them back to the United States.  Assign long prison sentences to all perpetrators who do not return their ill-gotten gains to victims of their crimes.  

    In all other instances, the best solution is enforcement of lifestyle.  Force the perpetrators to live out the rest of their lives at minimum wage jobs until they reach the age of 65.  Then make them live only on Social Security benefits. 

    What makes matters worse is that the accounting profession is now seen as helping criminals get away with misdeeds.  

    A survey of Canadian business executives shows immense support for auditing reforms. Find out what reforms scored highest on their list. 

    I vote for monetary fine in place of time outs!

    "Wall St. Turns to the Time Out as Punishment," by Jenny Anderson, The New York Times, December 8, 2004 ---

    Regulators are wielding a new weapon against Wall Street firms in the hope that it might hurt more than multimillion-dollar fines: temporarily shutting down certain business lines.

    Last week, NASD prohibited Merrill Lynch and Wachovia Securities from registering brokers for five business days on top of fining the firms: $1.6 million for Merrill Lynch and $650,000 for Wachovia. Each firm had failed to report to NASD on-time information including customer complaints, regulatory actions and criminal charges and convictions about its brokers. Twenty-seven other firms were charged with the same late reporting, but Merrill and Wachovia faced the five-day suspension for both the sheer number of reporting violations as well as the two firms' track record of regulatory actions.

    Merrill and Wachovia were not the first to incite the regulators' ire over late reporting. In July, Morgan Stanley was fined $2.2 million for being late with more than 1,800 incidents of late reporting about its brokers. NASD imposed a five-day suspension for registering new brokers, saying in a public statement that the severity of the punishment was related to the number of late filings and the fact that the tardiness impaired its ability to conduct other investigations. Wachovia, Merrill and Morgan Stanley all agreed to the sanctions while neither admitting nor denying the allegations.

    Continued in the article

    "WHITE-COLLAR CRIMINALS Enough Is Enough They lie they cheat they steal and they've been getting away with it for too long." 
    Clifton Leaf, Fortune magazine, March 18, 2002, pp. 60-78 --- 

    The Odds Against Doing Time
    Regulators like to talk tough, but when it comes to actual punishment, 
    all but a handful of Wall Street cheats get off with a slap on the wrist.
    What Really Happens (From Fortune, March 18, 2002, p. 72)

    In the ten-year period from 1992 to 2001, SEC officials felt that 609 of its civil cases were egregious enough to merit criminal charges. These were referred to U.S. Attorneys.

    Of the initial 609 referrals, U.S. Attorneys have disposed of 525

    Defendants prosecuted 187

    Found guilty 142

    Went to jail 87








    Feeling cynical?

      If you aren’t now, you will by the time you finish the new Bebchuk and Fried paper on executive compensation.  They paint a fairly gloomy picture of managers exerting their power to “extract rents and to camouflage the extent of their rent extraction.”  Rather than designed to solve agency cost problems, the paper makes the case that executive pay can by an agency cost in and of itself.  Let’s hope things aren’t this bad.

    They say that patriotism is the last refuge
    To which a scoundrel clings.
    Steal a little and they throw you in jail,
    Steal a lot and they make you king.
    There's only one step down from here, baby,
    It's called the land of permanent bliss. 
    What's a sweetheart like you doin' in a dump like this?

    Lyrics of a Bob Dylan song forwarded by Amian Gadal [DGADAL@CI.SANTA-BARBARA.CA.US

    "The Accounting Cycle Does Senator Enzi Support Accounting Lies? by J. Edward Ketz, SmartPros, November 24, 2003 ---

    I continue to find amazing some public statements enunciated by members of Congress. It reminds me of the witticism to be sure that your brain is engaged before putting your mouth into gear.

    Consider recent comments by Senator Mike Enzi (R-Wyoming), who is holding hearings to allow small business executives to spout off against accounting reform. Specifically, these managers are yet again attempting to thwart the the Financial Accounting Standards Board's efforts to require the expensing of stock-based compensation. Of course, they covet the privilege of abusing corporate resources instead of acting as good stewards for the owners -- the stockholders of the business enterprise.

    The Washington Post reports that the senator berated the chairman of the FASB Robert Herz with the comment, "I’m hoping small businesses don’t have to wage an 11th-hour campaign to get FASB to listen." He also chided Herz to contemplate the effects upon small businesses. Oddly, the senator didn’t advise Herz to ask investors and creditors about the consequences of poor and reprehensible accounting practices.

    These corporate officials provide no new arguments or theories to bolster their claims, but rely on vacuous assertions. They claim that expensing options will hurt their search for talented managers, but cannot generate any evidence to that effect. Given that Microsoft now expenses stock-based compensation and appears not to have troubles hiring good people, I believe the assertion false.

    Continued in the article

    March 2004 Update
    From The American Assembly --- 
    The Future of the Accounting Profession --- 

    What Went Wrong? 
    As the bubble economy encouraged corporate management to adopt increasingly creative accounting practices to deliver the kind of predictable and robust earnings and revenue growth demanded by investors, governance fell by the wayside. All too often, those whose mandate was to act as a gatekeeper were tempted by misguided compensation policies to forfeit their autonomy and independence. The technology stock bubble of the late 1990s – and the puncturing of that bubble in 2000 – coincided with significant failures in corporate governance.

    On November 13, 2003, fifty-seven men and women, including leaders from the worlds of accounting, finance, law, academia, investment banking, journalism, non-governmental organizations, as well as the current and former regulatory officials from The Federal Reserve Board, the Securities and Exchange Commission (SEC), the General Accounting Office (GAO), the Public Company Accounting Oversight Board (PCAOB), The Financial Accounting Standards Board (FASB), and the International Accounting Standards Board (IASB) gathered at the Lansdowne Resort, Leesburg, Virginia, for the 103rd American Assembly entitled “The Future of the Accounting Profession.” Over the course of the Assembly, the distinguished professionals considered three broad areas of the accounting profession: its present state, its desired future state, and how it might reach that future state. 

    This Assembly project was co-directed by Roderick M. Hills, Partner, Hills & Stern, and former Chairman of the SEC, and Russell E. Palmer, CEO, The Palmer Group, former CEO, Touche Ross & Co. Initiated by the co-directors in fall 2000, this project showed an extraordinary prescience of the material events that subsequently unfolded. The project benefited greatly from the advice and active guidance of an eminent steering committee, whose names and affiliations are listed in the appendix of this report.

    There are too many conclusions and recommendations to summarize concisely.  Several that caught my eye are as follows:

    Accounting firms must seek out job candidates with a strong knowledge of business and finance. We believe that the Big Four.  Accounting firms must seek out job candidates with a strong knowledge of business and finance. We believe that the Big Four

    The consolidation of the accounting industry has come at a cost for the profession. With fewer alternatives, companies may have few options to their current auditors. This may be a situation that is difficult to correct, but it is one that demands that regulators seek to maintain public confidence in the surviving Big Four accounting firms, and where auditing firms themselves strive to overcome the limitations created by their market dominance.

    To remain a profession, auditors need to address issues ranging from the potential problems or conflicts created by the consolidation of their industry to the need to restore their credibility to attract the ‘best and the brightest’ of college graduates.

    Auditing firms must place the appropriate value on the partners who conduct top-quality audits, not solely on those ‘rainmakers’ who bring in the most new business. The goal must be to maintain topnotch auditing standards.

    Bob Jensen's Conclusions

    The names of the participants are included in the above final report.  Given the tremendous amount of talent and experience of this group, I was disappointed in the rather unimaginative conclusions.  In the end, a song came to mind with the lyrics "Is that all there is?"   

    What is wrong with the report it that it is like focusing on medical doctors to correct the exploding problem of diabetes, prostate cancer, and breast cancer in urban society.  Another analogy would be to focus on the police to correct the problem of crime in large U.S. Cities or the Border Patrol to stop the rising tide of illegal immigration in the United States.

    The recent flood of scandals in the accounting, tax, and auditing professions were inevitable in the growing sickness of urban society and culture where families more pride in money than in honor and/or the breakdown of family infrastructure altogether.  Honesty begins at home.  If home fails, then honesty  is forced by the sanctions imposed by strict law enforcement such as we find in very few societies other than Singapore.  Law enforcement has not broken down in the United States, which is one of the major factors that makes the U.S. a better place to live than in many other nations.   But many think that we are now fighting a losing battle. 

    But law enforcement is broken when it comes to white collar crime in nearly all nations of the world and especially in the United States.  Business leaders violate the laws and push unethical behavior to the edge because these shameful acts pay big time even in the unlikely event they will be caught.  

    Conclusions that are lacking in the above report include the following conclusion by Bob Jensen:

    Unmentioned Recommendation 1  
    The accounting profession must develop a strategy and funding to combat white collar crime and tax evasion where it will do the most good in modern times.  There are many fronts on which this war can be fought, including the following:

    • Commence a major lobbying effort and media blitz to promote stiff penalties that will discourage white collar crime and ethics violations.  Instead of lobbying against corruption-preventative like tax shelters legislation, the accountancy profession should undertake an expensive lobbying effort to curb the crimes of their clients and punish the wrong doers in ways that effectively discouraging wrong doing.  For one thing, wrong doers should be required to recompense the victims of their crimes for the rest of their lives such that the wrongdoers cannot emerge from bankruptcy and/or Club Fed and live a life of luxury while their victims wallow in poverty.
    • Just as important as stiffer penalties are the curbing abuses used by white collar criminals to not be indicted.  For example, Tyco's CEO and other executives were allowed to appoint their co-conspirators to Boards of Directors who then approved those executive's ploys to loot the corporations for personal gain.  The entire process of appointing Boards of Directors and Audit Committees is flawed in favor of white collar criminals at the executive level.
    • Instead of lobbying for abusive tax shelters in Washington DC, all accountancy lobbying resources should be aimed at eliminating tax shelters even though elimination of tax shelters results in lower client fees.

    • Commence a major lobbying effort that encourages and rewards whistle blowing both in client firms and in auditing firms.

    Unmentioned Recommendation 2  
    Make all persons in society accountable for their resources and life styles.  One means of doing this is doing this is to eliminate cash in all economic affairs.  Every economic transaction should be accompanied by an auditable trail.  A cashless society that is now technologically feasible is one way to start.  The accounting profession should commence to seriously lobby for a cashless society.

    I guess what I am really trying to say is that the accounting profession will never solve the problems that are emerging without solving the causes of those underlying problems.  Medical doctors cannot stop the rising tide of diabetes without devoting their professional efforts and resources to changing life styles, food quality, and eating trends in modern society.  Juvenile crime and drug addiction cannot be solved without creating economic incentives to strengthen family values and parental controls.  White collar crime cannot be solved without providing genuine preventative measures aimed at the root causes.

    March 5, 2004 reply from Roger Collins [rcollins@CARIBOO.BC.CA

    Bob, in response to your challenge - under Unmentioned recommendation 1 you say that

    the accountancy profession should undertake an expensive lobbying effort to curb the crimes of their clients

    Did you mean "expensive" - "extensive" or perhaps both ? :-)

    One other thought. White collar crime seems to be so ubiquitous these days that its almost an alternative career path; if you get caught, its Club Fed; when you've done your time, it could well be back to your cosy little niche in the business pantheon. Maybe the powers that be should consider a more creative sentencing regime that separates these crooks from their place in society. I suppose that we won't get the chance to bring back the stocks or the pillory - but instead of 5 years in the (play) pen at taxpayer expense, how about twenty years at the neighbourhood car wash or sewage farm, accompanied by compulsory relocation to one of the "nicer" inner-city neighbourhoods (Watts, say, or Cook county)? As I said, just a thought ... :-)


    March 5, 2004 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU

    Roger's comments about light sentences for corporate fraud crimes reminded me of a session I attended last week on governance matters. One of the speakers was a retired federal judge. He showed a copy of the sentencing guidelines for various federal crimes and noted that those guidelines provide for potential prison terms for Sarbanes-Oxley type crimes that are longer than for murder. 

    Denny Beresford

    March 6, 2004 reply from Bob Jensen

    Hi Denny,

    If the odds are 99-1 that you won’t get caught and 10-1 that you can plea bargain down to no jail time, the expected value of a $1 million heist is pretty high.

    After after seeing the light sentences (e.g., Fastow got the "huge" ten years and Waksal got eight years), the new Sarbanes guidelines are a welcome relief.  However, the National Association of Defense Lawyers, a very powerful lobbying group, is still in there fighting against tough sentences and for loopholes.  Spit will most likely freeze in the Mojave Desert the day that any non-violent CEO or CFO gets more than 10 years in Club Fed in spite of the sentencing guidelines.  The Association of Defense Lawyers wrote the following in a lobbying letter --- 
    Note that a $1 million theft may ultimately get you “41-51” months.

    Given that the statutory maximum constraints on the offense levels have been substantially revised by the Congress via Sarbanes-Oxley, the current loss table, supplemented by carefully-tailored specific offense characteristic enhancements (including those in the proposed permanent amendments), will more than adequately punish those offenders who operate at the highest levels of economic crime. Many of the offenses potentially affected by a wholesale revision of the loss table involve criminal statutes and scenarios untouched by the Sarbanes-Oxley amendments. Most of the cases affected by the economic guidelines and loss table involve individual defendants who are low-to-mid-level employees who engage in some unremarkable fraud scheme or involve defendants who are not corporate employees at all. There is no suggestion in either the legislative history or the statutory directive that Sarbanes-Oxley was designed to increase sentences for garden-variety fraud or economic offenses, much less those offenses subject to the application of the loss table that do not involve corporate crime. Nor is there any basis or proof to suggest that the current guidelines are not acting as severe enough penalty for, or deterrent to, criminal conduct. A generalized request to “get tough” on crime, arising in the middle of any wave of media stories about corporate or other types of wrongdoing should not be the grounds for changing sentences or guidelines. Indeed, it is precisely in times of passion and emotion that statutes and rules, including those addressing penalties and sentences, should remain constant so that balances that have been carefully struck over time are not tipped for the excitement of the moment.

    . . . 

    The incremental increases in offense levels at the higher end of the consolidated theft and fraud table instituted via the ECP significantly exceed those of their previous separate tables. For example, a $1 million loss in year 2000, even with application of the more than minimal planning offense characteristic, would result in a 30-37 month sentencing range; in contrast, the same offender after the implementation of the ECP loss tables is subject to a 41-51 month range, an approximately 25% increase. Thus, the upward trend will accelerate over the next few years as the sentence increases built into the ECP begin to take effect.

    There are times in life when the project at hand calls for the "bigger hammer" ---

    March 6, 2004 reply from Dave Storhaug [storhaug@BTINET.NET

    In my humble opinion, no true reform will occur until the accounting profession is split into two groups: 1. SEC / Big 4 and 2. Non SEC and NON Big 4 - which is where the true original spirit of the CPA profession still resides. (Note that the "BIG 4" don't even have the words "Public accounting" in theirs names anymore).

    Dave Storhaug Bismarck, ND


    March 5, 2004 reply from Todd Boyle [tboyle@ROSEHILL.NET

    1. Transaction semantics.

    Until accountants agree on unambiguous semantics at the transaction level, there is little hope. Transactions happen between principal parties. Do you call them, parties, persons? or call them by their roles, buyer, seller? This is an example of a few hundred concepts that need accountants' participation and discussion.

    Until we get on the same page with descriptive semantics, there is no hope of having an honest set of books, that agrees with the counterparty in exchanges, let alone, honest financial statements. See Bill McCarthy's stuff. and efforts such as UBL, ebXML, as well as newer work of edifact, and x12.

    2. Drilldown.

    Stakeholders should be entitled to drill down into the numbers in financial statements of publicly listed corporations, period. We need a freedom of information act (FOIA) but meanwhile accountants might lend a hand, ensuring that what is in the financial statements is more objectively tied to the native transaction semantics that arise between the principals in the transactions, instead of our high-fallutin, abstract summary buckets.

    3. Externalities.

    A good case can be made that today's transaction records are essentially, incomplete. (I would not be so charitable! ) A seller of goods or services is rewarded for what they deliver, and rewarded for avoiding and minimizing their costs. Only those persons having some physical power or role to get paid, are paid. Costs to the commons are not paid. Costs to future generations or faraway people, are not paid, nor, the harms or costs inflicted on people who do not have recognized title, within our monolithic global title system, to be paid.

    When I was in school in the 1970s there was a lot of discussion about social costs and externalities. I think this is an essential element in accounting reform, if financial statements are to be viewed as anything other than sophisticated lies, to protect the interests of the powerful and the privileged.

    Accountants maintaining the GAAP framework need to admit the truth: economic substance includes more than the systems of title and commercial law in each jurisdiction.

    Can't we contribute, with other professions, towards a conceptual framework for economic substance of commons, like the environment? That alone would be a priceless contribution. Today's decisions, based on incomplete quantitative models, are doing immeasurable harm.

    Another candidate for increased work would be measurement of economic costs, of disenfranchised stakeholders in economic processes such as workers. There are other categories of unacknowledged and unrecorded economic advantage.

    There is a worldwide anti-globalization movement. Their basic message is that corporations should not move operations wherever protections for labor and the environment are most underdeveloped. The delta between such things as environmental compliance costs, pension and health benefits in different jurisdictions is a rich source of quantitative bases for improved financial statements.

    The other broad complaint of anti-globalization concerns income inequality. Here again, accountants are in a position to help, with transparency. Transparency invariably results in greater fairness and freer competition.

    In summary let's take a step back from the transactions records, long enough to realize, they are so incomplete as to be essentially, a sophisticated lie. A self-serving fairy tale, accurate to the penny with the quantities agreed by arms-length haggling between the powerful, while excluding material interests of other stakeholders.

    When the very numbers in your bank account are a lie, is it any wonder the financial statements of the global 500 corporations are a lie?

    Todd Boyle ex-CPA 
    Kirkland WA - 425-827-3107  , 

    CEOs gain from poor performance of share prices
    Limiting severance pay for chief executives has been an increasingly popular idea among investors. Shareholder proposals like Mr. Chevedden's went to a vote at 21 companies last year and received an average of 51 percent of the votes.  But AMR was not going to let its shareholders vote on the matter just because it may have seemed to be what investors wanted. No, AMR officials first wanted to make sure that Mr. Chevedden was still eligible to put something on the ballot. So it checked to see how much his shares were worth.  As it turned out, AMR has performed so poorly in the last few years - the price of its stock has fallen about 70 percent since mid-2001 - that Mr. Chevedden's 100 shares are now worth just $900. And that is well below the $2,000 minimum stake the S.E.C. says a shareholder must have if he or she wants to make a proxy proposal.  AMR asked the regulators for permission to exclude Mr. Chevedden's suggestion for that reason. The company even provided evidence of how weak its stock has been lately.  Last month, Mr. Chevedden complained to regulators that AMR was "implicitly bragging about the declining price" of its stock, and he appealed to their sense of fairness. He asked them not to use the ownership requirements to "disenfranchise long-term continuous shareholders" simply because "the company stock price has sunk."  But rules are rules, so the commission sided with AMR. An AMR spokesman said that the company had no choice but to disqualify Mr. Chevedden.
    Patrick McGeehan, "The Fine Print Keeps Small Investors Silent," The New York Times, March 13, 2005 --- 

    What is moral hazard?  How is a new reward policy by Microsoft creating moral hazard?

    Moral hazard arises when a system or policy within government, corporations, families, law, or elsewhere creates an opportunity to gain from being immoral and/or unethical.  In many cases the hazard invites an illegal act for personal gain.  The best known moral hazard is an insurance contract.  For example, during the S&L crisis it was reported that some owners of luxury cars who had lost their jobs and could no longer afford high car payments were leaving them parked on San Antonio streets in high crime areas with the keys in the car.  This was an open invitation to have the cars stolen just to collect insurance money in a city where thousands of cars are stolen each month and disappear south of the Rio Grande.  

    Where's the moral hazard?  The moral hazard arises when it was more profitable to simply collect insurance money than to take the time, cost, and risk of selling in a down market.  Arson is frequently committed because of the moral hazard of fire insurance.  Life insurance sometimes creates a moral hazard for murder or faked suicide.

    Much of the recent looting of corporations by top management was caused by moral hazard arising from lax oversight by "gatekeepers" such as auditors, audit committees, and boards of directors.  Lax punishment of white collar crime is a huge source of moral hazard --- 

    Another similar type of moral hazard is caused by lax law enforcement.  Near the south Texas border, children from Mexico who steal vehicles in Texas are seldom prosecuted.  Instead they are returned to Mexico and reappear the next day attempting to steal more vehicles.  Adults use very young children in organized gangs because children are less likely to be prosecuted.

    Microsoft is creating somewhat of a moral hazard with a new policy of offering rewards for the capture of hackers.  The reward $250,000 is probably pretty good pay for teenagers in countries where penalties are very lax for first-time teenage offenders.  Germany is one of those countries with lax penalties.  

    If I were a teenager hacker in Germany, I might think about raising some hell for Microsoft and then have my friends or parents turn me in for the reward.  Chances for probation are very high, and the reward collected may be enough to finance my college education.

    It is not clear that Microsoft really "won one."

    "In Virus Wars, Microsoft Wins One," by Nick Wingfield, The Wall Street Journal, May 10, 2004, Page A3 ---,,SB108401726263605863,00.html?mod=home_whats_news_us 

    Firm's Cash-Reward Offer Yields Its First Arrest Sasser Suspect in Germany

    Microsoft Corp. claimed a breakthrough in the war against computer viruses, after the software company's cash-reward program led to the arrest of a German teenager believed to be responsible for the disruptive "Sasser" and "Netsky" programs.

    After a whirlwind three-day effort to validate a tip from informants, authorities in the German state of Lower Saxony on Friday arrested an 18-year-old engineering student at a local technical school. The suspect, who wasn't identified by name, later confessed, German police said.

    Microsoft said its Munich offices received the tip by telephone from acquaintances of the suspect. Executives at the Redmond, Wash., company said the informants will together collect a $250,000 reward from Microsoft if the suspect is convicted. The company wouldn't identify the informants or give much additional information about them, other than to say there was more than one person and fewer than five.

    "For us, this is something of a defining moment in demonstrating our ability to combat malicious code in collaboration with the authorities," said Brad Smith, Microsoft senior vice president and general counsel.

    The arrest is the first time a suspect has been nabbed under a reward program that Microsoft launched in November, setting up a $5 million fund, in conjunction with Interpol, the Federal Bureau of Investigation and the Secret Service. Writers of viruses, worms and other disruptive programs typically target computers running Microsoft's dominant Windows operating system and other software. The increasingly debilitating impact of the malicious programs has started to hurt Microsoft's software sales to corporations.

    Security flaws in its software have proved difficult for Microsoft to eliminate. But if more hackers prove willing to snitch on each other for money, virus writers could be deterred by the threat of jail time from releasing their creations. Files found on suspects' computers also could lead to additional arrests, and provide other information to help security experts block malicious code.

    Sasser began infecting computers across the Internet just over a week ago. Unlike other malicious programs, which typically infect computers after users click on attachments to e-mail messages, Sasser doesn't require a user to take any action. Instead, the worm scans the Internet for vulnerable computers, infects them and uses those machines to search for other potential targets. Sasser doesn't erase files on a user's computer, but it does slow down computers, causing them to crash in some cases.

    Security experts believe Sasser has infected millions of computers globally on the Internet. Last week, it infected a third of Taiwan's post-office branches, and 20 British Airways flights were each delayed about 10 minutes Tuesday due to Sasser troubles at check-in desks, according to the Associated Press.

    Despite the arrest of its suspected creator, Sasser is expected to continue its disruptions. "It's a bit like Pandora's box -- once the box has been opened, you can never put it away," said Graham Cluley, a senior technology consultant at Sophos Inc., a security software firm in Lynnfield, Mass. "We believe the worm will carry on infecting people for months to come."

    Early yesterday, not long after the German suspect's arrest was announced, a new variant of the Sasser began infecting computers in Portugal, France and other European countries, according to executives at PandaLabs, a security software firm. "This fact confirms our fears that he is not the only person programming the Sasser and Netsky worms, but rather it is an organized group of delinquents," said Luis Corrons, head of PandaLabs.

    Security experts had previously suspected that a group called Skynet was responsible for both Sasser and Netsky, a program released early this year that has been followed by many variants. A message contained in a recent variant, Netsky.AC, claimed responsibility for the group.

    Microsoft said it received the tip Wednesday from the informants, who were aware of the reward program. Company investigators in Europe and the U.S. began working feverishly to verify technical information provided by its informants to prove that the suspect was the creator of the Sasser worm, the company said. Once it verified the information from the informants, which it declined to describe, Microsoft said it notified German police.

    Continued in the article


    Selected works of FRANK PARTNOY
    Bob Jensen at Trinity University  


    Will it ever be possible to prevent Wall Street from becoming rotten to the core without freezing it?

    This is a Very Depressing Commentary About Continued Rot

    Investors appear to be losing the war with Wall Street
    "The Street's Dark Side:  The markets can still be treacherous for investors," by Charles Gasparino, Newsweek Magazine, December 20, 2004 --- 

    The hammer came down quickly on Wall Street after the stock-market bubble burst. Regulators and lawmakers, under pressure to avenge the losses of millions of average Americans duped by unscrupulous brokers and corporate book-cookers, imposed swift reforms. Eliot Spitzer, the crusading New York state attorney general, demanded big brokerage firms overhaul their fraudulent stock research (they had been hyping companies that paid them huge investment banking fees). Congress passed the Sarbanes-Oxley Act to tighten up accounting and other standards for corporate behavior. With the reforms in place, Wall Street was again "an environment where honest business and honest risk-taking will be encouraged and rewarded," William Donaldson, chairman of the Securities and Exchange Commission, declared in a speech last year.

    Despite the changes, however, Wall Street remains a treacherous place for the small investor. The big financial firms are still rife with conflicts that put their own interests, and those of big banking clients, ahead of everyone else's. (Just last week, for example, Citigroup was fined $275,000 for steering customers to invest in certain Citigroup funds that were "unsuitable'' for them.) Also, watchdog agencies like the SEC, even with bulked-up resources, continue to be ill-equipped to root out corporate crime. And when investors think they've been cheated, the system for ruling on their complaints remains stacked against them. "There are all sorts of practices and conflicts of interest on Wall Street that still have to be addressed, " says John Coffee, a Columbia University law professor.

    . . . 

    Conflicts (Continued): During the 1990s, brokerage firms, regulators and lawmakers agreed to tear down the legal barriers that forced commercial bankers and investment bankers to operate independently. Wall Street quickly sought out merger partners, creating behemoths like Citigroup and JPMorgan Chase. They touted the convenience of one-stop shopping for consumers. But they also created incentives for staffers in different divisions to steer business to each other that would help the overall company. Spitzer's probe, for example, showed that many research analysts, supposedly peddling objective ratings, were working hand in glove with banking colleagues to win lucrative underwriting business from big corporate clients. The carrot for analysts: their compensation was tied in large part to the banking business they helped win. That's why analysts like Jack Grubman of Salomon Smith Barney told investors that he thought WorldCom was a "buy,'' even as it fell from more than $60 a share down to penny-stock territory.

    Spitzer's settlement with Wall Street in 2002 was supposed to establish a higher wall separating banking and research; analysts could no longer work with bankers to pitch to corporate clients, and their pay had to be separated from such deals. But what's really changed? Analysts, under the guise of "due diligence,'' can still meet with executives around the time they're considering which investment bankers to hire. And many Wall Street firms acknowledge that investment-banking fees continue to flow into a pool of money used to pay analysts.

    Are analysts' judgments more objective? Consider Google, which went public in August. Morgan Stanley's top Internet analyst, Mary Meeker, has been among Google's biggest boosters. Meeker was not supposed to play a direct role in helping Morgan land a slot to underwrite the IPO. But Morgan confirms that she did talk with Google founders Larry Page and Sergey Brin in meetings and lunches before the IPO. People familiar with the deal say those meetings helped play a big role in helping Morgan land the Google underwriting work. Meeker, along with the other four analysts whose firms underwrote the IPO, have been devoted cheerleaders of the stock, even as it has climbed from its $85 IPO price to above $171, a 101 percent increase in a matter of months. Clearly, it was a great call for those who bought at the outset. But many professional investors are now betting that at these levels, the stock is too pricey and due for a fall (recently the so-called short position on the stock jumped 34 percent in a month). Some Wall Street firms agree, particularly those who weren't part of the IPO underwriting. Morgan officials say that Meeker's call reflects her belief in the stock's potential.

    Weak Watchdogs: If Wall Street firms could use a few more walls, the regulators charged with overseeing the firms could use fewer. The task of policing sprawling companies like Citigroup and JPMorgan Chase, which employ hundreds of thousands of people, is difficult enough. But the responsibilities for regulating them are also divided among different agencies—the Federal Reserve oversees banking, while the SEC regulates the securities side. NEWSWEEK has learned a nasty turf battle has erupted between the two agencies. The SEC wanted to examine possible leaks of confidential information from a firm's bank-debt departments to its trading desk. People at the SEC say it could open up a whole new area of insider-trading abuse. Counterparts at the Fed, however, "went nuts," according to a high-level SEC official, and tried to block the exam. SEC chairman William Donaldson conceded in a recent interview with NEWSWEEK that the Fed's mission has at times put it at odds with SEC. Neither agency would comment on the incident. "We're a cop,'' he said, noting that the Fed's main task is to protect the banking system. "We have two different roles," he added.

    A more fundamental problem with much of Wall Street oversight is the notion of "self-regulation.'' Because of their limited resources, regulators ask Wall Street firms to police themselves in some areas. Their legal and "compliance" departments, for example, are supposed to provide "frontline'' regulation of their own brokerage departments. It doesn't always work out that way. Just ask Robert Pellegrini, who owns a winery on New York's Long Island. He says lax oversight allowed his financial adviser, Todd Eberhard, to steal about $1.2 million from his brokerage account. Eberhard later pleaded guilty to criminal securities fraud for making improper client trades, and he awaits sentencing that could land him in jail for 25 years. Pellegrini says in an arbitration claim that for several years, UBS PaineWebber processed Eberhard's illegal trades, despite numerous red flags. A simple background check by PaineWebber, his lawyer Jake Zamansky says, would have showed that three other firms refused to clear trades for Eberhard because of customer complaints. Eberhard Investment Advisors was not even registered with the NASD. A spokeswoman for PaineWebber said it "fully complied with its obligations as a clearing firm" and will "vigorously defend the allegations."

    Justice Served? When customers like Pellegrini think they've been misled by a Wall Street broker, they have only one option for pressing their claim: to submit to arbitration. (Investors, when they sign up for a brokerage account, effectively sign away their right to use any system to settle a dispute.) But investors complain the deck is stacked against them, because the arbitrators are appointed by the industry, resulting in decisions that often favor the Wall Street firms. Investors won about half their cases last year, for example. Spitzer has said they should be winning more. Speaking before a private meeting of lawyers in Ft. Lauderdale, Fla., two weeks ago, Spitzer, according to a lawyer who was present, said he was frustrated that arbitration panels were blocking the use of evidence of conflicted research that he released as part of his investigation.

    Investors appear to be losing the war with Wall Street in recovering money over conflicted research. Attorney Seth Lipner estimates that only 30 percent of all cases alleging that investors lost money because they relied on conflicted research has resulted in an award of money. Lipner blames the terms of the $1.4 billion settlement that Spitzer reached with Wall Street—the firms were allowed to pay the fine and agree to certain structural changes without having to admit guilt for misleading investors. "It has basically allowed arbitration panels to throw cases out," Lipner says. A spokesman for Spitzer says it's up to the courts to determine guilt, and that he simply laid out the evidence so investors could recoup their money. All of which proves that the best defense may be a twist on the old warning: caveat investor.

    Regulators are concerned about Wall Street firms tipping off selected investors to information about securities offerings.
    "Securities Cops Probe Tipoffs Of Placements," by Ann Davis, The Wall Street Journal, December 16, 2004; Page C1 ---,,SB110315579554001426,00.html?mod=home_whats_news_us 

    Regulators are examining whether insiders at Wall Street firms that oversee big securities offerings for corporate clients have tipped off selected investors with valuable information about deals that can cause stock prices to fall.

    Two recent cases demonstrate the regulators' concern: Federal prosecutors this week charged a former SG Cowen trader with trading on confidential knowledge that the firm's corporate clients were about to issue millions of dollars of new stock. Last month, the Ontario Securities Commission in Canada accused the Canadian brokerage house Pollitt & Co. and its president in a civil action of tipping off some clients to a pending deal involving bonds that could later be converted to stock. The Ontario authorities also accused one client of acting on the tip.

    Regulators also are concerned about inadvertent tip-offs. The Securities and Exchange Commission, the New York Stock Exchange and other regulators are especially worried about information related to corporate stock and bond deals that are executed quickly, sometimes overnight. Such deals require brokerage houses to contact potential buyers to see if they are interested in buying the newly available securities, thereby giving them insider information that could be misused. (See a related article.)

    Continued in article

    Bob Jensen's threads on proposed reforms are at 

    Bob Jensen's "Rotten to the Core" threads are at 


    1.  Who is Frank Partnoy?

    Cheryl Dunn requested that I do a review of my favorites among the “books that have influenced [my] work.”   Immediately the succession of FIASCO books by Frank Partnoy came to mind.  These particular books are not the best among related books by Wall Street whistle blowers such as Liar's Poker: Playing the Money Markets by Michael Lewis in 1999 and Monkey Business: Swinging Through the Wall Street Jungle by John Rolfe and Peter Troob in 2002.  But in1997.  Frank Partnoy was the first writer to open my eyes to the enormous gap between our assumed efficient and fair capital markets versus the “infectious greed” (Alan Greenspan’s term) that had overtaken these markets.

    Partnoy’s succession of FIASCO books, like those of Lewis and Rolfe/Troob are reality books written from the perspective of inside whistle blowers.  They are somewhat repetitive and anecdotal mainly from the perspective of what each author saw and interpreted. 

    My favorite among the capital market fraud books is Frank Partnoy’s latest book Infectious Greed: How Deceit and Risk Corrupted the Financial Markets (Henry Holt & Company, Incorporated, 2003, ISBN: 080507510-0- 477 pages).  This is the most scholarly of the books available on business and gatekeeper degeneracy.  Rather than relying mostly upon his own experiences, this book drawn from Partnoy’s interviews of over 150 capital markets insiders of one type or another.  It is more scholarly because it demonstrates Partnoy’s evolution of learning about extremely complex structured financing packages that were the instruments of crime by banks, investment banks, brokers, and securities dealers in the most venerable firms in the U.S. and other parts of the world.  The book is brilliant and has a detailed and helpful index.


    What did I learn most from Partnoy?

    I learned about the failures and complicity of what he terms “gatekeepers” whose fiduciary responsibility was to inoculate against “infectious greed.”  These gatekeepers instead manipulated their professions and their governments to aid and abet the criminals.  On Page 173 of Infectious Greed, he writes the following: 

    Page #173

    When Republicans captured the House of Representatives in November 1994--for the first time since the Eisenhower era--securities-litigation reform was assured.  In a January 1995 speech, Levitt outlined the limits on securities regulation that Congress later would support: limiting the statute-of-limitations period for filing lawsuits, restricting legal fees paid to lead plaintiffs, eliminating punitive-damages provisions from securities lawsuits, requiring plaintiffs to allege more clearly that a defendant acted with reckless intent, and exempting "forward looking statements"--essentially, projections about a company's future--from legal liability.

    The Private Securities Litigation Reform Act of 1995 passed easily, and Congress even overrode the veto of President Clinton, who either had a fleeting change of heart about financial markets or decided that trial lawyers were an even more important constituency than Wall Street.  In any event, Clinton and Levitt disagreed about the issue, although it wasn't fatal to Levitt, who would remain SEC chair for another five years.


    He later introduces Chapter 7 of Infectious Greed as follows:

    Pages 187-188

    The regulatory changes of 1994-95 sent three messages to corporate CEOs.  First, you are not likely to be punished for "massaging" your firm's accounting numbers.  Prosecutors rarely go after financial fraud and, even when they do, the typical punishment is a small fine; almost no one goes to prison.  Moreover, even a fraudulent scheme could be recast as mere earnings management--the practice of smoothing a company's earnings--which most executives did, and regarded as perfectly legal.

    Second, you should use new financial instruments--including options, swaps, and other derivatives--to increase your own pay and to avoid costly regulation.  If complex derivatives are too much for you to handle--as they were for many CEOs during the years immediately following the 1994 losses--you should at least pay yourself in stock options, which don't need to be disclosed as an expense and have a greater upside than cash bonuses or stock.

    Third, you don't need to worry about whether accountants or securities analysts will tell investors about any hidden losses or excessive options pay.  Now that Congress and the Supreme Court have insulated accounting firms and investment banks from liability--with the Central Bank decision and the Private Securities Litigation Reform Act--they will be much more willing to look the other way.  If you pay them enough in fees, they might even be willing to help.

    Of course, not every corporate executive heeded these messages.  For example, Warren Buffett argued that managers should ensure that their companies' share prices were accurate, not try to inflate prices artificially, and he criticized the use of stock options as compensation.  Having been a major shareholder of Salomon Brothers, Buffett also criticized accounting and securities firms for conflicts of interest.

    But for every Warren Buffett, there were many less scrupulous CEOs.  This chapter considers four of them: Walter Forbes of CUC International, Dean Buntrock of Waste Management, Al Dunlap of Sunbeam, and Martin Grass of Rite Aid.  They are not all well-known among investors, but their stories capture the changes in CEO behavior during the mid-1990s.  Unlike the "rocket scientists" at Bankers Trust, First Boston, and Salomon Brothers, these four had undistinguished backgrounds and little training in mathematics or finance.  Instead, they were hardworking, hard-driving men who ran companies that met basic consumer needs: they sold clothes, barbecue grills, and prescription medicine, and cleaned up garbage.  They certainly didn't buy swaps linked to LIBOR-squared.


    The book Infectious Greed has chapters on other capital markets and corporate scandals.  It is the best account that I’ve ever read about Bankers Trust the Bankers Trust scandals, including how one trader named Andy Krieger almost destroyed the entire money supply of New Zealand.  Chapter 10 is devoted to Enron and follows up on Frank Partnoy’s invited testimony before the United States Senate Committee on Governmental Affairs, January 24, 2002 ---

    The controversial writings of Frank Partnoy have had an enormous impact on my teaching and my research.  Although subsequent writers wrote somewhat more entertaining exposes, he was the one who first opened my eyes to what goes on behind the scenes in capital markets and investment banking.  Through his early writings, I discovered that there is an enormous gap between the efficient financial world that we assume in agency theory worshipped in academe versus the dark side of modern reality where you find the cleverest crooks out to steal money from widows and orphans in sophisticated ways where it is virtually impossible to get caught.  Because I read his 1997  book early on, the ensuing succession of enormous scandals in finance, accounting, and corporate governance weren’t really much of a surprise to me.

    From his insider perspective he reveals a world where our most respected firms in banking, market exchanges, and related financial institutions no longer care anything about fiduciary responsibility and professionalism in disgusting contrast to the honorable founders of those same firms motivated to serve rather than steal.

    Young men and women from top universities of the world abandoned almost all ethical principles while working in investment banks and other financial institutions in order to become not only rich but filthy rich at the expense of countless pension holders and small investors.  Partnoy opened my eyes to how easy it is to get around auditors and corporate boards by creating structured financial contracts that are incomprehensible and serve virtually no purpose other than to steal billions upon billions of dollars.


    Most importantly, Frank Partnoy opened my eyes to the psychology of greed.  Greed is rooted in opportunity and cultural relativism.  He graduated from college with a high sense of right and wrong.  But his standards and values sank to the criminal level of those when he entered the criminal world of investment banking.  The only difference between him and the crooks he worked with is that he could not quell his conscience while stealing from widows and orphans.


    Frank Partnoy has a rare combination of scholarship and experience in law, investment banking, and accounting.  He is sometimes criticized for not really understanding the complexities of some of the deals he described, but he rather freely admits that he was new to the game of complex deceptions in international structured financing crime.

    2.  What really happened at Enron? --- 


    3.  What are some of Frank Partnoy’s best-known works?

    Frank Partnoy, FIASCO: Blood in the Water on Wall Street (W. W. Norton & Company, 1997, ISBN 0393046222, 252 pages). 

    This is the first of a somewhat repetitive succession of Partnoy’s “FIASCO” books that influenced my life.  The most important revelation from his insider’s perspective is that the most trusted firms on Wall Street and financial centers in other major cities in the U.S., that were once highly professional and trustworthy, excoriated the guts of integrity leaving a façade behind which crooks less violent than the Mafia but far more greedy took control in the roaring 1990s. 

    After selling a succession of phony derivatives deals while at Morgan Stanley, Partnoy blew the whistle in this book about a number of his employer’s shady and outright fraudulent deals sold in rigged markets using bait and switch tactics.  Customers, many of them pension fund investors for schools and municipal employees, were duped into complex and enormously risky deals that were billed as safe as the U.S. Treasury.

    His books have received mixed reviews, but I question some of the integrity of the reviewers from the investment banking industry who in some instances tried to whitewash some of the deals described by Partnoy.  His books have received a bit less praise than the book Liars Poker by Michael Lewis, but critics of Partnoy fail to give credit that Partnoy’s exposes preceded those of Lewis. 

    Frank Partnoy, FIASCO: Guns, Booze and Bloodlust: the Truth About High Finance (Profile Books, 1998, 305 Pages)

    Like his earlier books, some investment bankers and literary dilettantes who reviewed this book were critical of Partnoy and claimed that he misrepresented some legitimate structured financings.  However, my reading of the reviewers is that they were trying to lend credence to highly questionable offshore deals documented by Partnoy.  Be that as it may, it would have helped if Partnoy had been a bit more explicit in some of his illustrations.

    Frank Partnoy, FIASCO: The Inside Story of a Wall Street Trader (Penguin, 1999, ISBN 0140278796, 283 pages). 

    This is a blistering indictment of the unregulated OTC market for derivative financial instruments and the million and billion dollar deals conceived in investment banking.  Among other things, Partnoy describes Morgan Stanley’s annual drunken skeet-shooting competition organized by a “gun-toting strip-joint connoisseur” former combat officer (fanatic) who loved the motto:  “When derivatives are outlawed only outlaws will have derivatives.”  At that event, derivatives salesmen were forced to shoot entrapped bunnies between the eyes on the pretense that the bunnies were just like “defenseless animals” that were Morgan Stanley’s customers to be shot down even if they might eventually “lose a billion dollars on derivatives.”
    This book has one of the best accounts of the “fiasco” caused almost entirely by the duping of Orange County ’s Treasurer (Robert Citron) by the unscrupulous Merrill Lynch derivatives salesman named Michael Stamenson. Orange County eventually lost over a billion dollars and was forced into bankruptcy.  Much of this was later recovered in court from Merrill Lynch.  Partnoy calls Citron and Stamenson “The Odd Couple,” which is also the title of Chapter 8 in the book.Frank Partnoy, Infectious Greed: How Deceit and Risk Corrupted the Financial Markets (Henry Holt & Company, Incorporated, 2003, ISBN: 080507510-0, 477 pages)Frank Partnoy, Infectious Greed: How Deceit and Risk Corrupted the Financial Markets (Henry Holt & Company, Incorporated, 2003, ISBN: 080507510-0, 477 pages)

    Partnoy shows how corporations gradually increased financial risk and lost control over overly complex structured financing deals that obscured the losses and disguised frauds  pushed corporate officers and their boards into successive and ingenious deceptions." Major corporations such as Enron, Global Crossing, and WorldCom entered into enormous illegal corporate finance and accounting.  Partnoy documents the spread of this epidemic stage and provides some suggestions for restraining the disease.

    "The Siskel and Ebert of Financial Matters: Two Thumbs Down for the Credit Reporting Agencies" by Frank Partnoy, Washington University Law Quarterly, Volume 77, No. 3, 1999 --- 

    4.  What are examples of related books that are somewhat more entertaining than Partnoy’s early books?

    Michael Lewis, Liar's Poker: Playing the Money Markets (Coronet, 1999, ISBN 0340767006)

    Lewis writes in Partnoy’s earlier whistleblower style with somewhat more intense and comic portrayals of the major players in describing the double dealing and break down of integrity on the trading floor of Salomon Brothers.

    John Rolfe and Peter Troob, Monkey Business: Swinging Through the Wall Street Jungle (Warner Books, Incorporated, 2002, ISBN: 0446676950, 288 Pages)

    This is a hilarious tongue-in-cheek account by Wharton and Harvard MBAs who thought they were starting out as stock brokers for $200,000 a year until they realized that they were on the phones in a bucket shop selling sleazy IPOs to unsuspecting institutional investors who in turn passed them along to widows and orphans.  They write. "It took us another six months after that to realize that we were, in fact, selling crappy public offerings to investors."

    There are other books along a similar vein that may be more revealing and entertaining than the early books of Frank Partnoy, but he was one of the first, if not the first, in the roaring 1990s to reveal the high crime taking place behind the concrete and glass of Wall Street.  He was the first to anticipate many of the scandals that soon followed.  And his testimony before the U.S. Senate is the best concise account of the crime that transpired at Enron.  He lays the blame clearly at the feet of government officials (read that Wendy Gramm) who sold the farm when they deregulated the energy markets and opened the doors to unregulated OTC derivatives trading in energy.  That is when Enron really began bilking the public.


    A Topic for Class Debate

    This might be a good topic of debate for an ethics and/or fraud course.  The topic is essentially the problem of regulating and/or punishing many for the egregious actions of a few.  The best example is the major accounting firm of Andersen in which 84,000 mostly ethical and highly professional employees lost their jobs when the firm's leadership repeatedly failed to take action to prevent corrupt and/or incompetent audits of a small number audit partners.  Clearly the firm's management failed and deserves to be fired and/or jailed for obstruction of justice and failure to protect the public in general and 83,900 Andersen employees.  A former Andersen executive partner, Art Wyatt, contends that Andersen's leadership did not get the message and that leadership in today's leading CPA firms are still not getting the message --- 

    Even better examples can be found in the likes of Merrill Lynch, Morgan Stanley, leading investment banks, leading insurance companies, and leading mutual funds that were rotten to the core but not necessarily on the edges where thousands of employees earned honest livings in ethical dedication to their professions.  Their new leaders still don't seem to be getting the message --- 

    The problem is how to clean out the core without destroying all that is good in an organization.  Another side of the problem is how to protect the public from bad organizations filled with mostly honest employees.

    Most of us view The Wall Street Journal (WSJ) as a good source for reporting on financial and accounting fraud and scandal.  By "reporting" I mean that WSJ reporters actually canvas the world and ferret out much of which later gets reported on TV networks (TV networks tend to rely on what newspapers like the WSJ actually discover).  But an editor of the WSJ actually stated to me one time that the WSJ is really two newspapers bundled into one.  The bulk of the paper is devoted to reporting.  But the Editorial Page is often devoted to defending the crooks that are scandalized on Page 1 of the WSJ.  My best example is the saga of felon Mike Milken who was constantly scandalized on Page 1 and defended on Page A14 (or wherever the Editorial Page happened to be that day).

    I tend to have a knee jerk reaction to to get the bad guys or the incompetent guys who should never be put in charge.  But in fairness there is something to be said for using a hammer where a scalpel might do the job.  We have two hammers in the United States.  One is called government regulation.  The other is called tort litigation.  Both can badly injure the innocent along with the guilty.  We have one major scalpel that is very dull and almost never used properly.  That is punishment that deters white collar crime.  White collar crime pays in the United States.  The criminal generally gets away with the crime or gets a very light punishment before retiring in luxury from the take of his or her crime.  In the meantime the crook's honest colleagues like the many employees of Andersen and Enron take the fall.  For my complaints about leniency and white collar crime see 

    Now the top crime fighters in the U.S., who I think are well intended, are taking the heat from Page A14 of the WSJ while Page 1 of the WSJ thinks they are often citing them for their good works.  

    "Mutual Displeasure," Editorial, The Wall Street Journal,  January 17, 2005; Page A14 ---,,SB110591631511827345,00.html?mod=todays_us_opinion 

    The Washington rumor mill has it that SEC Chairman William Donaldson is fighting for his job after a checkered two-year tenure. Whatever the merits of that gossip, Mr. Donaldson has been handed a golden opportunity to both exert some intellectual leadership and quiet his critics by reconsidering the agency's rule on mutual fund "independence."

    That step, we'd add, would also help restore some SEC credibility. No one denies the recent corporate scandals deserved a tough response, and the federal prosecution of individual offenders has usually hit the right targets. Far less thoughtful has been the Donaldson SEC's habit of punishing business as a class, especially with broad new rules that seem designed mainly to keep up with New York Attorney General Eliot Spitzer. An agency once admired for thoroughness has become known for its slapdash rule-making -- from shareholder access to hedge funds to stock-exchange regulation.

    The mutual fund "reform" of last summer is a case in point. Red-faced that Mr. Spitzer exposed the late-trading offenses, the SEC rushed to show its relevance with a regulation requiring that 75% of all mutual fund board directors be "independent," including the chairman. What this means in practice is that folks like Edward Johnson, who has run Fidelity Investments for three decades without scandal and whose reputation has helped to attract investors, now must step aside.

    Of hundreds of funds managing $7.5 trillion in assets, some 80% have chairmen from management, while about half fail the 75% "independent" standard. The process of identifying, recruiting and appointing independent members will not only be costly but will divert resources away from more profitable uses. The independent directors of one small fund ($218 million assets) estimate compliance with just the 75% independent director rule would cost its shareholders an average of $20,000 a year.

    The requirement is so arbitrary that Congress has asked the SEC to justify its actions, while the U.S. Chamber of Commerce is suing to have it thrown out. And with good cause. The SEC may not even have the authority under the 1940 Investment Company Act to require corporate governance standards -- and the agency knows it. That's why, rather than mandate the requirements straight out, it instead made the industry's continued use of certain standard regulatory exemptions (which the SEC does have power to grant) contingent on adopting the new requirements.

    Under the 1940 Act that established mutual fund standards, Congress considered and rejected a requirement that even a simple majority of the fund's directors be independent. Congressional testimony at the time noted that many investors were "buying" the management of a particular person, and that they wouldn't be served by a board that constantly overrode that person's decisions.

    Now, it's possible to argue that new times call for new ways to make boards more accountable. Yet the SEC didn't even try. Agencies have an obligation to examine what new rules mean for competition and capital formation, and when the mutual fund rule got rolling Republican Commissioner Cynthia Glassman called for economic analysis of independent- vs. management-chaired funds, as well as of the rule's costs. Mr. Donaldson claimed he too wanted more info.

    No report was ever done. Mr. Donaldson ignored research that did exist, in particular a Fidelity-sponsored study showing that fund companies with independent chairmen have worse investment performance. "There are no empirical studies that are worth much," he pronounced when he and the two Democratic Commissioners approved the rule by 3-2 vote in June. "You can do anything you want with numbers." Well, yes, as the SEC vote showed.

    The process was such a stinker that the two other GOP SEC Commissioners filed a rare official dissent. They noted the rule was arbitrary (why 75%?) and failed to consider less onerous alternatives, and they bemoaned the lack of analysis. The SEC had acted by "regulatory fiat" and "simply to appear proactive." Ouch.

    Led by New Hampshire Senator Judd Gregg, Congress has passed legislation demanding the SEC submit a report to Congress by May showing a "justification" for the new rule, including whether independent boards perform better or have lower expenses. But the SEC is so far giving Congress the back of its hand and last week rejected a U.S. Chamber request to delay the rule's imposition.

    What's really going on here is that an SEC regulatory staff that failed in its earlier mutual-fund oversight now wants to punish the law-abiding as well as the guilty. This is unnecessary, but it's also unfair. Far from being an embarrassing turnaround, a reassessment is a chance for Mr. Donaldson to prove that both he and his agency are more interested in getting things right, than simply getting things done.

    I might point out that my take on this is that Page A14 of the WSJ  is part and parcel to the establishment on Wall Street and Page 1 of the WSJ is written by reporters who are more concerned with discouraging egregious fraud and incompetence.

    They Just Don't Get It

    Chartered Jets, a Wedding At Versailles and Fast Cars To Help Forget Bad Times.
    As financial companies start to pay out big bonuses for 2003, lavish spending by Wall Streeters is showing signs of a comeback. Chartered jets and hot wheels head a list of indulgences sparked by the recent bull market.
    Gregory Zuckerman and Cassell Bryan-Low, "With the Market Up, Wall Street High Life Bounces Back, Too," The Wall Street Journal, February 4, 2004 ---,,SB107584886617919763,00.html?mod=home%5Fpage%5Fone%5Fus 

    "How Hazards for Investors Get Tolerated Year After Year." by Susan Pulliam, Susanne Craig, and Randal Smith, The Wall Street Journal, February 6, 2004 ---,,SB107602114582722242,00.html?mod=home%5Fpage%5Fone%5Fus

    Corporate Board Minutes Are Altered; Judgments In Arbitration Go Unpaid

    Tainted Wall Street research. IPO chicanery. Mutual-fund trading abuses. Corrupt corporate accounting.

    Investors have been hit with a wide array of scandals over the past two years, tarnishing the reputations of some of the nation's largest corporations and financial institutions. The facts have varied, but the scandals share a common thread: bad behavior that had been tolerated for years, often with regulators and industry insiders looking the other way.

    Savvy investors long knew that some research analysts were overly bullish in recommending shares of their firm's banking clients. But regulators ignored complaints until Eliot Spitzer, the New York attorney general, launched a probe leading to a $1.4 billion settlement with 10 top securities firms last year. Ditto for Wall Street firms that doled out hot initial public offerings of stock to corporate executives to get their companies' financing business -- and in the process, shut out the little guy.

    It also was no big secret that corporate boards rubber-stamped management decisions, stomping shareholders in the process. Abuses were left unchecked until a rash of accounting scandals led to sweeping reforms in 2002 that redefined the duties of directors.

    There are many more such "open secrets": practices that raise eyebrows but persist on Wall Street and in corporate boardrooms. Here are three open secrets -- regarding corporate-board minutes, payment of arbitration awards and pricing of municipal bonds -- that exemplify the hazards to investors.

    Altered Minutes

    One reason it has been so difficult to determine what top management and directors knew about -- and did to cause -- the business disasters of the late 1990s is the distortion of corporate-board minutes. All too often, these critical records are altered or left incomplete. When fraud comes to light, investigators struggle to assign blame, making it harder for investors to recoup losses and less likely that misbehavior will be deterred in the future.

    "The attitude is that it's OK to lie by omission in board minutes," says Charles Niemeier, a member of the Public Company Accounting Oversight Board. "It's the way it gets done, and the problem is that we have become accepting of this." The oversight board was set up under the Sarbanes-Oxley Act, legislation Congress passed in 2002 to improve corporate accountability. While the act addressed financial statements and public filings, lawmakers didn't look closely at problems concerning internal corporate documents.

    Name a corporate blowup, and there is usually an example of board minutes being altered or left incomplete. At Enron Corp., investigators traced the board's knowledge of one dubious off-balance-sheet vehicle only through handwritten notes taken by the corporate secretary during a board meeting in May 2000. The information from the scribbled notes suggested that at least some Enron directors knew the arrangement was an accounting maneuver, rather than something aimed at substantive economic activity. But the formal board minutes from that meeting contained no reference to the directors' knowledge on this point.

    There aren't hard rules on how thorough board minutes should be. As a result, some corporate lawyers routinely use bare-bones minutes as a shield to protect companies from liability.

    "There is a huge gulf between the two schools of thought on board minutes," says Rodgin Cohen, a partner at the New York law firm of Sullivan & Cromwell. "One is that they should be a full recording. The other is that they should be limited. Most lawyers would suggest that they should be quite limited," he says. "It's like anything: The more words you put down, the greater exposure you have." Mr. Cohen says that he advocates more extensive minutes.

    Amy Goodman, a lawyer at Gibson, Dunn & Crutcher who specializes in corporate-governance issues, says that after the recent wave of scandals, many corporate attorneys and their clients are re-evaluating whether they need to include more detail in minutes "to be able to show that directors have acted with due care and in good faith."

    In the WorldCom Inc. fiasco, a court-appointed bankruptcy examiner has found that the company created "fictionalized" board minutes in connection with its announcement in November 2000 of plans to create a so-called tracking stock that would correspond to the performance of its consumer business. The long-distance telephone company, now known as MCI, said at the time that the board had approved this move.

    In fact, the board hadn't given its approval, the bankruptcy examiner, Richard Thornburgh, a former U.S. attorney general, concluded. The board had held only a "minimal" discussion of the idea during a brief "informational" meeting on Oct. 31, 2000, Mr. Thornburgh's report said. WorldCom management decided to transform records from the October meeting into minutes of a formal board meeting, complete with references to a discussion about the tracking stock that hadn't really taken place, the report found.

    One WorldCom lawyer said during the examiner's investigation that transforming the Oct. 31 meeting into a "real meeting was 'wrong' and made the transaction 'look nefarious' when that was not the case," the report said. The examiner faulted former senior WorldCom executives for the decision, although board members and WorldCom lawyers also bear responsibility, the report said.

    The practice highlighted the lack of oversight by WorldCom's board, which contributed to the company's downfall and made it into a "poster child" for poor corporate governance, Mr. Thornburgh has said.

    Bradford Burns, an MCI spokesman, says the company has instituted reforms "to ensure what happened in the past will never happen again."

    Unpaid Judgments

    On those occasions when investors catch their brokers cheating and win an arbitration award -- no small feat -- the customer still sometimes ends up losing.


    Here are three 'open secrets' known to regulators and financial-industry insiders but still harmful to investors

    • Corporate-board minutes are often manipulated, with important facts changed or left out. That makes it difficult, once fraud is discovered, to determine what directors and top managers knew and what they did.

    • Arbitration awards to investors who have been cheated often go unpaid, as, for example, when suspect brokerage firms simply shut down. Wall Street has opposed certain changes that would ease the problem, such as requiring brokerage firms to have increased capital and more liability insurance.

    • Municipal bonds are difficult for individual investors to price because of a lack of information, often resulting in their paying too much. There have been improvements lately, but bond dealers are opposing certain additional reforms that would give investors real-time bond data.


    Fabien Basabe says that in the late 1990s, his brokerage firm recklessly traded away nearly $500,000 of his money. The 65-year-old Miami restaurateur filed an arbitration claim with the National Association of Securities Dealers, as many investors do when they clash with their brokers. In 2002, after a two-year fight, a state court in Florida confirmed an NASD arbitration-panel award ordering J.W. Barclay & Co. to pay Mr. Basabe more than $550,000, plus $150,000 in punitive damages.

    The problem was that the small New Jersey securities firm had closed its doors in early 2001, after it lost the initial round of arbitration. Mr. Basabe has yet to see any money. "I went through all of it for nothing," he says.

    In the first quarter of 2003, the NASD imposed $99 million in damage awards against brokerage firms and brokers nationwide. What the NASD doesn't trumpet is that investors haven't been able to collect $30 million -- or almost one-third -- of that amount during that period, the most recent for which numbers are available. For 2001, the most recent full year for which figures are available, 55% of the $100 million in arbitration awards went uncollected.

    The NASD can suspend the license of a broker or securities firm that refuses to pay up. But many firms and brokers just walk away rather than pay. Because of his disaster with Barclay & Co. (no relation to the big British bank Barclays PLC), Mr. Basabe says he lost his Italian restaurant, I Paparazzi, in the Breakwater Hotel in South Beach.

    In 1987, the Supreme Court ruled that securities firms may require customers to waive their right to sue in court as a condition of opening a brokerage account. Since then, arbitration generally has become the sole forum for customers to seek redress from Wall Street firms. And Wall Street has resisted some steps that could protect investors when firms fail to pay.

    In 2000, the General Accounting Office, the investigative arm of Congress, issued a report calling for improvements in arbitration-award payouts. The NASD has responded by installing a system that tracks unpaid awards and requiring firms to certify they have paid, among other steps.

    But securities firms have successfully lobbied against two other potentially effective reforms. One would increase capital requirements, so that firms would have cash on hand to pay awards. The other would require firms to carry more liability insurance to cover awards. The Securities and Exchange Commission, which oversees the NASD and has jurisdiction on these issues, has reinforced this resistance in its own comments to the GAO.

    In reports released in 2000 and last year, the GAO recounted arguments made by the SEC that increasing capital requirements could force many brokerage firms out of business and potentially penalize responsible firms. The SEC also has argued that stiffer insurance requirements could raise investor costs. Securities-industry executives have told the GAO that carrying more insurance to cover arbitration awards "could raise costs on broker-dealers industrywide and ultimately on investors."

    An SEC spokesman says the agency "continues to explore ideas about how to improve investor recovery of losses from firms that go out of business."

    Investors' inability to collect arbitration awards has broader ripple effects: "A lot of lawyers won't even touch these cases because they know they have no hope of collecting money," says Mark Raymond, Mr. Basabe's attorney.

    The NASD arbitration panel found that the Barclays broker who handled Mr. Basabe's account, Anton Brill, engaged in "intentional misconduct" when he made unauthorized trades. Mr. Brill now works at another securities firm in Florida. He has yet to pay the $6,000 in punitive damages levied against him, or any of the remainder of the arbitration award, for which he is jointly liable.

    In an interview, Mr. Brill said the case took place "a long time ago," adding that the matter is "still under negotiation." He declined to elaborate. After receiving questions about the case from The Wall Street Journal, an NASD spokeswoman said that the association had begun proceedings to suspend Mr. Brill's license.

    Murky Municipals

    In October 2002, John Macko bought $15,000 of municipal bonds issued by a trust organized by the government of Puerto Rico. The 57-year-old lawyer in Geneseo, N.Y., discovered after the fact that he had paid $25 to $44 more per $1,000 bond than brokers paid for the same type of bond during the same trading day. This information wasn't available to him at the time he made his purchases. The muni-bond market, Mr. Macko says, "is very opaque."

    State and local governments issue municipal bonds to raise money for public projects. The bonds typically are exempt from federal taxes, and most are seen as relatively safe investments. Munis trade on an open market, but there isn't a place small investors such as Mr. Macko can go to figure out whether they are getting a fair price. (In contrast, stock prices are reported minute-to-minute by exchanges, and mutual-fund prices are set once a day. Treasury bonds and many corporate bonds are priced throughout the day with a short delay.)

    Bond dealers, with their superior knowledge of the market, can make a legitimate profit on the difference between what they buy bonds for and their sales prices. But dealers have gone a step further: opposing full online dissemination of real-time muni-bond prices that would help small investors. The dealers say that because many munis trade infrequently, it's difficult to determine precise prices. Immediate disclosure of some prices, they add, might increase volatility in the market and cause some dealers to stop trading certain bonds.

    Without fresh data on bond trading, individuals can fall prey to brokers who tack on excessive "markups." An example: Last May, the NASD alleged that Lee F. Murphy, a former broker at Morgan Keegan & Co., charged too much in 35 bond sales, including deals in 2001 for bonds sold by St. James Parish, La., to raise money for solid-waste disposal. Mr. Murphy obtained markups from investors ranging from 4.07% to 7.18%. There aren't specific limits on markups, but the industry rule of thumb is that margins should be well below 5%, unless there are exceptional circumstances, such as the strong possibility that a municipality will default.

    In the case involving the Morgan Keegan broker, the bonds "were readily available in the marketplace, and Murphy offered no special services justifying an increased markup," the NASD alleged. Mr. Murphy, who settled the administrative charges without admitting or denying wrongdoing, was suspended for 15 days and fined $6,000.

    Thomas Snyder, a managing director at Morgan Keegan, says the trades were part of a unique situation in which Mr. Murphy didn't have full information about a volatile, unrated bond. Morgan Keegan officials add that the firm hadn't been sanctioned and that it canceled the trades in question and reimbursed investors. Mr. Murphy wasn't available at the New Orleans office of his current employer, Sterne, Agee & Leach Inc.

    Investors in theory can shop around, as they would for a car. But as a practical matter, most individuals buy municipal bonds through their regular broker and don't do much comparing. Securities laws hold brokers to a higher standard of protecting customers' interests than is applied to merchants such as car dealers.

    Individual investors -- who directly own an estimated $670 billion of the $1.9 trillion in outstanding munis -- are better off than they were just a year ago. That's when the Municipal Securities Rulemaking Board expanded the amount of muni-bond data available on a Web site called The MSRB, a congressionally created self-regulatory body, provides the price, size and time of each trade -- but typically with a delay of up to 24 hours. The board plans to report same-day trade data for many bonds beginning next year.

    But Wall Street is resisting. Brokers are lobbying the MSRB to delay the release of real-time data for some larger trades and lower-quality bonds so that the impact of the disclosures can be examined. These brokers point to the argument about increasing volatility, which, they say, could heighten the risk of trading losses for both dealers and investors.

    Regulatory actions such as the NASD's move against Mr. Murphy have been relatively infrequent, but that may be changing. The SEC and the NASD have launched separate probes of bond pricing, focusing on whether brokers have choreographed transactions among themselves that drive muni prices up or down, to the detriment of customers.

    "OVERCOMPENSATING In Fraud Cases Guilt Can Be Skin Deep," by Alex Berenson, The New York Times, February 29, 2004 ---

    The new wave of corporate fraud trials was supposed to be about systemic problems with the way American companies are run. The trials were supposed to be about the collapse of accounting standards and the way huge stock option grants can corrupt executives.

    Instead prosecutors have spent a lot of courtroom time talking about perks and obstruction of justice - about floral arrangements and hotel bills run up by the indicted executives, as well as whether they lied to prosecutors or federal investigators.

    In the trial of L. Dennis Kozlowski, the former chairman of Tyco International who is accused of looting his company, prosecutors have repeatedly presented evidence of perks received by the defendant, even when the benefits seem only tangentially related to the charges at hand.

    The trial of John J. Rigas, the founder of Adelphia Communications, and his sons Timothy and Michael, which began last week, appears set to follow a similar tack. Prosecutors are preparing to present evidence about safari vacations and a $13 million golf course allegedly paid for out of corporate funds.

    Meanwhile, federal prosecutors investigating Computer Associates, the Long Island software giant, have focused on alleged lies that executives told to prosecutors, not the accounting chicanery that Computer Associates allegedly used to inflate its profits.

    Prosecutors have good tactical reasons for making these trials more about executive greed or obstruction of justice than about accounting or securities fraud, securities lawyers say. White-collar crime cases are often difficult to prove, as prosecutors learned again Friday when the judge in the Martha Stewart case dismissed a securities fraud charge against Ms. Stewart that was at the core of the indictment against her.

    So prosecutors look for every possible way to simplify the cases for jurors - and to make defendants look bad.

    Evidence of defendants' lavish lifestyles is often used to provide a motive for fraud. Jurors sometimes wonder why an executive making tens of millions of dollars would cheat to make even more. Evidence of habitual gluttony helps provide the answer.

    "You're trying to make the case that this individual is greedy, should not be viewed as credible, is only out for himself,'' said Joel Seligman, dean of the Washington University School of Law. "It does have a kind of relevance.''

    But prosecutors have other reasons for introducing evidence of extravagant spending. Because the details of the fraud charges can be so difficult to understand, jurors' decisions may ultimately turn on their personal impressions of the indicted executives.

    "It's a lot more interesting to show the tape of Jimmy Buffett playing in the background and people walking around nude and drunk than to show the dry accounting evidence,'' said James Cox, a professor of corporate and securities law at Duke University, in reference to a videotape played by prosecutors in the Tyco trial about a birthday party for Mr. Kozlowski's wife, Karen. Tyco paid $1 million, about half the cost, for the party.

    "The trial is partly about what the rules are, but a lot about what the defendant is,'' Mr. Cox said.

    Continued in the article

    Sarbanes-Oxley:  What is too much of a seemingly good thing?

    "Class-Action Sarbox," The Wall Street Journal,  January 7, 2006; Page A6 --- 

    At first glance, the study from Stanford University and Cornerstone Research seems to be good news, noting that the number of class-action suits filed in 2005 dropped to 176 from 213 in 2004 -- a 17% decrease. Good-governance types are claiming this decline is a direct result of the 2002 Sarbanes-Oxley legislation working as intended, keeping companies on the straight and narrow.

    Yet as any first-year Wall Street analyst knows, this minor legal reprieve is better attributed to last year's relatively stable stock market. Class-action suits arise out of booms and busts in equity markets: As share prices dive, plaintiffs' lawyers swarm. Yet with last year's stock market less volatile than at any point since 1996, the "strike suit" pickings were lean.

    So what then accounts for those 176 suits? Try . . . Sarbanes-Oxley. It appears the tort bar is now using the law's strict financial-reporting requirements as its latest excuse to sue. A whopping 89% of the suits alleged misrepresentations in financial documents, while 82% claimed false forward-looking statements. Lawyers have certainly used financial documents as a reason to sue in the past, but this year's notable uptick in the number of suits filed that cite this cause of action suggests that the tort bar has found a whole new line of business.

    The real news here is that lawyers managed to drum up so many results-related suits in a year when the stock market was stable and corporate earnings were strong. Just wait for the next economic downturn, when class-action lawyers will be able to exploit Sarbox's new "internal controls" documentation as a roadmap. Our guess is that we have only begun to discover the ways in which Sarbox will be a trial-bar bonanza.

    Continued in article

    Jensen Comments
    A useful reference site from Cornerstone is at
    A Stanford University Press Release is at
    The Stanford University Law School Class Action Clearinghouse is at





    Accounting Tricks and Creative Accounting

    Fake Invoice Fraud
    The owner of the nation's largest computerized machine tool maker was arrested yesterday morning at his California home and charged with orchestrating a tax fraud that cost the government nearly $20 million as well as intimidating witnesses and a federal agent investigating the case.Gene F. Haas, 54, of Camarillo, Calif., the owner of Haas Automation and other companies, was accused in a 52-page indictment of running a bogus invoicing scheme to create fake tax deductions. Mr. Haas was held without bail after his arraignment in Federal District Court in Los Angeles.
    David Cay Johnston, "Executive Accused of Tax Fraud and Witness Intimidation," The New York Times, June 20, 2006 ---

    Bob Jensen's fraud updates are at

    U.S. companies must do a far better job of disclosing financial information, the chief of a federal accounting oversight board said Thursday.
    SmartPros, November 5, 2004 --- 

    U.S. companies must do a far better job of disclosing financial information, the chief of a federal accounting oversight board said Thursday.

    "Some companies are doing the right thing and some business groups are saying the right thing," William McDonough, the chairman of the Public Company Accounting Oversight Board, told a conference of the Securities Industry Association.

    But he added that "vastly more needs to be done, and soon."

    McDonough, a former president of the New York Federal Reserve Bank, began his speech by saying "potential accounting abuses at public companies are still a threat to public trust."

    With a Nov. 15 deadline for meeting financial reporting requirements under the Sarbanes-Oxley Act, McDonough said that now is the time to start thinking about how investors will react to auditors' assessments of companies' "internal controls."

    Internal controls are procedures a company must have in place to make sure financial data like assets and transactions is correctly reflected on its statements.

    The audit board was created by the Sarbanes-Oxley Act in the wake of Enron's 2001 and WorldCom's 2002 collapse. Accounting fraud forced both the corporate debacles.

    The board essentially audits company auditors to make certain financial information is accurately represented and investors get a clear picture of a given company.

    Several corporations have struggled to meet the demands of the Sarbanes-Oxley Act, and McDonough appeared to predict that some will not meet them by the deadline.

    "I am encouraging executives to begin considering now their responses to deficiencies within their companies' internal controls -- not just in making plans to correct those deficiencies, but in deciding how to communicate those corrections to investors and the larger public that relies on transparency in our markets," he said.

    "Continuing Dangers of Disinformation in Corporate Accounting Reports," by Edward J. Kane, NBER Working Paper No. W9634 --- 


    Abstract: Insiders can artificially deflect the market prices of financial instruments from their full-information or 'inside value' by issuing deceptive accounting reports. Incentive support for disinformational activity comes through forms of compensation that allow corporate insiders to profit extravagantly from temporary boosts in a firm's accounting condition or performance. In principle, outside auditing firms and other watchdog institutions help outside investors to identify and ignore disinformation. In practice, accountants can and do earn substantial profits from credentialling loophole-ridden measurement principles that conceal adverse developments from outside stakeholders. Although the Sarbanes-Oxley Act now requires top corporate officials to affirm the essential economic accuracy of any data their firms publish, officials of outside auditing firms are not obliged to express reservations they may have about the fundamental accuracy of the reports they audit. This asymmetry in obligations permits auditing firms to continue to be compensated for knowingly and willfully certifying valuation and itemization rules that generate misleading reports without fully exposing themselves to penalties their clients face for hiding adverse information. It is ironic that what are called accounting 'ethics' fail to embrace the profession's common-law duty of assuring the economic meaningfulness of the statements that clients pay it to endorse.

    What is round tripping?

    What are the best ways to keep debt off the balance sheet?

    How did Enron deceive readers of financial statemetns?

    How did Andersen's audit of Enron fail?


    Principle-based accounting "works well when the financial implications of a transaction can be consistently interpreted by accounting professionals," says Anthony Sanders, a finance professor at Ohio State University who laments that off-the-books deals are often too complicated and esoteric to expect consistent application of accounting principles. "These things are heavily structured and not easy to interpret." 
    'Off the Books' Cleanup Turns Out to Be Tough, by Cassel ?Bryan-Low and Carrick Mollenkamp, The Wall Street Journal, January 13, 2003, Page C1 ---,,SB1042413640174608024,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs  

    "An Analysis of Restatement Matters: Rules, Errors, Ethics, For the Five Years Ended December 31, 2002," free from the Huron Consulting Group --- 

     Objective: Analyze issues relating to public companies that filed restated financial statements (10-K/ A's and 10-Q/A's) during the five-year period from January 1, 1998, through December 31, 2002.

    Purpose: The purpose of our analysis was to identify common attributes within these restatements including the size of the companies, their industry, and ultimately the underlying accounting error that necessitated the restatement. Procedures:

    • Performed a search of all 10K/A and 10Q/A filings in the Edgar database from 1998 through 2002 using the keywords "restate," "restated," "restatement," "revise," and "revised."

    • Refined search to include only "restatements" defined as a restatement of financial statements that was the result of an error, as defined in APB 20. Our report excludes restatements due to changes in accounting principles and non-financial related restatements.

    • Prepared a database and input relevant information for each restatement identified, including the following fields: Company Name; SIC Code; Annual Revenues (from most recent filing); Footnote Disclosure Describing the Restatement Issue; Classification of Restatement Issue; Restating 10K or 10Q; Auditor of Record (limited to amended annual financial statements). 

    Filed restatements went from 158 in 1998 to 330 in Year 2002. Major accounting issues in all years seem to be Revenue Recognition, Reserves/Accruals/Contingencies, Equity, Acquisition Accounting, and Capitalization/Expense of Assets.

    Note the following:

    Not only have the number of restatements been on the rise, but also the number of public registrants is actually decreasing, which makes the restatement growth during the past few years even more dramatic.



    Outrageous Executive and Director Compensation Schemes That Reward Failure and Fraud


     The salary of the chief executive of a large corporation is not a market award for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.
    John Kenneth Galbraith --- Click Here

    If you aren’t (cynical) now, you will by the time you finish the new Bebchuk and Fried paper on executive compensation.  They paint a fairly gloomy picture of managers exerting their power to “extract rents and to camouflage the extent of their rent extraction.”  Rather than designed to solve agency cost problems, the paper makes the case that executive pay can by an agency cost in and of itself.  Let’s hope things aren’t this bad.

    They say that patriotism is the last refuge
    To which a scoundrel clings.
    Steal a little and they throw you in jail,
    Steal a lot and they make you king.
    There's only one step down from here, baby,
    It's called the land of permanent bliss.
    What's a sweetheart like you doin' in a dump like this?

    Lyrics of a Bob Dylan song forwarded by Damian Gadal [DGADAL@CI.SANTA-BARBARA.CA.US

    Bankers bet with their bank's capital, not their own. If the bet goes right, they get a huge bonus; if it misfires, that's the shareholders' problem.
    Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital Louria Hahn, "Missing:  How Poor Risk-Management Techniques Contributed to the Subprime Mess," CFO Magazine, March 2008, Page 53 ---
    Now that the Fed is going to bail out these crooks with taxpayer funds makes it all the worse.
    Bob Jensen's "Rotten to the Core" threads are at

    That some bankers have ended up in prison is not a matter of scandal, but what is outrageous is the fact that all the others are free.
    Honoré de Balzac

    I’d been working for the bank for about five weeks when I woke up on the balcony of a ski resort in the Swiss Alps. It was midnight and I was drunk. One of my fellow management trainees was urinating onto the skylight of the lobby below us; another was hurling wine glasses into the courtyard. Behind us, someone had stolen the hotel’s shoe-polishing machine and carried it into the room; there were a line of drunken bankers waiting to use it. Half of them were dripping wet, having gone swimming in all their clothes and been too drunk to remember to take them off. It took several more weeks of this before the bank considered us properly trained. . . . By the time I arrived on Wall Street in 1999, the link between derivatives and the real world had broken down. Instead of being used to reduce risk, 95 per cent of their use was speculation - a polite term for gambling. And leveraging - which means taking a large amount of risk for a small amount of money. So while derivatives, and the financial industry more broadly, had started out serving industry, by the late 1990s the situation had reversed. The Market had become a near-religious force in our culture; industry, society, and politicians all bowed down to it. It was pretty clear what The Market didn’t like. It didn’t like being closely watched. It didn’t like rules that governed its behaviour. It didn’t like goods produced in First-World countries or workers who made high wages, with the notable exception of financial sector employees. This last point bothered me especially.
    Philipp Meyer, American Rust (Simon & Schuster, 2009) ---
    American excess: A Wall Street trader tells all - Americas, World - The Independent 
    Jensen Comment
    This book reads pretty much like an update on the derivatives scandals featured by Frank Partnoy covering the Roaring 1990s before the scandals broke. There were of course other insiders writing about these scandals as well ---
    It would seem that bankers and investment bankers do not learn from their own mistake. The main cause of the scandals is always pay for performance schemes run amuck.
    The End of Investment Banking ---

    Perks, Payouts, and Pricey Breakups (think golden parachutes) : Takeaways From 2019’s Public-College Presidential-Pay Survey ---

    Jensen Comment
    Except for the golden parachutes I'm all for high salaries and perks that are tied to increased funds that are pegged to exceptional efforts to raise additional funds. The left complains about enormous salaries and perks of CEOs in the private sector. Although I think that some of these in the private sector are outrageous (such as Elon Musk's $56 billion new salary from Tesla). I'm not opposed to very high salaries that can be attributed to efforts of executives.

    The problem is differentiating "success" to the performance of the CEO versus events that would have led to "success" under most any CEO. For example, a $100 million gift to a college may have come about from efforts of former CEOs --- a gift that just happened to come to fruition later on. And there could be other reasons for the gift. The 2020 $100 million gift to the University of Arkansas that follows other huge gifts from the Walton Foundation is probably more a function of location of flagship University of Arkansas since Sam Walton commenced Walmarts and Sam's Clubs in Bentonville, Arkansas that continues to be the home base of this trillion-dollar company.

    The success of Microsoft under CEO Steve Ballmer is probably due more to the prior efforts of Bill Gates. However, the recent remarkable success of Microsoft is probably due more to the efforts of CEO Satya Nadella than to prior CEOs Bill Gates and Steve Ballmer. Nadella transformed the company form a decadent system of fiefdoms into a hugely successful system of collaborators. ---
    Nadella earns every penny of his salary and perks.

    And the Bill Gates and the Gates Foundation benefited from the billions of dollars increase in the value of Microsoft common stock under Satya Nadella.

    As I said enormous CEO salaries are sometimes justified and sometimes not justified. The trick is not overpaying the CEO's who did not really earn those huge salaries and perks.

    Harvard:  CEO Pay is Even More Outrageous Than It Seems

    From the CFO Journal's Morning Ledger on June 29, 2018

    Good morning. Large U.S. companies are increasingly putting caps on director pay, but at levels that are often significantly above existing compensation levels, reports the WSJ's Theo Francis.

    About half of the 100 largest U.S. firms have limited pay to between $500,000 and $1 million, according to a new study by pay consultancy Compensation Advisory Partners. Most set limits at least triple what they currently pay in equity grants, CAP found. 

    Median pay for non-management directors rose 3.4% to $300,000 or more last year, up from $290,000 in 2016, according to the study. Median director pay for a similar group of companies was $257,000 in 2012 and $225,000 in 2008.

    The change comes in response to challenges from shareholders, said Dan Laddin, founding partner of CAP. “The view was that directors had paid themselves too much, and because directors get to decide their own pay, there’s an inherent conflict of interest.”


    "The Pay-for-Performance Myth,"  By Eric Chemi and Ariana Giorgi, Bloomberg Businessweek, July 22, 2014 ---

    Aside from outrageous compensation levels of top executives, my biggest gripe is how executives are paid outrageous salaries and golden parachutes even when they fail

    Jensen Note
    This could be made into a good accounting teaching case on how to account for all of this.

    "Investors Get Stung Twice by Executives’ Lavish Pay Packages," by Grechen Morgenson, The New York Times, July 8, 2016 ---

    . . .

    When compared with those companies’ earnings or revenue, $20 million may not sound like much. But looking at pay another way, said David J. Winters, chief executive at Wintergreen Advisers, a money management firm in Mountain Lakes, N.J., brings a clearer picture of the costs that these lush packages mean for shareholders.

    The analysis suggested by Mr. Winters focuses on the stock awards given to top corporate executives every year, and the two kinds of costs they impose on shareholders. Stock grants are a substantial piece of the pay puzzle: Last year, they accounted for $8.7 million of the $20 million median C.E.O. package, according to Equilar, a compensation analysis firm in Redwood City, Calif.

    Cost No. 1 is the dilution for existing shareholders that results from these grants. As a company issues shares, it reduces the value of existing stockholders’ stakes.

    A second cost to consider, Mr. Winters said, is the money companies pay to repurchase their shares in trying to offset that dilutive effect on other stockholders’ stakes.

    “We realized that dilution was systemic in the Standard & Poor’s 500,” Mr. Winters said in an interview, “and that buybacks were being used not necessarily to benefit the shareholder but to offset the dilution from executive compensation. We call it a look-through cost that companies charge to their shareholders. It is an expense that is effectively hidden.”

    Mr. Winters and his colleague Liz Cohernour, Wintergreen’s chief operating officer, totaled the compensation stock grants dispensed by S.&P. 500 companies and added to those figures the share repurchases made by the companies to reduce the dilution associated with the grants.

    What they found: The average annual dilution among S.&P. 500 companies relating to executive pay was 2.5 percent of a company’s shares outstanding. Meanwhile, the costs of buying back shares to reduce that dilution equaled an average 1.6 percent of the outstanding shares. Added together, the shareholder costs of executive pay in the S.&P. 500 represented 4.1 percent of each company’s shares outstanding.

    Of course, these numbers are far greater at certain companies. The 15 companies with the highest combination of dilution and buybacks had an average of 10.2 percent of their shares outstanding.

    “It’s not only today’s expense,” Mr. Winters said. “It’s that the costs of dilution over time have been going up, so you have a snowballing effect.”

    FIFA World Cup Soccer ---

    Bloomberg, June 3, 2016

    FIFA’s Top Three Bosses Netted $80 Million in Pay and Severance

    Disgraced ex-president Sepp Blatter, former Secretary-General Jerome Valcke and former CFO Markus Kattner shared more than $80 million over the past five years in bonuses, incentives and salary increases that they signed off on themselves, according to soccer’s global governing body. All three men had already been suspended or fired by FIFA. In a separate statement, the Swiss authorities said they raided FIFA’s offices a day ago.

    Bob Jensen's Fraud Updates ---

    Outrageous CEO Perks

    From 24/7 Wall Street on December 11, 2013

    CEO compensation, relative to the amount the average american is paid, has skyrocketed in the past few decades. In 1965, the average CEO pay was 18.3 times the average worker pay. By 2012, CEOs made 200 times workers pay. In addition to huge paychecks, the nation’s biggest corporate heads are also often receiving special treatment and perks that arguably cross the line of fair compensation for work performed. But that's frequently just the beginning.

    Here are eight outrageous CEO perks.

    The total return of the S&P 500 index fell by nearly 40% last year, the second-worst performance by America’s stockmarket since 1825 ---

    But Wall Street's pay packages in 2009 are shooting for all time highs --- Click Here

    "Compensation and the Myth of the Corporate Superstar," by Charles M. Elson and Craig K. Ferrere, Harvard Business Review Blog, February 1, 2012 --- Click Here

    The public is up in arms about some of the big bonuses being paid to the CEOs of big bailed-out banks. The boss of Britain's RBS, one of the biggest casualties of the banking crash, has felt obliged to turn down a $1.5 million bonus in the face of mounting anger and the threat of legislation.

    It all used to be very different. Al Dunlap, the former Sunbeam CEO, and once handsomely rewarded corporate icon, was fond of reminding his investors that "the best bargain is an expensive CEO." Great managers, the argument went, deserve the big bucks because of the tremendous wealth they create.

    According to this logic, expecting RBS to pay its CEO, Stephen Hester, less is analogous to asking that it pay less for any other necessary business commodity. If executive talent has a price, a firm will get only that which it pays for. So if Stephen Hester were not paid his bonus, another firm would bid away his services and RBS would not be able to attract and retain similar talent at more modest pay levels.

    This notion that there is an open and competitive market for highly talented executives is at the heart of the process by which CEO pay is set. Board compensation committees rely almost exclusively on comparisons to CEO compensation at companies of similar size and in similar industries.

    This practice, known as peer benchmarking, is used to approximate the next best employment option for that executive in the labor-market, the reservation wage. Pay is typically targeted at the 50th, 75th, or 90th percentile of this group. The implicit assumption is that a talented manager is interchangeable between firms, and thus should be paid very nearly what other executives are paid.

    But although the notion that talent is a competitive market is both attractive and plausible, it is highly questionable. Executive talent is not fully transferable between companies. Scholars have long recognized a distinction between firm-specific and general skills. It is quite apparent that successful CEOs leverage not only their intrinsic talents but also, and more importantly, a vast accumulation of firm-specific knowledge developed over a multi-year career. Whether it is deep knowledge of an organization's personnel or the processes specific to a particular operation, this skill set is learned carefully over a long tenure with a company and not easily capable of quick replication at other firms. In fact, when "superstar" executives change companies, the result is usually disappointing.

    If this is true, then the CEO labor market is less competitive than CEO compensation committees implicitly assume. Executives are in fact to a great extent captive to their companies, which ought to provide boards with scope for negotiating actively on compensation rather than relying on peer comparisons. The best bargain in corporate America, then, is not Al Dunlap's superstar CEO, but rather the home-grown executive, with whom fair and modest pay is negotiated, often less than suggested by peer comparisons.

    Continued in article

    Bob Jensen's threads about outrageous executive compensation are at

    "Charles O'Reilly: Narcissists Get Paid More Than You Do:  New research explores why some CEOs have such big salaries," Stanford Graduate School of Business, July 2014 ---

    Larry Ellison towered again among the top ranks of the highest-paid CEOs in 2013 with total compensation of $78 million. He is in plentiful company. Sixty-five chief executives took home annual pay of more than $20 million last year. What prompts boards of directors to grant such astounding sums? And why would individuals, who by any objective measure have all their needs satisfied, seek such exaggerated amounts?

    New research by Stanford management professor Charles A. O’Reilly shows that it is the persuasive personality and aggressive “me first” attitude embodied by narcissistic CEOs that helps them land bloated pay packages. Specifically, narcissistic CEOs are paid more than their non-narcissistic (and merely self-confident) peers. There is also a larger gap between narcissists’ compensation and that of their top management teams than is found with CEOs who do not display the trait. The longer the narcissists have held the top post, the bigger the differential, according to the study published in The Leadership Quarterly earlier this year.

    Narcissism is a personality type characterized by dominance, self-confidence, a sense of entitlement, grandiosity, and low empathy. Narcissists naturally emerge as leaders because they embody prototypical leadership qualities such as energy, self-assuredness, and charisma.

    “They don’t really care what other people think, and depending on the nature of the narcissist, they are impulsive and manipulative,” says O’Reilly, whose research examines grandiose narcissism, a form associated with high extraversion and low agreeableness.

    The study that O’Reilly coauthored with UC Berkeley doctoral student Bernadette Doerr, Santa Clara University professor David F. Caldwell and UC Berkeley professor Jennifer A. Chatman, surveyed employees in 32 large publicly traded technology companies to identify the narcissistic CEOs among them. Employees filled out personality assessments about their CEOs, which included rating the chiefs’ degree of narcissistic qualities such as “self-centered,” “arrogant,” and “conceited.”

    They also completed a Ten Item Personality Inventory (TIPI) about their CEOs. In addition, researchers scanned CEOs’ shareholder letters and earnings call transcripts for an abundance of self-referential pronouns such as “I.” Narcissists use first person pronouns and personal pronouns more often than their non-narcissistic peers, prior research shows.

    The scholars chose to focus on the quickly changing, high-stakes technology industry, in part because it prizes individuals who are convinced of their own vision and who are willing to take risks. They figured correctly that it would bolster narcissists with large pay contracts. “In places like Silicon Valley, where grandiosity is rewarded, we almost select for these people,” says O’Reilly. “We want people who want to remake the world in their images.”

    Narcissistic CEOs secure these pay contracts, at least in part, by winning over board members. The study found that companies with highly narcissistic top bosses do not necessarily perform better than those led by less narcissistic chiefs.

    Narcissistic CEO/founders obtained even larger compensation than their narcissistic peers who didn’t found their companies. O’Reilly says this is logical given the extreme self-confidence and persistence of founders, who have to raise capital and overcome obstacles in order to survive.

    “From the board member’s perspective, you’ve got this person who is quite charming, charismatic, self-confident, visionary, action-oriented, able to make hard decisions (which means the person doesn’t have a lot of empathy) and the board says, ‘This is a great leader,’” O’Reilly says, adding that board members might not necessarily see their self-serving, superficial qualities.

    The paper notes that the CEO is often involved in hiring a compensation consultant who sets the CEO’s pay. Thus, it is in the consultant’s interest to make sure the chief is well paid. Unencumbered by a sense of fairness toward others, narcissists believe they are special and will often manipulate others in order to get large pay contracts they believe is their due.

    The study also found that the longer the narcissistic chief executive was in charge, the farther ahead of his team his pay progressed, because he had recurring exchanges with the board, seeking more money for himself and less for his team.

    A large pay divide between the CEO and other top executives can chip away at company morale, leading to higher employee turnover and lower satisfaction, according to O’Reilly’s research. Given the dissatisfaction and protests this pay gap can breed among employees, the researchers questioned how narcissistic CEOs could occupy the big office for so long. While some employees leave on their own accord, the paper supposes that CEOs may “eliminate those who might challenge them or fail to acknowledge their brilliance.” The same lack of empathy that makes narcissists less likeable to underlings also helps these CEOs fire them with little guilt.

    Continued in article

    "The Pay-for-Performance Myth,"  By Eric Chemi and Ariana Giorgi, Bloomberg Businessweek, July 22, 2014 ---


    Bonuses for What?
    The only guy to make almost a $100 Million dollars at GE is the CEO who destroyed shareholder value by nearly 50% in slightly less than a decade

    "GE has been an investor disaster under Jeff Immelt," MarketWatch, March 8, 2010 ---

    When things go well, chief executives of major companies rack up hundreds of millions of dollars, even billions, on their stock allotments and options.

    It's always justified on the grounds that they've created lots of shareholder value. But what happens when things go badly?

    For one example, take a look at General Electric Co. /quotes/comstock/13*!ge/quotes/nls/ge (GE 16.27, +0.04, +0.22%) , one of America's biggest and most important companies. It just revealed its latest annual glimpse inside the executive swag bag.

    By any measure of shareholder value, GE has been a disaster under Jeffrey Immelt. Investors haven't made a nickel since he took the helm as chairman and chief executive nine years ago. In fact, they've lost tens of billions of dollars.

    The stock, which was $40 and change when Immelt took over, has collapsed to around $16. Even if you include dividends, investors are still down about 40%. In real post-inflation terms, stockholders have lost about half their money.

    So it may come as a shock to discover that during that same period, the 54-year old chief executive has racked up around $90 million in salary, cash and pension benefits.

    GE is quick to point out that Immelt skipped his $5.8 million cash bonus in 2009 for the second year in a row, because business did so badly. And so he did.

    Yet this apparent sacrifice has to viewed in context. Immelt still took home a "base salary" of $3.3 million and a total compensation of $9.9 million.

    His compensation in the previous two years was $14.3 million and $9.3 million. That included everything from salary to stock awards, pension benefits and other perks.

    Too often, the media just look at each year's pay in isolation. I decided to go back and take the longer view.

    Since succeeding Jack Welch in 2001, Immelt has been paid a total of $28.2 million in salary and another $28.6 million in cash bonuses, for total payments of $56.8 million. That's over nine years, and in addition to all his stock- and option-grant entitlements.

    It doesn't end there. Along with all his cash payments, Immelt also has accumulated a remarkable pension fund worth $32 million. That would be enough to provide, say, a 60-year-old retiree with a lifetime income of $192,000 a month.

    Yes, Jeff Immelt has been at the company for 27 years, and some of this pension was accumulated in his early years rising up the ladder. But this isn't just his regular company pension. Nearly all of this is in the high-hat plan that's only available to senior GE executives.

    Immelt's personal use of company jets -- I repeat, his personal use for vacations, weekend getaways and so on -- cost GE stockholders another $201,335 last year. (It's something shareholders can think about when they stand in line to take off their shoes at JFK -- if they're not lining up at the Port Authority for a bus.)

    Clawback ---

    PwC:  Executive Compensation: Clawbacks 2013 proxy disclosure study --- Click Here

    "A Dangerous Pattern: Rewarding Failure," by Ron Kensas, Harvard Business Review Blog, March 9, 2010 ---

    Over the past few months there has been growing anger and frustration about outsized Wall Street bonuses awarded by institutions that were rescued by taxpayer funds. At the core of this anger is the feeling that the pursuit of big payoffs caused bankers to develop complex products and take big risks which ultimately caused the financial system to crash — and if this dynamic is not curbed, it will happen again. At the same time, there is also a feeling, reinforced by President Obama, that Wall Street bankers have not really been held accountable for their risky actions and, in fact, are being unduly rewarded while everyone else continues to suffer.

    Unfortunately, the focus on Wall Street masks a more dangerous pattern of rewarding failure that is deeply embedded in the highest levels of corporate and governmental culture. For example, President Obama's point person for reforming Wall Street is Treasury Secretary Timothy Geithner. But somehow Geithner himself has not been held accountable for the financial crisis. This is despite the fact that as president of the Federal Reserve Bank of New York Geithner was responsible for the supervision of Wall Street banks. His reward for allowing these banks to create unsustainable balance sheets: He was made Treasury Secretary.

    Similarly Geithner's boss in the Federal Reserve, Ben Bernanke, was not held accountable for the interest rate and regulatory policies that some say caused the crisis. Instead, he was confirmed for a second term by a wide margin in the Senate. And to complete the failure trifecta, Lawrence Summers, who supported many of the policies that caused the financial crisis and resigned from his position as President of Harvard after making unfortunate statements about the capabilities of women, was given a senior role as a White House economic policy advisor.

    But this culture of rewarding failure is not limited to the highest levels of government. Virtually every senior corporate leader of a failed institution walks away with millions of dollars. Many move on to other senior corporate jobs or board positions. Take Robert Nardelli as an example. After not getting the top job at GE in 2001, Nardelli became the CEO of Home Depot where he made a series of strategic missteps and displayed an arrogance that alienated employees and customers. After being ousted from that job (with millions of dollars) he was hired by Cerberus to turn around Chrysler — another failure which ultimately resulted in its acquisition by Fiat. And while thousands of Chrysler employees and dealers lost their jobs and their incomes, again Nardelli walked away with his fortune intact and enhanced.

    None of this is to blame Geithner, Bernanke, Summers or Nardelli. The point of this argument is that at the highest levels of government and corporations, we have accepted a culture of rewarding failure. That is why perhaps the best job in America is to be a failed CEO. You receive millions in severance and are once more given opportunities to either try it again, or serve on a board of directors where you can again escape accountability for failure. In fact, while President Obama calls for "clawbacks" of banker's bonuses, nobody seems to be calling for directors to return the compensation that they received for poorly "supervising" financial institutions and other corporations that struggle or fail.

    Steve Kerr, former chief learning officer of GE and Goldman Sachs, notes that the biggest problem with compensation is what he calls "asking for A while rewarding B." If we are serious about asking for excellent performance, then we have to stop rewarding failure. It's a simple equation — and until we get it right, the President's calls for greater accountability will have a hollow ring.

    What do you think?

    "Five Ways to Heal American Capitalism," by Roger Marti, Harvard Business Review Blog, March 3, 2010 ---

    Bob Jensen's threads on outrageous executive compensation are at

    "How CEO Pay Became a Massive Bubble," An interview with Mihir Desai Harvard Business School, Harvard Business Review Blog, February 23, 2012 ---
    Click Here  

    Do big bonuses lead to worse performance?

    "Does Bigger Bonus Equal Worse Performance?Around the turn of every year, bankers can think of only one thing: the size of their bonuses," by Dan Ariely, Wall Street Technology, June 18, 2010 ---
    Thanks Jagdish!

    Around the turn of every year, bankers can think of only one thing: the size of their bonuses.

    Even beyond bonus season, they run different scenarios and assumptions, trying to calculate their number.

    This distracts them so much that the bigger the bonus at stake, the worse the performance, according to behavioral economist Dan Ariely, who lays out his theory in his new book "The Upside of Irrationality" (HarperCollins, $27.99).

    "For a long time we trained bankers to think they are the masters of the universe, have unique skills and deserve to be paid these amounts," said Ariely, who also wrote the New York Times bestseller "Predictably Irrational."

    "It is going to be hard to convince them that they don't really have unique skills and that the amount they've been paid for the past years is too much."

    Ariely's findings come as regulators try to rein in Wall Street's bonus culture after the 2008 financial collapse. The financial industry argues it needs to pay large bonuses to attract and motivate its top employees.

    In an experiment in India, Ariely measured the impact of different bonuses on how participants did in a number of tasks that required creativity, concentration and problem-solving.

    One of the tasks was Labyrinth, where the participants had to move a small steel ball through a maze avoiding holes. Ariely describes a man he identified as Anoopum, who stood to win the biggest bonus, staring at the steel ball as if it were prey.

    "This is very, very important," Anoopum mumbled to himself. "I must succeed." But under the gun, Anoopum's hands trembled uncontrollably, and he failed time after time.

    A large bonus was equal to five months of their regular pay, a medium-sized bonus was equivalent to about two weeks pay and a small bonus was a day's pay.

    There was little difference in the performance of those receiving the small and medium-sized bonuses, while recipients of large bonuses performed worst.


    More than a century ago, an experiment with rats in a maze rigged with electric shocks came to a similar conclusion. Every day, the rats had to learn how to navigate a new maze safely.

    When the electric shocks were low, the rats had little incentive to avoid them. At medium intensity they learned their environment more quickly.

    But when the shock intensity was very high, it seemed the rats could not focus on anything other than the fear of the shock.

    This may provide lessons for regulators who want to change Wall Street's bonus culture, Ariely said. Paying no bonus or smaller bonuses could help fix skewed incentives without loss of talent.

    "The reality is, a lot of places are able to attract great quality people without paying them what bankers are paid," Ariely said. "Do you think bankers are inherently smarter than other people? I don't." (Reporting by Kristina Cooke; Editing by Daniel Trotta)

    Bob Jensen's threads on outrageous compensation are at

    From The Wall Street Journal Accounting Weekly Review on October 29, 2010

    Shareholders Hit the Roof Over Relocation Subsidies
    by: Joann S. Lublin
    Oct 25, 2010
    Click here to view the full article on

    TOPICS: Board of Directors, Corporate Governance, Executive Compensation, Financial Reporting

    SUMMARY: "Activist investors are turning up the heat on companies that give relocating executives generous benefits to cover the cost of their depressed home values....The root problem: The protracted housing downturn in the U.S. is colliding with a rebound in management hiring. So more employers help pick up the tab for relocated executives losing money on their home sales." The issue could become more visible next year with the implementation of the "say on pay" component of the financial-overhaul legislation requiring shareholder advisory votes on executive compensation.
    CLASSROOM APPLICATION: The article is useful in any class covering corporate governance and/or executive compensation.

    1. (Introductory) What benefits are being paid to top executives at many U.S. corporations when they hire?

    2. (Advanced) What investor groups are opposing these practices? Explain who these investors groups are and how they help to all investors to focus on governance issues such as this one. In your answer, also define the notion of "corporate governance."

    3. (Introductory) What is "say on pay"? When was a U.S. government provision on "say on pay" implemented?

    4. (Advanced) Why will "say on pay" requirements likely cause more of a stir in corporate annual meetings with shareholders next year?

    Reviewed By: Judy Beckman, University of Rhode Island

    "Shareholders Hit the Roof Over Relocation Subsidies," by: Joann S. Lublin, The Wall Street Journal, October25, 2010 ---

    Activist investors are turning up the heat on companies that give relocating executives generous benefits to cover the cost of their depressed home values.

    Microsoft Corp. and Wal-Mart Stores Inc. may face investor criticism at their next annual meetings. So far this year, proxy adviser Institutional Shareholder Services has urged investors to oppose the re-election of directors who oversaw home-loss payouts at eight concerns, including Electronic Arts Inc. and Boston Scientific Corp. That's twice the number in 2009.

    Home-loss subsidies could become more contentious next year, when all U.S. public companies must hold an advisory investor vote on executive pay—as mandated by the new financial-overhaul law. ISS expects such payments will influence whether it endorses executive-pay practices.

    The root problem: The protracted housing downturn in the U.S. is colliding with a rebound in management hiring. So more employers help pick up the tab for relocated executives losing money on their home sales.

    Experience WSJ professional Editors' Deep Dive: Shareholder Activism a Growing TrendMERGERS & ACQUISITIONS REPORT Proxy Access Rules Create Uncertainty .New York Law Journal Dodd-Frank: Selected Provisions on Executive Pay .The Legal Intelligencer Say on Pay Is Here to Stay. Access thousands of business sources not available on the free web. Learn More ."Home-loss provisions are a hot-button issue with our institutional clients," explains Patrick McGurn, special counsel for ISS. "We have been seeing extraordinary relocation payments being made to bail out transferred executives."

    Microsoft may see fireworks over the issue at its annual meeting next month. Stephen Elop, recruited as president of its business division in 2008, got $5.5 million in relocation benefits and related tax payments. The package includes Microsoft's $3.7 million loss on the 2009 sale of his seven-bathroom house in Los Altos Hills, Calif.

    Mr. Elop quit to run Nokia Corp. in September. He had to repay $667,000 of his $2 million signing bonus because he stayed less than three years, but Microsoft had only negotiated a one-year "clawback" for his relocation package.

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    Wal-Mart's Brian C. Cornell .The unrecovered benefits aroused the ire of CtW Investment Group, an arm of labor federation Change to Win, whose union pension funds own Microsoft shares. Hefty home-sale subsidies reflect "the board's failure to appropriately constrain the risk of such egregious non-performance related payments," CtW said in an Oct. 15 letter to Dina Dublon, chairman of Microsoft's board pay panel. The letter urged directors to end home-loss relocation benefits and asked her to discuss similar corrective measures during the annual meeting.

    Microsoft "has taken steps to minimize that kind of risk in the relocation program going forward," a spokesman says.

    In a Friday regulatory filing, the company announced identical recovery periods for relocation payments and signing bonuses plus "reasonable caps" on relocation benefits. Those moves come after the company had already responded to investor criticism by extending relocation-aid clawbacks to two years shortly before its 2009 annual meeting.

    William Patterson, CtW's executive director, praises the changes but says "there's still room for improvement."

    About 74% of companies reimburse some or all of a staff member's home-sale loss, according to a March survey by Weichert Relocation Resources Inc. of 185 companies. That's up from 63% in a similar 2008 survey.

    Nineteen companies divulged largely sizable outlays for residential losses of a relocated senior officer in their latest proxy statement, reports Equilar, an executive-compensation research firm. Seven occurred at the 100 biggest businesses, ranging from Delta Air Lines Inc. to Wal-Mart. No Fortune 100 concern disclosed the reimbursements in their 2007 proxies.

    Proponents defend the perk as necessary for businesses to attract and keep star players. "They simply need those executives to move," says James D.C. Barrall, head of the global executive compensation and benefits practice at Latham & Watkins LLP.

    Continued in article

    "CEO Pay in FTSE 100: Pay Inequality, Board Size and Performance," by William Patrick Forbes, SSRN, September 1, 2012 ---

    Abstract: n this paper we examine the agency costs of seemingly excessive pay awards to CEO's within the FTSE 100 in the last decade. Are CEOs taking a large proportion of the total pot (a big "pay slice") more, or less, able to return value to shareholders by better management? In presenting this evidence we describe variations in whole distribution of executive pay, rather than invoking some arbitrary cut-off point (e.g. the CEO's pay as a percentage of their five highest paid peers or the CPS), to determine how changes in shareholder value match to concurrent changes in the distribution of executive pay. We ask is the impact of executive pay-inequality a function of board size, rendering the CPS measure problematic in this context? If so how does the interaction of board size and corporate performance size, as measured by shareholder returns, explain variation in the sensitivity of the pay-performance relationship for UK FTSE executives? We advance the Gini coefficient as a preferable measure of executive pay inequality in order to capture the impact of perceived inequality upon corporate performance.

    Jensen Comment
    Although the findings in this study in terms of CEO pay, I strongly object to the Gini coefficient for comparison of poverty levels between countries. For example, Canada and North Korea have roughly the same Gini coefficient. Yeah Right! You get a higher Gini coefficient just for spreading the poverty equally.

    Having said that, I'm a long-time advocate for curbing excessive executive compensation, especially those that reward failure and fraud ---
    On CBS news last week, it was stated that Putin's in house in Russia cost a mere $1 billion. When it comes to corruption, start at the top with government.
    This is the graph of political corruption.

    Bob Jensen's threads on the American Dream ---



    Our Broken Corporate Governance Model
    "Why Executive Pay is So High," by Neil Weinberg, Forbes, April 22, 2010 ---

    How can investors reel in pay and get more out of corporate bosses? Here's one view: Kick the chief executive out of the boardroom.

    When it comes to the way corporate boards oversee chief executives--or, all too often, fail to--few people have as many war stories to tell from as many vantage points as Gary Wilson. He was Walt Disney Co. ( DIS - news - people )'s chief financial officer and, as a director, the subject of scorn when its board was twice ranked the worst in the country. As a Yahoo ( YHOO - news - people ) director Wilson was targeted by investor Carl Icahn, who sought to oust the board during a 2008 failed shotgun marriage with Microsoft ( MSFT - news - people ). As a private equity guy he led the 1989 Northwest Airlines ( NWA - news - people ) buyout along with Alfred Checchi.

    So Wilson can say, with more than a little credibility, that the boards supposedly overseeing management are instead packed with lackeys with appalling frequency. It's a familiar complaint but one that he believes is responsible for out-of-control pay, the short-term greed that helped spawn the recent financial meltdown and a staggering waste of resources. Wilson's solution: Abolish the joint role of chief executive and chairman and install independent bosses to oversee boards.

    "From what I've seen, managers are interested in what goes into their pockets and willing to use lots of leverage to add short-term profits, boost the stock price and sell their options," says Wilson, 70. "Long-term shareholders risk getting screwed."

    The Alliance, Ohio native has joined up with Ira Millstein, a Wall Street attorney, and Harry Pearse, former General Motors general counsel and Marriott Corp. director, to push for independent chairmen. Their platform is the Millstein Center for Corporate Governance at Yale.

    Does splitting the title benefit shareholders? Evidence is inconclusive, but here's an indicator suggesting they're on to something: 76% of the 25 bosses who rank lowest on our annual survey comparing compensation to shareholder return hold dual titles. Only 44% of the best 25 hold both titles. The dual players include Richard D. Fairbank of Capital One, Ray Irani of Occidental Petroleum ( OXY - news - people ), David C. Novak of Yum Brands and Howard Solomon of Forest Labs. ( FRX - news - people ) Wilson and Pearse insist that they saw boards transformed overnight from supplicants to independents when the roles were separated at companies where they were directors.

    Boards occasionally go through spasms of feistiness. In 1992 General Motors' board ousted Robert Stemple as chairman, which led to similar moves at American Express ( AXP - news - people ), Westinghouse and other companies. But today only 21% of boards are chaired by bona fide independents, says RiskMetrics Group, a New York financial advisory firm that owns ISS Proxy Advisory Services. In 43% of big companies the roles are ostensibly split, but the chairman, says RiskMetrics, is an ex-chief executive or otherwise defined as a company "insider."

    In some cases nothing less than corporate survival is at stake, Wilson argues. He points to Lehman Brothers ( LEHMQ - news - people ), where Richard Fuld was chief executive and chairman for 15 years and where management took the sorts of big risks that ultimately sank the firm.

    Wilson isn't against stock options but believes in tying them to long-term returns with strike prices that rise at the rate of inflation plus some risk premium, as he has done at some companies he has invested in. That way management isn't rewarded just for showing up.

    Independent boards might also rein in pay. In Europe Wilson sat on KLM's advisory board and says it's no coincidence that (a) chief executives typically run a management board, which reports up to the separate advisory board, and (b) pay is well below U.S. levels. At many U.S. companies, he says, the combined boss often recruits board members and then "directors feel obligated to the CEO/chairman, make the friendliest member chairman of the compensation committee and then hire a friendly consultant to do an analysis that favors high management pay."

    Continued in Article

    Comment Letter from 80 Business and Law Professors Regarding Corporate Governance
    I submitted to the SEC yesterday a comment letter on behalf of a bi-partisan group of eighty professors of law, business, economics, or finance in favor of facilitating shareholder director nominations. The submitting professors are affiliated with forty-seven universities around the United States, and they differ in their view on many corporate governance matters. However, they all support the SEC’s “proxy access” proposals to remove impediments to shareholders’ ability to nominate directors and to place proposals regarding nomination and election procedures on the corporate ballot. The submitting professors urge the SEC to adopt a final rule based on the SEC’s current proposals, and to do so without adopting modifications that could dilute the value of the rule to public investors.
    Lucian Bebchuk, Harvard Law School, on Tuesday August 18, 2009 --- Click Here

    Bob Jensen's threads on corporate governance ---

    Long Time WSJ Defenders of Wall Street's Outrageous Compensation Turn Into Hypocrites
    At each stage of the disaster, Mr. Black told me -- loan officers, real-estate appraisers, accountants, bond ratings agencies -- it was pay-for-performance systems that "sent them wrong." The need for new compensation rules is most urgent at failed banks. This is not merely because is would make for good PR, but because lavish executive bonuses sometimes create an incentive to hide losses, to take crazy risks, and even, according to Mr. Black, to "loot the place through seemingly normal corporate mechanisms." This is why, he continues, it is "essential to redesign and limit executive compensation when regulating failed or failing banks." Our leaders may not know it yet, but this showdown between rival populisms is in fact a battle over political legitimacy. Is Wall Street the rightful master of our economic fate? Or should we choose a broader form of sovereignty? Let the conservatives' hosannas turn to sneers. The market god has failed.
    Thomas Frank, "Wall Street Bonuses Are an Outrage:  The public sees a self-serving system for what it," The Wall Street Journal, February 4, 2009 --- 

    Bob Jensen's threads on corporate governance are at

    "Golden coffins, golden offices, golden retirement:  Ten of the most egregious executive perks,"
    by Allistair Barr, Market Watch, May 13, 2009 ---

    Clawback Teaching Case:  Earnings Management and Creative Accounting

    "Clawbacks: Prospective Contract Measures in an Era of Excessive Executive Compensation and Ponzi Schemes," by Miriam A. Cherry and Jarrod Wong, SSRN, August 23, 2009 ---

    In the spring of 2009, public outcry erupted over the multi-million dollar bonuses paid to AIG executives even as the company was receiving TARP funds. Various measures were proposed in response, including a 90% retroactive tax on the bonuses, which the media described as a "clawback." Separately, the term "clawback" was also used to refer to remedies potentially available to investors defrauded in the multi-billion dollar Ponzi scheme run by Bernard Madoff. While the media and legal commentators have used the term "clawback" reflexively, the concept has yet to be fully analyzed. In this article, we propose a doctrine of clawbacks that accounts for these seemingly variant usages. In the process, we distinguish between retroactive and prospective clawback provisions, and explore the implications of such provisions for contract law in general. Ultimately, we advocate writing prospective clawback terms into contracts directly, or implying them through default rules where possible, including via potential amendments to the law of securities regulation. We believe that such prospective clawbacks will result in more accountability for executive compensation, reduce inequities among investors in certain frauds, and overall have a salutary effect upon corporate governance.

    Clawback in the Context of TARP ---

    On October 14, 2008, Secretary of the Treasury Paulson and President Bush separately announced revisions in the TARP program. The Treasury announced their intention to buy senior preferred stock and warrants in the nine largest American banks. The shares would qualify as Tier 1 capital and were non-voting shares. To qualify for this program, the Treasury required participating institutions to meet certain criteria, including: "(1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on the financial institution from making any golden parachute payment to a senior executive based on the Internal Revenue Code provision; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive." The Treasury also bought preferred stock and warrants from hundreds of smaller banks, using the first $250 billion allotted to the program.

    The first allocation of the TARP money was primarily used to buy preferred stock, which is similar to debt in that it gets paid before common equity shareholders. This has led some economists to argue that the plan may be ineffective in inducing banks to lend efficiently.[15][16]

    In the original plan presented by Secretary Paulson, the government would buy troubled (toxic) assets in insolvent banks and then sell them at auction to private investor and/or companies. This plan was scratched when Paulson met with United Kingdom's Prime Minister Gordon Brown who came to the White House for an international summit on the global credit crisis.[citation needed] Prime Minister Brown, in an attempt to mitigate the credit squeeze in England, merely infused capital into banks via preferred stock in order to clean up their balance sheets and, in some economists' view, effectively nationalizing many banks. This plan seemed attractive to Secretary Paulson in that it was relatively easier and seemingly boosted lending more quickly. The first half of the asset purchases may not be effective in getting banks to lend again because they were reluctant to risk lending as before with low lending standards. To make matters worse, overnight lending to other banks came to a relative halt because banks did not trust each other to be prudent with their money.[citation needed]

    On November 12, 2008, Secretary of the Treasury Henry Paulson indicated that reviving the securitization market for consumer credit would be a new priority in the second allotment

    From The Wall Street Journal Accounting Weekly Review on August 13, 2010

    Clawbacks Divide SEC
    by: Kara Scannell
    Aug 07, 2010
    Click here to view the full article on

    TOPICS: Accounting, Auditing, Executive Compensation, Restatement, Sarbanes-Oxley Act, SEC, Securities and Exchange Commission, Stock Options

    SUMMARY: During the settlement with Dell, Inc. in which founder Michael Dell agreed to pay a $4 million penalty without admitting or denying wrongdoing, Commissioner Luis Aguilar raised the issue of "clawing back" compensation to executives based on inflated earnings. "The SEC alleged Mr. Dell hid payments from Intel Corp. that allowed the company to inflate earnings....Under [Section 304 of the 2002 Sarbanes-Oxley law], the SEC can seek the repayment of bonuses, stock options or profits from stock sales during a 12-month period following the first time the company issues information that has to be restated." The SEC has been working on a formal policy to guide them in cases in which an executive has not been accused of personal wrongdoing, "but hammering out a policy acceptable to the five-member Commission...may be difficult." The related article announced the clawback provision when it was enacted into law in July and compares it to the previous requirements related to executive compensation under Sarbanes-Oxley.

    CLASSROOM APPLICATION: The article covers topics in financial reporting related to restatement, executive compensation topics, the Sarbanes-Oxley law, and the SEC's recent enforcement efforts in general.

    1. (Introductory) Based on the main and related article, define and describe a "clawback" policy.

    2. (Introductory) Why will most publicly traded companies implement change as a result of the new law and resultant SEC requirements?

    3. (Advanced) When must a company restate previously reported financial results? Cite the authoritative accounting literature requiring this treatment.

    4. (Advanced) Describe one executive compensation plan impacted by reported financial results. How would such a plan be impacted by a restatement?

    5. (Introductory) What is the difficulty with applying the new clawback provisions to executive stock option plans? Based on the related article, how are companies solving this issue?

    6. (Advanced) Is it possible that executives who are innocent of any wrongdoing could be affected financially by these new clawback provisions? Do you think that such executives should have to repay to their companies compensation amounts received in previous years? Support your answer.

    7. (Advanced) Refer to the main article. Consider the specific case of Dell Inc. founder Michael Dell. Do you believe Mr. Dell should have to return compensation to the company? Support your answer.

    8. (Introductory) How do the new requirements under the financial reform law enacted in July exceed the requirements of Sarbanes-Oxley? In your answer, include one or two statements to define the Sarbanes-Oxley law.

    Reviewed By: Judy Beckman, University of Rhode Island

    Law Sharpens 'Clawback' Rules for Improper Pay
    by JoAnn S. Lublin
    Jul 25, 2010
    Online Exclusive

    "Clawbacks Divide SEC," by: Kara Scannell, The Wall Street Journal, August 7, 2010 ---

    A dispute over how to claw back pay from executives at companies accused of cooking the books is roiling the Securities and Exchange Commission.

    Commissioner Luis Aguilar, a Democrat, has threatened not to vote on cases where he thinks the agency is too lax, people familiar with the matter said. That prompted the SEC to review its policies for the intermittently used enforcement tool.

    "The SEC ought to use all the tools at its disposal to try to seek funds for deterrence," Mr. Aguilar said in an interview on Tuesday. "It's important for us to the extent possible to try to deter, and part of that means using tools Congress has given us."

    The issue of clawbacks came up during the SEC's recent settlement with Dell Inc. and founder Michael Dell, people familiar with the matter said.

    The SEC alleged Mr. Dell hid payments from Intel Corp. that allowed the company to inflate earnings. He agreed to pay a $4 million penalty to settle the case without admitting or denying wrongdoing, but didn't return any pay.

    Mr. Aguilar initially objected to the Dell settlement, according to people familiar with the matter. It is unclear whether the penalty—considered high by historical standards for an individual—swayed Mr. Aguilar's vote or whether he removed himself from the case.

    In the interview, Mr. Aguilar spoke generally about clawbacks and declined to discuss Dell or other specific cases.

    A spokesman for the SEC declined to comment.

    Section 304 of the 2002 Sarbanes-Oxley law gave the SEC the ability to seek reimbursement of compensation from the chief executive and chief financial officer of a company when it restates its financial statements because of misconduct.

    Under the law, the SEC can seek the repayment of bonuses, stock options or profits from stock sales during a 12-month period following the first time the company issues information that has to be restated.

    Last year, the SEC used the tool for the first time against an executive who wasn't accused of personal wrongdoing.

    In that case the SEC sued Maynard Jenkins, the former chief executive of CSK Auto Corp., for $4 million in bonuses and stock sales. Mr. Jenkins is fighting the allegations.

    SEC attorneys have been working on a more formal policy to guide them in such cases, people familiar with the matter said. They were seeking to tie the amount of the clawback to the period of wrongdoing, these people said.

    Mr. Aguilar felt the emerging new policy wasn't stringent enough and told the SEC staff he would recuse himself from cases when he didn't agree with the enforcement staff's recommendations, the people said.

    Amid the standoff, SEC enforcement chief Robert Khuzami has halted the initial policy and set up a committee to take another look at the matter, the people said.

    Hammering out a policy acceptable to the five-member commission, which has split on recent high-profile cases, may be difficult.

    The divisions worry some within the SEC because the absence of an agreement could affect cases in the pipeline, especially on close calls where Mr. Aguilar's vote might be necessary to go forward.

    Mr. Aguilar's hard line on clawbacks was bolstered by the Dodd-Frank law, signed by President Obama on July 21. It says stock exchanges need to change listing standards to require companies to have clawback policies in place that go further than the Sarbanes-Oxley policy.

    Section 954 of the law says that pay clawbacks should apply to any current or former employee and instructs companies to seek pay earned during the three-year period before a restatement "in excess of what would have been paid to the executive under the accounting restatement."

    Since becoming a commissioner in late 2008, Mr. Aguilar has called for a tougher enforcement approach, including a rework of the agency's policy of seeking penalties against companies.

    In a speech in May, Mr. Aguilar took up the issue of executive pay in the context of the SEC's lawsuit against Bank of America Corp. for failing to disclose to shareholders the size of bonuses paid to Merrill Lynch executives. The bank agreed to pay $150 million to settle the matter.

    Mr. Aguilar said that penalty "pales" in comparison to the $5.8 billion in bonuses paid during the merger.

    "Perhaps what should happen is that, when a corporation pays a penalty, the money should be required to come out of the budget and bonuses for the people or group who were the most responsible," he said.

    Bob Jensen's Fraud Updates are at

    CEO Pay:  How to get your bailout taxpayer cake and eat it too

    The new Chrysler is among the first companies to fall under rules outlined in February by Treasury Secretary Timothy Geithner, for companies getting "extraordinary assistance" from the Treasury that would cap pay for top executives at $500,000, excluding restricted shares of stock. The final rules for the limits have not been released. . . . Fiat CEO Sergio Marchionne has already indicated he will replace Chrysler CEO Bob Nardelli. But under the deal, any of Chrysler's top officers can be deemed a Fiat employee who's "seconded" to Chrysler, and therefore take pay from Fiat beyond any Treasury cap.
    "Fiat plans to bypass U.S. exec pay limits," by Justin Hyde and Greg Gardner,, May  13, 2009---
    PS:  Fiat is not putting up any cash to get control of Chrysler. What a deal!

    Bob Jensen's threads on options accounting scandals are at

    Outrageous Bonus Frenzy

    AIG now says it paid out more than $454 million in bonuses to its employees for work performed in 2008. That is nearly four times more than the company revealed in late March when asked by POLITICO to detail its total bonus payments. At that time, AIG spokesman Nick Ashooh said the firm paid about $120 million in 2008 bonuses to a pool of more than 6,000 employees. The figure Ashooh offered was, in turn, substantially higher than company CEO Edward Liddy claimed days earlier in testimony before a House Financial Services Subcommittee. Asked how much AIG had paid in 2008 bonuses, Liddy responded: “I think it might have been in the range of $9 million.”
    Emon Javers, "AIG bonuses four times higher than reported," Politico, May 5, 2009 ---

    "Let's Move Their Cheese:  We can get better bank management for a fraction of the cost," The Wall Street Journal on May 6,  2009 ---

    Incentives work, all right. Just look at the way our bankers come back to bonuses, finding in every occasion a good opportunity to cut themselves a slice of largess. Their determination is unrelenting, monomaniacal. It's like Republicans returning to tax cuts, the universal solution to every problem.

    Some institutions, we read, are struggling to free themselves from the TARP, because of its exuberance-chilling compensation limits. Others have decimated their workforces, apparently so they might continue to shower money on the favored ones. Still other institutions have signaled that they would rather borrow at higher rates of interest than accept the compensation limits that come with cheaper federal loans. And certain banks are on track to return to pre-recession compensation levels this year, according to a story last week in the New York Times. Goldman Sachs, for example, set aside $4.7 billion for compensation in the first quarter alone.

    Another way incentives work is this: They have kept the debate over incentives from getting off the dime for years. There is no amount of shame that will deter the bonus class from pressing their demand, no scandal that will put it off limits, no public outrage over AIG or Enron or really expensive Merrill Lynch trash cans that will silence the managers' monotonous warble: "Attract and retain top talent!"

    And there is no possible objection to inflated compensation you can make that will not be instantly maligned as senseless populism.

    In truth, however, the verdict has been in for years. Pay for performance systems, at least as they exist in many places, are a recipe for disaster.

    What they have "incentivized" executives to do, in countless cases, is not to perform, but to game the system, to smooth the numbers, to take insane risks with other people's money, to do whatever had to be done to ring the bell and send the dollars coursing their way into the designated bank account.

    It may well be true that those in our bonus class are geniuses, but in far too many cases their fantastic brain power is focused not on serving shareholders or guiding our economy but simply on getting that bonus.

    One might say that events of the last year had proved this fairly conclusively.

    Or one could quote the immortal words of Franklin Raines, the onetime CEO of Fannie Mae, as they were recorded by Business Week in 2003: "My experience is where there is a one-to-one relation between if I do X, money will hit my pocket, you tend to see people doing X a lot. You've got to be very careful about that. Don't just say: 'If you hit this revenue number, your bonus is going to be this.' It sets up an incentive that's overwhelming. You wave enough money in front of people, and good people will do bad things."

    Will they ever. They might, for example, pull an accounting fraud of the kind Fannie Mae itself was accused of committing in 2004, in which earnings were allegedly manipulated to, ahem, hit certain revenue numbers and make the bonuses go bang.

    They might rig the game to take the credit -- and reap the rewards -- when good luck befalls an entire industry. If they're bankers, they might even try to claim that their firm's recovery, made possible by TARP money and government guarantees, was actually a fruit of their personal ingenuity. Bring on the billions!

    Of course, they will also threaten to leave if they don't get exactly what they want. Take last week's news story about the supersuccessful energy trading unit of Citibank, whose star trader scored $125 million in 2005, owns a castle in Germany, and collects Julian Schnabel paintings. This merry band of traders is apparently thinking about a white-collar walkout should the government refuse to lift its compensation restrictions.

    At first one feels pity for Citi and its resident geniuses, brought to these straits by the interfering hand of government. But then it dawns on you: Should a company receiving billions of public dollars really be gambling on speculative energy trades? After all, the bank's ordinary, everyday deposits would have to be made good by you and me through the FDIC should one of their bright traders pull a Nick Leeson someday.

    Besides, why is Citi so anxious to give in to these guys? It can't be that hard to "retain top talent" when New York is awash with unemployed bankers and traders who are no doubt anxious for a chance to prove their own brilliance.

    Here's a Wall Street solution to Wall Street's problems: Let's offshore trading operations to lands where ethics are more highly esteemed -- Norway, for instance. And while we're at it, let's replace our gold-plated, Lear-jetting American CEOs with thrifty Europeans, who may not write management books but who will do the work better, and for a fraction of the cost.

    Richard Campbell notes a nice white collar crime blog edited by some law professors --- 

    "Executive Compensation and Boards of Directors," by J. Edward Ketz, SmartPros, July 2009 ---

    It has been amazing to listen to the discourse over executive compensation during the past year or so. On one side we have the pure capitalists who tell us that government ruins everything, neatly forgetting that unbridled capitalism exploits those with little power and ignoring the fact that many CEOs do not provide enough value to shareholders to justify their compensation. On the other extreme we have those who trust government to cure all ills, overlooking the idiocy of many bureaucrats and the possibility of a dangerous slide toward totalitarianism. We shall not find a solution at either end of this spectrum.

    The Bush administration leaned toward the pure capitalists by appointing Harvey Pitt and Christopher Cox to head the SEC. Both of them slept during scandalous times, Enron and WorldCom occurring on Pitt’s watch and the collapse of the banking industry on Cox’s. They failed shareholders by allowing CEOs to run roughshod over the investors.

    The Obama administration wants to intervene by setting maximum compensation levels for corporate managers and to regulate bonuses. It may come as a shock to this administration and its supporters, but neither Obama nor anybody on his team is omniscient. They just do not have a sufficient knowledge of business and economics to determine these parameters. In fact, some of the decisions already made are so faulty that one wonders just how much economics anybody in this administration understands (increasing the deficit by more than the deficits produced by all previous presidents combined and attempting to pass an energy tax during a recession are two examples).

    It is no wonder the public is starting to stir over the compensation issue—some CEOs are indeed overpaid. While numerous current examples exist, my favorite illustration remains Sprint in 2003. Somehow Sprint CEO William Esrey and President Ronald LeMay finagled the firm to give, and the board of directors to approve, so many stock options that they made approximately $1.9 billion. Clearly, the two of them did not add that much value to the firm! But the question is what to do about these problems.

    After lying dormant on this issue for years, the SEC on July 1 voted 5-0 to require business entities that received bailout money to permit shareholders to vote on executive pay {}. They also voted to require all SEC registrants to disclose more information about executive compensation. These issues must still be aired in public for two months before becoming final. This is a step in the right direction as it attempts to deal with the issue but without having Big Brother dictate the actual salary and bonus.

    The SEC proposal is quite disappointing, however, because the vote is nonbinding. Given that, I’m not sure what the point is. It is almost as if they want to fail so that Big Brother will have to intervene and set prices for all of us.

    What the SEC and Congress and the President should be doing is creating incentives and disincentives so that the economic system would function more smoothly. They should stay out of the details because they don’t have the knowledge to make the right decisions and because we would like to keep some freedoms in our society. Perhaps they should read Hayek’s The Road to Serfdom.

    The central problem continues to be the enervation of shareholders by the management class. We need to rectify this imbalance and empower the shareholders to regain control over their own companies. After all, they are the owners!

    The other thing to do is to put some fire under the directors at corporate enterprises. The board of directors supposedly represents the shareholders, but often belies that point by assisting mangers in their grab for power and wealth. The Congress could help by enacting legislation that would allow investors to sue directors when the directors abrogate their duties to the shareholders. (Recall that the Supreme Court greatly restricted the liability of directors in Central Bank of Denver v. First Interstate Bank of Denver.)

    Of course, the impotence of most boards of directors is frequently the consequence of allowing managers to choose their buddies to be on the board. “Independent directors” is a joke; I don’t if very many of them are really independent. So another thing that should be done is to give shareholders the right to vote for the directors. And not with a manager-stacked deck of choices as if we lived in some communist country. Give the shareholders the opportunity to add candidates to the ballot. Again, they are the owners!

    The executive compensation issue remains a hot-button item. But it cannot be ignored by the pure capitalists nor remedied by the governments’ controlling the price of labor. A more moderate approach is appropriate. I think the key institution in this matter is the board of directors. If empowered and if held accountable for their decisions, I think the board of directors could properly address the issue of executive compensation.

    Bob Jensen's threads on corporate governance are at

    "The Case for Cutting the Chief's Paycheck," by William J. Holstein, The New York Times, January 29, 2006 ---


    Yet Again the SEC Amends Executive Compensation Disclosure (particularly regarding stock options)
    The US Securities and Exchange Commission has amended its executive and director compensation disclosure rules to more closely conform the reporting of stock and option awards to FASB Statement No. 123 (revised 2004) Share-Based Payment. FAS 123R is similar to IFRS 2 Share-based Payment. The amendment modifies rules that were adopted in July 2006.
    SEC Press Release 2006 219 ---


    Bob Jensen's threads on accounting for employee stock options are at



    Bank of America pays $33M SEC fine over Merrill bonuses
    Bank of America Corp. has agreed to pay a $33 million penalty to settle government charges that it misled investors about Merrill Lynch's plans to pay bonuses to its executives, regulators said Monday. In seeking approval to buy Merrill, Bank of America told investors that Merrill would not pay year-end bonuses without Bank of America's consent. But the Securities and Exchange Commission said Bank of America had authorized New York-based Merrill to pay up to $5.8 billion in bonuses. That rendered a statement Bank of America mailed to 283,000 shareholders of both companies about the Merrill deal "materially false and misleading," the SEC said in a statement.
    Yahoo News, August 3, 2009 ---

    Professor Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve Board ---

    "When Greed Is Not Good:  Wall Street has quickly rediscovered the virtues of mammoth paychecks. Why hasn't there been more financial reform?" by Alan S. Blinder, The Wall Street Journal, January 11, 2010 ---

    I hear Gordon Gekko is making a comeback. So is greed.

    They say markets are alternately ruled by greed and fear. Well, our panic-stricken financial markets have been ruled by fear for so long that a little greed might serve as an elixir. But everybody knows you can overdose on an elixir.

    When economists first heard Gekko's now-famous dictum, "Greed is good," they thought it a crude expression of Adam Smith's "Invisible Hand"—which is one of history's great ideas. But in Smith's vision, greed is socially beneficial only when properly harnessed and channeled. The necessary conditions include, among other things: appropriate incentives (for risk taking, etc.), effective competition, safeguards against exploitation of what economists call "asymmetric information" (as when a deceitful seller unloads junk on an unsuspecting buyer), regulators to enforce the rules and keep participants honest, and—when relevant—protection of taxpayers against pilferage or malfeasance by others. When these conditions fail to hold, greed is not good.

    Plainly, they all failed in the financial crisis. Compensation and other types of incentives for risk taking were badly skewed. Corporate boards were asleep at the switch. Opacity reduced effective competition. Financial regulation was shamefully lax. Predators roamed the financial landscape, looting both legally and illegally. And when the Treasury and Federal Reserve rushed in to contain the damage, taxpayers were forced to pay dearly for the mistakes and avarice of others. If you want to know why the public is enraged, that, in a nutshell, is why.

    American democracy is alleged to respond to public opinion, and incumbents are quaking in their boots. Yet we stand here in January 2010 with virtually the same legal and regulatory system we had when the crisis struck in the summer of 2007, with only minor changes in Wall Street business practices, and with greed returning big time. That's both amazing and scary. Without major financial reform, "it" can happen again.

    It is true that regulators are much more watchful now, that Bernie Madoff is in jail (where he should have more company), and that much of "fancy finance" died a violent death in the marketplace. All good. But history shows that financial markets have a remarkable ability to forget the past and revert to their bad old ways. And we've made essentially no progress on lasting financial reform.

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    Chad Crowe Perhaps reformers just need more patience. The Treasury made a fine set of proposals that the president's far-flung agenda left him little time to pursue—so far. The House of Representatives passed a pretty good financial reform bill late last year. And while there's been no action in the Senate as yet, at least they are talking about it. As Yogi Berra famously said, "it ain't over 'til it's over."

    But I'm worried. The financial services industry, once so frightened that it scurried under the government's protective skirts, is now rediscovering the virtues of laissez faire and the joys of mammoth pay checks. Wall Street has mounted ferocious lobbying campaigns against virtually every meaningful aspect of reform, and their efforts seem to be paying off. Yes, the House passed a good bill. Yet it would have been even better but for several changes Financial Services Committee Chairman Barney Frank (D., Mass.) had to make to get it through the House. Though the populist political pot was boiling, lobbyists earned their keep.

    I expect they'll earn more. Even before Senate Banking Committee Chairman Christopher Dodd (D., Conn.) announced his retirement, it appeared likely that any bill that could survive the Senate would be weaker than the House bill. Then came Mr. Dodd's announcement, which reshuffled the deck.

    There are two diametrically opposed hypotheses about how his retirement will affect the legislation. Conventional wisdom holds that it is good news for reformers: Freed from crass political concerns, Mr. Dodd can now steer his committee more firmly toward a better bill. Let's hope so. But an opposing view reminds us that lame ducks lose power rapidly in power-mad Washington. To lead, someone must be willing to follow.

    My fear is that a once-in-a-lifetime opportunity to build a sturdier and safer financial system is slipping away. Let's remember what happened to health-care reform (a success story!) as it meandered toward 60 votes in the Senate. The world's greatest deliberative body turned into a bizarre bazaar in which senators took turns holding the bill hostage to their pet cause (or favorite state). With zero Republican support, every one of the 60 members of the Democratic caucus held an effective veto—and several used it.

    If financial reform receives the same treatment, we are in deep trouble, both politically and substantively.

    To begin with the politics, recent patterns make it all too easy to imagine a Senate bill being bent toward the will of Republicans—who want weaker regulation—but then garnering no Republican votes in the end. We've seen that movie before. If the sequel plays in Washington, passing a bill will again require the votes of every single Democrat plus the two independents. With veto power thus handed to each of 60 senators, the bidding war will not be pretty.

    On substance, while both health-care and financial reform are complex, health care at least benefited from broad agreement within the Democratic caucus on the core elements: expanded but not universal coverage, subsidies for low-income families, enough new revenue to pay the bills, insurance exchanges, insurance reform (e.g., no denial of coverage for pre-existing conditions), and experiments in cost containment to "bend the curve." The fiercest political fights were over peripheral issues like the public option, abortion rights (how did that ever get in there?), and whether Nebraskans should pay like other Americans (don't try to explain that one to foreigners).

    But financial regulatory reform is not like that. Every major element is contentious: a new resolution authority for ailing institutions, a systemic risk regulator, a separate consumer protection agency, whether to clip the Fed's wings or broaden them, restrictions on executive compensation, regulation of derivatives, limits on proprietary trading, etc.

    The elements are interrelated; you can't just pick one from column A and two from column B. What's worse, several components would benefit from international cooperation—for example, consistent regulation of derivatives across countries. This last point raises the degree of difficulty substantially. No one worried about international agreement while Congress was writing a health-care bill.

    All and all, enacting sensible, comprehensive financial reform would be a tall order even if our politics were more civil and bipartisan than they are. To do so, at least a few senators—Republicans or Democrats—will have to temper their partisanship, moderate their parochial instincts, slam the door on the lobbyists, and do what is right for America. Figure the odds. Gordon Gekko already has.

    Bob Jensen's threads on outrageous executive compensation are at


    Fodder for Accounting and Finance Agency Theorists to Digest

    Principle-Agent Theory ---

    In political science and economics, the principal-agent problem or agency dilemma treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent. Various mechanisms may be used to try to align the interests of the agent with those of the principal, such as piece rates/commissions, profit sharing, efficiency wages, performance measurement (including financial statements), the agent posting a bond, or fear of firing. The principal-agent problem is found in most employer/employee relationships, for example, when stockholders hire top executives of corporations. Numerous studies in political science have noted the problems inherent in the delegation of legislative authority to bureaucratic agencies. Especially since bureaucrats often have expertise that legislators and executives lack, laws and executive directives are open to bureaucratic interpretation, creating opportunities and incentives for the bureaucrat-as-agent to deviate from the preferences of the constitutional branches of government. Variance in the intensity of legislative oversight also serves to increase principal-agent problems in implementing legislative preferences.

    Four principles of contract design

    • 3.1 Informativeness Principle
    • 3.2 Incentive-Intensity Principle
    • 3.3 Monitoring Intensity Principle
    • 3.4 Equal Compensation Principle
    • 3.5 A linear model
    • 3.6 Nonlinearities

    "Compensation Under Competition," by Richard Posner, The Becker-Posner Blog, April 7, 2008 ---

    There is a long-standing concern that corporate executives are more risk averse than a corporation's shareholders, because the latter can eliminate firm-specific risk by holding a diversified portfolio, while the former cannot, because they have firm-specific human capital that they will lose if the firm tanks. The solution to this problem was thought to consist in making stock options a large part of the executive's compensation, so that his incentives would be closely aligned with those of the shareholders. True, because he would bear more risk, he would have to be paid more in total compensation than if he did not receive a large part of his compensation in the form of stock options. But the cost to the corporation of the additional pay would presumably be offset by the gain to the shareholders from the executives' enhanced incentives to maximize shareholder wealth.

    But we are beginning to realize that the grant of stock options may make corporate executives take more risks than the shareholders desire [Jensen insert:  To say nothing of cheating on earnings reports]. Suppose that instead of being compensated for bearing risk just by being paid a higher salary or given even more stock options, the executive is guaranteed generous retirement and severance benefits that are unaffected by the price of the corporation’s stock. Now he has a hedge against risk, and can take more risks in operating the corporation because his personal downside risk has been truncated. Perhaps this was a factor in the recent stock market bubbles--the one that burst in 2000 with the crash of the high-tech stocks and the one that burst this year as a result of the collapse of the subprime mortgage market and the resulting credit crunch. A bubble is both a repellent and a lure. It is a lure because during the bubble values are rising steeply, so an investor who exits before the bubble has peaked may be leaving a good deal of money on the table. He will be especially loath to do that if he is hedged against the consequences of the bubble's eventual bursting.

    Boards of directors could devise compensation schemes that limited the attractiveness of risky undertakings, but they have little incentive to do so. The boards tend to be dominated by CEOs and other high corporate executives of other firms, who have an interest in keeping executive compensation high and who are abetted by compensation consultants who naturally recommend generous compensation packages to directors who are recipients of generous compensation and therefore believe that the CEOs of the companies on whose boards they sit should be paid top dollar.

    It is not clear what the free-market antidote to this tendency to ratchet up executive compensation is. The compensation of the CEO and other high officials of a large corporation is usually only a small part of the corporation's costs, so shaving such compensation is unlikely to be a powerful competitive weapon. But more important, what rival corporation would have the governance structure that would enable such shaving to be accomplished by overcoming the obstacles that I have discussed? The private-equity firm is a partial answer, because it has only a few shareholders and so need not delegate compensation to a board of directors that has other interests besides the welfare of the shareholders at heart. The reason it is only a partial answer is that there are too few owners of capital who want or have the ability or experience to participate as actively in management as the private-equity entrepreneurs and there are too many efficiently large corporations for all of them to have the good fortune of being owned by a handful of entrepreneurial investors. There is a vast pool of passive equity capital that can be put to work only in companies that are organized in the traditional board-governed corporate form.

    Here is another though related example of a stubborn efficiency-in-compensation problem, also in a highly competitive sector of the economy: law-firm billing practices. Major law firms, with few exceptions, base their bills to their clients on the number of hours that the firm's lawyers work on the client's case or other project. In other words, they bill on the basis of inputs rather than outputs. This is rational when output is difficult to evaluate, as is often the case with a law firm's output because of the uncertainty of litigation (in nonlitigation practice, because of legal and factual uncertainties). The fact that a firm loses a case doesn't mean that it did a bad job; both the winner's firm and the loser's firm may have done equally good jobs--the lawyers don't control the outcome. A law firm can give the client a pretty good idea of the quality of the lawyers it assigns to the client's case, because there are observable proxies for a lawyer's unobservable quality, proxies such as his educational and employment history. What the client cannot readily judge is whether the law firm put in excessive hours on the case, and the result, according to persistent and cumulatively persuasive anecdotage, is a tendency for law firms to invest hours in a case beyond the point at which the marginal value of the additional hour is just equal to the marginal cost to the client. Young lawyers often feel that they are being assigned work to do that has little value to the client but that will increase the firm's income because the firm bills its lawyers' time at a considerably higher rate than the cost of that time to the firm. The very high turnover at many law firms is attributed in part to dissatisfaction of young lawyers with the amount of busywork that they are assigned, work that bores them and does not contribute to the development of their professional skills, yet may be very time-consuming.

    The problem is compounded by the distorted incentives of corporate general counsels. A general counsel wants to show his boss, the corporate CEO, that he monitors expenses carefully, and, since he knows that he is likely to lose at least some of his cases, he also wants to be able to avoid if possible being blamed by his boss for the loss. Hourly billing serves both of these ends. The law firm and the general counsel play a little game, in which the law firm prices its hours on the assumption that it will not be able to collect its billing rates on all of them, and the general counsel reduces the number of hours that he is willing to pay for. He can then show his CEO that he squeezed the water out of the law firm's bills. At the same time, by paying a prominent law firm by the hour, he can assure his CEO, in the event a case is lost, that he had told the firm to do as much work as was needed to maximize the likelihood of a favorable outcome, rather than paying a fixed rate agreed to at the outset that might have induced the law firm to skimp on the amount of work it put into the case.

    One can imagine a law firm's adopting a different method of pricing, in which it would charge at the outset a fixed fee, subject to adjustments up or down at the end of the case based on outcome, amount of work, or some other performance measure or combination of such measures. The conventional law firm billing system is a form of cost-plus pricing, which is considered wasteful. But litigation is risky, and cost-plus pricing diminishes risk by eliminating a contractor's incentive to cut corners. If the disutility of risk to a general counsel is great, he will prefer to "overpay" law firms rather than trying to explain to the CEO that the novel compensation deal that he worked out with the law firm that lost the case was not a factor in the loss; that he had not been penny wise and pound foolish.

    Although the compensation practices that I have described seem inefficient, it does not follow that corrective measures would be appropriate. They would be costly and the net benefits might well be negative. It is efficient to live with a good deal of inefficiency. Stated otherwise, the fact that competitive markets contain large pockets of inefficiency is not in itself inefficient. For example, while cartel pricing is inefficient, if the cost of preventing cartelization exceeded the benefits one wouldn't want to prevent it. Yet cartel pricing would still be inefficient in the sense of misallocating resources, relative to the allocation under competition. We must live with a good deal of inefficiency, but it is still inefficiency.

    Continued in article

    "Compensation Under Competition," by Nobel Laureate Gary Becker, The Becker-Posner Blog, April 7, 2008 ---

    Executive compensation has been criticized both for being too generous, and for encouraging excessive risk-taking relative to the desires of stockholders. Yet while there are links between the level of pay and the amount of risk chosen, these are mainly distinct issues. Executives may be paid little, but the pay can be structured to have a much better payoff when profits are high than when profits are low. In this case, the average level of pay over both good and bad times would not be particularly generous, but its structure would tend to encourage risk-taking behavior. On the other hand, a CEO's pay might be excessively high on average, but not appreciable better when his company does well than when it does badly. He would be overpaid, but he would not have a financial incentive to take much risks.

    Does the pay structure in American corporations, with the growing emphasis during the past several decades on stock options, bonuses, and severance and retirement pay, encourage excessive risk-taking, where "excessive" is defined relative to the desires of stockholders? It may look that way now with the sizable number of major financial companies that have taken huge write downs in their mortgage-backed and other assets, while top executives of some of these companies have only had modest declines in their pay (although others, such as the head of Bears Sterns, have taken huge hits). However, these financial difficulties do not necessarily imply that heads of most financial companies knowingly engaged in more speculative activities than desired by stockholders because of the incentives CEOs had. A more compelling explanation is that heads of companies have undervalued the risks involved in holding derivatives and other exotic securities, particularly securities that were rather new and not well understood. Let me stress, however, that I am not trying to excuse the many CEOs in the financial sector and in other sectors who got off much too easily for terrible investment decisions.

    Bubbles are prolonged periods of excessive optimism where the true longer-term risk to holding particular assets is generally underestimated. The housing boom of the past few years now appears to have been a serious bubble where pervasive optimism about housing price movements raised the rate of increase in housing prices far beyond sustainable levels. Sophisticated lenders as well as low-income borrowers underestimated the risks involved in the residential housing market, as they appeared to have assumed that housing prices would continue to rise for a number of years in excess of ten percent per year.

    Evidence suggesting that the risk taken by companies during the recent boom was not mainly due to a principal-agent problem between executives and stockholders is that the major private equity firms also experienced serious loses on their investments, especially on their housing investments. Private equity companies have much less of a principal-agent problem than do Citicorp, Bears Sterns and other publicly traded companies because private equity companies have a concentrated ownership. Also borrowers in the residential housing market have basically no principal-agent problems since they buy for themselves; yet many of them too took on excessive risk because of undo optimism about the housing market.

    The private equity example provides a more general way to test whether CEOs take greater risks than their stockholders desire. One can analyze the relation between the degree of concentration of stock ownership in different companies and various measures of risk, such as their year-to-year variance earnings, adjusted for industry and other relevant determinants of this variance. The excessive risk argument would suggest that the more concentrated the ownership, the smaller would be the actual exposure to earnings and asset risk.

    Another test of the excessive risk argument is whether the trend toward greater compensation in the form of stock options and other performance contingent compensation increased the risk taking of companies. Some have attributed much of the dot-com bubble to increased performance based compensation. However, most dot-com companies that went under were quite small and rather closely held by venture capitalists and similar investors. Hence these companies did not have a sharp conflict between stockholders and managers. Moreover, during the dot-com bubble, assets of minor Internet companies were raised in market value to more than 100 times earnings, even when they had no sales, let alone earnings. Such huge earnings-profits ratios suggest excessive risk taking by stockholders more than by managers.

    Economic theory does imply that the increasing trend toward performance-based compensation would increase the degree of risk-taking by top executives. It is much less clear whether this effect is large- doubts are expressed by Canice Prendergast in his study "The Tenuous Trade-Off Between Risk And Incentives", Journal of Political Economy, 2002, (Oct), 1071-1102. It is also unclear if CEOs have been induced to take more risks than the level of risk desired by stockholders. Furthermore, and most important, there is no persuasive evidence that the structure of CEO compensation played an important roll in either the dot-com or housing bubbles.

    Bob Jensen's threads on accounting for employee stock options are at



    Teaching Case:  A Real World Example of Zero-Based Budgeting

    Unease Brewing at Anheuser as New Owners Slash Costs
    by David Kesmodel and Suzanne Vranica
    The Wall Street Journal

    Apr 29, 2009
    Click here to view the full article on ---

    TOPICS: Budgeting, Cost Accounting, Cost Management, Managerial Accounting

    SUMMARY: At Anheuser-Busch in St. Louis, Missouri, "...executives and others now work a few feet apart" at clustered desks after new owners InBev eliminated executive perks, demolished plush offices, and began requiring sharing secretarial services. "...InBev has turned a family-led company that spared little expense into one that is focused entirely on cost-cutting and profit margins, while rethinking the way it sells beer."

    CLASSROOM APPLICATION: The article includes a discussion of zero-based budgeting that can be used in managerial accounting course covering the topic.

    1. (Introductory) Who is InBev? How was the company formed? What iconic American beer brands are now owned by this company?

    2. (Introductory) What cultural differences are evident between owners of InBev and Anheuser-Busch? What factors do you think lead to these cultural differences?

    3. (Introductory) How has InBev "focused on cost-cutting and profit margins"? Cite all points in the article related to these strategies. In your answer, define the term "profit margin" as it relates to the strategies being undertaken.

    4. (Advanced) What is zero-based budgeting? How does that process help to focus on cost-cutting efforts?

    5. (Advanced) What strategies indicate that InBev is "rethinking the way it sells beer"? What evidence in the article indicates success in these efforts? What arguments might refute the fact that strategy change accounts for this improvement?

    Reviewed By: Judy Beckman, University of Rhode Island

    "Unease Brewing at Anheuser As New Owners Slash Costs," by David Kesmodel and Suzanne Vranica, The Wall Street Journal, April 29, 2009 ---

    Construction crews arrived at One Busch Place a few months ago and demolished the ornate executive suites at Anheuser-Busch Cos. In their place the workers built a sea of desks, where executives and others now work a few feet apart.

    It is just one piece of a sweeping makeover of the iconic American brewer by InBev, the Belgian company that bought Anheuser-Busch last fall. In about six months, InBev has turned a family-led company that spared little expense into one that is focused intently on cost-cutting and profit margins, while rethinking the way it sells beer.

    The new owner has cut jobs, revamped the compensation system and dropped perks that had made Anheuser-Busch workers the envy of others in St. Louis. Managers accustomed to flying first class or on company planes now fly coach. Freebies like tickets to St. Louis Cardinals games are suddenly scarce.

    Suppliers haven't been spared the knife. The combined company, Anheuser-Busch InBev NV, has told barley merchants, ad agencies and other vendors that it wants to take up to 120 days to pay bills. The brewer of Budweiser, a company with a rich history of memorable ads, has tossed out some sports deals that were central to marketing at the old Anheuser-Busch.

    The changes have been tough for workers to swallow. Some are grappling with heavier workloads, anxious about job security and frustrated with the emphasis on penny-pinching, say people close to the brewer. Former executives say workers feel less appreciated in a no-frills culture with fewer perks.

    InBev's response: It's more effective to make "sweeping, dramatic changes" than incremental ones, said a spokeswoman for the Belgian company, which has a history of many past mergers and acquisitions. Asked if morale in the U.S. is suffering, Dave Peacock, a 40-year-old Anheuser-Busch veteran who heads the U.S. division, said, "I think there's probably some truth....Some people react very well, some people struggle with it." Returning to the issue later in an interview, he said the newly merged company "is like a start-up....That excites some people and turns off others."

    It isn't yet clear how well the megadeal will pan out. The combination created the world's largest brewer by sales. But the tumult could offer an opening for MillerCoors LLC, which is exhorting its people to exploit the transition by trying to grab more shelf space at large retailers.

    Anheuser-Busch has nearly half of the U.S. beer market. It got a stronger challenger last summer, however, when SABMiller PLC and Molson Coors Brewing Co. linked their U.S. divisions in the joint venture called MillerCoors, with 29% of the U.S. market. "The next chapter in American beer is being written," MillerCoors President Tom Long said at a conference last month.

    Market-Share Gain But it was Anheuser-Busch InBev that logged a market-share gain the first quarter of this year, an increase of about three-quarters of a percentage point at sales at retail stores excluding Wal-Mart Stores Inc. The figures, from Information Resources Inc., show Anheuser-Busch InBev lifting its U.S. beer sales 5.7% in dollar terms from a year earlier. Bars and restaurants aren't included.

    The U.S. market is holding up well despite the recession, Anheuser-Busch InBev Chief Executive Carlos Brito said Tuesday. "In tough times, it's a great market to be exposed to," Mr. Brito, 48, said at a news conference after the company's annual meeting in Brussels. He declined to be interviewed for this article.

    InBev emerged as a beer heavyweight five years ago through the linkup of Brazil's AmBev, known for Brahma beer, and the Belgian producer of Stella Artois, Interbrew SA. Though it was based in Leuven, Belgium, the Brazilians' culture came to dominate. That approach stresses a sharp eye on costs and incentive-based pay structures.

    InBev eschews fancy offices and company cars, and groups of its executives share a single secretary. It uses zero-based budgeting -- meaning all expenses must be justified each year, not just increases. The company says it saved €250,000 ($325,000) by telling employees in the U.K. to use double-sided black-and-white printing, spending the money to hire more salespeople.

    "We always say, the leaner the business, the more money we'll have at the end of the year to share," Mr. Brito, the CEO, said in a speech last year to students at his alma mater, Stanford University business school.

    Anheuser-Busch took a different path, spending amply on everything from top beer ingredients to the best hotel accommodations. Executives didn't just have secretaries -- many also had executive assistants, who traveled with their bosses, took notes and learned the business in a kind of apprenticeship.

    Most employees, even those at the company's Sea World and Busch Gardens theme parks, got free beer. Once the owner of the St. Louis Cardinals, the company continued to shell out heavily for tickets to Cardinals games, used in marketing. Employees who wanted the company to donate beer or merchandise for community events faced little red tape. The St. Louis company often made "best places to work" lists.

    Heavy ad spending on sports events, often as the exclusive beer advertiser, helped Anheuser-Busch become the U.S.'s dominant brewer. But its growth and stock performance turned sluggish in recent years as U.S. sales of imports and small-batch "craft" beers rose faster than the St. Louis giant's brands.

    After InBev swooped in last fall with a $52 billion takeover, it sacked about 1,400 employees in the U.S., equal to 6% of the U.S. work force before the merger, and 415 contractor positions. These followed 1,000 employee buyouts accepted at Anheuser-Busch just before the merger.

    InBev has overhauled the U.S. division's compensation system for salaried employees, as part of what an internal memo called "an increased focus on meritocracy." In the future, the company will pay salaried workers 80% to 100% of the market rate for comparable jobs, "and any increases above that require special justification and approvals," said the memo. That changed a system in which "high performers...might have seen fewer rewards as dollars were spread more evenly."

    Continued in article


    Complicated Math by Design:  Derivative Instruments Fraud in the 1990s and Executive Compensation in the 21st Century

    Before derivative financial instruments were well understood by buyers, sellers of such instruments like Merrill Lynch and many other top investment banking firms on Wall Street became fraudulent bucket shops selling derivatives packages that were so needlessly mathematical and complicated that they intentionally deceived buyers like pension and trust fund managers, When buyers commenced to lose millions upon millions of dollars, the SEC commenced to investigate one of the more serious set of scandals to ever hit wall street ---
    If you want to cry and laugh at the same time watch this expert (John Grant) try to understand a derivatives contract sold by Merrill Lynch to Orange County in California that eventually cost the County over a billion dollars (and forced it into bankruptcy.

    The video is an excerpt from a CBS Sixty Minute 1990sprogram (slow loading) ---\FAS133/SIXTY01.avi

    The point is that the investment banking firms in those days built in complicated mathematics to deceive investors regarding the risk in the investments these bankers were trying to sell in the 1990s. And it worked! Investors lost millions.

    In a similar manner in the 21st Century executives are trying to circumvent the SEC's new compensation disclosure rules by making the compensation contracts so complicated that nobody could comprehend what is being disclosed.

    "(New Math) x (SEC Rules) + Proxy=Confusion Firms Disclose Formulas Behind Executive Pay, Leaving Many Baffled," by Phred Dvorak, The Wall Street Journal, March 21, 2008; Page A1 ---
    (but not quite as complicated as the investment banking formulas for fraud in derivatives instruments selling)

    The latest proxy statement from Applied Materials Inc. tells exactly how the company set 2007 bonuses for top executives:

    "Base Salary x Individual Target Percentage x (Weighted Score + Total Stockholder Return Adder, if Achieved)."

    Of some help may be Applied's definition of weighted score:

    "(Performance Measure 1 x Weight as Percentage) + (Performance Measure 2 x Weight as Percentage)."

    And so on.

    As a maker of semiconductor equipment, Applied Materials belongs to an industry of mathematical whizzes. Yet the complexity of its proxy this year reflects a trend that extends far beyond Silicon Valley. Even Deere & Co., the maker of tractors, has produced a proxy that uses three formulas, four tables and a graph to illustrate the calculation of executive bonuses.

    This explosion of mathematics was sparked by the Securities and Exchange Commission, which in 2006 began requiring more information about how companies calculate executive pay. After the first batch of proxies using the new rules arrived last year, the SEC told 350 companies they hadn't been specific enough.

    Among those companies was Applied Materials. So this year, it expanded by 76% the word count of its proxy's compensation section. In all, the compensation section contains 16,245 words -- twice the length of the U.S. Constitution and its 27 Amendments -- along with 10 formulas, 10 tables and 155 percent signs.

    The result, according to some experts, is unfathomable. "Can even the executives figure out what they have to do to get these awards?" asks Carol Bowie, head of corporate-governance research at RiskMetrics Group Inc., which helps investors sort through such filings.

    The SEC has said that it wants disclosure to be clear and concise, as well as comprehensive. But striking that balance is difficult, companies say. So, many are erring on the side of detail.

    "Bonus multiple x target bonus x base salary earnings = payout," explains the new proxy from drug maker Eli Lilly & Co., which last year received a letter from the SEC calling its executive-pay disclosure inadequate. Just in case that term "bonus multiple" isn't clear, the proxy explains that it is "(0.25 x sales multiple) + (0.75 x adjusted EPS multiple)." To find the sales and EPS multiples, investors must consult graphs.

    Some firms may be throwing up their hands and deluging the public with figures. "I know a couple of companies where the frustration level with the SEC was so large that they said, 'Just put it all in,'" says John A. Hill, a trustee at mutual-fund giant Putnam Funds. Mr. Hill often chats about pay practices with officials of companies whose stock Putnam investors own.

    An SEC spokesman says it's too early to comment on 2008 proxies.

    Even activist investors who pushed for more disclosure on executive pay are scratching their heads. "There have been some proxies when I've gone through and said, 'Wow, I have no idea what I just read,'" says Scott Zdrazil, director of corporate governance at union-owned Amalgamated Bank, which manages around $12 billion in pension-fund assets.

    The Smell Test

    Mr. Zdrazil says he uses a "smell test" to judge whether companies are trying to obscure poor pay practices with lots of detail, or just being wonky. "If you can clearly understand the algebra involved, it passes," he says.

    One that doesn't pass his test is software maker Novell Inc. Its proxy tosses around such terms as "assigned weighted quantitative performance objective achievement percentage," and describes a two-step process for calculating executive bonuses:

    First: "Bonus Funding Percentage x Weighted Quantitative Performance Objectives Achievement x Qualitative Performance Factor = Performance Factor."

    Then: "Performance Factor x Target Bonus Percentage x Base Salary = Recommended Bonus Amount."

    Mr. Zdrazil says Novell fails to explain how difficult it is for executives to achieve performance targets.

    Asked about the formulas, Novell says it gave more detail in response to the SEC's push and that its proxy statement complies with SEC rules.

    At first glance, the bonus formula at software maker Adobe Systems Inc. seems straightforward: "Target Bonus x Unit Multiplier x Individual Results."

    But then comes the definition of unit multiplier. Adobe says it is:

    "Derived from aggregating the target bonus of all participants in the Executive Bonus Plan multiplied by the funding level determined under the funding matrix, and allocating a portion of the funding level to each business or functional unit of Adobe based on that unit's relative contribution to Adobe's success, and then dividing the allocated funding level by the aggregate target bonuses of participants working within each such unit." Got that?

    After all that calculating, Adobe's top five executives somehow received the exact same unit multiplier -- 200%. Adobe says that was the highest possible percentage and that it reflects how well the company performed.

    Degree of Transparency

    Adobe also says it "strives for a high degree of transparency" in financial reporting, and that it added detail this year on executive compensation "in that spirit, and in response to new SEC requirements."

    Applied's bonus formula was created a decade ago by an employee who majored in math, but the company hadn't previously included it in its filings. General Counsel Joe Sweeney says the new compensation discussion has won praise from investors and lawyers. Proxy adviser Glass Lewis & Co., which says it has no financial relationship with Applied, called the company's proxy "clear and concise."

    But Applied shareholder Robert Friedman, a retired computer programmer, isn't so sure. "This is too much," he says, munching on a cookie and flipping through a proxy moments before the company's March 11 annual meeting. "I own about a dozen companies, and if I did this for every company..."

    For all its length, Applied's proxy doesn't reveal some crucial information, such as the target to which the company would like to see its market share increase. That number -- key to calculating the CEO's bonus according to the formula -- must be kept from rivals, Mr. Sweeney, the general counsel, says. For the same reason, the document also excludes some information about other executives' performance goals. "I hate to think how long the [compensation section] would have been if we had included all the factors for all the individuals," says Mr. Sweeney.

    So if some important factors remain secret, what's the point of all the math? Mr. Sweeney says it is meant to give shareholders a taste of the decision-making process.


    CEOs are rewarded hundreds of millions of dollars even when they fail. This is not competitive capitalism!

    "Stanley O'Neal who is leaving Merrill Lynch after giving it a big fat gift of a $8 billion dollar write-off thanks to risky investments. The board just can't help but feed this obesity epidemic. They're giving him $160 million plus in severance for his troubles as he heads for the door. At some point, the nation's corporations, or most pointedly, their corporate boards, will realize throwing money at their CEOs is probably not the best idea"
    "Obesity Epidemic Among CEO Pay," The Huffington Post, November 1, 2007 ---


    From The Wall Street Journal Accounting Weekly Review on April 27, 2007

    "House Clears an Executive-Pay Measure,"  by Kara Scannell, The Wall Street Journal, April  21, 2007 Page: A3 ---

    TOPICS: Accounting, Disclosure, Disclosure Requirements, Regulation, Securities and Exchange Commission

    SUMMARY: This article reports on legislation passed by a 269-134 margin in the House to give "...shareholders a nonbinding vote on executive pay packages and a separate vote on any compensation negotiated as part of a purchase or sale of a company..." (a golden parachute). The legislation "would require the Securities and Exchange Commission to write rules under which investors could use company-issued ballot forms to vote on executive pay on an advisory basis, starting in 2009." This legislation builds on a law passed last year requiring greater disclosure about executive compensation, including a total compensation figure--an item difficult to determine from previous corporate financial statements. Business and the White House generally disagree with the legislation, in part because of fears that labor union negotiations would result in pay determinations based on inequality issues rather than performance ones. A related article identifies further specifics on the SEC's role in resolving these and other hot issues.

    1.) Summarize the legislation passed by the House. What will be the next step in attempts to pass this legislation? How would it be implemented?

    2.) Does this legislation show any impact from the political process on financial reporting practices? In your answer, consider also the general process undertaken by the SEC to resolve "hot" issues as well.

    3.) If the shareholders vote on the issues discussed in this article are not binding under the law if it is ultimately passed and implemented, then how would the law change current practices in executive compensation?

    4.) Despite President Bush's comments on executive compensation in this year's State of the Union address, administrators in the White House now say they do not support the proposed law but prefer to allow time for recently enacted reforms to take effect. What are these reforms? When were they implemented?

    5.) Focus in particular on the disclosure of executive pay packages in answer to question 4. How might these disclosure requirements work to change current practices in executive compensation?

    Reviewed By: Judy Beckman, University of Rhode Island

    RELATED ARTICLES: The SEC's Mr. Consensus by Kara Scannell, The Wall Street Journal, Apr 20, 2007 Page: C1



    From The Wall Street Journal Accounting Weekly Review on February 1, 2008

    SEC Unhappy with Answers on Executive Pay
    by Kara Scannell and JoAnn S. Lublin
    The Wall Street Journal

    Jan 29, 2008
    Page: B1
    Click here to view the full article on ---

    TOPICS: Accounting, Disclosure, Disclosure Requirements, Executive compensation, SEC, Securities and Exchange Commission, Stock Options

    SUMMARY: During summer and fall 2007, the SEC sent letters to 350 companies regarding the way in which they make financial disclosures about top executive pay. The SEC has reviewed the disclosures as "...part of its effort to bring more information about executive pay to shareholders after years of high-profile pay packages and perquisites that many view as excessive. Shareholder advocates are also pressing hard to give shareholders a greater say in executive pay." Of particular concern is the role of individual performance in Boards of Directors pay decisions about chief executives. As a result, some practitioners and academics think that companies may switch to using performance targets that they prefer to disclose. The article focuses on SEC interaction with Bristol-Myers Squibb.

    CLASSROOM APPLICATION: Issues surrounding disclosure of executive pay packages can be discussed in MBA courses on financial reporting, prior to coverage of stock compensation accounting in intermediate and advanced accounting courses, and other ways.

    1.) Based on discussion in the article, what are the current difficulties with disclosures regarding executive compensation?

    2.) Based on discussion in the related article, what SEC disclosure requirements for executive compensation were recently established?

    3.) Consider the requirement to describe performance targets that form the basis for executive compensation. Why are investors interested in that information? What information does it provide beyond presentation of annual executive compensation in historical cost based financial statements? In your answer, address comments from Baxter International's corporate secretary and associate general counsel, David P. Scharf, and quoted in the article.

    4.) Consider the opinion, held by some, that companies might prefer not to disclose performance targets and therefore change the measures by which their Boards assess executive compensation. Why might disclosure of these targets cause competitive harm? Should competitive harm be considered in the SEC's assessment of the disclosures it requires? Support your answer.

    5.) From where did the authors obtain the data about SEC letters that is included in this article? In your answer, specifically examine data for one of the companies referenced in the article that is available through the SEC's web site.

    6.) What is a proxy statement? Describe the compensation disclosures given by one of the companies referenced in the article in its 2006 proxy statement.

    Reviewed By: Judy Beckman, University of Rhode Island

    SEC Asks Firms to Detail Top Executives' Pay
    by Kara Scannell and JoAnn S. Lublin
    Aug 31, 2007
    Page: B1


    "SEC Unhappy With Answers on Executive Pay," by Kara Scannell and Joann S. Lublin, The Wall Street Journal, January 29, 2008; Page B1 ---

    The Securities and Exchange Commission sent letters to 350 companies last summer and fall critiquing the way they described the pay of their top executives. But the federal watchdog isn't happy with most of the answers it got.

    A majority of the companies have now received second letters, according to an SEC official, and of 26 companies whose cases were closed, 21 were chided for not giving enough information about the role of individual performance in their pay decisions.

    In writing to one of them, Bristol-Myers Squibb Co., the SEC noted that individual performance "was a primary determinate of compensation" but that the New York drug maker didn't properly describe how that measure translated to the pay it handed out.

    Sandra Leung, Bristol-Myers's general counsel and corporate secretary, promised to do better in the future -- in so many words. In an Oct. 10 letter, she said Bristol-Myers will elaborate in future filings "on the manner in which the named executive officers' performance against individual financial and operational objectives...impacted their resultant compensation." And Robert Zito, a Bristol-Myers spokesman, added that this year's proxy statement "will certainly be prepared consistent with our response to the SEC comment letter."

    The increasing SEC scrutiny could spur changes in how companies calculate compensation, including moving away from individual performance as a measure of success -- one of the areas the SEC focused on as particularly weak -- in favor of companywide financial targets, such as earnings or stock prices.

    "Quantifying individual performance targets isn't the easiest thing to do," said James D.C. Barrall, a Los Angeles attorney and executive-pay specialist at Latham & Watkins LLP, who expects to see such a shift.

    The companies most likely to change would be those that use performance targets they'd prefer to keep confidential, such as return on capital, said Ronald Mueller, a compensation expert at the law firm Gibson, Dunn & Crutcher in Washington, D.C. "In my experience, some companies switched to performance targets that they would be more comfortable disclosing," he said.

    Another possible result is that companies will stuff even more information into company proxy statements, which are already larded with charts and footnotes. That could mean an additional table with top officers' individual goals and how their pay stacks up against colleagues' rewards. Scott Olsen, head of the rewards practice at PricewaterhouseCoopers in New York, says a lot of people think that's what "the SEC is looking for."

    The scrutiny could have the unintended consequence of pushing companies to focus on short-term measures such as earnings or stock prices, which, critics say, can distort how companies are managed. An obsession with stock prices was one factor in the raft of corporate frauds that accompanied the end of the boom. Last year a panel organized by the U.S. Chamber of Commerce, the nation's largest business lobby, recommended that CEOs stop giving quarterly earnings guidance as part of a push to refocus on long-term results.

    The review by the SEC is part of its effort to bring more information about executive pay to shareholders after years of high-profile pay packages and perquisites that many view as excessive. Shareholder advocates are also pressing hard to give shareholders a greater say in executive pay.

    Letters from the 26 completed cases were recently made public on the SEC's Web site. The others will be posted 45 days after the SEC considers itself satisfied.

    In response, Mr. Tobin wrote on Nov. 9 that his "limited" raise reflected that "the company had only achieved quarterly sales and earnings targets in two of four quarters in 2005, Taxus market share lagged expectations and the launch of Taxus in Japan had been delayed." The company didn't state the specific quarterly targets.

    Spokesmen for Baxter International Inc., DuPont Co., Safeway Inc. and Electronic Data Systems Corp. -- other recipients of SEC letters -- said it is too early to offer details beyond their response letters because they're still discussing possible changes with directors or preparing their 2008 proxy statements.

    "We are just now completing financial reporting and analysis for the year and are evaluating performance and potential compensation decisions with our board," said a spokeswoman for Baxter, a health-products concern in Deerfield, Ill.

    David P. Scharf, Baxter's corporate secretary and associate general counsel, wrote that there were limits on what he was willing to tell the SEC.

    In his Oct. 22 response, he said additional information will be limited by the company's desire to avoid disclosing confidential information about unquantifiable "qualitative elements" of each top officer's pay. In any case, he continued, such revelations would not provide "substantial value to investors in understanding our compensation policies and decisions."


    Where were the auditors?
    Firms cook the books to set executive pay
    And these same executives are protesting Sarbanes-Oxley



    "Firms cook the books to set executive pay," Editorial, The New York Times, December 19, 23006 ---

    Among the corporate deceits that buttress America's obscene executive pay is the one about comparability. But a new federal rule may help expose the reality of so-called "peer groups." Far too often, the list of comparable CEOs is cooked.

    As the New York Times reported in its latest installment on executive pay, former New York Stock Exchange chairman Richard Grasso was a poster child for the abuse. His $140-million compensation package was rationalized, in part, by comparing his job to those at companies with median revenues 25 times the size of the exchange, assets 125 times and employee bases 30 times the size.

    Grasso was hardly alone. Executives have learned that the path to personal riches is paved by "peer groups" that include big and profitable companies. Eli Lilly compared itself to eight companies that had much higher profit margins. Campbell Soup used one set of companies for executive pay and a separate one as a benchmark for stock performance. Ford Motor Co. compared itself to other industries, its proxy statement said, because "the job market for executives goes beyond the auto industry."

    The "job market" argument is particularly disingenuous. As the New York Times noted, ousted Hewlett-Packard chief executive Carly Fiorina was replaced by a data processing executive who was earning less than half her pay. His company, NCR, never appeared on the Hewlett-Packard "peer group."

    The growth in executive pay has been so meteoric in the past quarter-century that it is demeaning the contributions of average workers and undermining public faith in corporate America. Last year, according to the Corporate Library, the average pay for an S&P 500 chief executive was $13.5-million. The average CEO now earns 411 times the average worker, up from 42 times in 1980.

    The new Securities and Exchange Commission disclosure rules went into effect on Friday, and compensation consultants are scrambling to cover their tracks. But stockholders who have been kept mostly in the dark will now at least have a chance to see the playbook. That's the first step toward ending these games of executive greed.

    Bob Jensen's fraud updates are at



    Bob Jensen's threads on fraudulent and incompetent auditing are at


    Four Banks Charged in Parmalat Failure
    A Milan judge has ordered Citigroup, UBS, Morgan Stanley and Deutsche Bank to stand trial for market-rigging in connection with dairy firm Parmalat's collapse, judicial sources said. Judge Cesare Tacconi also ordered 13 individuals to face trial on the same charges, at the end of preliminary hearings into the case, the sources told Reuters on Wednesday.
    Reuters, June 13, 2007 --- Click Here

    Parmalat's external auditor was Grant Thornton ---

    Yahoo Shareholders View Executive Pay as Excessive
    I.S.S., along with Glass Lewis and Proxy Governance, criticized the compensation committee for awarding bonus and retention pay in the form of 6.8 million stock options to Terry S. Semel, Yahoo’s chief executive, in a year when the company’s shares dropped nearly 35 percent. I.S.S. valued Mr. Semel’s pay in 2006 at $107.5 million, making him one of the nation’s best-paid executives. Separately, Yahoo shareholders rejected approximately 2-to-1 a proposal that would have tied executive compensation to competitive performance. They also rejected, by wider margins, proposals to establish a committee to oversee Yahoo’s human rights practices and to require the company to fight censorship and protect freedom of access to the Internet in countries with repressive regimes.
    Miguel Helft,  "Dissident Shareholders Send Message to Yahoo," The New York Times, June 13, 2007 --- Click Here

    How KB Home CEO's pay went through the roof
    KB Home may be the fifth-largest U.S. home builder, but it was No. 1 when it came to pay for its chief executive. Over the last three years, former CEO Bruce Karatz made $232.6 million in compensation.
    Kathy M. Kristof and Annette Haddad, LA Times, December 17, 2006 ---

    Jensen Comment
    I'd be more impressed if KB homes bought back the fundamentally-flawed cracked foundations of all those defective homes built in Texas ---

    Recall when "agency theory" assumed that CEO's had personal incentives to make accounting transparent without the need for outside regulation requirements? This is probably still being taught in accounting theory courses where instructors rely on old textbooks and journal articles.
    In the latest twist in the stock options game, some executives may have changed the so-called exercise date — the date options can be converted to stock — to avoid paying hundreds of thousands of dollars in income tax, federal investigators say . . . As those cases have progressed, at least 46 executives and directors have been ousted from their positions. Companies have taken charges totaling $5.3 billion to account for the impact of improper grants, according to Glass Lewis & Company, a research firm that advises big investors on shareholder issues. And further investigations, indictments and restatements are expected. Securities regulators are now focusing on several cases where it appears the exercise dates of the options were backdated, according to a senior S.E.C. enforcement official, who asked not to be identified because of the agency’s policy of not commenting on active cases. Besides raising disclosure and accounting problems, backdating an exercise date can result in tax fraud.
    Eric Dash, "Dodging Taxes Is a New Stock Options Scheme," The New York Times, October 30, 2006 ---

    You can read about agency theory at

    You can read the following at

    Incentive-Intensity Principle

    However, setting incentives as intense as possible is not necessarily optimal from the point of view of the employer. The Incentive-Intensity Principle states that the optimal intensity of incentives depends on four factors: the incremental profits created by additional effort, the precision with which the desired activities are assessed, the agent’s risk tolerance, and the agent’s responsiveness to incentives. According to Prendergast (1999, 8), “the primary constraint on [performance-related pay] is that [its] provision imposes additional risk on workers…” A typical result of the early principal-agent literature was that piece rates tend to 100% (of the compensation package) as the worker becomes more able to handle risk, as this ensures that workers fully internalize the consequences of their costly actions. In incentive terms, where we conceive of workers as self-interested rational individuals who provide costly effort (in the most general sense of the worker’s input to the firm’s production function), the more compensation varies with effort, the better the incentives for the worker to produce.

    Monitoring Intensity Principle

    The third principle – the Monitoring Intensity Principle – is complementary to the second, in that situations in which the optimal intensity of incentives is high correspond to situations in which the optimal level of monitoring is also high. Thus employers effectively choose from a “menu” of monitoring/incentive intensities. This is because monitoring is a costly means of reducing the variance of employee performance, which makes more difference to profits in the kinds of situations where it is also optimal to make incentives intense.

    Bob Jensen's threads on earnings management and agency theory are at

    Corrupt Corporate Governance
    For years, the health insurer didn't tell investors about personal and financial links between its former CEO and the "independent" director in charge of compensation
    Jane Sasseen, "The Ties UnitedHealth Failed to Disclose:  For years, the health insurer didn’t tell investors about personal and financial links between its former CEO and the "independent" director in charge of compensation," Business Week, October 18, 2006 --- Click Here

    "Gluttons At The Gate:  Private equity are using slick new tricks to gorge on corporate assets. A story of excess," by Emily Thornton, Business Week Cover Story, October 30, 2006 --- Click Here

    Buyout firms have always been aggressive. But an ethos of instant gratification has started to spread through the business in ways that are only now coming into view. Firms are extracting record dividends within months of buying companies, often financed by loading them up with huge amounts of debt. Some are quietly going back to the till over and over to collect an array of dubious fees. Some are trying to flip their holdings back onto the public markets faster than they've ever dared before. A few are using financial engineering and bankruptcy proceedings to wrest control of companies. At the extremes, the quick-money mindset is manifesting itself in possibly illegal activity: Some private equity executives are being investigated for outright fraud.

    Taken together, these trends serve as a warning that the private-equity business has entered a historic period of excess. "It feels a lot like 1999 in venture capital," says Steven N. Kaplan, finance professor at the University of Chicago. Indeed, it shares elements of both the late-1990s VC craze, in which too much money flooded into investment managers' hands, as well as the 1980s buyout binge, in which swaggering dealmakers hunted bigger and bigger prey. But the fast money--and the increasingly creative ways of getting it--set this era apart. "The deal environment is as frothy as I've ever seen it," says Michael Madden, managing partner of private equity firm BlackEagle Partners Inc. "There are still opportunities to make good returns, but you have to have a special angle to achieve them."

    Like any feeding frenzy, this one began with just a few nibbles. The stock market crash of 2000-02 sent corporate valuations plummeting. Interest rates touched 40-year lows. With stocks in disarray and little yield to be gleaned from bonds, big investors such as pension funds and university endowments began putting more money in private equity. The buyout firms, benefiting from the most generous borrowing terms in memory, cranked up their dealmaking machines. They also helped resuscitate the IPO market, bringing public companies that were actually making money--a welcome change from the sketchy offerings of the dot-com days. As the market recovered, those stocks bolted out of the gate. And because buyout firms retain controlling stakes even after an IPO, their results zoomed, too, as the stocks rose. Annual returns of 20% or more have been commonplace.

    The success has lured more money into private equity than ever before--a record $159 billion so far this year, compared with $41 billion in all of 2003, estimates researcher Private Equity Intelligence. The first $5 billion fund popped up in 1996; now, Kohlberg Kravis Roberts, Blackstone Group, and Texas Pacific Group are each raising $15 billion funds.

    And that's the main problem: There's so much money sloshing around that everyone wants a quick cut. "For the management of the company, [a buyout is] usually a windfall," says Wall Street veteran Felix G. Rohatyn, now a senior adviser at Lehman Brothers Inc. (LEH ) "For the private equity firms with cheap money and a very well structured fee schedule, it's a wonderful business. The risk is ultimately in the margins they leave themselves to deal with bad times."

    Continued in article

    Insiders are still screwing the investing public
    "Trading in Harrah's Contracts Surges Before LBO Disclosure:  Options, Derivatives Make Exceptionally Large Moves; 'Someone...Was Positioning'," by Dennis K. Berman and Serena Ng, The Wall Street Journal, October 4, 2006; Page C3 ---

    Bob Jensen's threads on "Corporate Governance" are at

    Bob Jensen's "Rotten to the Core" threads are at

    Compensation Special Report, Parts I & II, CFO Magazine, November 2006 --- 

    A Farewell to Perks?

    The SEC's new compensation-disclosure rules could mean the end of luxurious wine cellars and questionable stipends.

    IRS Chief: CFO Pay Should Be Fixed
    At a Senate hearing, Internal Revenue Service Commissioner Mark Everson says finance chiefs shouldn't be paid in options, and a ranking senator seems itching to legislate.

    Battle Lines Drawn on Executive Pay
    A House bill would require shareholder approval for corporate compensation policies.

    Study: Director Pay Hikes Slowing Down
    Further, fewer companies are making stock options a component of directors' compensation packages, with 53 percent providing them 2005— down from 59 percent in 2004 and 66 percent in 2003.

    Directors Say Exec Pay Hurts Image
    Two-thirds of board members also believe that the current model for executive compensation has contributed to superior corporate performance, according to a new survey; less than one-quarter of institutional investors share that view. Executive Pay Prognosis: Marginal Change The market for senior management pay is likely to keep compensation up—even in the face of more disclosure. Survey Says Comp Rules No Big Deal Even as multiple Senate hearings focus on executive compensation, a survey of human resource professionals says new SEC rules will have little impact on compensation or company performance.

    Study: Talent Will Cost More
    Hiring qualified employees could hit companies in the wallet in the coming year.

    State's Rights: Many Lift Minimum Wage
    While Congress fiddles, the states are raising the minimum wage.

    When Is Backdating a Crime?
    The burden will be on DoJ prosecutors to prove Brocade executives deliberately misled investors. Is Spring-loading Wrong? Testimony on Capitol Hill today did nothing to resolve the ongoing debate over whether spring-loading of stock options is illegal or unethical. Backdating Blamed on 1993 Tax Rule Disturbed by the manipulation of option grants, Congress is toying with eliminating the $1 million tax cap on executive compensation.

    "25 Reasons Employees Lie, Cheat, and Steal," SmartPros, September 2006 ---

    On-the-job theft goes beyond greed, according to authorities in white-collar crime (criminologists, sociologists, auditors, risk managers, etc.), who cite a large list of reasons for employee theft.

    In fact, a new edition of Fraud Auditing and Forensic Accounting lists a long list of 25 reasons -- some of which are common knowledge, but others may surprise. They include:

    • The employee believes he can get away with it.
    • No one has ever been prosecuted for stealing from the organization.
    • Employees are not encouraged to discuss personal or financial problems at work or to seek management's advice and counsel on such matters.

    Read the entire list and check out Book Corner for more details on the book.

    Bob Jensen's threads on theft and fraud are at

    What do companies and executives who back dated options fear the most?

    The Internal Revenue Service is examining as many as 40 companies ensnared in various stock options investigations to determine whether they owe millions of dollars in unpaid taxes. In the last few weeks, the agency has directed its corporate auditors to start reviewing the tax returns of dozens of executives and companies, which may have improperly reported stock option grants. These preliminary investigations are expected to take months, but if there is early evidence of widespread tax trouble, I.R.S. officials said they were prepared to step up their effort. “Where there are indications of mischief, we want to now look at those cases and see if they complied with tax laws,” said Bruce Ungar, the agency’s deputy commissioner for large and midsize businesses. “It is possible that they are compliant, but the early indication is that there is a good likelihood there is some noncompliance.
    Eric Dash, "I.R.S. Reviewing Companies in Options Inquiries," The New York Times, July 28, 2006 --- Click Here
    Jensen Comment
    The first 40 companies are only a drop in this scandalous bucket. Over 2,000 companies are suspected of this unethical compensation ploy.

    It appears that thousands of CEOs were allowed by their boards to bet on yesterday's horse race
    In theory, directors are supposed to help keep wayward practices like options backdating in check at most companies, but at Mercury it was the directors themselves — who received a final seal of approval from the company’s compensation committee — who kept the backdating ball rolling. Now, as federal investigations of possible regulatory and accounting violations related to options backdating have expanded to include more than 80 companies. Mercury’s pay practices — and the actions of the three outside directors on its compensation and audit committees — have come under scrutiny. In late June, the Securities and Exchange Commission advised the three men that it was considering filing a civil complaint against them in connection with dozens of manipulated options grants.
    Eric Dash, "Who Signed Off on Those Options?" The New York Times, August 27, 2006 ---

    Bob Jensen's threads on executive options compensation scandals are at

    Executives Are Betting On Yesterday's Horse Races

    As an aside, once again this shows that finance and accounting go hand in hand as Collins, Gong, and Li are accounting professors!

    From Jim Mahar's blog on May 23, 2006 ---

    Do managers backdate options?

    Do managers backdate options? It sure seems that way.

    A U.S. government probe into stock option grants for executives widened on Tuesday with more technology companies being called on to explain the way these grants are awarded.

    The investigation focuses on whether companies are giving executives backdated options after a run-up in the stock. Backdated securities are priced at a value before a rally, which boosts their returns.

    From NPR:

    The Securities and Exchange Commission (SEC) is reportedly examining the timing of stock option awards by corporations." (BTW this is included to you can listen to it--has several professors speaking on it.)

    From the LA Times:

    ""The stock-option game is supposed to confer the potential for profit, but also some risk," said John Freeman, a professor of business ethics at the University of South Carolina Law School who was a special counsel to the SEC during the 1970s. "When in essence the executives are betting on yesterday's horse races, knowing the outcome, there's no risk whatever.""

    What does past academic research have to say on this? Most of the evidence suggests that backdating probably does occur.

    For years there have been papers showing that managers tend to announce bad news prior to option grants and even time the grants prior to price run ups (see Yermack 1997) it has only been more recently that researchers have noticed that the price appreciation was not merely due to firm specific factors (which managers may be able to control and time) but also market wide factors (i.e. the stock market goes up after option grants).

    Last year a paper by Narayanan and Seyhun suggested that this may be the result of backdating the option grants. More recently two papers by Collins, Gong, and Li (a) and (b) find further evidence that backdating is (or at least was) happening and that unscheduled grant dates (where this can occur) tend to be found more commonly at firms whose management has relatively more control over their board of directors.
    Stay tuned!!

    * A quick comment to any manager who may have done this: Why bother? Why risk it all cheating for a few extra dollars? (Indeed it reminds me of the Adelphia case where the firm outsourced snow plowing to a Rigas owned firm. It just doesn't seem worth it.)

    *As an aside, once again this shows that finance and accounting go hand in hand as Collins, Gong, and Li are accounting professors!

    Bob Jensen's threads on outrageous executive compensation are at

    How excessive is executive compensation and what can be done about it?

    From Jim Mahar's Blog on August 22, 2006 ---

    Are CEOs overpaid?

    Yeah, I know I said I would go a while before posting, but Rich forwarded this to me and I think many of you will be interested. It is from MSNBC/Newsweek:

    A few look-ins:
    *"Ogling executive pay is the spectator sport of business. The catcalls from the stands have gotten louder as new studies throw out eye-popping statistics about how rich CEOs are getting, while the rest of us worry about keeping our jobs out of China. One such: the U.S.-based Institute for Policy Studies notes that CEOs made 142 times more than the average worker in 1994—and 431 times more in 2004."

    *"Democratic Congressman Barney Frank is proposing a Protection Against Executive Compensation Abuse Act, which would limit tax deductions for companies that pay executives more than 25 times the lowest paid worker. But even as the drumbeat for reform grows louder, some new research is questioning just how out of proportion these megapackages really are—and whether more regulation is the best way to scale them down.
    First, there's the issue of metrics....[the article then shows that using medians reduced the average CEO to average worker pay mulltple to 187].

    *Xavier Gabaix of MIT and Augustin Landier of NYU say that since 1980 the pay of CEOs has risen in lock step with the market capitalization of their companies: both are up 500 percent.

    *"Good governance still plays some part in determining pay—the researchers say that CEOs can garner 10 to 20 percent more by going to a firm with a weak board. And cultural mores play some role, too; many of the Japanese firms studied were as big as American firms, but executives were paid less and changed jobs less often."

    *"...nearly all firms are moving toward heavier reliance on bonuses. The average dollar amount of bonuses has doubled in the last three years, as they make up a growing proportion of pay...."

    Interesting article and an easy read so it is perfect for the final "lazy, hazy, crazy days of summer."

    Bob Jensen's threads on outrageous executive compensation are at

    "Overpaid Management: Their Cover Is Blown," by Mark Maisonneuve, The Wall Street Journal, June 22, 2006; Page A17 ---

    Jeremy Siegel ("The 'Noisy Market' Hypothesis," editorial page, June 14) blithely blames advisers for advocating capitalization-weighted indexes when in fact academics were the drivers. While individual advisers can move their small set of clients in any direction, academics have to consider that their research would apply to everyone. By definition everyone constitutes the total market and the total market can be held only on a cap-weighted basis.

    But he redeems himself with the noisy market hypothesis, though in a way he might not have considered. With one blow we are rid of the justification for CEO pay bloat on the basis that the shareholders have been rewarded with a higher stock price. Noisy markets imply that the higher price may only be a chimera of temporary overvaluation. To Prof. Siegel's factors of diversification, liquidity and taxes I would add financial manipulation by the group most rewarded by overvaluation -- stock-option-laden senior management. Now that their cover is blown, shareholders and their boards can work to ensure that high pay is earned by real gains in fundamental value.

    "The Winding Road to Grasso's Huge Payday," by Landon Thomas, The New York Times, June 25, 2006 ---

    In the spring of 2003, the chairman of the New York Stock Exchange, Richard A. Grasso, had his eyes on a very rich prize. Although Mr. Grasso's annual compensation at the time was about $12 million, on a par with the salaries of Wall Street titans whose companies the exchange helped regulate, he had accumulated $140 million in pension savings that he wanted to cash in — while still staying on the job.

    Now Henry M. Paulson Jr., the chairman of Goldman Sachs and a member of the exchange's compensation committee, was grilling Mr. Grasso about the propriety of drawing down such an enormous amount and suggested that he seek legal advice. So Mr. Grasso said he would call Martin Lipton, a veteran Manhattan lawyer and the Big Board's chief counsel on governance matters. Would it be legal, Mr. Grasso subsequently asked Mr. Lipton, to just withdraw the $140 million if the exchange's board approved it? Mr. Grasso told Mr. Lipton that he worried that a less accommodating board might not support such a move, according to an account of the conversation that Mr. Lipton recently provided to New York State prosecutors. (Mr. Grasso has denied voicing that concern.) Mr. Lipton said he told Mr. Grasso not to worry; as long as directors used their best judgment, Mr. Grasso's request was appropriate.

    Mr. Grasso continued to fret. What about possible public distaste for the move? Yes, there would be some resistance from corporate governance activists, Mr. Lipton recalled telling him, but given his unique standing in the business community he was "fully deserving of the compensation."

    Then Mr. Lipton, a founding partner of Wachtell Lipton Rosen & Katz and a longtime adviser to chief executives on the hot seat, dangled another, hardball option in front of Mr. Grasso. If a new board resisted a payout, Mr. Lipton advised, Mr. Grasso could just sue the board to get his $140 million. The conversation represented a pivotal moment at the exchange, occurring when corporate governance and executive compensation were already areas of public concern. Mr. Grasso eventually secured his pension funds. But the particulars surrounding the payout later spurred Mr. Paulson to organize a highly publicized palace revolt against Mr. Grasso, leading to the Big Board's most glaring crisis since Richard Whitney, a previous president, went to jail on embezzlement charges in 1938.

    An examination of thousands of pages of depositions from participants in the Big Board drama, as well as other recent court filings, highlights the financial spoils available to those in Wall Street's top tier. It also shines a light on deeply flawed governance practices and clashing egos at one of America's most august financial institutions, all of which came into sharp relief as Mr. Grasso jockeyed to secure his $140 million.

    ELIOT SPITZER, the New York State attorney general, sued Mr. Grasso in 2004, contending that his Big Board compensation was "unreasonable" and a violation of New York's not-for-profit laws. With a trial looming this fall, prosecutors have closely questioned both Mr. Lipton and Mr. Grasso about their phone call. Prosecutors are likely to highlight Mr. Grasso's own doubts about the propriety of cashing in his pension; on two separate occasions Mr. Grasso withdrew his pension proposal from board consideration before finally going ahead with it.

    The depositions paint a portrait of Mr. Grasso as a man who paid meticulous attention to every financial perk, from items like flowers and 99-cent bags of pretzels that he billed to the exchange, to his stubborn determination to corral his $140 million nest egg. While the board ultimately approved his deal, court documents also show a roster of all-star directors, including chief executives of all the major Wall Street firms, often at odds with one another or acting dysfunctionally.

    A recent filing by Mr. Spitzer contended that Mr. Grasso's chief advocate, Kenneth G. Langone, a longtime friend and chairman of the Big Board's compensation committee, was less than forthcoming in keeping the exchange's 26-member board in the loop about how Mr. Grasso's rising pay was also inflating his retirement savings.

    Continued in article

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    As Workers' Pensions Wither, Those for Executives Flourish
    This is the pension squeeze companies aren't talking about: Even as many reduce, freeze or eliminate pensions for workers -- complaining of the costs -- their executives are building up ever-bigger pensions, causing the companies' financial obligations for them to balloon.
    Ellen E. Schultz and Theo Francis, "As Workers' Pensions Wither, Those for Executives Flourish:  Companies Run Up Big IOUs, Mostly Obscured, to Grant Bosses a Lucrative Benefit The Billion-Dollar Liability," The Wall Street Journal, June 23, 2006; Page A1 ---

    Outrageous Executive Audacity

    "That Other Guy From Omaha," by Gretchen Morgenson, The New York Times, August 29, 2006

    Mr. Gupta is, shall we say, a piece of work. He often prevents large shareholders from asking questions on conference calls. He has received compensation that was not earned under the terms of the company’s executive compensation program, according to a lawsuit that Cardinal Value Equity Partners, infoUSA’s largest outside holder, filed against the company. And, the suit alleges, his board has given him free rein to dispense stock options to whomever he likes.

    Related-party transactions are also routine at infoUSA. The Cardinal lawsuit contends that infoUSA paid a company owned by Mr. Gupta about $608,000 in 2003 to buy his interest in a skybox at the University of Nebraska’s Memorial Stadium. The university is Mr. Gupta’s alma mater and home of the Cornhuskers football team. In June 2005, the suit says, infoUSA paid $2.2 million for a long-term lease of his yacht. The yacht, named American Princess, is 80 feet long and has an all-female crew, according to a report in The Triton, a monthly publication for boat captains and crews.

    Leases on an H2 Hummer, a gold Honda Odyssey, a Glacier Bay Catamaran, a Mini Cooper, a Lexus 330, a Mercedes SL500 ­ all used by the Gupta clan ­ as well as rent on a Gupta family condominium on Maui have also been financed by infoUSA shareholders, the suit said.

    Shareholders also paid a company owned by Mr. Gupta’s wife $64,200 for consulting services in 2003 and 2004. Shareholders have also covered the Gupta family’s personal use of a corporate jet ­ leased by infoUSA from a company owned by the family ­ to have fun in the sun in Hawaii and the Bahamas. Mr. Gupta apparently wasn’t in a mood to return the favor: during a four-year period ending in 2004, infoUSA paid $13.5 million to Mr. Gupta’s private company for use of the aircraft.

    What to make of all of this? The Cardinal lawsuit contends that the carnivalesque spending amounts to unregulated perquisites and evidence of a somnambulant board. Sleepy, perhaps, but always on the move. Some 15 directors have spun through infoUSA’s boardroom door over the last decade; five of them stayed less than a year.

    It wasn’t until two years ago ­ November 2004 ­ that infoUSA’s board created guidelines for the approval of related-party transactions over $60,000. The Cardinal lawsuit alleges that some of infoUSA’s related-party dealings with certain board members “did not have a sufficient record to show authorizations and whether the services could be procured from other sources at comparable prices.”

    None of the infoUSA board members returned phone calls seeking comment. Mr. Gupta did not return several phone calls, either.

    But Mr. Gupta’s biggest faux pas occurred in June 2005, when infoUSA warned that its earnings would not be up to expectations. The stock fell from $11.94 a share to $9.85 the day after the announcement. Less than a week later, Mr. Gupta offered to acquire infoUSA for $11.75 a share, far less than the $18 a share he had said the company was worth just a few months earlier.

    A special committee of the company’s board was set up to evaluate Mr. Gupta’s offer and to field bids from other possible partners in order to secure the highest possible price for infoUSA shareholders. Almost exactly a year ago, the committee concluded that the $11.75 offer was too low and that it should be subject to a “market check.”

    At a board meeting on Aug. 26, 2005, Mr. Gupta said that he would not sell any of his shares to a third party in an alternative transaction, according to the lawsuit. Some directors might have used this opportunity to give Mr. Gupta a well-earned public rebuke. But a majority of the sleepwalkers at infoUSA just got into lockstep with their chief executive.

    The directors responded by deciding that there was no need for infoUSA’s special committee to exist. They voted 5 to 3 (with one abstention) to abolish it. The only directors voting for the committee’s continuance were three of its four members; the fourth abstained from voting. The stock closed that day at $10.89.

    The vote was the last straw for Cardinal Value Equity Partners. It filed suit in February against Mr. Gupta, some of infoUSA’s directors and the company itself.

    “Our suit says that the special committee was prematurely terminated, that they didn’t get to finish their work and that was the wrong decision by the entire board,” said Robert B. Kirkpatrick, a managing director at Cardinal Capital Management. “We’re not asking for $100 billion; we ask that the special committee be reconstituted to be able to have the time to fulfill their original mandate as dictated by the board.”

    In other words, to reopen the possibility of a buyout.

    IN the meantime, all is right in Mr. Gupta’s gilded world. About three weeks ago, on Aug. 4, infoUSA announced that it was buying Opinion Research, a consulting services company, for $12 a share, an almost 100 percent premium to Opinion Research’s market price the day before the announcement.

    Lo and behold, who owned Opinion Research shares the day the deal was announced? The Vinod Gupta Revocable Trust, according to a regulatory filing, owned 33,000 shares. The trust, controlled by Mr. Gupta, sold 22,000 of its shares after the merger announcement sent Opinion Research’s stock rocketing.

    The trust’s shares don’t represent a huge stake, but it is worth asking: Did infoUSA’s directors know that the Gupta trust was an Opinion Research shareholder when they signed off on the premium-priced deal? And what gains did the trust record when it sold into the deal-jazzed market? For now, the answers are unclear.

    In coming weeks, a judge in Delaware will rule on whether the Cardinal lawsuit can proceed. InfoUSA has asked the judge to dismiss the case, saying that it has no merit.

    “Unfortunately, the system is broken in this case,” said Donald T. Netter, senior managing director at Dolphin Financial Partners, a private investment partnership in Stamford, Conn., that is an infoUSA shareholder. “The board has failed to protect the unaffiliated shareholders. When the system works properly, you shouldn’t get into these situations.”

    No kidding.

    Many CEOs Receive Dividends on 'Phantom' Stock
    Amid the drive to tie executive pay more closely to company results, a little-known and poorly disclosed practice is allowing many executives to receive hundreds of thousands of dollars a year in dividends on performance stock -- shares that they may never earn . . . Performance, or "phantom," shares are a form of restricted stock paid to an executive only if the company meets certain performance targets. Dozens of other CEOs are paid dividends on unvested restricted stock, which typically requires the recipient only to wait several years before actually receiving the shares, regardless of performance.
    Scott Thurm, "Extra Pay: Many CEOs Receive Dividends on 'Phantom' Stock," The Wall Street Journal, May 4, 2006; Page A1 ---

    "Surprise! CEOs Are Still Highly Paid! "Deserve" has nothing to do with it," by Holman W. Jenkins, The Wall Street Journal, May 03 2006 ---

    It must be (insert time of day, season or year here) because the air is filled with complaints about CEO pay. To wit, CEOs are paid too much because they are "greedy." They are paid too much because their wages are the product of a corrupt bargain with crony boards. Sacred norms are violated: The average CEO makes 300 times an average worker's salary. What is the "right" number and where does it come from? The Bible? We'll get back to you.

    You could do worse than revisit the case of one Joseph Nacchio, former CEO of Qwest Communications, one of those shamelessly overpaid CEOs of the '90s. It shows, in the end, that very large CEO compensation is awarded in a logical and deliberate manner because it serves the legitimate interests of those awarding it.

    Mr. Nacchio, an executive at AT&T, was recruited to Qwest by the company's founder, Denver billionaire Philip Anschutz. Mr. Anschutz, a famously shrewd dealmaker, dangled an offer of three million stock options, the explicit temptation being: Sign away five years of your life and I will give you the chance to become extraordinarily wealthy.

    This is the basic transaction behind most "outrageous" CEO pay. And Mr. Nacchio had the good sense to go where Mr. Anschutz was leading him. Qwest's stock price soared and Mr. Nacchio eventually exercised options for a pre-tax gain of $250 million.

    Now we come to the reason for focusing on Mr. Nacchio. In 2001, Mr. Anschutz prevailed on him to stay, offering essentially the same deal over again, and Mr. Nacchio sat down with the Rocky Mountain News to explain his compensation. What followed was a rare exercise in realism about CEO pay.

    He noted that several Qwest executives with large stock-option windfalls had already left. "Look, it's very hard to keep guys and gals who work in the normal corporate structure and then all of a sudden over the period of two or three years, make $50 to $70 million. . . . Most people who make that kind of money will immediately say: 'seen it, done it in the corporate world, I'm going to do something else.'"

    "I was faced with the choice: I either got to leave at the end of five [years], or I have to stay for a substantive period of time. . . . Look, I could go sit on the beach right now and never have to do another day's work."

    He added: "You might say if you want to stay, why don't you just work for free? I think there are limits to how much you want to do something. If I did that, then my investors would judge my rationality and everything else I did."

    There's a lot here, but suffice it to say, when you hear Pfizer's board being criticized for having guaranteed Hank McKinnell an $83 million retirement payout despite a crummy decade for drug stocks, remember Mr. McKinnell is a rich man and could be on a beach too.

    Notice we don't use the language of "deserve" or "worth" or "reward," common in complaints about CEO pay. These are after-the-fact judgments, and any board that dishes up large pay for performance that's already in the books isn't doing shareholders any favor. "Pay for performance" is paying for the past, not the future, which is what stock prices care about.

    That's why CEO pay is about incentives -- the incentive to commit to the job in the first place, the incentive to make decisions that benefit shareholders. Should a company go for broke on a new investment project or play it safe? Should it conserve cash or spend lavishly on customer service and advertising? Should it pay bonuses to employees or direct the same cash to the bottom line?

    A shareholder is hardpressed to make these calls from the sidelines. Meanwhile, tugging at a CEO's elbow all the time are competing constituents who also want something at the company's expense. Hence the use of stock options, unabated by controversy and fully supported by valuations in the stock market, to put CEOs in the place of owners when making these choices. In turn, the market sits in judgment on a CEO's every move, adding or subtracting in a nanosecond a sum from the company's market value that dwarfs even the CEO's pay package.

    You can complain, as critics do, that when boards are giving away stock options or any company asset, they aren't giving away something that belongs to them, so what do they care? Yep, that's also true of the guy who fills the supply closet or authorizes a new roof for the factory. It's true of the politicians who spend our tax dollars and the charities that dispose of our donations. "Agency" is a feature of organized life.

    None of this means an Enron doesn't happen occasionally. Very large sums dangled in front of people will make some crazy (and we should note Mr. Nacchio is still fighting insider trading charges related to his Qwest stock sales). But notice that the average CEO, by the time he or she has spent a working life in one corporate job after another, would not have succeeded without a finely tuned sense of impulse control, a capacity to temper wishful thinking with realism, a capacity for coolness and restraint in dealing with frustration, opposition and risk.

    What you get with the typical CEO, a few exceptions notwithstanding, is a seasoned grown-up capable of acting wisely and well under the heady incentives (and dangers) of corporate life.

    Rote disapproval has been a feature of the landscape since pundits began noticing executive compensation 20 years ago, but the critics should at least have the courage of their resentment and stop trying to rationalize their disapproval with claims that CEO pay isn't, by and large, an honest product of the marketplace. High CEO pay exists because intelligent, savvy, self-interested investors and their representatives believe it's in their interest to award high CEO pay. And for that reason, high CEO pay won't be going away.

    Why linking pay to stock prices is liable to do more harm than good.

    "Why Rules Can't Stop Executive Greed," by Daniel Akst, The New York Times, March 5, 2006 ---

    In the arena of executive compensation, two recent developments stand out against the backdrop of continuing looting. First, the Securities and Exchange Commission announced plans to make corporations more fully disclose executive pay. Second, a study by Mercer Human Resource Consulting found that more companies were imposing performance targets on the stock and options they granted to C.E.O.'s.

    To the uninitiated, these events may suggest that some moderation is in the offing, but ultimately neither will help much. Any benefit from shining the cleansing light of day on executive greed will probably be outweighed by the inflationary effect of additional disclosure, which will provide more ammunition for executives and consultants seeking to justify additional increases. They have to keep up with the Joneses, they'll say.

    Tying pay more firmly to performance won't help, either. Boards will find ways around the requirements if performance isn't up to snuff, and they will continue to bid irrationally for unduly coveted executives.

    As Rakesh Khurana showed in his insightful book, "Searching for a Corporate Savior: The Irrational Quest for Charismatic C.E.O.'s" (Princeton University Press, 2002), there is a much wider pool of potential chief executives than soaring pay levels would seem to imply. But companies insist on bidding for a savior, not a capable leader who knows the business at hand, which may be why typical C.E.O. tenures are now so short. Even in the boardroom, charisma carries you only so far.

    Indeed, linking pay to stock prices is liable to do more harm than good. A stock price isn't much of a measure of executive performance, anyway. A huge part of that price reflects industry conditions; energy companies soared not because they were run by paragons of diligence or insight, but because of world events beyond any executive's control. In hard times, moreover, a company's stock may take a hit, but those are precisely the times when good leadership is most difficult — and valuable.

    Other performance metrics can be equally troublesome, encouraging executives to massage earnings, sacrifice long-term strength for higher short-term sales and profits and otherwise act in ways detrimental to everyone but the C.E.O., his family and a few lucky divorce lawyers.

    Perverse incentives notwithstanding, this focus on metrics is a sad acknowledgment by corporate directors that they cannot control themselves or the pay they hand over to their top five executives. In one study, two professors, Lucian A. Bebchuk of Harvard and Yaniv Grinstein of Cornell, found that from 2001 to 2003, such pay totaled roughly 10 percent of corporate profits at public companies. It's a bizarre twist on the tradition of tithing, one that benefits the rich instead of the needy and conscripts America's shareholders as involuntary donors.

    Although more disclosure and pay-for-performance requirements won't dampen runaway C.E.O. compensation, both are useful for illustrating a larger lesson: that it's naïve to place too much faith in the power of rules to limit human behavior. Indeed, the problem of C.E.O. compensation suggests that, as in many aspects of modern life, few mechanisms of constraint are as effective as one on which we relied so often in the past. That mechanism was shame.

    You'd think that more disclosure would produce more shame, and thus less pay, for C.E.O.'s and other top executives. Unfortunately, disclosure of a few more million here and there won't fundamentally change a hiring system that actively recruits the most grasping and hubristic candidates. Consider the incentives: by offering lavish pay and perks that would make royalty blush, corporate directors today are perhaps unwittingly selecting C.E.O.'s for shamelessness and egotism rather than leadership.

    HISTORY teaches that there is no ultimate solution to the so-called agency problem, or the tendency of those who merely work in an enterprise to act in their own interest rather than that of the owners. Rules and incentives can help, of course, but they cannot take the place of an honest sense of obligation, duty and loyalty — values that ought to run in all directions in any decent corporate culture.

    Continued in article

    Seeing Fakes, Angry United Airline Employee-Shareholders Should be Confronting the Bankruptcy Judge
    The deal went through — with staggering compensation to Wall Street — and in 1994 the American employees of UAL, as a group, became its largest owners. Within a few years, overseas personnel were allowed the privilege of tossing their life savings into UAL, too. Trouble was not far behind. The employees found management demanding pay cuts, big (and, for passengers, inconvenient) changes and cuts in scheduling and services, and even silly changes in their once-great flight attendant uniforms. Then came the blows of 9/11 and a recession, and then rising fuel costs. There were demands for more cuts in pay and benefits and more layoffs. That was not enough. About three years ago, UAL was "forced" to enter bankruptcy to stay alive. This step meant that UAL could drastically cut workers' pay — and it did. Pensions were simply jettisoned and made the burden of the federal government's Pension Benefit Guaranty Corporation, which meant cuts of close to two-thirds in some pilots' pension payments. And, of course, the bankruptcy simply eliminated all of that equity in UAL that the employees had bought with their hard-earned savings.
    Ben Stein, "When You Fly in First Class, It's Easy to Forget the Dots," The New York Times, January 29, 2006 ---

    Here comes the good part: management has asked the bankruptcy court to let it have — free — roughly 15 percent of the stock in the new company, or about $900 million. Mr. Tilton, the chief executive, who plays the Orson Welles character in this drama, would get about $90 million personally for his hard work shepherding UAL through bankruptcy (for which he was already paid multiple millions of dollars).

    The bankruptcy court, instead of ordering Mr. Tilton's arrest, instead cut the management share to about 8 percent, so he will get more than $40 million, more or less. That is more than Lee R. Raymond, the chief executive of Exxon Mobil, one of the most successful companies of all time, was paid in 2004 (not counting Mr. Raymond's 28 million shares of restricted stock).

    So here it is in a nutshell: employees are goaded into investing a big chunk of their wages and benefits in UAL stock. They lose that. Then they lose big parts of their pay and pensions. They become peons of UAL. Management gets $480 million, more or less. "Creative destruction?" Or looting?

    Wait, Mr. Tilton and Mr. Bankruptcy Judge. The employees were the owners of UAL. They were the trustors, and Mr. Tilton and his pals were trustees for them. How were the trustors wiped out while the trustees, the fiduciaries, became fantastically rich? Is this the way capitalism is supposed to work? Trustors save up, and their agents just take their savings away from them?

    If the company is worth so much that management has hundreds of millions coming to them, shouldn't the employee-owners get a taste? Does capitalism mean anything if the owners of the capital can be wiped out while their agents grow wealthy? Is this a way to encourage savings and the ownership society? Or is this a matter of to him who hath shall be given?

    I know that this is basically the same story I described recently concerning the Delphi Corporation, where something similar is going on. But that's exactly the point. Management is using competition, higher fuel costs and every other cost complaint to cut the pay and pensions of its own employees while enriching itself.

    And I can well imagine what goes through Mr. Tilton's mind as he does it: "Hey, I'm a great executive. Great executives in private-equity firms make more than I do. Why shouldn't I get the moolah? Basically, I've worked it so UAL is now a private-equity deal anyway. That's what it's all about now, isn't it? Who's got the most at the end of the day at Bighorn or the Reserve or whatever golf course I choose to retire at? And, anyway, wouldn't you take $48 million for a few of those dots we used to call our employees and owners to stop moving?"

    From The Wall Street Journal Accounting Weekly Review on January 13, 2006

    TITLE: SEC to propose overhaul of Rules on Executive Pay
    REPORTER: Kara Scannell
    DATE: Jan 10, 2006
    PAGE: A1
    TOPICS: Accounting, Disclosure, Disclosure Requirements, Executive compensation, Securities and Exchange Commission

    SUMMARY: "The Securities and Exchange Commission, responding to rising criticism of soaring--and partially hidden--executive pay, is poised to propose the most sweeping overhaul of pay disclosure rules in 14 years, seeking to push companies to divulge much more about their top executives' perquisites, retirement benefits and total compensation.'

    1.) According to the description in the article, what are the problems and issues associated with current disclosure requirements for executive compensation? Where are those disclosures made? What entity establishes the requirements for those disclosures?

    2.) What benefit will come from placing "the monetary value of stock-option grants...side by side with salary and bonus information"? How are those "monetary values" of stock option grants determined?

    3.) The article refers to a new FASB accounting standard related to stock options. Summarize the requirements of that new standard. Will the changes described in this article impact those requirements? Explain.

    4.) Is the SEC hoping to curb executive compensation with this new proposal? Explain your answer: if yes, indicate how disclosure might play a role in this process; if no, indicate how this disclosure change is independent of any desire to curb compensation.

    5.) Shering-Plough's chief executive, Fred Hassan, stated that his company's managements believes that "transparency is good for shareholders...particularly if additional disclosures allow shareholders to look at the compensation in the context of management's performance..." Describe one way in which you might undertake an analysis from an investor's point of view to use disclosures about executive compensation in this way.

    SMALL GROUP ASSIGNMENT: Assign group members to access corporate financial statements and proxy filings by industry, by student choice of company of interest, or any other method of choosing. Access the SEC's web site to obtain electronic access to both the most recent quarterly filing and the proxy statement. Ask students to describe the information found in these corporate filings and explain where they find the information. Make comparisons by company or across industry lines in amounts and types of executive compensation.

    Access filings on the SEC web using the following steps described for Google, Inc.:

    Click on Search for Company Filings Under General-Purpose Searches, click on Companies & Other Filers In the box for Company name, type Google and click "Find companies" Click on the third CIK, 0001288776 In the box for Form Type, type DEF 14A (for proxy statements) and 10-Q (for quarterly reports)

    Reviewed By: Judy Beckman, University of Rhode Island

    Correcting this CEO IPO fraud is long overdue

    "A Major Perk For Executives Takes a Big Hit:  McLeod Ruling Makes It Tougher To Accept Lucrative IPO Shares; Broader Definition of 'Spinning'," by Michael Siconolfi, The Wall Street Journal, February 21, 2006; Page C1 ---

    Corporate executives, take note: The definition of improper stock trading in your brokerage account just got broader.

    A New York state court recently found former telecommunications executive Clark E. McLeod liable for receiving hot new stocks in his personal brokerage account. The rationale: His company was sending business to the same securities firm, Citigroup Inc.'s Salomon Smith Barney, that doled him the new stocks.

    That is a big change. Previously, "spinning" of initial public offerings of stock involved a direct quid pro quo. In a common form, securities firms allocated IPOs to the personal accounts of corporate executives, so the shares could then be sold, or "spun," for quick profits -- in exchange for business from the executives' companies.

    IPO shares are coveted because they often surge on their first trading day. Spinning has raised concerns among investors that the IPO market is rigged.

    Bottom line: Senior executives now could skate on thin legal ice if they receive IPO shares from a Wall Street firm with which their company at some point does business, and don't disclose it to their board or shareholders.

    The ruling has broader ramifications. Even though Mr. McLeod lived and worked in Cedar Rapids, Iowa, the judge said the New York attorney general could bring the case because the transactions were made through a New York firm. Most securities firms do business in New York.

    This is an "expansive interpretation" of corporate executives' duty, says Joseph Grundfest, a former commissioner at the Securities and Exchange Commission and now a law and business professor at Stanford University.

    The ruling comes as the IPO market heats up again. So far this year, there have been 32 new stock issues brought to market, raising $5.8 billion; the average first-day gain has been 11%, according to Richard Peterson, a senior researcher at Thomson Financial, a New York financial-data provider.

    Mr. McLeod, 59 years old, declined to comment. He will appeal the "completely novel" ruling, says one of his lawyers, Richard Werder, a partner at Jones Day.

    A former mathematics and science teacher, Mr. McLeod started a long-distance company out of his garage in 1980. He eventually founded McLeod Inc., a telecom upstart now known as McLeodUSA Inc. that fell victim to the bursting of the technology-stock bubble. He left as chief executive in April 2002; McLeodUSA emerged from bankruptcy-law protection last month. He currently is CEO of Fiberutilities of Iowa, a utility-management company.

    Continued in article

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    Figuring execs' pay hard, even for pros (like Denny Beresford)
    The question seems simple enough: What did Coca-Cola pay its chief executive, Neville Isdell, for his first year at the helm? Dennis Beresford is trying to come up with the answer as he digs into a disclosure report Coke released last year. Surely he's up to the task, being an accounting professor at the University of Georgia, chairman of audit committees at two major companies, and a former chairman of the Financial Accounting Standards Board. He takes nearly 20 minutes. But his answer --- "in the general area of $17 million"--- could be off by as much as $14 million. Seems Beresford missed a small footnote in the documents and didn't accurately assess the value of some stock options.
    Matt Kempner, "Figuring execs' pay hard, even for pros," Atlanta Journal-Constitution, January 21, 2006 ---

    A look at the proxy's "Summary Compensation Table" didn't give Beresford all the information he was looking for. He added up the dollar figures there and came up with nearly $11 million for Isdell. Then the professor scoured footnotes and other tables and decided to include an additional $6 million or so, representing about 450,000 stock options.

    That brought the total for Isdell to roughly $17 million.

    But as Beresford tried to complete the task quickly, he missed a footnote mentioning about 621,000 additional stock options. The options were awarded in early 2005 and based on Isdell's performance in 2004.

    "I was obviously not looking at every footnote as I went through, which I should have," Beresford said later. The additional options could have been worth an additional $8 million or so.

    Oops. Then came another issue. While Beresford saw an award of "Performance Share Units," they were based on Coke share prices that he didn't know off the top of his head. He didn't factor the units into the total, which could add an additional $5 million to $6 million.

    If all the extras were included, it could bump Isdell's total package from $17 million to about $31 million. And that doesn't include Isdell's potential pension benefits, which Beresford struggled to quickly tabulate since he couldn't find all the information he needed in the proxy.

    James Reda, a New York-based compensation consultant for corporate boards, said he isn't surprised that a sharp investor could be way off trying to total up executive pay.

    Smaller companies --- generally those with less than $200 million in revenue --- usually have pay deals that are easier to dissect. But with a large company, Reda said, his staffers spend more than three hours trying to come up with total compensation as well as payouts due when a CEO leaves.

    "Companies don't try to make it easy," he said.

    Even with the disclosure changes mandated by the SEC, Beresford questioned how much easier it will be for investors to come up with a realistic total of executive compensation. Pay packages are complex and can depend on a number of future variables.

    Said Beresford: "I suspect the simplified approach is going to be a very long document."

    At Coke, the company plans to review the SEC's proposed changes, Sutlive said. "We fully support transparency and clarity in corporate financial reporting, including executive compensation."

    To the company's credit, it disclosed some of the stock options and Performance Share Units awarded to Isdell even though it says it wasn't required to for another year.

    And what does Coke calculate Isdell's 2004 compensation package to be? Somewhere between $10.9 million and $17.5 million, depending on how you value the options.

    Continued in article

    Gee, why hadn't I thought of that?! This is a cool one!

    "a vast academic literature has emerged on executive compensation. A predominant focus of this literature has been equity-based compensation, paid in the form of restricted stock, stock options, and other instruments whose value is tied to future equity returns"

    "Overlooked almost entirely is the widespread practice of paying top managers with debt."

    From Jim Mahar's blog on January 20, 2006 ---

    Gee, why hadn't I thought of that?! This is a cool one!

    SSRN-Pay Me Later: Inside Debt and its Role in Managerial Compensation by Rangarajan Sundaram, David Yermack: "CEOs with high debt-based incentives manage their firms conservatively to reduce default risk; and that pension plan compensation strongly influences patterns of CEO turnover and CEO cash compensation."

    The authors make an important contribution by pointing out the obvious: namely that CEOs get pain in ways other than cash and equity. This is a fact that has largely been overlooked by researchers (at least partially due to data availability). From the paper:

    "a vast academic literature has emerged on executive compensation. A predominant focus of this literature has been equity-based compensation, paid in the form of restricted stock, stock options, and other instruments whose value is tied to future equity returns"

    "Overlooked almost entirely is the widespread practice of paying top managers with debt."

    CEO pay is rarely in the form of traditional market-based debt but several forms of pay (specifically pensions and long term deferred compensation contracts) have the same characteristics as debt. In Jensen and Meckling terms this 'inside debt" is hypothesized to affect the incentives of the CEOs.

    After a case study showing how deferred compenstaion and pension benefits were important in the Jack Welch/GE world, the authors show that this "inside debt" does make up a large portion of CEO pay and that this is more important as CEOs near retirement.

    Using large firms (237 forms from teh Fortune 500 of 2002) the authors report the expected; debt does change behavior with managers becoming more risk averse. (Rememeber if we assume managers are people and people respond to changes in incentives, then managers respond to incentives. So while important, the findings should not be seen as surprising.)

    "As CEO pension values increase relative to their equity values, risk-taking as measured by distance-to default declines."

    Good (and important) stuff! I^3!!!

    Cite: Sundaram, Rangarajan K. and Yermack, David, "Pay Me Later: Inside Debt and its Role in Managerial Compensation" (May 16, 2005). NYU, Law and Economics Research Paper No. 05-08; AFA 2006 Boston Meetings Paper.

    January 23, 2006 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU]


    No I didn't. I think the point is that compensation consultants and others will try to work around whatever the SEC finally requires in this area. That's just human nature and what they get paid to do!


    Coke Decides Enough is Enough
    Under pressure from one of its big shareholders, Coke adopted a new policy requiring that its stockholders approve certain executive severance agreements.

    Gretchen Morgenson, Severance Pay Doesn't Go Better With Coke," The New York Times, December 25, 2005 ---

    Executive Compensation:  Here's how it works even in bankruptcy
    Last Wednesday, the judge overseeing the UAL Corporation's reorganization approved an executive pay package that would give rich salaries and at least $115 million worth of stock to the airline company's chief executive, Glenn F. Tilton, and other senior managers, when UAL emerges from Chapter 11. UAL said the executive pay was necessary to attract and retain experienced managers. But the judge's approval surprised Brian Foley, an executive pay expert in White Plains. For starters, he noted, the plan was created by Towers Perrin for the UAL board. Towers Perrin also happens to have done work for UAL management.
    "A Little Too Close for Comfort at UAL?" The New York Times, January 22, 2006 ---
    Jensen Comment
    All the pilots, flight attendants, machinists, ticket agents, baggage handlers, and other UAL employees took pay cuts.  Why not the top brass? Just goes to show you that there's no economic law of supply and demand at the CEO level. It's all a matter of back scratching where the CEO appoints the Board that in turn decide how much the CEO can loot from shareholders.

    I don't know whether to post this to my "White Collar Crime" module or my "Outrageous Executive Compensation" module.  These days both modules should probably be merged.

    Did Enron change executive looting tendencies?
    Despite an array of new and expensive laws and regulations that were adopted to tighten corporate oversight after the wave of scandals earlier in the decade, serious accounting problems continue to trouble publicly owned companies. In the last year, a record number have been forced to correct erroneous earnings statements, which often led to sharp stock declines. Moreover, for all the widespread criticism of high pay of executives at Enron and other companies that later proved derelict, studies show that there is still little overall correlation between the performance of many companies and the executive compensation set by their directors.
    Stepen Labaton, "Four Years Later, Enron's Shadow Lingers as Change Comes Slowly," The New York Times, January 5, 2005 ---

    Dance with the one who brought (bought?) you!

    Financial performance reporting transparency or in this case lack thereof in accounting
    A growing number of companies are paying extra sums to cover executives' personal tax bills, even as CEO compensation continues to soar. Details of the "tax gross-ups" are often buried in impenetrable footnotes or obscure filings.

    "Latest Twist in Corporate Pay: Tax-Free Income for Executives," by Mark Maremont, The Wall Street Journal, December 22, 2005 ---

    Amid soaring CEO compensation, a number of companies are paying extra sums to cover executives' personal tax bills. Many companies are paying taxes due on core elements of executive pay, such as stock grants, signing bonuses and severance packages. Others are reimbursing taxes on corporate perquisites, which are treated as income by the Internal Revenue Service. They run the gamut from personal travel aboard corporate jets to country-club memberships and shopping excursions.

    "This smacks of Leona Helmsley-like treatment, that only little people pay taxes," says Patrick McGurn, an executive vice president of Institutional Shareholder Services Inc., an influential adviser to big investors that often critiques companies' corporate-governance practices. For these top executives, he says, companies "are removing taxes from the list of inevitable life experiences, leaving only death."

    Details of the little-known payments, called "tax gross-ups," are often buried in impenetrable footnotes or obscure filings. In its 2005 proxy statement, Home Depot didn't disclose many of the perks it must give Mr. Nardelli, or that the company is required to reimburse him for taxes related to those perks. The company provided specifics of these benefits and the gross-ups in his employment agreement, which was attached to a 2001 regulatory filing. (Read Home Depot's filing.)

    Continued in article

    The question is:  Why don't the auditors insist on transparent disclosures?

    Coke Decides Enough is Enough
    Under pressure from one of its big shareholders, Coke adopted a new policy requiring that its stockholders approve certain executive severance agreements.

    Gretchen Morgenson, Severance Pay Doesn't Go Better With Coke," The New York Times, December 25, 2005 ---


    “Dance with the one who brought you”


    “So long as owners remained in charge and hired managers to help run the business, salaries were ample but not extravagant. J.P. Morgan, for example, made it a point never to pay an executive more than twenty times the earnings of the lowliest employee in the organization. As late as 1900, salaries of $5,000 -$6,000 (or $80,000 - $95,000 in today’s currency) were not uncommon for presidents of substantial manufacturing companies, and the average compensation for top managers of large firms prior to World War I was slightly below $10,000. - less than the pay of a university president. Not until owners relinquished power, and managers were accountable only to thousands of shareholders, was the way clear to granting emoluments on the lavish scale we know today.”

    It is a part of the worldwide definition of the corporation that the shareholders elect the members of the board of directors and that the directors will be responsible for the conduct of the business, including the selection of executive officers.  And yet in reality shareholders do not elect the directors and directors are not responsible for the conduct of the business, and this gulf between myth and reality seems acceptable, even preferred. Shareholders do not elect directors; the Chief Executive Officer selects the board members; they are routinely “nominated” by a committee comprised of incumbent directors; theirs are the only names that appear on the company proxy which is distributed at corporate expense to all shareholders; management counts the votes and calls those who cast a vote against to try to persuade them to change their minds, and it is virtually impossible for anyone other than management to get a name on the company proxy, so challengers must bear all the expenses of providing alternate candidates while the management slate uses corporate funds. The result is that the “election” of the management slate is as safely guaranteed as that of the Chief Executive of Albania during the half century following World War II.

    Continued at 

    "Salary Is the Least of It," Fortune, April 28, 2003, Page 59

    While shocking in one sense, these developments are not wholly surprising.  For several decades now, CEO pay has been governed by the Law of Unintended Compensation, which holds that any attempt to reduce compensation has the perverse result of increasing it.

    • In 1989, Congress tries to cap golden parachutes by imposing an excise tax on payments above 2.99 times base salary.  Result: Companies make 2.99 the new minimum and cover any excise tax for execs.
    • In 1992, Congress tries to shame CEOs by requiring better disclosure of their pay.  Result: CEOs see how much everyone else is making, and then try to get more.
    • In 1993, Congress declares salaries over $1 million to be non-tax-exempt.  Result: Companies opt for huge stock option grants while upping most salaries to $1 million.

    You get the idea.  Regulation is a spur to innovation, and in the pay arena innovation always means "more."  As executive-pay critic Graef Crystal once put it, "The more troughs a pig feeds from, the fatter it gets."

    "CEO PAY: Have They No Shame?" by Jerry Useem, Fortune, April 14, 2003 ---,15114,443051,00.html 

    CEO performance stank last year, yet most CEOs got paid more than ever. Here's how they're getting away with it.

    But the pigs were so clever that they could think of a way round every difficulty.
    --George Orwell, Animal Farm

    Who says CEOs don't suffer along with the rest of us? As his company's stock slid 71% last year, one corporate chief saw his compensation fall 12%. Sure, he still earned $82 million, making him the second-highest-paid executive at an S&P 500 company in 2002, according to the 360 proxy statements that had rolled in as of April 9. And yeah, he's under indictment for the wholesale looting of his company, Tyco. But at least Dennis Kozlowski set a better example than the top-paid executive, who pulled in a whopping $136 million. That was Mark Swartz, his former CFO.

    Unusual, you might say, for one company to produce the two top earners in a given year. But three of the top six? Now that's truly striking--especially since the other person isn't part of Kozlowski's gang at all. It's Ed Breen, the guy hired to clean up the mess.

    You'd think that in the aftermath of a scandal that made Tyco a symbol of cartoonish greed, its board might want to make a point of frugality. Yet even as it was pressuring its former officers to "disgorge" their ill-gotten gains, it was letting its new man, who became CEO last July, gorge himself on $62 million worth of cash, stock, and other prizes. By all accounts Breen is doing a fine job so far (see Exorcism at Tyco), but still. And the gravy train didn't stop there. Tyco's board of directors dished out another $25 million for a new CFO, plus $25 million to a division head, putting them both on a par with the CEOs of Wal-Mart and General Electric. At least the company, now with a new board of directors, seems to recognize the need for some limits: Its bonus scheme "now caps out at 200% of base salary," notes Breen, "whereas before it was more like 600% or 700%."

    That, in a nutshell, is what a year of unprecedented uproar and outrage can do. Before, CEOs had a shot at becoming very, very, very rich. Now they're likely to get only very, very rich. More likely, in fact. FORTUNE asked Equilar, an independent provider of compensation data, to analyze CEO compensation at 100 of the largest companies that had filed proxy statements for 2002. Their findings? Average CEO compensation dropped 23% in 2002, to $15.7 million, but that's mostly because the pay of a few mega-earners fell significantly. A more telling number--median compensation, or what the middle-of-the-road CEO earned--actually rose 14%, to $13.2 million. This in a year when the total return of the S&P 500 was down 22.1%.

    "The acid test for reform," wrote Warren Buffett in his most recent letter to shareholders, "will be CEO compensation." With most of the results now in, the acid strip is bright red: Corporate reform has failed. Not only does executive pay seem more decoupled from performance than ever, but boards are conveniently changing their definition of "performance." "From a compensation point of view," says Matt Ward, an independent pay consultant, "it's a whole new bag of tricks."

    What did fall last year were monster grants of stock options, like the 20 million awarded to Apple's Steve Jobs in 2000. The declining use of options (which even Kozlowski once called a "free ride--a way to earn megabucks in a bull market") would seem cause for reformers to rejoice. But delve more closely into the data for those 100 big companies and what do you find? That every other form of compensation--including some burgeoning forms of stealth wealth--has grown.

    Continued in the article.

    Also see Enron's Cast of Characters at 

    From The Wall Street Journal Accounting Educators' Reviews, October 27, 2003

    TITLE: Everything You Wanted to Know About Corporate Governance . . . 
    REPORTER: Judith Burns 
    DATE: Oct 27, 2003 
    PAGE: R5-6 
    TOPICS: Corporate Governance, Internal Auditing, Sarbanes-Oxley Act, Securities and Exchange Commission, Audit Committee

    SUMMARY: A special section on corporate governance in the Oct. 27 WSJ addresses the issue of corporate governance in some detail. Included is the article by Judith Burns with a primer on what corporate governance is and relating it to the parties involved. Several related articles recount why this is a topical issue and what are the prospects in the future, including the Hymowitz article detailing the duties of a corporate board member.

    1.) Define corporate governance. Does it ensure superior firm performance? Why is it important to investors? Who are the major parties involved in this issue? Briefly discuss the roles each plays in it.

    2.) What are the responsibilities of: the Board of Directors; the Chief Executive Officer; the internal auditors; the external auditors; the Compensation Committee; the Nominating Committee; the Auditing Committee; and the SEC? Where they apparently exist, explain potential conflicts of interest and how this "muddies the waters" where the responsibilities are concerned.

    3.) What effects have this issue had on credit-rating agencies and insurance companies?

    4.) Does the CEO hire the Board of Directors? Why or why not? In the Maremont and Bandler article, who failed in the governance of Tyco?

    5.) How has the Sarbanes-Oxley Act affected these relationships? Have they had unintended consequences? On balance, has the Act met its intended purposes? Are more legislative changes anticipated?

    Reviewed By: Judy Beckman, University of Rhode Island 
    Reviewed By: Benson Wier, Virginia Commonwealth University 
    Reviewed By: Kimberly Dunn, Florida Atlantic University

    TITLE: How to Be a Good Director 
    REPORTER: Carol Hymowitz 
    PAGE: R1-4 
    ISSUE: Sep 27, 2002 

    TITLE: Now Playing: Corporate America's Funniest Home Video 
    REPORTER: Mark Maremont and James Bandler 
    PAGE: A1-8 
    ISSUE: Oct 29, 2003 
    (See the Yawn below)

    Corporate America's Funniest (read that most boring) Home Video
    The Wall Street Journal, October 29, 2003 
    20-minute video of an extravagant birthday party for the wife of former Tyco CEO L. Dennis Kozlowski depicts what many consider the height of corporate excess. Three videos can be downloaded from links below:


    Full:   Part 1 

    Full:  Part 2): 
    This is a Roman Orgy without the orgy.  Actually everybody looks pretty boring and bored.  Neither video shows the life-sized naked woman birthday cake.  And the sculpture of David peeing vodka was edited out of the flicks.  The cake and the sculpture were not shown to the jury in the Kozlowski trial.  Just why these were edited out is a mystery to me since they depict the sickness of this former Tyco CEO more than the tame stuff on the jury's videos where all the bored actors in togas wore underwear.  What's left on the tape isn't worth watching except to witness a boring waste of $2 million in corporate dough.  I've attended funeral parties (e.g., for my friend John Bacon) in Pilots Grill in Bangor, Maine where the guests had more fun.
    Bottom Line Conclusion:  Success of a corporate party is defined as what it cost rather than what it bought.

    Has anybody read whether any partners from PwC attended the birthday bash?

    An enormous mystery for the Manhattan prosecutors has been how much Tyco’s auditors knew about the about allegedly improper bonuses paid to Kozlowski and other executives along with the improper spending of corporate funds for personal expenses such as Kozlowski’s $65,000 New England golf club membership --- 

    October 29, 2003 reply from Patricia Doherty [pdoherty@BU.EDU

    -----Original Message----- 
    From: Patricia Doherty [mailto:pdoherty@BU.EDU]  
    Sent: Wednesday, October 29, 2003 9:20 AM 
    Subject: Re: Corporate America's Most Boring Home Video

    I suppose one interesting fact that emerged is the fact that his mistress planned his wife’s birthday party. Remarkable what some people will put up with for money. They deserve each other.

    "If not this, then what?
    If not now, then when?
    If not you, then who?"

    Patricia A. Doherty
    Instructor in Accounting
    Coordinator, Managerial Accounting
    Boston University School of Management
    595 Commonwealth Avenue
    Boston, MA 02215

    Bob Jensen's threads on corporate fraud --- 

    "Corporate Governance and Equity Prices," by Paul A. Gompers, et al. July 2002 --- 
    Note that this paper has a great Glossary of terms.

    The power-sharing relationship between investors and managers is defined by the rules of corporate governance. In the United States, these rules are given in corporate legal documents and in state and federal laws. There is significant variation in these rules across different firms, resulting in large differences in the balance of power between investors and managers. Using a sample of about 1,500 firms per year and 24 corporate-governance provisions during the 1990s, we build a Governance Index, denoted as “G”, to proxy for the balance of power between managers and shareholders in each firm. We then analyze the empirical relationship of this index to stock returns, firm value, operating measures, capital expenditure, and acquisition activity. 

    We find that corporate governance is strongly correlated with stock returns during the 1990s: an investment strategy that purchased shares in the firms with the lowest G (strongest shareholder rights), and sold short firms with the highest G (weakest shareholder rights), earned abnormal returns of 8.5 percent per year. At the beginning of the sample, there is already a significant relationship between valuation and governance: each one-point increase in G is associated with a 2.4 percentage point lower value for Tobin’s Q. By the end of the decade, this difference has increased significantly, with a one-point increase in G associated with an 8.9 percentage point lower value for Tobin’s Q.

    Continued at 

    "System Failure:  Corporate America:  We Have a Crisis," Fortune Magazine Cover Story, June 24, 2002 ---

    Pay CEOs, Yeah--But Not So Much Before they stumbled, they cashed in. Enron's Jeff Skilling made $112 million off his stock options in the three years before his company collapsed. Tyco's Dennis Kozlowski cashed in $240 million over three years before he got the boot. Joe Nacchio, who's still in charge at Qwest but has left investors billions poorer, made $232 million off options in three years.

    If you're looking for reasons corporate America is in such ill repute, this kind of over-the-top CEO piggishness is a big one. Investors and in some cases employees lost everything, while the architects of their pain laughed all the way to the bank.

    The funny thing is, we asked for it. "Pay for performance" was what investors wanted--and to a significant extent, got: For the first time in memory, CEOs' cash compensation actually dropped in 2001, by 2.8%, according to Mercer Human Resource Consulting. The value of top executives' stock and options holdings in many cases dropped by a lot more than that.

    But while CEO pay has become more variable--and study after study has shown it to be more closely linked to company performance than it used to be--it has also grown unspeakably generous. Fifteen years ago the highest-paid CEO in the land was Chrysler's Lee Iacocca, who took home $20 million. Last year's No. 1, Larry Ellison of Oracle, made $706 million.

    There are a lot of complicated, difficult-to-change reasons for this. Some are addressed in the next item, on corporate governance (see also "The Great CEO Pay Heist" in Some may be insoluble. In any case, we're probably due an acrimonious national debate over just what a CEO is worth. But for now, here's a straightforward suggestion: Force companies to stop pretending that the stock options they give their executives are free.

    It's probably safe to say that Oracle's board would never have paid Larry Ellison $706 million in cash or any other form that would have to show up on the company's earnings statement. All that money (Ellison didn't get a salary last year) came from exercising stock options that the company had given him in earlier years. And because of the current screwed-up accounting for stock options, Oracle's earnings statement says that Ellison's bonanza didn't cost the company a cent.

    Options are by far the biggest component of CEO pay these days. Virtually all of the most eye-popping CEO bonanzas have come from options exercises. While it is sometimes argued that options are popular because they link the interests of executives with those of shareholders, there are other, possibly better ways to do that--outright grants of stock, for instance--that don't get used nearly as much as options because they have to be expensed.

    Do the markets really have trouble seeing through this kind of financial gimmickry? Are boards really so influenced by an accounting loophole? In a word, yes. "Anybody who fights the reported-earnings obsession does so at their own peril," says compensation guru Ira Kay of the consulting firm Watson Wyatt. So let's make companies charge the estimated value of the options they give out against their earnings, and see if the options hogs are up to the fight.

    The past six months have featured a parade of corporate leaders who were irresponsible stewards of other people's money and trust. They were apparently so consumed by greed that they never dreamed of getting caught, ruining companies, and shaming themselves. In so doing, they have created what Al Vicere, a professor of strategic leadership at Pennsylvania State University's Smeal College of Business, calls a CEO "credibility crisis." All of which raises the question: Why? What is it about the character of today's corporate chieftains that has led them into CEO-gate -- which at times prompts them to indulge in behavior more reminiscent of fallen TV ministers than of upstanding community leaders?

    One of the best sites that I have encountered regarding news and issues in corporate governance is maintained by Robert Monks at 
    The site should also be of great interest to those interested in ethics, environmental, and social responsibility.  Robert Monks is a veteran director of over a dozen large corporations.  At best he is only cautiously optimistic about reforms that might emerge from the current scandals like Enron, WorldCom, and Andersen.  He most certainly thinks that members of the audit committees and boards of directors are ineffective in controlling corporate graft, because they do not have access to company resources needed for such a task   Robert Monks  is featured on Page 35 of the June 2002 issue of Financial Executive --- 

    The Biggest Crime of All:  They Still Don't Get It 

    "Wall Streets CEOs Still Get Fat Paychecks Despite Woes," by Susanne Craig, The Wall Street Journal, March 3, 2003

    Chiefs' Packages Decline Overall Still, $10 Million or More Isn't Bad

    Stock markets are down. Corporate public offerings are out. Investors are on the sidelines. And financial firms continue to cut staff.

     But there is still a bull market in one pocket of Wall Street -- the pay of securities-firm CEOs.

    Amid one of the worst operating environments in years, Wall Street chief executives continue to pull down annual paychecks topping $10 million. Even though their pay is down overall, it is still turning heads in many quarters. Morgan Stanley's CEO Philip Purcell received a 2002 pay package of $11 million. Goldman Sachs Group Inc.'s Henry Paulson made $12.1 million and Lehman Brothers Holdings Inc.'s Richard Fuld took home a pay package valued at $12.5 million.


    Citigroup Inc.'s Chief Executive Sanford I. Weill, whose banking firm has been dogged by regulatory probes this year, volunteered not to receive a cash or stock bonus for 2002 because the share price of the company, which owns Salomon Smith Barney, dropped 25% during the year.

    But Citigroup's board granted Mr. Weill stock options for 2003 with an current estimated value of $17.9 million, more than the $17 million cash bonus Mr. Weill received in 2001. At Bear Stearns Cos., one of the few securities firms that actually saw its profit rise in 2002, CEO James Cayne saw his total compensation more than double to $19.6 million last year.


    The still-hefty paychecks are drawing criticism as being out of whack with these tough economic times. On Wall Street, fees from the most profitable businesses -- such merger-and-acquisition advice and underwriting initial public offerings of stock -- have all but dried up.

    "The problem is there is no strong indication the bear market is over and we are a long way from justifying these type of packages," says Mike Corasaniti, director of research at boutique investment firm Keefe, Bruyette & Woods Inc. and an adjunct professor in the business department of  Columbia University in New York .


    "In good times boards justify the big pay packages by saying the executives are doing a great job and in bad times they justify the pay by saying they are managing in a difficult environment. No matter what, they seem to find a way to rationalize it."

    Officials at the various firms declined to comment

    Of course, a Wall Street CEO's pay is tied to performance. And the job hasn't been easy. But the tough decision to cut staff may have in fact boosted the pay packages of many top executives, as the cost-cutting measures kicked in. With the exception of a few firms, notably Credit Suisse Group's Credit Suisse First Boston, most Wall Street firms have actually been making money during the bear market. CSFB reported a loss for 2002 of $811 million, due to $813 million in charges to cover items ranging from 1,500 previously announced job cuts to a provision for civil-litigation costs.

    Also see 


    Additional Reading

    The New Robber Barons --- 

    Derek C. Bok, The Cost of Talent How Executives and Professionals are Paid and How It Affects America (Free Press 1993)

    Peter Drucker, The Bored Board, in Toward the Next Economics and Other Essays, Harper & Roe, New York, 1981

    Bob Jensen's threads on corporate governance are at



    Corporate Boards and the SEC Will Not Solve Corporate Governance the Crisis
      Riches Without Restraint:  The Sad State of Corporate Governance

    Why did Hewlett-Packard needed to plug leaks from its board of directors?

    "Zip It," by James Surowiecki, The New Yorker, October 9, 2006 ---

    Ever since the news broke that investigators working for Hewlett-Packard had engaged in a series of unsavory (and possibly illegal) tactics in an attempt to discover which members of its board of directors were leaking information to the press, attention has focussed on the scandalous investigative methods that were used. This isn’t surprising: the decision to sic the gumshoes on the leakers was an act of spectacularly bad judgment, and the consequences have been appropriately severe. HP’s chairman of the board resigned, California’s attorney general claims that he has enough evidence for indictments, and last week Congress allocated two full days of hearings to the subject. Amid the uproar, though, something important has been forgotten: the leaks were a serious problem. HP was wrong to resort to Plumbers-style snooping but right to think that the leaks needed plugging.

    Leaks from a company’s board of directors are a problem because they magnify the decision-making flaws that have plagued boards for their entire institutional history. Boards are supposed to be vigilant monitors of management and stewards of long-term strategy. But, as Franklin Gevurtz, a law professor at University of the Pacific, has shown in a recent article, there have always been complaints about the supine nature of boards and the unwillingness (or inability) of directors to actually direct. In “The Way We Live Now,” published in 1875, Anthony Trollope describes a board meeting at the company run by the fraudster Melmotte: “Melmotte himself would speak a few slow words . . . always indicative of triumph, and then everybody would agree to everything, somebody would sign something, and the ‘Board’ . . . would be over.” Not much had changed by 1971, when the Harvard Business School professor Myles Mace said that most directors were little more than “ornaments on a corporate Christmas tree.” And, historically, boards were often packed with corporate insiders and cronies of management. (When Michael Eisner was the C.E.O. of Disney, his board for years included his personal attorney and the architect who designed his house.)

    Over the past two decades, though, and especially after the major corporate scandals of 2001 and 2002, much effort has gone into improving board performance. A checklist of good board characteristics—not having the C.E.O. also serve as chairman of the board, increasing the number of outside directors, and so on—has been put to use. Since 2001, the number of new independent directors appointed at major corporations has risen sharply, and more than eighty per cent of all directors now qualify as independent.

    These are welcome improvements, but they’re not enough to reform boards. (Enron’s board, after all, was full of independent directors.) Successful boards require what Jeffrey Sonnenfeld, a professor at the Yale School of Management, calls “a culture of open dissent,” where members are free to criticize the C.E.O. and each other, and where there is no artificial attempt to impose consensus on the group. This is hard to achieve, because dissenting opinions often get interpreted as personal attacks. Social scientists like to say that good decision-making groups engage in “task conflict,” fighting over the best solutions to particular problems, while bad ones engage in “relationship conflict,” interpreting differences of opinion as differences of character. But, as Tony Simons and Randall Peterson, of Cornell, mention in a study of seventy top management teams, groups that engage in “task conflict” also often suffer from “relationship conflict.” In other words, it seems you can be collegial and friendly and make bad decisions, or you can be locked in a room with people who can’t stand each other and make better decisions.

    Simons and Peterson identified a surprisingly simple way out of this dilemma: trust. They found that groups whose members trusted one another’s competence and integrity were more likely to engage in task conflict without succumbing to relationship conflict. Paradoxically, the more people trust one another, the more willing they are to fight with each other. And this is why the leaks at H.P. were a problem: they undermined the sense of trust and solidarity that a board needs to be effective. The original leaks came in 2005, when the board was debating the future of its then C.E.O., Carly Fiorina, and they were clearly an attempt to spin the debate over Fiorina toward the position the leaker favored. In other words, they were meant to bring outside pressures to bear on board decisions, and to put the interests of individuals above those of the group. The later leak, which provided details of long-term strategy discussions at a board retreat, was relatively anodyne, but it violated an agreement that board members had made not to disclose private information, and so insured further erosion of trust. In addition, the violations of confidentiality have made people less likely to speak openly. The leaks both magnified the possibility of relationship conflict and diminished the chances of open dissent.

    Continued in article

    "Gilded Paychecks:  Ties That Bind With Links to Board, Chief Saw His Pay Soar," by Julie Creswell, The New York Times, May 24, 2006

    Every October, some 50 former Home Depot managers, calling themselves the Former Orange-Blooded Executives, after the home-improvement chain's trademark bright orange color, gather in Atlanta to reminisce, chat about new jobs and pass around pictures of their children.

    The discussion inevitably turns to the changes at Home Depot under its chief executive, Robert L. Nardelli. A growing source of resentment among some is Mr. Nardelli's pay package. The Home Depot board has awarded him $245 million in his five years there. Yet during that time, the company's stock has slid 12 percent while shares of its archrival, Lowe's, have climbed 173 percent.

    Why would a company award a chief executive that much money at a time when the company's shareholders are arguably faring far less well? Some of the former Home Depot managers think they know the reason, and compensation experts and shareholder advocates agree: the clubbiness of the six-member committee of the company's board that recommends Mr. Nardelli's pay.

    Two of those members have ties to Mr. Nardelli's former employer, General Electric. One used Mr. Nardelli's lawyer in negotiating his own salary. And three either sat on other boards with Home Depot's influential lead director, Kenneth G. Langone, or were former executives at companies with significant business relationships with Mr. Langone.

    In addition, five of the six members of the compensation committee are active or former chief executives, including one whose compensation dwarfs Mr. Nardelli's. Governance experts say people who are or have been in the top job have a harder time saying no to the salary demands of fellow chief executives. Moreover, chief executives indirectly benefit from one another's pay increases because compensation packages are often based on surveys detailing what their peers are earning.

    To its critics, the panel exemplifies the close personal and professional ties among board members and executives at many companies ­ ties that can make it harder for a board to restrain executive pay. They say this can occur even though all of a board's compensation committee members technically meet the legal definition of independent, as is the case at Home Depot.

    "When you have a situation like this where it is so incestuous, it creates uncertainty whether Nardelli's pay is a reflection of these relationships or from his performance," said Jesse M. Fried, a professor of law at the University of California, Berkeley, and co-author of a book on executive compensation, "Pay Without Performance."

    A showdown could occur at the annual meeting tomorrow as firms that advise large shareholders and activist groups are urging shareholders to withhold votes from several directors. The shareholder groups are also seeking the right to vote on the compensation committee's annual report and plan a rally outside the meeting in Wilmington, Del., to protest Mr. Nardelli's pay.

    None of the current or former members of the compensation committee returned calls seeking comment, and the company would not make Mr. Nardelli available.

    In an e-mail statement, Mr. Langone said: "Each and every board member at Home Depot is totally independent. Candidates for service have been suggested and put through the nominating process by a wide variety of directors, myself included. That is why there is such a diversity of thought, opinion and experience on the board and why our discussions are open, robust and objective."

    Mr. Langone was instrumental in bringing the former G.E. star into the company. While he is not on the compensation committee, he has led the committee that nominates directors for the last seven years.

    No stranger to controversy, Mr. Langone is currently under fire for his role as head of the compensation committee at the New York Stock Exchange, which granted the former chief executive Richard A. Grasso a pay package worth more than $140 million. Mr. Grasso sat on Home Depot's board from 2002 to 2004, including a stint on the compensation committee.

    Mr. Langone "created the Home Depot board in his own philosophical image," said Richard Ferlauto, director of pension investment policy for the American Federation of State, County and Municipal Employees, whose pension fund owns shares in the company. "Arguably, Langone is the ringleader and the one who pulls the strings in this network," he added.

    Riches With Restraint

    The co-founders of Home Depot, Arthur M. Blank and Bernard Marcus, grew very rich on company stock that soared in value. But under them, Home Depot embraced a culture of restraint when it came to pay, said Paul D. Lapides, a corporate governance expert at Kennesaw State University in Georgia. "Bernie and Art took home a salary of $1 million or less and refused bonuses. The attitude was one of 'we're all in this together,' " said Mr. Lapides, who has never worked at Home Depot but has studied the company for years.

    Representatives of Mr. Marcus and Mr. Blank, both retired from Home Depot, said neither would comment for this article.

    Since hiring Mr. Nardelli, 58, the board has awarded him more than $87 million in deferred stock grants and $90 million in stock options, according to an analysis by Brian Foley, a compensation consultant in White Plains. Mr. Nardelli's salary, bonuses and a company loan make up most of the rest of his $245 million compensation.

    Even last year, when Home Depot's stock was unchanged, the board raised his salary 8 percent, to $2.164 million, and increased his bonus 22 percent, to $7 million.

    By contrast, from 2000 until his retirement early last year, the former chief executive of Lowe's, Robert L. Tillman, was awarded less than a quarter of what Mr. Nardelli was awarded through the end of last year, according to Mr. Foley. The many connections among Home Depot's directors cause some critics to ask whether the nominating committee is failing in finding truly "independent" board members. "The fact that you have so much overlapping boards here says to me: what was the nomination process to get on the board here, how wide was the net really cast?" asked Eleanor Bloxham, president of the Value Alliance, a group that advises companies on corporate governance issues.

    The net may not have been cast much farther than Mr. Langone's circle of friends and associates, critics say. For instance, there is Bonnie G. Hill, who leads the Home Depot compensation committee.

    The owner of a corporate-governance consulting firm, Ms. Hill is on the board of Yum Brands with Mr. Langone. Until recently, she served on the board of ChoicePoint, another company with which Mr. Langone has deep ties, including serving as a director. Mr. Langone's statement defending the ties of board members said the idea that they could not share friendships was ridiculous: "It not only sets up a make-believe standard but it is designed to please an agenda driven by activists with ulterior motives."

    Ms. Hill is also on the compensation committee of Albertson's, the grocery chain, where she is determining the pay for the chief executive, Lawrence R. Johnston, who is also a Home Depot director. "Would Johnston be as eager to promote strict pay practices on the Home Depot board, where one of his pay setters is in a position to apply the same pay principles to his own pay package?" asked Jackie Cook, a senior research associate at the Corporate Library, an institutional advisory firm in Portland, Me.

    Mr. Johnston was at G.E. at the same time as Mr. Nardelli, running the appliances unit.

    Mr. Johnston turned to a well-known compensation lawyer, Robert J. Stucker, to negotiate his compensation package at Albertson's when he joined in 2001. Mr. Stucker had negotiated Mr. Nardelli's package at Home Depot just months earlier.

    When it comes time for Mr. Nardelli to renegotiate his own contract, Mr. Johnston, as a member of the Home Depot compensation committee, is forced to negotiate against his own lawyer, said Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. "By utilizing the same legal counsel, if there's ever a dispute between the company and Mr. Nardelli over pay, it puts a member of the compensation committee in a very awkward position," Mr. Elson said. A call to Mr. Stucker was not returned.

    More links to G.E. are evident with Claudio X. Gonzalez, a board member. The longtime chairman and chief executive of Kimberly-Clark de Mexico, a unit of Kimberly-Clark, Mr. Gonzalez has known Mr. Langone and Mr. Nardelli for years as a G.E. director.

    Besides Mr. Gonzalez and Mr. Johnston, the compensation panel includes three other current or former chief executives: Angelo R. Mozilo, who heads Countrywide Financial; John L. Clendenin, the former chief of BellSouth; and Richard H. Brown, the former chief of Electronic Data Systems.

    Mr. Brown also has ties to Mr. Langone, who, as an investment banker, took Electronic Data Systems public in 1968 and was a large E.D.S. shareholder for years. Later, at his own investment bank, Invemed Associates, Mr. Langone underwrote security offerings by E.D.S. while Mr. Brown was chief executive. Mr. Brown is not up for re-election to the Home Depot board this year.

    In his statement, Mr. Langone said: "Dick Brown is one of the finest business minds this country has ever produced and I am proud to call him my friend. He was not suggested for service on the board by me but I heartily endorsed the idea."

    This Year's ' Disney'

    The ire of shareholder activists was raised even more with the addition of Mr. Mozilo to the board in February. Mr. Mozilo now sits on the compensation committee.

    His pay package, which is bigger than Mr. Nardelli's, already made him a target of governance groups. Last year alone, Mr. Mozilo took home $70 million, including salary, bonus, stock options, payments for tax- and investment-advisory services and country club memberships. "Good grief," said Paul Hodgson, a compensation analyst at the Corporate Library. "He's hardly likely to be an influence of restraint given his own pay package."

    Shareholder activists are taking a more aggressive stance toward directors this year. "Home Depot, I think, is the Disney of this shareholder season," said Mr. Ferlauto, referring to the 2004 annual meeting of Disney shareholders at which 45 percent of the votes cast were withheld from the chief executive, Michael D. Eisner, in part because of his pay. Mr. Eisner later resigned.

    At the Home Depot annual meeting tomorrow, several factions are recommending that investors withhold support from most of the directors. The dissidents include A.F.S.C.M.E.; the state pension fund of Connecticut; the California Public Employees Retirement System, the country's largest public pension fund; and Institutional Shareholder Services, which advises pension funds and mutual funds.

    I.S.S. claims there is a "disconnect" between Mr. Nardelli's pay and Home Depot's performance. "Moreover, poor compensation design, a lucrative employment agreement, and arguably egregious compensation practices call into question the fitness of the company's Compensation Committee members to serve as directors," the advisory firm said in a report it issued two weeks ago.

    The board disagrees, saying that it based Mr. Nardelli's pay and bonus last year on the company's "outstanding operating performance," his "continuing success in developing a new foundation for long-term growth" and his "continuing superior leadership," according to a statement from the company.

    Mr. Langone concurs. "I have long felt that Bob Nardelli's abilities are absolutely first rate," he said in his statement. "He's doing a great job and the strong fundamentals he has built during his tenure are proof of his keen leadership. There are a whole variety of long-term indicators I find encouraging such as earnings growth, sales growth, equity value in the brand as well as systematic enhancements put in place companywide that have dramatically improved efficiency."

    Last year Home Depot reported record earnings per share, record gross and operating margins and record sales of $81.5 billion. Yet, over the last five years, Home Depot stock has fallen 12 percent, performing worse than its peers and the Standard & Poor's 500 index, which fell 4 percent. Mr. Nardelli has also created a fair amount of friction since he joined the company, say some of his critics among the Former Orange-Blooded Executives, a few of whom were forced out once Mr. Nardelli took over. He moved quickly to introduce G.E.-inspired performance measures; issued edicts about store displays to managers who once enjoyed a great deal of autonomy; and replaced several longtime Home Depot executives with former G.E. associates.

    Today, two of Home Depot's four highest-paid executives hail from G.E., including its director of human resources. A third executive, the general counsel, Frank L. Fernandez, was a lawyer in upstate New York who was occasionally hired as an outside counsel for G.E. when Mr. Nardelli ran its power systems group in the area.

    In his latest moves, Mr. Nardelli is trying to retool Home Depot, snapping up lumber and building materials companies last year in order to push into the professional contractor market.

    "He has made a big decision to get into the supply business, and Wall Street has greeted that decision with a yawn," said Eric Bosshard, a stock analyst at FTN Midwest Securities who does not own shares in the company. Despite these bold moves, Home Depot did not even know it was looking for a fix-it man when Mr. Nardelli hit its radar in the fall of 2000. The chief executive at the time, Mr. Blank, one of the co-founders, was actually on the hunt for a second-in-command, someone he could groom to take over his job eventually.

    Those plans went out the window over Thanksgiving weekend that year when Mr. Nardelli, who had been in charge of G.E. Power Systems for five years, learned he had lost out to Jeffrey R. Immelt to succeed G.E.'s longtime chief executive, John F. Welch Jr. (Mr. Nardelli may have lost the battle for the title, but he is winning in the total compensation wars. Mr. Immelt has been awarded $108 million since taking over as G.E.'s chief, according to Mr. Foley, while the company's stock has fallen 19 percent.)

    Mr. Langone, who sat on G.E.'s board and had watched Mr. Nardelli's career, moved fast to avoid losing the executive star. Hard-charging and ambitious, Mr. Nardelli was interested, but not in a No. 2 position. Worried he would go elsewhere, the Home Depot board decided Mr. Blank should step aside and Mr. Nardelli, who had no retail experience, should take his place.

    Luring an executive of Mr. Nardelli's repute, however, came at a high price. Despite the fact that Mr. Nardelli had little incentive to remain at G.E., he required that he be "made whole," meaning he would have to be paid for what he was walking away from. He was given a stock option grant of 3.5 million shares. One million of those shares vested immediately and were worth $25 million.

    That was just the beginning. He also received perks like use of a company plane for personal trips; a new car every three years, one similar in price to the Mercedes Benz S series; and a $10 million loan with an annual interest rate of 5.8 percent that would be forgiven over five years.

    That $10 million loan wound up costing shareholders $21 million after the board agreed to pay all taxes on it, a so-called gross-up. Congress banned loans like this in 2002 after Mr. Nardelli joined the company.

    And when it appeared that Mr. Nardelli might not hit one of the few performance goals the board had set to cause payment of a long-term incentive plan, the board lowered the goalposts, according to the Corporate Library.

    The target for Mr. Nardelli had been total shareholder return ­ share price increases plus reinvested dividends ­ compared with a peer group, and the company was performing poorly by that measure in 2003, according to the Corporate Library. But that year, the board changed the target to one of growth in average diluted earnings per share, which takes into account the per share earnings decrease that occurs when stock options are awarded. In a report released in March of this year, the Corporate Library labeled Home Depot one of its 11 "Pay for Failure Companies."

    A Question of Incentives

    The change in the incentive target appeared to be "designed to ensure a payout," rather than provide an incentive to improve performance, the report said. Other critics say the new hurdle is even easier to hit with a board-approved share-repurchase program. Since 2002, the company has bought back nearly $10 billion of its own stock.

    The one threat to Mr. Nardelli's pay is a proposal by A.F.S.C.M.E., the government workers' union, that would allow Home Depot shareholders to approve or reject the report from the compensation committee. But even if the proposal is accepted, any future rejection of the board panel's compensation report would be merely symbolic. The board can simply ignore shareholders and pay executives what they wish.

    So far, similar proposals have been rejected at two other companies whose executive pay A.F.S.C.M.E. identified as a problem: Merrill Lynch and U.S. Bancorp. The Home Depot board is urging its shareholders to vote against the proposal.

    Skepticism about Mr. Nardelli's strategy to move the company away from its retailing roots and concerns about a cooling in the housing market have caused some large investors to move out of the stock, said Michael E. Cox, a stock analyst at Piper Jaffray in Minneapolis, who does not personally own shares in the stock.

    But like the majority of analysts on Wall Street, Mr. Cox recommends Home Depot's stock to investors because he believes that Mr. Nardelli's strategy will pay off in the long term for the company.

    Furthermore, Mr. Nardelli's reputation has not been tarnished, insisted Gerard R. Roche, the high-profile recruiter who helped bring Mr. Nardelli to the retailer. "I know he has been approached by other companies. There are a number of people interested in lifting Nardelli out," Mr. Roche said. "I can tell you there are a number of companies telling me to get them another Nardelli."

    "A Boss for the Boss," by Roger Lowenstein, The New York Times Magazine, December 14, 2003 --- 

    ''People being human, there will always be someone cutting corners and acting in their own self-interest,'' observes Ira Millstein, the lawyer most active in the suddenly trendy field of corporate governance. And so, regulators, investors, academics and even corporate directors are coming round to the idea that Millstein has been championing for two decades: a better way must be found to govern the corporation from within.

    This intellectual ferment has upended life in that formerly cozy preserve known as the corporate boardroom. A transfer of accountability has occurred, a reapportionment of turf. ''People used to say problems were management's concern,'' Millstein says. ''When it comes to the scandals of the 90's, they are blaming the passivity of boards.'' These scandals are making plain the futility of merely blaming C.E.O.'s or even ''greedy C.E.O.'s.'' C.E.O.'s are greedy, often obscenely so. Presumably, they will be that way in 100 years. The question is not how to enlighten them, but how, and who, to restrain them.

    It may seem curious that no one, until recently, thought that it was a matter for directors or fretted if a chief executive stacked his board with friends. The Disney board once included Michael Eisner's lawyer, his architect and the principal of his kids' school. With this type of oversight, C.E.O.'s could do no wrong. Consider Tyco, whose chief executive, L. Dennis Kozlowski, is now on trial for stealing from his shareholders. In 2001, shortly before his supposed crimes came to light, Kozlowski demanded a contract that guaranteed his severance, even if he committed a felony. The directors might have reasonably asked if Kozlowski were plotting a little arson or, perhaps, a discreet murder. Instead, they met his terms.

    Nell Minow, a shareholder activist, says no board would grant such a blank check today, and not only because the rules for directors have changed. The culture is also changing. ''It used to be considered rude to ask a question,'' she says. ''Now they are all vying to ask the toughest question.''

    Optimism must be tempered by the experience of two prior periods of activism, neither of which solved the governance riddle. There is a metaphysical sense in which the problem is irresolvable. Plato argued for a society run by perfect guardians; Juvenal is said to have replied, ''And who will guard the guardians?'' That has always been the dilemma

    Continued in the article



    Incompetent and Corrupt Audits are Routine

    When the Securities and Exchange Commission found evidence in e-mail messages that a senior partner at Andersen had participated in the fraud at Waste Management, Andersen did not fire him. Instead, it put him to work revising the firm's document-retention policy. Unsurprisingly, the new policy emphasized the need to destroy documents and did not specify that should stop if an S.E.C. investigation was threatened. It was that policy David Duncan, the Andersen partner in charge of Enron audits, claimed to be following when he shredded Andersen's reputation.

    Floyd Norris (see below)

    Andersen's demise didn't solve the broader problem of the cozy collaboration between auditors and their corporate clients. "This is day-to-day business in accounting firms and on Wall Street," says former SEC Chief Accountant Lynn Turner. "There is nothing extraordinary, nothing unusual, with respect to Enron." Will Congress and the SEC do what's needed to restore trust in the system?
    See "More Enrons Ahead" video in the list of Frontline (from PBS) videos on accounting and finance regulation and scandals ---

    "PCAOB Finds Problems At PricewaterhouseCoopers (PwC)," by David Reilly, The Wall Street Journal, December 16, 2006; Page A4 ---

    The Public Company Accounting Oversight Board, in an inspection report released Friday, cited PricewaterhouseCoopers LLP for deficiencies in some of its audits of public companies.

    The PCAOB noted the firm had failed in some cases to catch or address errors in the way companies applied accounting rules or lacked sufficient evidence to back up some of its decisions. The PCAOB singled out for criticism nine audits done by PricewaterhouseCoopers, saying in a number of the cases the firm failed to adequately check the value of revenue, inventory and accounts receivable at companies whose books it was approving. The board's inspections entail reviews of a sampling of audits, not every audit done by a firm.

    In keeping with the board's policies, the report doesn't identify the companies that had their audits cited. In addition, only a portion of the report is made public. A section that includes criticisms related to an accounting firm's quality-control systems is kept secret and never made public if a firm is able to show that it has corrected the problems cited within 12 months of the report's issuance.

    In a comment letter included in the PCAOB report, PricewaterhouseCoopers said, "We have addressed each of the specific findings raised in the report and, where necessary, performed additional procedures or enhanced the related audit documentation." A spokesman for PricewaterhouseCoopers issued a statement saying that the firm believes it is "performing quality audits" and that it "will incorporate the board's findings" into the firm's practices.

    The board's inspection reports are the only public assessment of audit firms' work available to investors and the corporate audit committees, which hire, fire and negotiate how much to pay the accounting firms.

    The report is the second this year that the PCAOB has issued for a Big Four accounting firm covering inspections conducted last year of the firms' audits of companies' 2004 financial results. Earlier this month the agency issued its 2005 report for Deloitte & Touche LLP.

    The PCAOB, which has been criticized for the length of time it is taking to issue annual reports, has yet to issue 2005 inspection reports for Ernst & Young LLP or KPMG LLP, the other two members of the Big Four. The board has until the end of the year to do so.

    The PCAOB must issue an annual inspection report for any accounting firm that audits 100 or more public companies. Firms that audit fewer than 100 public companies are inspected every three years, although the PCAOB on Friday said it would look to amend this rule.

    PricewaterhouseCoopers' response to its PCAOB report was in contrast to that of Deloitte, which included strong rebuttals of many of the board's findings.

    Bob Jensen's threads on PwC troubles are at

    Where were the auditors?
    Firms cook the books to set executive pay
    And these same executives are protesting Sarbanes-Oxley



    "Firms cook the books to set executive pay," Editorial, The New York Times, December 19, 23006 ---

    Among the corporate deceits that buttress America's obscene executive pay is the one about comparability. But a new federal rule may help expose the reality of so-called "peer groups." Far too often, the list of comparable CEOs is cooked.

    As the New York Times reported in its latest installment on executive pay, former New York Stock Exchange chairman Richard Grasso was a poster child for the abuse. His $140-million compensation package was rationalized, in part, by comparing his job to those at companies with median revenues 25 times the size of the exchange, assets 125 times and employee bases 30 times the size.

    Grasso was hardly alone. Executives have learned that the path to personal riches is paved by "peer groups" that include big and profitable companies. Eli Lilly compared itself to eight companies that had much higher profit margins. Campbell Soup used one set of companies for executive pay and a separate one as a benchmark for stock performance. Ford Motor Co. compared itself to other industries, its proxy statement said, because "the job market for executives goes beyond the auto industry."

    The "job market" argument is particularly disingenuous. As the New York Times noted, ousted Hewlett-Packard chief executive Carly Fiorina was replaced by a data processing executive who was earning less than half her pay. His company, NCR, never appeared on the Hewlett-Packard "peer group."

    The growth in executive pay has been so meteoric in the past quarter-century that it is demeaning the contributions of average workers and undermining public faith in corporate America. Last year, according to the Corporate Library, the average pay for an S&P 500 chief executive was $13.5-million. The average CEO now earns 411 times the average worker, up from 42 times in 1980.

    The new Securities and Exchange Commission disclosure rules went into effect on Friday, and compensation consultants are scrambling to cover their tracks. But stockholders who have been kept mostly in the dark will now at least have a chance to see the playbook. That's the first step toward ending these games of executive greed.

    Bob Jensen's fraud updates are at


    Bob Jensen's threads on outrageous executive compensation are at


    Self Regulation Really Works in New York --- It Kept a Few Drunks From Performing Bad Audits
    Out of roughly 50,000 accountants licensed in New York, only 16 were disciplined by the state last year-most of them for drunk driving. In fact, only one was reprimanded on professional grounds.

    NEW YORK, March 18, 2002 (Crain's New York Business) — 

    Difficult times for auditors to claim financial statement audits should not uncover massive fraud
    HealthSouth Corp. has filed suit accusing its former outside auditor, Ernst & Young, of intentionally or negligently failing to uncover a massive accounting fraud at the medical services chain.
    "HealthSouth Sues Ernst & Young for Fraud," SmartPros, April 6, 2005 ---
    Bob Jensen's threads on E&Y's legal woes are at

    "Chief Executive at Health Insurer Is Forced Out in Options Inquiry," by Eric Dash and Milt Freudenheim, The New York Times, October 15, 2006 --- Click Here

    Dr. William W. McGuire, a medical entrepreneur who built the UnitedHealth Group into a colossus in its field, was forced to resign from the company yesterday and to give up a portion of the $1.1 billion he holds in harshly criticized stock options.

    . . .

    In a sweeping report released yesterday that was highly critical of management, a law firm hired by UnitedHealth to investigate the timing of stock options concluded that the company was riddled with poor controls and conflicts of interest. The report, which the company posted on its Web site, found that UnitedHealth had backdated options to maximize employees’ compensation.

    The company said yesterday that the disputed options would be repriced from the lowest share price for the years in question to the highest prices, scaling back the earnings of Dr. McGuire and others. The company did not say precisely how much its executives would give up.

    Continued in article

    Bob Jensen's threads on options accounting scandals are at

    What auditing firms are associated with worst options accounting abuses?

    "Study Finds Backdating of Options Widespread," by Stephanie Saul, The New York Times, July 17, 2006 ---

    More than 2,000 companies appear to have used backdated stock options to sweeten their top executives’ pay packages, according to a new study that suggests the practice is far more widespread than previously disclosed.

    The new statistical analysis, which comes amid a broadening federal inquiry of the practice of timing options to the stock market, estimates that 29.2 percent of companies have used backdated options and 13.6 percent of options granted to top executives from 1996 to 2005 were backdated or otherwise manipulated.

    So far, more than 60 companies have disclosed that they are the targets of government investigations, are the subject of investor lawsuits or have conducted internal audits involving the practice, in which options are backdated to days when the company’s shares trade at low prices. They include Apple Computer, CNet and Juniper Networks.

    Last week, the United States attorney in San Francisco announced a task force to investigate the backdating of options, which appears to have been particularly popular in Silicon Valley during the 1990’s dot-com boom. The study found that the abuse was more prevalent in high-technology firms, where an estimated 32 percent of unscheduled grants were backdated; at other firms, an estimated 20 percent were backdated.

    An author of the study said the analysis suggested that the disclosures so far about backdated stock options may be just the tip of the iceberg.

    “It is pretty scary, and it’s quite surprising to see,” said Erik Lie, an associate professor of finance at the Tippie College of Business at the University of Iowa.

    Professor Lie said the findings were so surprising that he asked several colleagues to check his numbers. Together, they concluded that the numbers probably erred on the low side.

    The study by Professor Lie and Randall A. Heron, of the Kelley School of Business at Indiana University, was posted Saturday to a University of Iowa Web site. Using information from the Thomson Financial Insider Filing database of insider transactions reported to the Securities and Exchange Commission, the two men examined 39,888 stock option grants to top executives at 7,774 companies dated from Jan. 1, 1996 to Dec. 1, 2005.

    The findings were based on an analysis of whether share values increased or declined after option grant dates. “Half should be negative and half should be positive,” said Professor Lie. “That’s the underlying logic.”

    But the analysis revealed that the distribution was shifted upward.

    “This is not random chance. It’s something that’s manipulated, clearly,” said Professor Lie.

    Of the companies examined, 29.2 percent, or 2,270, had at some point during the period manipulated stock option grants, the study estimated.

    “Over all, our results suggest that backdated or otherwise manipulated grants are spread across a remarkable number of firms, although these firms did not manipulate all their grants,” the authors said.

    The study concluded that before Aug. 29, 2002, 23 percent of unscheduled grants — as distinguished from grants that companies routinely schedule annually — were backdated. Unscheduled grants are easier to backdate.

    On that day, the S.E.C. tightened reporting requirements to require that executives report stock option grants they receive within two business days. After that, the backdating figure declined to 10 percent of unscheduled grants, the paper said.

    Professor Lie said that a number of companies simply ignored the new reporting rule. “You still see problems. The rule is not enforced,” he said.

    Professor Lie, who first alerted S.E.C. investigators to problems with backdating after an analysis that he conducted in 2004, said there was some positive news in his new research.

    “It has been suggested that some accounting firms have been pushing this practice more than others,” he said. “There’s actually very little evidence of that, which to me is very comforting.”

    The study found that smaller auditors rather than larger ones were associated with a larger proportion of late filings and unscheduled grants, which most likely lead to more backdating and manipulative practices.

    It also singled out two firms — PricewaterhouseCoopers and KPMG — as being associated with a lower percentage of manipulation.

    "The Effect of Information on Uncertainty and the Cost of Capital," David James Johnstone, University of Sydney, July 31, 2014 ---

    It is widely held that better financial reporting makes investors more confident in their predictions of future cash flows and reduces their required risk premia. The logic is that more information leads necessarily to more certainty, and hence lower subjective estimates of firm "beta" or covariance with other firms. This is misleading on both counts. Bayesian logic shows that the best available information can often leave decision makers less certain about future events. And for those cases where information indeed brings great certainty, conventional mean-variance asset pricing models imply that more certain estimates of future cash payoffs can sometimes bring a higher cost of capital. This occurs when new or better information leads to sufficiently reduced expected firm payoffs. To properly understand the effect of signal quality on the cost of capital, it is essential to think of what that information says, rather than considering merely its "precision", or how strongly it says what it says.

    Bob Jensen's threads on accounting theory ---

    "The thing I think that is more problematic is there have been some allegations that auditors knew about this and counseled their clients to do it," said Joseph Carcello, director of research for the corporate-governance center at the University of Tennessee. "If that turns out to be true, they will have problems."

    "Backdating Woes Beg the Question Of Auditors' Role," by David Reilly, The Wall Street Journal, June 23, 2006; Page C1 ---

    Where were the auditors?

    That question, frequently heard during financial scandals earlier this decade, is being asked again as an increasing number of companies are being probed about the practice of backdating employee stock options, which in some cases allowed executives to profit by retroactively locking in low purchase prices for stock.

    For the accounting industry, the question raises the possibility that the big audit firms didn't live up to their watchdog role, and presents the Public Company Accounting Oversight Board, the regulator created in response to the past scandals, its first big test.

    "Whenever the audit firms get caught in a situation like this, their response is, 'It wasn't in the scope of our work to find out that these things are going on,' " said Damon Silvers, associate general counsel at the AFL-CIO and a member of PCAOB's advisory group. "But that logic leads an investor to say, 'What are we hiring them for?' "

    Others, including accounting professionals, aren't so certain bookkeepers are part of the problem. "We're still trying to figure out what the auditors needed to be doing about this," said Ann Yerger, executive director of the Council of Institutional Investors, a trade group. "We're hearing lots of things about breakdowns all through the professional-advisor chains. But we can't expect audit firms to look at everything."

    One pressing issue: Should an auditor have had reason to doubt the veracity of legal documents showing the grant date of an option? If not, it is tough for many observers to see how auditors could be held responsible for not spotting false grant dates.

    "I don't blame the auditors for this," said Nell Minow, editor of The Corporate Library, a governance research company. "My question is, 'Where were the compensation committees?' "

    To sort out the issue, the PCAOB advisory group -- comprising investor advocates, accounting experts and members of firms -- last week suggested the agency provide guidance to accounting firms on backdating of stock options. A spokeswoman for the board said, "We are looking to see what action they may be able to take."

    To date, more than 40 companies have been put under the microscope by authorities over the timing of options issued to top executives. Federal authorities are investigating whether companies that retroactively applied the grant date of options violated securities laws, failed to properly disclose compensation and in some cases improperly stated financial results. A number of companies have said they will restate financial statements because compensation costs related to backdated options in questions weren't properly booked.

    All of the Big Four accounting firms -- PricewaterhouseCoopers LLP, Deloitte & Touche LLP, KPMG LLP and Ernst & Young LLP -- have had clients implicated. None of these top accounting firms apparently spotted anything wrong at the companies involved. One firm, Deloitte & Touche, has been directly accused of wrongdoing in relation to options backdating. A former client, Micrel Inc., has sued the firm in state court in California for its alleged blessing of a variation of backdating. Deloitte is fighting that suit.

    The big accounting firms haven't said whether they believe there was a problem on their end. Speaking at the PCAOB advisory group's recent meeting, Vincent P. Colman, U.S. national office professional practice leader at PricewaterhouseCoopers, said his firm was taking the issue "seriously," but more time is needed "to work this through" both "forensically" and to insure this is "not going to happen going forward."

    Robert J. Kueppers, deputy chief executive at Deloitte, said in an interview: "It is one of the most challenging things, to sort out the difference in these [backdating] practices. At the end of the day, auditors are principally concerned that investors are getting financial statements that are not materially misstated, but we also have responsibilities in the event that there are potential illegal acts."

    While the Securities and Exchange Commission has contacted the Big Four accounting firms about backdating at some companies, the inquiries have been of a fact-finding nature and are related to specific clients rather than firmwide auditing practices, according to people familiar with the matter. Class-action lawsuits filed against companies and directors involved in the scandal haven't yet targeted auditors.

    Backdating of options appears to have largely stopped after the passage of the Sarbanes-Oxley corporate-reform law in 2002, which requires companies to disclose stock-option grants within two days of their occurrence.

    Backdating practices from earlier years took a variety of forms and raised different potential issues for auditors. At UnitedHealth Group Inc., for example, executives repeatedly received grants at low points ahead of sharp run-ups in the company's stock. The insurer has said it may need to restate three years of financial results. Other companies, such as Microsoft Corp., used a monthly low share price as an exercise price for options and as a result may have failed to properly book an expense for them.

    At the PCAOB advisory group meeting, Scott Taub, acting chief accountant at the Securities and Exchange Commission, said there is a "danger that we end up lumping together various issues that relate to a grant date of stock options." Backdating options so an executive can get a bigger paycheck is "an intentional lie," he said. In other instances where there might be, for example, a difference of a day or two in the date when a board approved a grant, there might not have been an intent to backdate, he added.

    "The thing I think that is more problematic is there have been some allegations that auditors knew about this and counseled their clients to do it," said Joseph Carcello, director of research for the corporate-governance center at the University of Tennessee. "If that turns out to be true, they will have problems."

    Where were the auditors?
    Firms cook the books to set executive pay
    And these same executives are protesting Sarbanes-Oxley



    "Firms cook the books to set executive pay," Editorial, The New York Times, December 19, 23006 ---

    Among the corporate deceits that buttress America's obscene executive pay is the one about comparability. But a new federal rule may help expose the reality of so-called "peer groups." Far too often, the list of comparable CEOs is cooked.

    As the New York Times reported in its latest installment on executive pay, former New York Stock Exchange chairman Richard Grasso was a poster child for the abuse. His $140-million compensation package was rationalized, in part, by comparing his job to those at companies with median revenues 25 times the size of the exchange, assets 125 times and employee bases 30 times the size.

    Grasso was hardly alone. Executives have learned that the path to personal riches is paved by "peer groups" that include big and profitable companies. Eli Lilly compared itself to eight companies that had much higher profit margins. Campbell Soup used one set of companies for executive pay and a separate one as a benchmark for stock performance. Ford Motor Co. compared itself to other industries, its proxy statement said, because "the job market for executives goes beyond the auto industry."

    The "job market" argument is particularly disingenuous. As the New York Times noted, ousted Hewlett-Packard chief executive Carly Fiorina was replaced by a data processing executive who was earning less than half her pay. His company, NCR, never appeared on the Hewlett-Packard "peer group."

    The growth in executive pay has been so meteoric in the past quarter-century that it is demeaning the contributions of average workers and undermining public faith in corporate America. Last year, according to the Corporate Library, the average pay for an S&P 500 chief executive was $13.5-million. The average CEO now earns 411 times the average worker, up from 42 times in 1980.

    The new Securities and Exchange Commission disclosure rules went into effect on Friday, and compensation consultants are scrambling to cover their tracks. But stockholders who have been kept mostly in the dark will now at least have a chance to see the playbook. That's the first step toward ending these games of executive greed.

    Bob Jensen's fraud updates are at


    Bob Jensen's threads on outrageous executive compensation are at


    Bob Jensen's threads on fraudulent and incompetent auditing are at

    On July 14, 2006, Greg Wilson inquired about what the implications of poor auditing are to investors and clients?

    July 14, 2006 reply from Bob Jensen

    Empirical evidence suggests that when an auditing firm begins to get a reputation for incompetence and/or lack of independence its clients’ cost of capital rises. This in fact was the case for the Arthur Andersen firm even before it imploded. The firm’s reputation for bad audits and lack of independence from Andersen Consulting, especially after the Waste Management auditing scandal, was becoming so well known that some of its major clients had already changed to another auditing firm in order to lower their cost of capital.

    Bob Jensen

    Bob Jensen's threads on accounting and auditing theory are at

    Bob Jensen's threads on the Andersen/Enron/Worldcom scandals are at

    July 14, 2006 reply from Ed Scribner [escribne@NMSU.EDU]

    I think the conventional wisdom is that poor audits reduce the ability of information to reduce uncertainty, so investors charge companies for this in the form of lower security prices.

    In a footnote on p. 276 of the Watts and Zimmerman "Market for Excuses" paper in the April 79 Accounting Review, WZ asserted the following:

    Share prices are unbiased estimates of the extent to which the auditor monitors management and reduces agency costs... . The larger the reduction in agency costs effected by an auditor (net of the auditor's fees), the higher the value of the corporation's shares and bonds and, ceteris paribus, the greater the demand for that auditor's services. If the market observes the auditor failing to monitor management, it will adjust downwards the share price of all firms who engage this auditor... .

    Sometime in the 1980s, Mike Kennelley tested this assertion on the then-recent SEC censure of Peat Marwick. (I think his article appeared in the Journal of Accounting and Economics, but I can't find it at the moment.) The Watts/Zimmerman footnote suggests a negative effect on all of Peat Marwick's client stock prices, but Mike, as I recall, found a small positive effect.

    Because agency theory seems to permit arguing any side of any argument, a possible explanation was that the market interpreted this adverse publicity as a wakeup call for Peat Marwick, causing it to clean up its act so that its audits would be impeccable.

    A couple of other examples of the empirical research:

    (1) Journal of Empirical Legal Studies Volume 1 Page 263 - July 2004 doi:10.1111/j.1740-1461.2004.00008.x Volume 1 Issue 2

    Was Arthur Andersen Different? An Empirical Examination of Major Accounting Firm Audits of Large Clients Theodore Eisenberg1 and Jonathan R. Macey2

    Enron and other corporate financial scandals focused attention on the accounting industry in general and on Arthur Andersen in particular. Part of the policy response to Enron, the criminal prosecution of Andersen eliminated one of the few major audit firms capable of auditing many large public corporations. This article explores whether Andersen's performance, as measured by frequency of financial restatements, measurably differed from that of other large auditors. Financial restatements trigger significant negative market reactions and their frequency can be viewed as a measure of accounting performance. We analyze the financial restatement activity of approximately 1,000 large public firms from 1997 through 2001. After controlling for client size, region, time, and industry, we find no evidence that Andersen's performance significantly differed from that of other large accounting firms.

    ... Hiring an auditor, at least in theory, allows the client company to "rent" the reputation of the accounting firm, which rents its reputation for care, honesty, and integrity to its clients.

    ... From the perspective of audit firms' clients, good audits are good investments because they reduce the cost of capital and increase shareholder wealth. Good audits also increase management's credibility among the investment community. In theory, the capital markets audit the auditors.

    (2) Journal of Accounting Research Volume 40 Page 1221 - September 2002 doi:10.1111/1475-679X.00087 Volume 40 Issue 4

    Corporate Financial Reporting and the Market for Independent Auditing: Contemporary Research Shredded Reputation: The Cost of Audit Failure Paul K. Chaney & Kirk L. Philipich In this article we investigate the impact of the Enron audit failure on auditor reputation. Specifically, we examine Arthur Andersen's clients' stock market impact surrounding various dates on which Andersen's audit procedures and independence were under severe scrutiny. On the three days following Andersen's admission that a significant number of documents had been shredded, we find that Andersen's other clients experienced a statistically negative market reaction, suggesting that investors downgraded the quality of the audits performed by Andersen. We also find that audits performed by Andersen's Houston office suffered a more severe decline in abnormal returns on this date. We are not able to show that Andersen's independence was questioned by the amount of non-audit fees charged to its clients.

    Ed Scribner
    New Mexico State University, USA

    July 17, 2006 reply from Paul Clikeman [pclikema@RICHMOND.EDU]

    Keith Moreland (Auditing: A Journal of Practice and Theory, Spring 1995) found that SEC sanctions against audit firms are associated with lower earnings response coefficients of client firms, suggesting that investors lose confidence in the quality of the reported earnings.

    July 18, 2006 reply from Gregg Wilson [greggwil@OPTONLINE.NET]

    Hi Bob Jensen

    Thanks again for the reply.  Would this imply that, if auditing was divorced from consulting, and if auditors were made criminally liable for signing off on accounting statements that they know were clearly misleading, then the result would be a boon to the markets and to the economy?

    Gregg Wilson

    July 19, 2006 reply from Bob Jensen

    Hi Gregg,

    As with any accounting research it is difficult to make law-like and broad-sweeping generalizations akin to those found in the natural sciences. Human behavior is just too adaptive and non-stationary.

    It is also not clear that the problem was with collusion among auditing and consulting divisions in the roaring 1990s. The problem in many instances was mainly revenue proportions and profitability. Andersen made roughly a million per week from Enron, half of which was for auditing services and half of which was for consulting services. The consulting services were more profitable and became a lever that Enron used on Andersen with the implication that if Duncan raised too much of a fuss on the auditing side there would be a loss of revenue on the consulting side.

    Hence the problem was not so much back room collusion between Andersen consultants and auditors as it was threatened loss of the consulting revenue (including internal auditing revenue billed by Andersen) if auditors did not fudge.

    Keep in mind that changing auditors is an expensive process that sends all sorts of negative signals to owners, creditors, and potential investors. Companies like Enron could more divert consulting revenues elsewhere much easier than diversion of auditing revenues. Hence threatened loss of consulting revenue loss is a very real threat to an auditing firm that makes huge profits from consulting with audit clients.

    The problem was also that substantive testing in auditing was becoming too expensive on audits before SOX made it possible to greatly increase audit fees. In the 1990s auditors increasingly relied upon unreliable risk-based auditing to reduce audit costs --- 

    Bob Jensen

    The settlements announced today, including the largest penalties ever imposed on individual auditors, reflect the seriousness with which the SEC regards the responsibilities of gatekeepers."

    It took forever, but KPMG partners finally settle with the SEC on the really old Xerox accounting fraud
    The Commission (SEC) has announced on February 22, 2006 that all four remaining defendants in an action brought against them and KPMG LLP by the agency in connection with a $1.2 billion fraudulent earnings manipulation scheme by the Xerox Corporation from 1997 through 2000 have agreed to settle the charges against them. Three partners agreed to permanent injunctions, payment of record civil penalties and suspensions from practice before the Commission with rights to reapply in from one to three years. The fourth partner agreed to be censured by the Commission. "This case represents the SEC's willingness to litigate important accounting fraud allegations against major accounting firms and their audit partners, even where the accounting was complex," said Linda Chatman Thomsen, the SEC's Director of Enforcement. "The settlements announced today, including the largest penalties ever imposed on individual auditors, reflect the seriousness with which the SEC regards the responsibilities of gatekeepers."
    Andrew Priest, "FOUR CURRENT OR FORMER KPMG PARTNERS SETTLE SEC LITIGATION RELATING TO XEROX AUDITS," Accounting Education News, February 23, 2006 ---

    You can read more about the Xerox case and other KPMG woes at

    "Some CPAs Escape State Disciplinary Action," AccountingWeb, June 20, 2006 ---

    There have been more than 50 accountants sanctioned over 2005 and 2006 for professional misconduct and few of them have compensated shareholders for their complicity or neglect. The Associated Press reports that although sanctioned not to practice public accounting for between one and ten years by the SEC, these accountants still prepare, audit or review financial statements for public companies.

    They also remain able to perform these services for private companies. While firms such as Arthur Andersen and others have paid huge sums in accounting damages, the individual accountants have escaped their professional penance, according to the Associated Press.

    The disconnect seems to be an established communication system that would allow the SEC to advise state accounting boards of federal sanctions against rogue accountants. Another aspect of the disconnect is that state accountancy boards do not have staff to handle the number or reach of financial scandals such as Cendant, Enron or WorldCom.

    Texas is one of many states facing this situation. License renewals are not a verifiable method of finding out about SEC sanctions unless without the accountant completing the questions truthfully. A spokesman for the Georgia board told the Associated Press that a CPA recently renewed his license online without disclosing his disciplinary action by the SEC.

    William Treacy, executive director of the Texas State Board of Public Accountancy, told the Associated Press, “We don’t have the staff on board to manage the extra workload that the profession has been confronted over the last few years, so we contracted with the attorney general’s office to provide extra prosecutorial power.”

    One of the problems and potential fixes to this situation may be to fine accountants. After a landmark SEC settlement in which three partners at KPMG agreed to pay a combined fine totaling $400,000 for their complicity in the $1.2 billion fraud at Xerox, the Associated Press reports that one of the partners still holds his license in New York.

    David Nolte of Fulcrum Financial Inquiry told the Associated Press, “The SEC has never sought serious money from errant CPAs. Unfortunately, the small fines in the Xerox case set a record of the amount paid, so everyone else has gotten off easy.”

    With the heavy investment in internal controls and procedures by CPA firms, the human element of accounting and auditing helps even large CPA firms fail to identify accounting problems. Members of an audit team can identify insufficient knowledge, misrepresentation of information, sloppy accounting or even simple misrepresentation of information but must be able to see the warning signs of other risky behavior. The CPA Journal suggests a 360-degree assessment of members on an audit team. As a structured, systematic way to collect information, evaluators include the person’s boss, peers, direct reports, and even clients.

    Continued in article

    The Sad State of Professional Discipline in Public Accountancy

    "SEC Accountant Fines Largely Go Unpaid," SmartPros, June 7, 2006 ---

    The Securities and Exchange Commission has taken disciplinary action against more than 50 accountants in 2005 and 2006 for misconduct in scandals big and small. But few have paid a dime to compensate shareholders for their varying levels of neglect or complicity.

    It also turns out that nearly half of them continue to hold valid state licenses to hang out their shingles as certified public accountants, based on an examination of public records by The Associated Press.

    So while the SEC has forbidden these CPAs from preparing, auditing or reviewing financial statements for a public company, they remain free to perform those very same services for private companies and other organizations that may be unaware of their professional misdeeds.

    Some would say the accounting profession has taken its fair share of lumps, particularly with the abrupt annihilation of Arthur Andersen LLP and the jobs of thousands of auditors who had nothing to do with the firm's Enron Corp. account. Meantime, the big auditing firms are paying hundreds of millions of dollars in damages - without admitting or denying wrongdoing - to settle assorted charges of professional malpractice.

    Individual penance is another matter, however, and here the accountants aren't being held so accountable.

    Part of the trouble is that there doesn't appear to be an established system of communication by which the SEC automatically notifies state accounting regulators of federal disciplinary actions. In several instances, state accounting boards were unaware a licensee had been disciplined by the SEC until it was brought to their attention in the reporting for this column. The SEC says it refers all disciplinary actions to the relevant state boards, so the cause of any breakdowns in these communications is unclear.

    Another obstacle may be that some state boards do not have ample resources to tackle the sudden swell of financial scandals. It's not as if, for example, the Texas State Board of Public Accountancy had ever before dealt with an accounting fraud as vast as that perpetrated at Houston-based Enron.

    "We don't have the staff on board to manage the extra workload that the profession has been confronted with over the last few years," said William Treacy, executive director of the Texas board. "So we contracted with the attorney general's office to provide extra prosecutorial power."

    Treacy said his office is usually notified of SEC actions concerning Texas-licensed CPAs, but the process isn't automatic.

    With other states, communications from the SEC appear less certain. If nothing else, many boards rely upon license renewals to learn about SEC actions, but that only works if the applicants respond truthfully to questions about whether they've been disciplined by any federal or state agency. A spokeswoman for Georgia's board said one CPA recently disciplined by the SEC had renewed his license online without disclosing it.

    Ransom Jones, CPA-Investigator for the Mississippi State Board of Public Accountancy, said most of his leads come from other accountants, media reports and annual registrations.

    "The SEC doesn't necessarily notify the board," said Jones, whose agency revoked the licenses of key players in the scandal at Mississippi-based WorldCom.

    Some state boards appear more vigilant than others in policing their membership. The boards in California and Ohio have punished most of their licensees who have been disciplined by the SEC since the start of 2005.

    New York regulators haven't yet penalized any locals targeted by the SEC in that timeframe, though they have taken action against two disciplined by the SEC's new Public Company Accounting Oversight Board. It is conceivable that cases are underway but not yet disclosed, or that some individuals have been cleared despite the SEC's findings. A spokesman for the New York State Education Department said all SEC referrals are probed, but not all forms of misconduct are punishable under local statute. New rules now under consideration would strengthen those disciplinary powers, he said.

    Meanwhile, although the SEC deserves credit for de-penciling those CPAs who've breached their duties as gatekeepers of financial integrity, barely any of those individuals have been asked to make amends financially.

    No doubt, except for those elevated to CEO or CFO, most accountants are not paid as handsomely as the corporate elite. That said, partners from top accounting firms are were [sic] paid well enough to cough up more than the SEC has sought, which in most cases has been zero.

    Earlier this year, in what the SEC crowed about as a landmark settlement, three partners for KPMG LLP agreed to pay a combined $400,000 in fines regarding a $1.2 billion fraud at Xerox Corp. One of those fined still holds his license in New York.

    "The SEC has never sought serious money from errant CPAs," said David Nolte of Fulcrum Financial Inquiry LLP. "Unfortunately, the small fines in the Xerox case set a record of the amount paid, so everyone else has also gotten off easy."

    It's not that the CPAs found culpable in scandals don't deserve a right to redemption, or just to earn a living. Most of the bans against practicing before the SEC are temporary, spanning anywhere from a year to 10 years.

    But the presumed deterrent of SEC action is weakened if federal and state regulators don't work together on a consistent message so bad actors don't get a free pass at the local level.

    Bob Jensen's thread on proposed reforms are at


    Enhancing Auditors’ Capabilities to Detect Fraud
    EY Faculty Connection
    Fall 2005 ---  

    SAS 99 (AU 316) states, “The auditor has the responsibility to plan and to perform the audit to provide reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.” PCAOB Chairman William McDonough stated it differently when asked the question, “How do you respond to auditor’s insistence that it isn’t their job to detect fraud? He replied, “We have a very clear view that it is their job. If we see fraud that wasn’t detected and should have been, we will be very big on the tough and not so big on the love.” As I read these two quotes, it appears to me that, the bar is being raised. Regulators, audit committees, management, and auditors all play a vital role in preventing or detecting fraud . As educators, how can we do a better job of training tomorrow’s business leaders–and especially auditors--to detect material fraud?

    Over my career, I have both taught auditing and have been an expert witness in numerous cases where auditors were sued for negligence because of not detecting fraud. In one such case, the fraud had been going on for 16 years and the perpetrator has embezzled over 10% of the company’s assets. Several times, while conducting annual audits, the auditors had identified real fraud symptoms but had dismissed them based on client representations. In another case, auditors sent confirmations to addresses that were really only rental mail boxes that appeared to be physical addresses only to have the perpetrators fly to the location, complete the confirmations and confirm that everything was okay. In a multi-billion dollar case, it was alleged that auditors not only saw fraud symptoms but must have been participants in the fraud not to recognize those symptoms.

    Detecting and proving fraud are extremely difficult. Recent cases where CEOs have been acquitted attest to the difficulty of proving fraud. However, given that auditors may be held liable for failing to detect material fraud, it is incumbent upon all of us who prepare tomorrow’s auditors to make them better fraud detectors.

    People who commit fraud do not fit the profile of typical criminals. Instead, they look just like us. They have rationalized committing fraud either because (1) they lack basic ethical values, (2) they have basic ethical values but don’t know how to translate those values to business settings and decisions, (3) they know how to translate their ethical values to business settings but they lack the ethical courage to make the right decision even when it is costly or (4) they work in an environment where ethical leadership is absent and they are taught to be dishonest through unethical modeling and labeling. They have also perceived an opportunity to commit and conceal the dishonest acts and, most often, they have some kind of firm or individual pressure that is motivating them to take advantage of the perceived opportunity and to rationalize the dishonesty.

    Given that most fraud perpetrators look like us and are first-time offenders, how can auditors better detect fraud? I believe that both the firms and educators must do a better job in teaching fraud detection. Most of our students and firms’ young staff members wouldn’t recognize a fraud if it hit them between the eyes. Here are some ways educators can better teach our students fraud detection techniques:

    We should use major fraud cases to teach accounting principles throughout our curriculum. Students will understand accounting principles better when they see how they have been abused. For example, the difference between assets and expenses can be effectively taught using WorldCom. Our students need to know that throughout their careers they will be exposed to fraud, as an auditor, consultant, coworker or victim. Fraud is now so common that all of us will witness it in one form or another. We must force our students to face ethical and fraud dilemmas in every course in our accounting curricula. Most good textbooks now contain ethical dilemmas or cases related to the subject matter being taught. Unfortunately, most professors don’t use these or other fraud and ethics cases. Students should be exposed to and learn to recognize potential conflicts of interest, fraudulent behavior, illegal activities and “shrewd” business practices that push the limits of propriety.

    We can teach a dedicated fraud course where students learn why and how fraud is committed and how to prevent, detect and investigate fraud. Regardless of the careers our students choose, learning how to skeptically examine records, conduct better interviews and use technology to detect fraud are skills that will be valuable to them.

    In our classes, we should use pedagogical tools such as inquiry, data mining and brainstorming that our students will be using as professionals to detect fraud.

    To establish a proper tone, our business schools should establish a code of ethical conduct and invite all students, staff, and faculty to pledge to honor it. The code should be discussed and made a prominent part of our business schools.

    The firms, too, must become better in training their auditors to detect fraud. They must spend time in both separate and integrated training sessions and on the job teaching auditors about deception, the nature of fraud, how to conduct fraud risk assessments, how to analyze journal entries for fraud, common fraud schemes, how to mine data, how to better conduct interviews and brainstorming sessions, and in working through fraud case studies. Auditing firms must continuously reinforce the fact that they are in the business of detecting fraud, regardless of what the standards say. The purpose of an audit has come full circle. The first edition of the Montgomery auditing text, published in 1917, states that an audit had three objectives: (1) detection of fraud, (2) detection of technical errors, and (3) detection of errors in principle. Through a series of frauds (e.g. McKesson Robbins, etc.) and issuance of new standards, the responsibility to detect fraud evolved from “…the ordinary examination…is not designed and cannot be relied upon to disclose defalcations and other similar irregularities” (SAP 1) to “…an audit gives consideration to the possibility of fraud” (SAP 30) to “…auditors must plan the audit to search for material errors or irregularities” (SAS 16) to “…auditors must design the audit to provide reasonable assurance of detecting material fraud,” (SAS 53) to “the auditor must plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement whether caused by error or fraud (SAS 82 & 99) to “…it is their job to detect fraud.” (William McDonough, PCAOB)

    Given this renewed responsibility, both educators and firms must be more diligent and pro-active in teaching students and employees how to detect fraud. We can no longer say it is someone else’s responsibility. Not doing so will result in increased regulation, litigation, and lesser esteem and respect for our profession.

    W. Steve Albrecht
    Professor of Accounting
    Brigham Young University

    Links to Bob Jensen’s fraud documents ---

    When Four Just Isn't Enough!

    When audits go bad, the clients just get traded around.  It appears that Deloitte may take the Fannie Mae audit from KPMG due to SEC pressures.  But Deloitte is not facing a life-threatening lawsuit.  The SEC is pressuring TIAA-CREF to drop E&Y due to violation of auditor independence.  The SEC is acting on bad audits but appears to be limited in how to correct the situation since there are only four in the Big Four.

    "Fannie Restatement Sparks Debate Over Fate of Auditor:  Investors, Experts Question Quality of KPMG's Work; Checking the Annual Fees," by Jonathan Weil and Diya Gullapalli, The Wall Street Journal, December 17, 2004; Page C3 ---,,SB110324068628902772,00.html?mod=todays_us_money_and_investing 

    The Securities and Exchange Commission's decision directing Fannie Mae to restate its earnings is sparking a debate among investors, proxy advisers and accounting experts about whether the mortgage titan should dump outside auditor KPMG LLP.

    And as demonstrated by the recent experience of Fannie's government-chartered cousin, Freddie Mac, once a company gets a fresh set of eyes to pore over its books and records, there's no telling what other accounting issues may pop up.

    A proposal by the Office of Federal Housing Enterprise Oversight could require Fannie to change its auditor by Jan. 1, 2006, and rotate its auditor at least every 10 years after that. The proposal is under review by the White House Office of Management and Budget.

    With both the SEC and Ofheo agreeing that Fannie violated the accounting rules for derivative financial instruments, "they should immediately change auditors given this apparent lack of quality in the audit work," says Mike Lofing, an analyst in Broomfield, Colo., at Glass Lewis & Co., one of the nation's most prominent proxy-advisory firms. If Fannie doesn't replace KPMG, he says, his firm likely would advise its institutional-investor clients to oppose the ratification of KPMG as Fannie's auditor at the company's annual meeting next spring.

    A Fannie spokeswoman declined to comment on any possible change in auditors. In a statement, KPMG said: "We accept the company's decision to follow the direction of the [SEC's] Office of the Chief Accountant with respect to Fannie Mae's prior financial statements." A KPMG spokesman declined to respond to suggestions that Fannie should replace KPMG as its auditor.

    To be sure, not all investors believe an immediate auditor switch is necessary. "I'd like to get more information about why [the SEC's staff] made their interpretation" before deciding on whether KPMG should be replaced, says David Dreman, chairman of investment firm Dreman Value Management LLC, which held about eight million shares as of Sept. 30.

    Still, two years ago, Freddie Mac's decision to replace the imploding Arthur Andersen LLP with PricewaterhouseCoopers LLP helped the company turn over a new leaf. Shortly after the switch, the new auditor found widespread accounting manipulations, including false asset valuations. After restating financials and ousting its chief executive officer last year, Freddie's stock has risen over 20% this year and the firm is gaining market share from Fannie.

    In the same vein, a new auditor at Fannie might identify potentially bigger issues than the ones identified by Ofheo and the SEC. Fannie's estimate last month that a restatement could reduce its past earnings and regulatory capital by $9 billion is based on the assumption that the derivatives and other assets and liabilities on Fannie's balance sheet already were being valued appropriately as of Sept. 30. Conceivably, a new auditor might find they weren't.

    "It would be astute for Fannie to contemplate whether an auditor that was not involved with the prior circumstance might not bring more credibility to their future financial statements," adds Tom Linsmeier, an accounting professor and derivatives specialist at Michigan State University, who testified last year before Congress on Fannie's accounting practices.

    The audit fees that Fannie paid KPMG in recent years were paltry, raising questions among investors and analysts about just how much audit work KPMG could have been performing. Last year Fannie paid KPMG $2.7 million to audit its financial statements. It paid even less in years before -- just $1.4 million in 2001. By himself, Fannie Mae Chief Financial Officer Tim Howard got $5.4 million in compensation last year, including stock options. By comparison, Freddie Mac, with roughly $800 billion of assets at Dec. 31, paid PricewaterhouseCoopers more than $46 million for its 2003 audit.

    The Fannie debacle comes at a critical time for KPMG, which has been in crisis-management mode for the past few years over a host of audit failures and government investigations. Among other things, the firm's sales of allegedly abusive tax shelters remain the focus of a criminal grand-jury investigation that began about a year ago.

    If Fannie wants a new Big Four auditor, the least likely choice would appear to be Ernst & Young LLP, which is advising Fannie's audit committee in responding to the government probes. Conceivably, Fannie could hire Deloitte & Touche LLP, which has been assisting Ofheo's examination.

    Continued in the article

    Bob Jensen's threads on troubles of big accounting firms are at 

    Bob Jensen's threads on the Fannie Mae accounting scandals are at

    Nothing like admitting defeat before the charges are filed
    The chief executive of Refco Inc.'s outside auditor, Grant Thornton LLP, said the accounting firm has ample resources to withstand the government probes and investor lawsuits it will face as a result of the brokerage firm's meltdown last week. In his first interview since Refco's scandal broke a week ago, Grant Thornton's Edward Nusbaum said the firm is well capitalized and has outside liability insurance it can tap if necessary to cover legal expenses, including potential settlements. "We anticipate the legal costs will be expensive, as they are in every case," Mr. Nusbaum said. "But Grant Thornton is very sound financially, and we anticipate any legal costs will be absorbed by the firm. We have insurance, if it is needed."
    Jonathan Weil, "Grant Thornton Expects to Weather Scandal of Client," The Wall Street Journal, October 17, 2005; Page C1 ---

    A Who Done it?:  Grant Thornton's Case of the Unknown Debt
    Some of the IPO underwriters had previous experience with Refco. Two of those three firms, CSFB and Bank of America, also played lead roles, along with Deutsche Bank AG, in arranging an $800 million term loan for the Lee buyout, as well as a related $600 million debt sale, according to Thomson Financial. Bank of America, Deutsche Bank and Sandler O'Neill & Partners, a smaller firm that specializes in financial services, all were advisers on the Lee firm's investment in Refco . . . Those companies' extensive experience with Refco, together with the fees they collected, is sure to be scrutinized in court claims brought by aggrieved investors. The role of Refco's outside auditors Grant Thornton LLP in failing to discover the chief executive's debt sooner will come under the microscope. For now, the Wall Street firms aren't publicly discussing the matter, but some people familiar with their executives' thinking say they believe both they and the auditors were duped. A Grant Thornton spokesman said in a statement issued yesterday, "We are continuing our investigation related to the matters reported by Refco." The accounting firm likely will argue that its auditors were lied to, people familiar with the matter said. Executives at Thomas H. Lee won't discuss the matter publicly, but people familiar with its thinking say the buyout shop relied on underwriters and two auditing firms when it made the investment.
    Randall Stith, Robin Sidel, and Kara Scannell, "From Wall Street Pros To Auditors, Who Knew? Refco Disclosures Raise 'Due Diligence' Issues; Why Thomas Lee Invested," The Wall Street Journal, October 12, 2005; Page C3 ---

    Ed Ketz sums it up pessimistically at

    Accounting frauds are here to stay. When the prophet said "the heart is deceitful above all things," he included the hearts of corporate managers. Whatever one's religious beliefs, one has to admit that the empirical evidence in the world of corporate accounting confirms Jeremiah's insight. Managers don't employ accounting; they bend, twist, and distort it to display the set of numbers that helps them look good. Who cares about truth?

    Continued in article

    Bob Jensen's threads on Grant Thornton's legal woes are at

    What grades do nearly 2,000 clients give to their outside auditors?

    Nothing higher than a low C average.  The marks of all Big Four firms are shown below.

    "Auditing The Auditors," Business Week, November 22, 2004, Page 160 --- 

    In a world informed by the accounting scandals that engulfed Enron (ENRNQ ), Time Warner (TWX ), Freddie Mac (FRE ), and other formerly trusted giants, J.D. Power & Associates is now evaluating the very audit firms that are supposed to protect investors from such improprieties. And it's a report card no grade-schooler would want to take home to Mom and Dad.

    Power surveyed nearly 2,000 chief financial officers and audit committee chairmen, asking them to rate auditing firms on 13 traits essential to reviewing the books properly. Among larger companies, Deloitte & Touche gets top marks, Ernst & Young comes in second, and PricewaterhouseCoopers and KPMG are third and fourth. But even at No. 1, Deloitte can't exactly celebrate. Out of a possible 1,000 points, it got 734, or roughly a "C." KPMG, which ranked last of the big firms, barely passed with a 673. Among smaller companies with under $1 billion in sales, Grant Thornton International and BDO Seidman LLP finished on top, with the smaller firms getting points for industry and company knowledge.

    Most worrisome, only 44% of those surveyed said they were "extremely" or "very" confident in the accounting profession, down from 53% last year. Ron Conlin, the J.D. Power partner who headed up the survey, blames the fact that auditors are expected to do more work these days to comply with Sarbanes-Oxley and are getting stretched too thin. Auditors reached for comment say they're committed to boosting quality.

    Deloitte did well largely because its most senior personnel handle its largest clients, and its auditors have the deepest knowledge of each customer's business and industry. Conlin, who hopes to sell the report to the audit firms, says there is a strong correlation between auditors that clients say ask the toughest questions and those that g