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
http://faculty.trinity.edu/rjensen/Pictures.htm
can be changed to corrected link
http://faculty.trinity.edu/rjensen/Pictures.htm
However in some cases files had to be removed to reduce the size of my Website
Contact me at 
rjensen@trinity.edu 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) --- 

http://www.ey.com/global/download.nsf/US/Corporate_Reform_SEC_Auditor_Independence_Rules/$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 --- http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation 

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?

   http://faculty.trinity.edu/rjensen/FraudRotten.htm#Media  

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 ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#Lawmakers

Rotten to the Core --- http://faculty.trinity.edu/rjensen/FraudRotten.htm

Take the Enron Quiz --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

More on Accounting Theory and All Its Problems --- http://faculty.trinity.edu/rjensen/Theory01.htm
 

 

 

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 --- http://faculty.trinity.edu/rjensen/Fraud.htm 

Bob Jensen's Enron Quiz (and answers) ---
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

Bob Jensen's threads on professionalism and independence are at http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism

Bob Jensen's threads on special purpose (variable interest) entities are at http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm

Bob Jensen's threads on ethics and accounting education are at 
http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation

The Saga of Auditor Professionalism and Independence ---
http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism  

Incompetent and Corrupt Audits are Routine ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits

Bob Jensen's threads on accounting theory are at http://faculty.trinity.edu/rjensen/theory.htm 

Bob Jensen’s threads on the future of auditing

Bob Jensen’s threads on the weaknesses of risk-based auditing are at
 http://faculty.trinity.edu/rjensen/fraud001.htm#RiskBasedAuditing

Bob Jensen's threads on pro forma frauds are at http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#ProForma 

Bob Jensen's threads on accounting theory are at http://faculty.trinity.edu/rjensen/theory.htm 

Bob Jensen's threads on options accounting scandals are at
http://faculty.trinity.edu/rjensen/theory/sfas123/jensen01.htm

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 --- http://en.wikipedia.org/wiki/Accounting_scandals

Bob Jensen's threads on such scandals:

Bob Jensen's threads on audit firm litigation and negligence ---
http://faculty.trinity.edu/rjensen/Fraud001.htm

Current and past editions of my newsletter called Fraud Updates ---
http://faculty.trinity.edu/rjensen/FraudUpdates.htm

Bob Jensen's fraud conclusions ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm

Bob Jensen's threads on auditor professionalism and independence are at
http://faculty.trinity.edu/rjensen/Fraud001c.htm

Bob Jensen's threads on corporate governance are at
http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance 

Enron --- http://faculty.trinity.edu/rjensen/FraudEnron.htm

Rotten to the Core --- http://faculty.trinity.edu/rjensen/FraudRotten.htm

Fraud Updates --- http://faculty.trinity.edu/rjensen/FraudUpdates.htm

American History of Fraud --- http://faculty.trinity.edu/rjensen/FraudAmericanHistory.htm

Fraud in General --- http://faculty.trinity.edu/rjensen/Fraud.htm

Future of Auditing --- Click Here

AICPA Fraud Resource Center --- Click Here
http://www.aicpa.org/INTERESTAREAS/FORENSICANDVALUATION/RESOURCES/FRAUDPREVENTIONDETECTIONRESPONSE/Pages/fraud-prevention-detection-response.aspx

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,
Eileen

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 --- http://www.acfe.com/
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 ---
http://snipurl.com/acleselfstudy      [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 --- http://faculty.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's threads on fraud --- http://faculty.trinity.edu/rjensen/Fraud.htm

FBI Corporate Fraud Chart in August 2008 --- http://www.aicpa.org/pubs/jofa/aug2008/ataglance.htm#Chart1.htm

A great blog on securities and accounting fraud --- http://lawprofessors.typepad.com/securities/

Bob Jensen's threads on fraud and forensic accounting ---
http://faculty.trinity.edu/rjensen/Fraud.htm

 

 


 

The Consumer Fraud Portion of this Document Was Moved to http://faculty.trinity.edu/rjensen/FraudReporting.htm 

 

 

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) --- 

http://www.ey.com/global/download.nsf/US/Corporate_Reform_SEC_Auditor_Independence_Rules/$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 --- http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation 

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?

   http://faculty.trinity.edu/rjensen/FraudRotten.htm#Media  

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 ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#Lawmakers

Rotten to the Core --- http://faculty.trinity.edu/rjensen/FraudRotten.htm

Take the Enron Quiz --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

More on Accounting Theory and All Its Problems --- http://faculty.trinity.edu/rjensen/Theory01.htm
 

 

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 http://www.microsoft.com/msft/tools.htm 


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 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=104443

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 http://faculty.trinity.edu/rjensen/Fraud.htm


    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 --- http://www.adtmag.com/ 

     

    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 --- http://faculty.trinity.edu/rjensen/xmlrdf.htm 

    "Financial Reporting on the Internet – Instant, Economical, Global Communication," by Glen Gray, Information Technology, May 20021 --- http://www.ifac.org/Library/SpeechArticle.tmpl?NID=979235133150990 

    "Financial reporting on the Internet and the external audit," by Roger Debreceny and Glen Gray, The European Accounting Review, Volume 8, Number 2, 1999 --- http://www.bham.ac.uk/EAA/ear/conts/volume8.html 

    "Electronic Based Financial Reporting, by Hasri Bin Mustafa and Nor Azman Bin Shaari --- http://www.spk.uum.edu.my/azizi/electronic%20financial%20reporting.htm 

    Electronic Corporate Reporting Website --- http://accounting.rutgers.edu/SUMMA/corp/papers/papers.html 

     

    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 --- http://www.aicpa.org/pubs/jofa/may2002/jones.htm 

    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 --- http://faculty.trinity.edu/rjensen/245glosap.htm 

     

    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.

    From http://www.xbrl.org/Overview.htm 

    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! 
    http://www.xbrl-deutschland.de/xg_memberlist.htm
      

    Additional Reading

    XBRL Home Page --- http://www.XBRL.org

     XML, VoiceXML, XLink, XHTML, XBRL, XForm, XSLT, RDF and Semantic Web Watch --- http://faculty.trinity.edu/rjensen/xmlrdf.htm 

     

     

    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
    http://www.accountingweb.com/item/77788
     
    I guess the SEC did not read about Ebenezer at http://faculty.trinity.edu/rjensen/cpaaway.htm#2020 

    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 --- http://www.smartpros.com/x34375.xml 

    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 --- http://aaahq.org/ic/browse.htm

    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 http://faculty.trinity.edu/rjensen/245glosap.htm
    Also see http://faculty.trinity.edu/rjensen/FraudConclusion.htm#ERP  


    Additional Reading

    Canadian Continuous Disclosure Obligations:  OSC Rule 51-801
    http://www.osc.gov.on.ca/en/Regulation/Rulemaking/Rules/rule_51-102_20020621_notice_roc.pdf
     

    "AICPA Top 5 Emerging Impacts on You!" by Roman H. Kepczyk, CPA (Published in Accounting Today - April 25, 1999) --- http://www.itpna.com/Vision/1999/990510%20AICPA%20Top%205%20Emerging%20Technologies.htm 

    "Non-stop Auditing," by Greg Shields, CA Magazine, September 1998, --- http://www.camagazine.com/Library/EN/1998/Sep/e_d2.pdf 

    Texas A&M Center for Continuous Auditing --- http://www.tamu.edu/univrel/aggiedaily/news/stories/01/120701-7.html 

    S. Michael Groomer and Uday S. Murthy, Accounting Information Systems:  A Database Approach --- http://www.cybertext.com/ 

    ISACA/IIA Los Angeles, March 25, 2002 --- http://www.isaca-la.org/doc/2000may%20Continuous%20Auditing%20IIA.pdf 

     

    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 --- http://accounting.rutgers.edu/raw/aaa/pubs.htm 

    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 --- http://accounting.rutgers.edu/raw/aaa/pubs.htm 

    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 (http://www.napster.com ), Gnutella (http://gnutella.wego.com), InfoSearch (http://infosearch.com ), Freenet  (http://www.freenet.com ), and Pointera (http://www.spinfrenzy.com ). 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 --- 
    http://faculty.trinity.edu/rjensen/napster.htm
     

     

     

    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 http://faculty.trinity.edu/rjensen/fraud.htm#Blame 


    Additional Reading

    Paul Pacter's great site at http://www.iasplus.com/index.htm 

    IASB Home Page --- http://www.iasc.org.uk/cmt/0001.asp 

    IAS Around the World --- http://www.iasc.org.uk/cmt/0001.asp?n=56&s=841341&sc={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. http://www.accountingweb.com/item/83467 

    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. http://www.accountingweb.com/item/83984 

     

    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 --- http://online.wsj.com/article/0,,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. --- http://snipurl.com/Turley2004 

    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. http://www.accountingweb.com/item/65518 

    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." --- http://www.smartpros.com/x32053.xml 

    Additional Reading

    Bob Jensen's Threads on Accounting Fraud, Forensic Accounting, Securities Fraud, and White Collar Crime --- http://faculty.trinity.edu/rjensen/fraud.htm 

    Proposed Accounting and Auditing Reforms in the Wake of the Enron Scandal --- http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm 

    Teaching Ethics -- Bill Christie once helped bust Nasdaq price fixers. Now, he's Vanderbilt's B-school dean -- and bringing those lessons to MBAs http://www.businessweek.com/mediacenter/list/bs01.htm 

     

    Expansion of the Accounting Profession into Assurance Services

    "Deloitte & Touche Launches DTect Financial Fraud Investigation Service," SmartPros, September 7, 2004 --- http://www.smartpros.com/x45061.xml 

    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," www.aicpa.org).

    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 http://www.aicpa.org/assurance/index.htm 

     

    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 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99840 


    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 --- http://www.smartpros.com/x44464.xml 

    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 --- http://polisci.wisc.edu/users/kritzer/research/CLRP/clrp.htm 

    Law & Economics Class Notes of Professor William M. Landes, March 29, 2000, University of Chicago --- http://blsa.uchicago.edu/Upper%20class/Law&EconNotes-Landes2000.doc 

     

     

     

    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 http://faculty.trinity.edu/rjensen/000aaa/0000start.htm 

    Bob Jensen's Threads on Cross-Border (Transnational) Training and Education --- http://faculty.trinity.edu/rjensen/crossborder.htm 

     

     

     

     

    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 --- http://iom.edu/Activities/Nutrition/NutritionSymbols.aspx

    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 ---
    http://www.brainpickings.org/index.php/2013/07/02/spinach-popeye-error-half-life-of-facts/

    35 Science 'Facts' That Are Totally Wrong ---
    http://www.businessinsider.com/science-misconceptions-and-myths-2013-7?op=1


    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 ---
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2482610

    Abstract
    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 ---
    http://faculty.trinity.edu/rjensen/Theory01.htm

    Bob Jensen's threads on case writing and teaching ---
    http://faculty.trinity.edu/rjensen/000aaa/thetools.htm#Cases


    Bloomberg's 2015 Ranking of the Top MBA Programs ---
    http://www.bloomberg.com/features/2015-best-business-schools/?cmpid=BBD102015_BIZ

    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 http://grad-schools.usnews.rankingsandreviews.com/best-graduate-schools/top-business-schools/mba-rankings
    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 ---
    http://images.businessweek.com/slideshows/2012-04-09/best-colleges-for-return-on-investment#slide1

    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
    http://faculty.trinity.edu/rjensen/HigherEdControversies.htm#BusinessSchoolRankings

     


    More on Accounting Theory and All Its Problems --- http://faculty.trinity.edu/rjensen/Theory01.htm
     

    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 --- http://faculty.trinity.edu/rjensen/fraud.htm#DerivativesFraud 

    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 http://faculty.trinity.edu/rjensen/fraud.htm#Farm 

    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 dot.com-type 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.

    See http://faculty.trinity.edu/rjensen/fraud.htm#Hoax 

    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 
    LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1011663305696657240.djm  
    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.

    QUESTIONS: 
    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 --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

     

     

    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 
    http://faculty.trinity.edu/rjensen/fraud.htm#Hoax
     

    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 http://faculty.trinity.edu/rjensen/fraud.htm#Hoax 

    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.
      http://faculty.trinity.edu/rjensen/cpaaway.htm 

     

    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 
    http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
     

    Return on Business Valuation, Business Combinations, 
    Investment (ROI), and Pro Forma Financial Reporting http://faculty.trinity.edu/rjensen/roi.htm

     

     

    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)

    MR. ELLIOTT:

    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 --- http://faculty.trinity.edu/rjensen/theory.htm 

    Baruch Lev's Home Page --- http://www.stern.nyu.edu/~blev/main.html 

    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 --- www.cim.sfu.ca/newsletter 

    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 --- http://faculty.trinity.edu/rjensen/Theory01.htm
     

     

    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 http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales 
    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.---
    https://newrepublic.com/article/144969/club-fed-why-government-goes-easy-federal-crime

    Rotten to the Core ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm


    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 ---
    http://dailycaller.com/2017/12/04/navy-commander-sent-to-jail-for-18-months-over-services-largest-fraud-scheme/


    Question
    How profitable is insider trading?

    Answer
    Insanely profitable ---
    http://fortune.com/2014/10/20/insider-trading-profits/


    "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 ---
    http://nationalreview.com/article/359333/corrupt-and-set-life-jillian-kay-melchior

    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 pensionhttp://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays 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


    Question
    How profitable is insider trading?

    Answer
    Insanely profitable ---
    http://fortune.com/2014/10/20/insider-trading-profits/

    White collar crime pays even if you know you're going to get caught ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays


    "Inside the Mind of the White-Collar Criminal," by Bill Barrett, AccountingWeb, August 19, 2013 ---
    http://www.accountingweb.com/article/inside-mind-white-collar-criminal/222228

    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 ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
    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: http://www.trinity.edu/rjensen/fraud.htm) . 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.

    Best2U,

    Bill


    What Affects Our Trust in Government?
    http://daily.jstor.org/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 ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays 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 pińata 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 ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm


    "CEO in fraud case needs more than seven days prison: court," by Jonathan Stempel, Reuters, February 15, 2013 ---
    http://www.reuters.com/article/2013/02/15/us-ceo-sentencing-decision-idUSBRE91E0W320130215

    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 ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

     


    The following is from Kurt Eichenwald's, Conspiracy of Fools (Broadway Books, 2005, pp. 671-672) --- http://www.bookreporter.com/reviews2/0767911784.asp 

    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 ---
    http://www.rollingstone.com/politics/news/gangster-bankers-too-big-to-jail-20130214

    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---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking

    Bob Jensen's Fraud Updates ---
    http://faculty.trinity.edu/rjensen/FraudUpdates.htm

     


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

    Question
    What is the main temptation of white collar criminals?

    Answer from http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#01
    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 ---
    http://www.slate.com/articles/business/the_dismal_science/2012/09/business_school_and_ethics_can_we_train_mbas_to_do_the_right_thing_.html

    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 --- http://en.wikipedia.org/wiki/New_Orleans_Saints_bounty_scandal

     

    Question
    What is the main temptation of white collar criminals?

    Answer from http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#01
    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 http://faculty.trinity.edu/rjensen/FraudRotten.htm
    The exact quotation from Jane Bryant Quinn at http://faculty.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

    Bob Jensen's threads on professionalism and ethics ---
    http://faculty.trinity.edu/rjensen/Fraud001c.htm

    Bob Jensen's Rotten to the Core threads ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm

    September 5, 2012 reply from Paul Williams

    Bob,

    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.

    Paul

    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
    http://en.wikipedia.org/wiki/Corruption_%28political%29

     

     

    Respectfully,
    Bob Jensen


    "Federal Tax Crimes, 2013," by John A. Townsend, SSRN, February 5, 2013 ---
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2212771

    Abstract:     
    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 ---
    http://faculty.trinity.edu/rjensen/FraudUpdates.htm

     


    "RESTORING CRIMINAL LIABILITY FOR FINANCIAL FRAUD," by Anthony H. Catanach and J. Edward Ketz, Grumpy Old Accountants, October 1, 2012 ---
    http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/779 

    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 kquinn@ethicsgame.com.

    “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
    http://www.cbsnews.com/8301-18560_162-57336042/prosecuting-wall-street/?tag=pop;stories
    Note that this episode features my hero Frank Partnoy

    Sarbanes–Oxley Act (Sarbox, SOX) ---
    http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act

     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 ---
    http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act#Sarbanes.E2.80.93Oxley_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.
      http://www.bloomberg.com/news/2011-02-24/what-vikram-pandit-knew-and-when-he-knew-it-commentary-by-jonathan-weil.html
       
    • 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 ---
      http://www.nytimes.com/2011/07/21/business/countrywide-to-pay-borrowers-108-million-in-settlement.html
      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
      http://sec.gov/news/press/2010/2010-197.htm
      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 ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm

    Bob Jensen's threads on how white collar crime pays even if you get caught ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays


    "Should Some Bankers Be Prosecuted?" by Jeff Madrick and Frank Partnoy, New York Review of Books, November 10, 2011 ---
    http://www.nybooks.com/articles/archives/2011/nov/10/should-some-bankers-be-prosecuted/
    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 ---
     http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
     Watch the video!

    The greatest swindle in the history of the world ---
    http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
     

    Bob Jensen's threads on how the banking system is rotten to the core ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking


    View from the Left
    "Barclays and the Limits of Financial Reform," by Alexander Cockburn, The Nation, July 30, 2012 ---
    http://www.thenation.com/article/168834/barclays-and-limits-financial-reform

    White Collar Crime Pays Big Even If You Get Caught ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

    Bob Jensen's Threads on Accounting Fraud, Forensic Accounting, Securities Fraud, and White Collar Crime ---
    http://faculty.trinity.edu/rjensen/fraud.htm 


    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, CFO.com, December 9, 2011 ---
    http://www3.cfo.com/article/2011/12/compensation_executive-bonus-larre-towers-watson-

    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
    http://faculty.trinity.edu/rjensen/fraud001.htm#Governance


    Question
    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 ---
     http://www.nytimes.com/2011/06/28/business/28citi.html?_r=2&smid=tw-nytimesbusiness&seid=auto

    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

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

    Answer
    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 ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays


    "Ernst & Young — Cuomo Initiates Settlement Talks With Filing," by Walter Pavlo, Forbes, December 24, 2010 ---
    http://blogs.forbes.com/walterpavlo/2010/12/24/ernst-young-cuomo-initiates-settlement-talks-with-filing/?boxes=financechannelforbes
    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
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

    Bob Jensen's threads on the Lehman/Ernst Repo 105 scandal are at
    http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst


    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 http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales 
    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 --- http://news.yahoo.com/s/ap/20051228/ap_on_bi_ge/enron_causey

    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"

    See http://www.theprosandthecons.com/cons.htm 

    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 --- http://www.wsjclassroomedition.com/archive/03nov/care_unethical.htm  

     From: Walt Pavlo [mailto:waltpavlo@EtikaLLC.com]
    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

    Bob,

     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 : WaltPavlo@EtikaLLC.com

    Website: www.EtikaLLC.com


    "The Difficulty of Proving Financial Crimes," by Peter J. Henning, DealBook, December 13, 2010 ---
    http://blogs.law.harvard.edu/corpgov/2010/12/20/why-do-cfos-become-involved-in-material-accounting-manipulations/

    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 ---
    http://faculty.trinity.edu/rjensen/FraudUpdates.htm


    "Commissioner slams SEC settlement," SmartPros, July 13, 2011 ---
    http://accounting.smartpros.com/x72323.xml

    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).---
    http://abcnews.go.com/GMA/sec-pornography-employees-spent-hours-surfing-porn-sites/story?id=10452544

    Bob Jensen's Fraud Updates --- http://faculty.trinity.edu/rjensen/FraudUpdates.htm


    "The 11 Most Shocking Insider Trading Scandals Of The Past 25 Years," Business Insider, November 4, 2010 --- 
    http://www.businessinsider.com/biggest-insider-trading-scandals-2010-11#ixzz14WznUXEr

    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
    http://query.nytimes.com/gst/fullpage.html?res=9B0DEFD8113FF930A15757C0A961948260&n=Top/Reference/Times 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 ---
    http://faculty.trinity.edu/rjensen/FraudRotten.htm

    American History of Fraud ---  http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm

     

     


    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 --- http://www.nytimes.com/2007/01/06/business/06insider.html
    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 http://faculty.trinity.edu/rjensen/FraudRotten.htm


    Bob Jensen's threads on the Enron/Andersen frauds --- http://faculty.trinity.edu/rjensen/FraudEnron.htm

     

     

    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 --- http://www.buffalonews.com/editorial/20061203/1074150.asp

    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 http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst


    "Director Capture," The Icahn Report, January 20, 2009 --- http://www.icahnreport.com/

    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 http://www.amazon.com 

    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 http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance

    Bob Jensen's threads on great minds in management are at http://faculty.trinity.edu/rjensen/theory/00overview/GreatMinds.htm


    "SEC Accountant Fines Largely Go Unpaid," SmartPros, June 7, 2006 --- http://accounting.smartpros.com/x53399.xml

    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 --- http://online.wsj.com/article/0,,SB112741852577848939,00.html?mod=todays_us_money_and_investing

    Bob Jensen's threads on HealthSouth and Ernst & Young are at http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst

    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--- http://online.wsj.com/article/SB113815854524255591.html?mod=todays_us_money_and_investing 


    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 --- http://www.nytimes.com/2006/01/22/business/yourmoney/22suits.html
    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--- http://online.wsj.com/article/SB113643186947238360.html?mod=todays_us_money_and_investing 

    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 --- http://www.nytimes.com/2005/03/13/business/yourmoney/13restate.html


    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 --- http://online.wsj.com/article/SB113415352157818617.html?mod=todays_us_page_one

    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 --- http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst
     


    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 --http://online.wsj.com/article/0,,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 ---
    http://online.wsj.com/article/0,,SB112376796515410853,00.html?mod=todays_us_money_and_investing

    A WSJ video is available at http://snipurl.com/SullivanVideo

    Bob Jensen's threads on the Worldcom accounting scandal are at http://faculty.trinity.edu/rjensen/FraudEnron.htm#WorldCom


    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 --- http://online.wsj.com/article/0,,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 --- http://www.nytimes.com/2004/08/15/business/yourmoney/15win.html 


    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--- http://online.wsj.com/article/0,,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 --- http://accounting.smartpros.com/x54052.xml

    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 --- http://online.wsj.com/article/0,,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 --- http://online.wsj.com/article/0,,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 http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays 

    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 --- http://online.wsj.com/article/0,,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 http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm 

    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 --- http://online.wsj.com/article/0,,SB110123997986182154,00.html?mod=home_whats_news_us 
    Bob Jensen's thread on securities trading frauds are at http://faculty.trinity.edu/rjensen/fraudRotten.htm 

    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 --- http://www.smartpros.com/x45590.xml 
    Bob Jensen's threads on insurance frauds are at http://faculty.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 

    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 --- http://www.nytimes.com/2005/04/03/business/yourmoney/03pay.html?
    Bob Jensen's threads on corporate fraud are at http://faculty.trinity.edu/rjensen/fraud.htm
    Bob Jensen's updates on fraud are at http://faculty.trinity.edu/rjensen/fraudUpdates.htm


    "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 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=206662 

    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  http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=206662  


    "No Wonder C.E.O.'s Love Those Mergers," by Gretchen Morgenson, The New York Times, July 18, 2004 --- http://www.nytimes.com/2004/07/18/business/yourmoney/18watch.html 

    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. http://www.accountingweb.com/item/70425 


    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 --- http://www.nytimes.com/2004/12/08/business/08wall.html

    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 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=206659&_DARGS=%2Fhtml%2Fmag_archive%2Fmag_archive_index.html.6_A&_DAV=Home 

    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

     

    609

    525

    187

    142

    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. 
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=364220

    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 --- http://www.smartpros.com/x41471.xml

    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 --- http://www.hypermediative-dev1.net/index.php 
    The Future of the Accounting Profession --- http://snipurl.com/AccountingFuture 

    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.

    Preface 
    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 ... :-)

    Roger


    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 --- http://snipurl.com/DefenseLawyers 
    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" --- http://www.biggerhammer.net/


    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. http://www.msu.edu/user/mccarth4/ 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 

    http://www.ledgerism.net/  , http://refusenik.org 


    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 --- http://www.nytimes.com/2005/03/13/business/yourmoney/13agenda.html 


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

    Answer
    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 --- http://faculty.trinity.edu/rjensen/fraudconclusion.htm#CrimePays 

    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 --- http://online.wsj.com/article/0,,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 --- http://www.msnbc.msn.com/id/6700786/site/newsweek/ 

    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 --- http://online.wsj.com/article/0,,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 http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm 

    Bob Jensen's "Rotten to the Core" threads are at http://faculty.trinity.edu/rjensen/fraudRotten.htm 

     


    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 --- http://www.senate.gov/~gov_affairs/012402partnoy.htm

    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? --- http://faculty.trinity.edu/rjensen/FraudEnron.htm#FrankPartnoyTestimony 

     

    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 --- http://ls.wustl.edu/WULQ/ 

    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 --- http://aaahq.org/AM2003/WyattSpeech.pdf 

    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 --- http://faculty.trinity.edu/rjensen/fraudRotten.htm 

    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 http://faculty.trinity.edu/rjensen/FraudConclusion.htm#CrimePays 

    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 --- http://online.wsj.com/article/0,,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 --- http://online.wsj.com/article/0,,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 --- http://online.wsj.com/article/0,,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.

    IN PLAIN SIGHT

    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 Investinginbonds.com. 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 ---  http://www.nytimes.com/2004/02/29/weekinreview/29bere.html

    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 --- http://online.wsj.com/article/SB113659722018040446.html?mod=opinion&ojcontent=otep 

    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 http://www.cornerstone.com/fram_res.html
    A Stanford University Press Release is at http://securities.stanford.edu/scac_press/20060103_CR_SCAC.pdf
    The Stanford University Law School Class Action Clearinghouse is at http://securities.stanford.edu/

     

     

     

     

    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 --- http://www.nytimes.com/2006/06/20/business/20tax.html?_r=1&oref=slogin

    Bob Jensen's fraud updates are at http://faculty.trinity.edu/rjensen/FraudUpdates.htm


    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 --- http://www.smartpros.com/x45750.xml 

    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 --- http://papers.ssrn.com/sol3/papers.cfm?abstract_id=396694# 
     --- 

     

    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?

    See http://faculty.trinity.edu/rjensen//theory/00overview/AccountingTricks.htm 

    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 --- http://online.wsj.com/article/0,,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 --- http://www.huronconsultinggroup.com//files/tbl_s6News/PDF134/112/HuronRestatementStudy2002.pdf 

    ********************
     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. 
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=364220

    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 --- http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
    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 http://faculty.trinity.edu/rjensen/FraudRotten.htm

    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) --- http://search.barnesandnoble.com/American-Rust/Philipp-Meyer/e/9780385527514/?itm=1
    American excess: A Wall Street trader tells all - Americas, World - The Independent
    http://www.independent.co.uk/news/world/americas/american-excess--a-wall-street-trader-tells-all-1674614.html 
    Jensen Comment
    This book reads pretty much like an update on the derivatives scandals featured by Frank Partnoy covering the Roaring 1990s before the dot.com scandals broke. There were of course other insiders writing about these scandals as well --- http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
    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 --- http://faculty.trinity.edu/rjensen/2008Bailout.htm#InvestmentBanking


    Perks, Payouts, and Pricey Breakups (think golden parachutes) : Takeaways From 2019’s Public-College Presidential-Pay Survey ---
    https://www.chronicle.com/interactives/what-presidents-make?utm_source=at&utm_medium=en&utm_source=Iterable&utm_medium=email&utm_campaign=campaign_1366850&cid=at&source=ams&sourceId=296279

    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. ---
    https://www.forbes.com/sites/grantfreeland/2019/03/18/microsoft-ceo-satya-nadellas-success-secret/#255dbe2f67ef
    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
    https://hbr.org/video/5728073095001/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 ---
    http://www.businessweek.com/articles/2014-07-22/for-ceos-correlation-between-pay-and-stock-performance-is-pretty-random?campaign_id=DN072214

    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 ---
    http://www.nytimes.com/2016/07/10/business/investors-get-stung-twice-by-executives-lavish-pay-packages.html?_r=0

    . . .

    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 --- https://en.wikipedia.org/wiki/FIFA_World_Cup

    Bloomberg, June 3, 2016
    http://www.bloomberg.com/news/articles/2016-06-03/fifa-top-three-bosses-netted-80-million-in-pay-and-severance?cmpid=BBD060316_BIZ&utm_medium=email&utm_source=newsletter&utm_campaign=

    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 --- http://faculty.trinity.edu/rjensen/FraudUpdates.htm


    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 --- http://www.simoleonsense.com/us-stockmarket-returns-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
    http://blogs.hbr.org/cs/2012/02/compensation_and_the_myth_of_t.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date

    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
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation


    "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 ---
    http://www.gsb.stanford.edu/news/headlines/charles-oreilly-narcissists-get-paid-more-than-you-do

    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 ---
    http://www.businessweek.com/articles/2014-07-22/for-ceos-correlation-between-pay-and-stock-performance-is-pretty-random?campaign_id=DN072214

     


    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 ---
    http://www.marketwatch.com/story/ge-has-been-an-investor-disaster-under-jeff-immelt-2010-03-08

    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 --- http://en.wikipedia.org/wiki/Clawback

    PwC:  Executive Compensation: Clawbacks 2013 proxy disclosure study --- Click Here 
    http://www.pwc.com/us/en/cfodirect/issues/human-resources/clawbacks-2013-proxy-disclosure-study.jhtml?display=/us/en/cfodirect/issues/human-resources&j=444160&e=rjensen@trinity.edu&l=727944_HTML&u=17822686&mid=7002454&jb=0


    "A Dangerous Pattern: Rewarding Failure," by Ron Kensas, Harvard Business Review Blog, March 9, 2010 ---
    http://blogs.hbr.org/ashkenas/2010/03/a-dangerous-pattern-rewarding.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE

    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 ---
    http://blogs.hbr.org/cs/2010/03/healing_american_capitalism_to.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE

    Bob Jensen's threads on outrageous executive compensation are at
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation


    "How CEO Pay Became a Massive Bubble," An interview with Mihir Desai Harvard Business School, Harvard Business Review Blog, February 23, 2012 ---
    Click Here
    http://blogs.hbr.org/ideacast/2012/02/how-ceo-pay-became-a-massive-b.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date  


    Question
    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 ---
    http://wallstreetandtech.com/career-management/showArticle.jhtml?articleID=225700612&cid=nl_wallstreettech_daily
    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.

    SHOCK TREATMENT

    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
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation


    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 WSJ.com

    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.


    QUESTIONS:
    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 ---
    http://online.wsj.com/article/SB10001424052702303864404575571972286910174.html?mod=djem_jiewr_AC_domainid

    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.

    View Full Image

    Reuters

    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 ---
    http://ssrn.com/abstract=2140204

    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 ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
    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 ---
    http://www.cs.trinity.edu/~rjensen/temp/SunsetHillHouse/SunsetHillHouse.htm

     

     


    Our Broken Corporate Governance Model
    "Why Executive Pay is So High," by Neil Weinberg, Forbes, April 22, 2010 ---
    http://www.forbes.com/forbes/2010/0510/outfront-pay-bosses-ceo-chairman-why-executives-pay-is-high.html?boxes=Homepagetoprated

    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 ---
    http://faculty.trinity.edu/rjensen/Fraud001.htm#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 --- http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinion 

    Bob Jensen's threads on corporate governance are at
    http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance


    "Golden coffins, golden offices, golden retirement:  Ten of the most egregious executive perks,"
    by Allistair Barr, Market Watch, May 13, 2009 ---
    http://www.marketwatch.com/story/golden-coffins-10-of-the-most-egregious-ceo-perks?pagenumber=1


    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 --- http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1460104

    Abstract:
    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 --- http://en.wikipedia.org/wiki/Troubled_Asset_Relief_Program

    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 WSJ.com

    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.

    QUESTIONS: 
    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

    RELATED ARTICLES: 
    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 ---
    http://online.wsj.com/article/SB10001424052748703988304575413671786664134.html?mod=djem_jiewr_AC_domainid

    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
    http://faculty.trinity.edu/rjensen/FraudUpdates.htm


    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, Freep.com, May  13, 2009---
    http://www.freep.com/article/20090513/BUSINESS01/905130318
    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
    http://faculty.trinity.edu/rjensen/theory/sfas123/jensen01.htm


    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 --- http://www.politico.com/news/stories/0509/22134.html

    "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 --- http://online.wsj.com/article/SB124157594861790347.html

    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 --- http://lawprofessors.typepad.com/whitecollarcrime_blog/ 


    "Executive Compensation and Boards of Directors," by J. Edward Ketz, SmartPros, July 2009 ---
    http://accounting.smartpros.com/x67023.xml

    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 {http://www.sec.gov/news/press/2009/2009-147.htm}. 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
    http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance


    "The Case for Cutting the Chief's Paycheck," by William J. Holstein, The New York Times, January 29, 2006 --- http://www.nytimes.com/2006/01/29/business/yourmoney/29advi.html



     

    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 --- http://www.iasplus.com/usa/0612seccomp.pdf


     

    Bob Jensen's threads on accounting for employee stock options are at http://faculty.trinity.edu/rjensen/theory/sfas123/jensen01.htm

     

     



    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 --- http://news.yahoo.com/s/ap/20090803/ap_on_bi_ge/us_bank_of_america_sec
     


    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 --- http://en.wikipedia.org/wiki/Alan_S._Blinder

    "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 ---
    http://online.wsj.com/article/SB10001424052748703652104574652242436408008.html?mod=djemEditorialPage

    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.

    View Full Image

    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
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation

     


    Fodder for Accounting and Finance Agency Theorists to Digest

    Principle-Agent Theory --- http://en.wikipedia.org/wiki/Agency_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 --- http://www.becker-posner-blog.com/

    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 --- http://www.becker-posner-blog.com/

    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
    http://faculty.trinity.edu/rjensen/theory/sfas123/jensen01.htm

     


     

    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 WSJ.com ---
    http://online.wsj.com/article/SB124096182942565947.html?mod=djem_jiewr_AC

    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.

    QUESTIONS: 
    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 --- http://online.wsj.com/article/SB124096182942565947.html?mod=djem_jiewr_AC

    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

     


    Questions
    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 --- http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
    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) ---
    http://faculty.trinity.edu/rjensen/acct5341/Calgary/CDfiles/video\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 --- http://online.wsj.com/article/SB120604424097452677.html?mod=todays_us_page_one
    (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 ---
    http://www.huffingtonpost.com/eve-tahmincioglu/obesity-epidemic-among-ce_b_70810.html

     


    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.

    QUESTIONS:
    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 WSJ.com ---
    http://online.wsj.com/article/SB120156732373223843.html?mod=djem_jiewr_ac
     

    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.

    QUESTIONS: 
    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
     

    RELATED ARTICLES: 
    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 --- http://online.wsj.com/article/SB120156732373223843.html?mod=djem_jiewr_ac

    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 dot.com 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 --- http://www.sptimes.com/2006/12/19/Opinion/Firms_cook_the_books_.shtml

    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 http://faculty.trinity.edu/rjensen/FraudUpdates.htm

     

     

    Bob Jensen's threads on fraudulent and incompetent auditing are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits

     


    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 ---
    http://faculty.trinity.edu/rjensen/Fraud001.htm#GrantThornton


    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 --- http://www.latimes.com/services/site/premium/access-registered.intercept

    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 --- http://ths.gardenweb.com/forums/load/build/msg0122380524478.html?12


    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 --- http://www.nytimes.com/2006/10/30/business/30option.html?_r=1&oref=slogin

    You can read about agency theory at http://en.wikipedia.org/wiki/Agency_Theory

    You can read the following at http://en.wikipedia.org/wiki/Agency_Theory#Incentive-Intensity_Principle

    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 http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#Manipulation


    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 --- http://online.wsj.com/article_print/SB115992145253481882.html

    Bob Jensen's threads on "Corporate Governance" are at
    http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance

    Bob Jensen's "Rotten to the Core" threads are at http://faculty.trinity.edu/rjensen/FraudRotten.htm


    Compensation Special Report, Parts I & II, CFO Magazine, November 2006 --- http://www.cfo.com/guides/guide.cfm/7932402?f 

    DIRECTOR & OFFICER COMPENSATION
    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.

    EMPLOYEE COMPENSATION
    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.

    BACKDATING BLOWS UP
    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 --- http://accounting.smartpros.com/x54052.xml

    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 http://faculty.trinity.edu/rjensen/Fraud.htm


    Question
    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 --- http://www.nytimes.com/2006/08/27/business/yourmoney/27mercury.html

    Bob Jensen's threads on executive options compensation scandals are at http://faculty.trinity.edu/rjensen/theory/sfas123/jensen01.htm


    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 --- http://financeprofessorblog.blogspot.com/

    Do managers backdate options?

    Do managers backdate options? It sure seems that way.

    From
    Reuters:
     
    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 http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
     


    Question
    How excessive is executive compensation and what can be done about it?

    From Jim Mahar's Blog on August 22, 2006 --- http://financeprofessorblog.blogspot.com/

    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 http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
     


    "Overpaid Management: Their Cover Is Blown," by Mark Maisonneuve, The Wall Street Journal, June 22, 2006; Page A17 --- http://online.wsj.com/article/SB115094549688587219.html?mod=todays_us_opinion

    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 --- http://www.nytimes.com/2006/06/25/business/yourmoney/25grasso.html

    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

    Bob Jensen's fraud updates are at http://faculty.trinity.edu/rjensen/FraudUpdates.htm

    Bob Jensen's threads on corporate governance are at http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance

    Bob Jensen's "Rotten to the Core" threads are at http://faculty.trinity.edu/rjensen/FraudRotten.htm


    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 --- http://online.wsj.com/article/SB115103062578188438.html?mod=todays_us_page_one


    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 --- http://online.wsj.com/article/SB114671224745343502.html?mod=todays_us_nonsub_page_one


    "Surprise! CEOs Are Still Highly Paid! "Deserve" has nothing to do with it," by Holman W. Jenkins, The Wall Street Journal, May 03 2006 --- http://online.wsj.com/article/SB114661167480741940.html?mod=opinion&ojcontent=otep

    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 --- http://www.nytimes.com/2006/03/05/business/yourmoney/05cont.html

    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 naďve 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 --- http://www.nytimes.com/2006/01/29/business/yourmoney/29every.html

    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
    LINK: http://online.wsj.com/article/SB113686357913042428.html 
    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.'

    QUESTIONS:
    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.:

    Access www.sec.gov 
    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 ---
    http://online.wsj.com/article/SB114048274500878570.html?mod=todays_europe_money_and_investing

    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

    Bob Jensen's threads on security frauds are at
    http://faculty.trinity.edu/rjensen/FraudRotten.htm

    Bob Jensen's updates on fraud are at http://faculty.trinity.edu/rjensen/FraudUpdates.htm

     


    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 --- http://www.ajc.com/

    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 --- http://financeprofessorblog.blogspot.com/

    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. http://ssrn.com/abstract=717102


    January 23, 2006 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU]

    Bob,

    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!

    Denny


    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 ---
    http://snipurl.com/CokeSeverancePay


    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 --- http://www.nytimes.com/2006/01/22/business/yourmoney/22suits.html
    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 --- http://snipurl.com/NYT0105


    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 --- http://online.wsj.com/article/SB113521937434129170.html?mod=todays_us_page_one

    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 ---
    http://snipurl.com/CokeSeverancePay


    COMPANY DIRECTORS - WHOM DO THEY SERVE? --- http://www.ragm.com/archpub/ragm/company_directors.html 

    “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 http://www.ragm.com/archpub/ragm/company_directors.html 


    "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 --- http://www.fortune.com/fortune/ceo/articles/0,15114,443051,00.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 http://faculty.trinity.edu/rjensen/FraudEnronCast.htm 


    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 
    LINK: http://online.wsj.com/article_print/0,,SB106676280248746100,00.html  
    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.

    QUESTIONS: 
    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

    --- RELATED ARTICLES IN THE WALL STREET JOURNAL --- 
    TITLE: How to Be a Good Director 
    REPORTER: Carol Hymowitz 
    PAGE: R1-4 
    ISSUE: Sep 27, 2002 
    LINK: http://online.wsj.com/article_print/0,,SB10667541869215200,00.html 

    TITLE: Now Playing: Corporate America's Funniest Home Video 
    REPORTER: Mark Maremont and James Bandler 
    PAGE: A1-8 
    ISSUE: Oct 29, 2003 
    LINK: http://online.wsj.com/article_print/0,,SB106735726682798800,00.html 
    (See the Yawn below)


    Yawn!
    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:

    Excerpt; http://play.rbn.com/?dowjones/wsj/demand/wsj_vid/tyco1_hi.rm 

    Full:   Part 1http://play.rbn.com/?dowjones/wsj/demand/wsj_vid/tyco2_hi.rm 

    Full:  Part 2):  http://play.rbn.com/?dowjones/wsj/demand/wsj_vid/tyco3_hi.rm 
    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 --- http://www.yourlawyer.com/practice/printnews.htm?story_id=2104 

    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 --- http://faculty.trinity.edu/rjensen/fraud.htm 


    "Corporate Governance and Equity Prices," by Paul A. Gompers, et al. July 2002 --- http://icf.som.yale.edu/Conference-Papers/Fall2001/gov.pdf 
    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 http://icf.som.yale.edu/Conference-Papers/Fall2001/gov.pdf 

    "System Failure:  Corporate America:  We Have a Crisis," Fortune Magazine Cover Story, June 24, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208314

    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 fortune.com). 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?
    FULL VERSION http://www.businessweek.com/bwdaily/dnflash/jun2002/nf20020613_9296.htm?c=bwcareersjun26&n=link1&t=email 


    One of the best sites that I have encountered regarding news and issues in corporate governance is maintained by Robert Monks at http://www.ragm.com/index.asp 
    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 --- http://www.fei.org/magazine/May2002.cfm 


    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 http://faculty.trinity.edu/rjensen/fraudVirginia.htm 


     

    Additional Reading

    The New Robber Barons --- http://www.labornet.org/viewpoints/workman.html 

    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
    http://faculty.trinity.edu/rjensen/Fraud001.htm#Governance

     

     

    Corporate Boards and the SEC Will Not Solve Corporate Governance the Crisis
      Riches Without Restraint:  The Sad State of Corporate Governance

    Question
    Why did Hewlett-Packard needed to plug leaks from its board of directors?

    "Zip It," by James Surowiecki, The New Yorker, October 9, 2006 --- http://www.newyorker.com/talk/content/articles/061009ta_talk_surowiecki

    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 --- http://www.nytimes.com/2003/12/14/magazine/14PHENOM.html 

    ''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 --- http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/


    "PCAOB Finds Problems At PricewaterhouseCoopers (PwC)," by David Reilly, The Wall Street Journal, December 16, 2006; Page A4 --- http://online.wsj.com/article/SB116622194790551886.html?mod=todays_us_page_one

    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
    http://faculty.trinity.edu/rjensen/Fraud001.htm#PwC


    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 --- http://www.sptimes.com/2006/12/19/Opinion/Firms_cook_the_books_.shtml

    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 http://faculty.trinity.edu/rjensen/FraudUpdates.htm

     

    Bob Jensen's threads on outrageous executive compensation are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation

     


    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) — http://www.smartpros.com/x33351.xml 


    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 --- http://accounting.smartpros.com/x47712.xml
    Bob Jensen's threads on E&Y's legal woes are at http://faculty.trinity.edu/rjensen/fraud001.htm#Ernst


    "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
    http://faculty.trinity.edu/rjensen/theory/sfas123/jensen01.htm


    Question
    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 --- http://www.nytimes.com/2006/07/17/business/17options.html

    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 ---
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2474950

    Abstract:     
     
    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 ---
    http://faculty.trinity.edu/rjensen/Theory01.htm


    "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 --- http://online.wsj.com/article/SB115102871998288378.html?mod=todays_us_money_and_investing

    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 --- http://www.sptimes.com/2006/12/19/Opinion/Firms_cook_the_books_.shtml

    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 http://faculty.trinity.edu/rjensen/FraudUpdates.htm

     

    Bob Jensen's threads on outrageous executive compensation are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation

     

    Bob Jensen's threads on fraudulent and incompetent auditing are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits


    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
    http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm

    Bob Jensen's threads on the Andersen/Enron/Worldcom scandals are at http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm

    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 --- http://faculty.trinity.edu/rjensen/fraud001.htm#RiskBasedAuditing 

    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 ---
    http://accountingeducation.com/index.cfm?page=newsdetails&id=142393

    You can read more about the Xerox case and other KPMG woes at
    http://faculty.trinity.edu/rjensen/Fraud001.htm#KPMG


    "Some CPAs Escape State Disciplinary Action," AccountingWeb, June 20, 2006 ---
    http://www.accountingweb.com/cgi-bin/item.cgi?id=102273

    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 --- http://accounting.smartpros.com/x53399.xml

    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
    http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm

     


    Enhancing Auditors’ Capabilities to Detect Fraud
    EY Faculty Connection
    Fall 2005 --- http://www.ey.com/global/content.nsf/US/EY_Faculty_Connection_(Issue_11)  

    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 --- http://faculty.trinity.edu/rjensen/Fraud.htm


    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 --- http://online.wsj.com/article/0,,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 http://faculty.trinity.edu/rjensen/fraud001.htm#others 

    Bob Jensen's threads on the Fannie Mae accounting scandals are at http://faculty.trinity.edu/rjensen/caseans/000index.htm


    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 --- http://online.wsj.com/article/SB112951490246670395.html?mod=todays_us_money_and_investing

    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 --- http://online.wsj.com/article/SB112908133517166268.html?mod=todays_us_money_and_investing

    Ed Ketz sums it up pessimistically at http://accounting.smartpros.com/x50181.xml

    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 http://faculty.trinity.edu/rjensen/fraud001.htm#GrantThornton


    Question
    What grades do nearly 2,000 clients give to their outside auditors?

    Answer
    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 --- http://www.businessweek.com/@@NGLIjWYQpcvg7RMA/premium/content/04_47/b3909150.htm 

    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 got the highest scores. That sounds good, but how would Enron's CFO and audit chair have rated their auditor?

    Bob Jensen's threads on scandals in the large auditing firms are tracked at http://faculty.trinity.edu/rjensen/fraud.htm#others


    The long-awaited PCAOB auditor inspection reports

    We had a visiting accounting researcher in recently who claimed that the Big Four can charge more for audits because they do better audits than the second tier auditing firms.  There are some global advantages of the largest firms, but audit quality does not necessarily justify higher pricing.

    The following is sad, because Deloitte was once viewed as the auditors' auditor much like a skilled physician is viewed as the doctors' doctor.

    "Deloitte Receives Criticism in 2004 Inspections Report," SmartPros, October 7, 2005 --- http://accounting.smartpros.com/x50107.xml

    The U.S. audit overseer on Thursday rebuked Deloitte & Touche LLP for weaknesses in its audits of public companies, including an instance where the accounting firm allowed a company to gloss over an auditing error.

    The Public Company Accounting Oversight Board said that an inspection of the accounting giant from May through November 2004 found that "in some cases, the deficiencies identified were of such significance that it appeared to the inspection team that the firm had not, at the time it issued its audit report, obtained sufficient competent evidential matter to support its opinion on the issuer's financial statements."

    The U.S. audit oversight board also noted that Deloitte & Touche had improperly applied lease accounting standards in one audit and that it had come to an inaccurate conclusion about a company's ability to continue as a going concern.

    "We have taken appropriate action to address the matters identified by the inspection team for each of the instances identified," said Deborah Harrington, a spokeswoman for Deloitte & Touche. "We are supportive of this process and committed to work collectively to continuously improve the independent audit process."

    The audit board was created by Congress in 2002 following a spate of accounting scandals that rocked the U.S. stock markets. Under law, it must inspect the Big Four firms each year. It does not identify any of the public companies alluded to in its inspections reports.

    The PCAOB's report did not include details about the quality-control systems at Deloitte & Touche or the "tone at the top." Under law, that information must remain confidential for at least a year. If firms fail to address criticism about their quality controls within 12 months, then the PCAOB may make public its criticisms.

    KPMG also had troubles in its inspection report.  The following appeared in my September 30, 2005 edition of New Bookmarks --- http://faculty.trinity.edu/rjensen/book05q3.htm#093005

    The long-awaited PCAOB auditor inspection reports

    Denny Beresford clued me into the fact that, after several months delay, the Big Four and other inspection reports of the PCAOB are available, or will soon be available, to the public --- http://www.pcaobus.org/Inspections/Public_Reports/index.aspx
    Look for more to be released today and early next week.

    The firms themselves have seen them and at least one, KPMG, has already distributed a carefully-worded letter to all clients.  I did see that letter from Flynn.

    Denny did not mention it, but my very (I stress very) cursory browsing indicates that the firms will not be comfortable with their inspections, at least not some major parts of them.

    I would like to state a preliminary hypothesis for which I have no credible evidence as of yet.  My hypothesis is that the major problem of the large auditing firms is the continued reliance upon cheaper risk analysis auditing relative to the much more costly detail testing.  This is what got all the large firms, especially Andersen, into trouble on many audits where there has been litigation --- http://faculty.trinity.edu/rjensen/Fraud001.htm#others


    Bob Jensen’s threads on the weaknesses of risk-based auditing are at
     http://faculty.trinity.edu/rjensen/fraud001.htm#RiskBasedAuditing

    At the above site the first message is the following AECM message from Roger Debreceny

     April 27, 2005 message from Roger Debreceny [roger@DEBRECENY.COM]

    Hi,

    While doing some grading, I have been listening to the Webcast of the February meeting of the PCAOB Standing Advisory Group (see http://www.connectlive.com/events/pcaob/) (yes, I know, I have no life! <g>). There is an interesting discussion on the role/future of the risk-based audit. See http://tinyurl.com/8f5nt at 42 minutes into the discussion. A variety of viewpoints are expressed in the discussion. This refers back to an earlier discussion we had on AECM.

    Roger

    --
    Roger Debreceny
    School of Accountancy
    College of Business Administration
    University of Hawai'i at Manoa
    2404 Maile Way
    Honolulu, HI 96822, USA

    www.debreceny.com  

    "PCAOB Finds 18 KPMG Auditing Flaws," SmartPros, October 7, 2005 --- http://accounting.smartpros.com/x50018.xml

    A required report by the Public Company Accounting Oversight Board, released last week, uncovered flaws in 18 audits performed by KPMG LLP for publicly held companies.

    The PCAOB reviewed just 76 of KPMG's 1,900 publicly traded clients between June and October 2004. Some of the failures by KMPG, according to the PCAOB, include not thoroughly evaluating some known or likely errors, not keeping crucial documentation, and not backing up its opinion with "sufficient competent evidential matter."

    In a prepared statement, KPMG Chairman Timothy Flynn said, "KPMG is committed to the goal of continuous improvement in audit quality. We appreciate the constructive dialogue and consider it an important element in the process of improving our system of quality controls."

    The Sarbanes-Oxley Act, which established the oversight board, requires the inspections. The PCAOB may not make certain criticisms public, however, so some portions of the KPMG report remain undisclosed. This report is the first of four reports that will inspect the nation's top four accounting firms. KPMG is the fourth-largest accounting firm. The remaining reports are expected in the coming weeks.

    "The Public Company Accounting Oversight Board found audit deficiencies at three major accounting firms," SmartPros, November 18, 2005 --- http://accounting.smartpros.com/x50712.xml

    Reports on the PCAOB's inspection of Ernst & Young LLP, PricewaterhouseCoopers LLP and BDO Seidman LLP, issued Thursday, said the inspection team identified matters it considered to be audit deficiencies.

    In the reports, the PCOAB said those deficiencies included failures by the firm "to identify and appropriately address errors in the issuer's application of GAAP (or generally accepted accounting principles)," and that one or more of those errors was "likely to be material to the firms' financial statement."

    In all three reports, the PCAOB said "the deficiencies also included failures by the firm to perform, or to perform sufficiently, certain necessary audit process."

    The three reports, which can be viewed on the PCAOB's Web site, www.pcaobus.org , provide details of specific cases, without mentioning the audited entities by name.

    Bob Jensen's threads about troubles in the large accounting firms are at http://faculty.trinity.edu/rjensen/Fraud001.htm#others

    Bob Jensen’s threads on the future of auditing are at
     http://faculty.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing

    Bob Jensen’s threads on the weaknesses of risk-based auditing are at
     http://faculty.trinity.edu/rjensen/fraud001.htm#RiskBasedAuditing

     


    On the heels of damaging audit inspection outcomes by the PCAOB in the U.S., the Canadian CPAB finds serious deficiencies in Canadian audits
    The CPAB report also called for firms to improve audit quality after it found five of 87 engagements chosen for review suffered "serious deficiencies," and were not conducted in accordance with Generally Accepted Auditing Standards. "In each of the cases, we felt the firm had not done enough audit work to support its opinion given the financial statements," he said.
    "Many accounting firm managers break policy: audit:  CPAB review finds over half did not report all their investments, securities of clients." Shirley Won, The Globe and Mail, December 20, 2005 ---  http://www.theglobeandmail.com/servlet/ArticleNews/TPStory/LAC/20051220/RACCOUNTING20/TPBusiness/Canadian 


    This is Auditing 101:  Where were the auditors?

    "SEC Uncovers Wide-Scale Lease Accounting Errors," AccountingWeb, March 1, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100600 

    Where were the auditors? That is the question being asked as more than 60 companies face the prospect of restating their earnings after apparently incorrectly dealing with their lease accounting, Dow Jones reported.

    Companies in the retail, restaurant and wireless-tower industries are among those affected in what is being called the most sweeping bookkeeping correction in such a short time period since the late 1990s.

    Among the companies on the list are Ann Taylor, Target and Domino's Pizza. You can view a full listing of the affected companies.

    "It's always disturbing when our accounting is not followed," Don Nicolaisen, chief accountant at the Securities and Exchange Commission, said last week during an interview. He published a letter on Feb. 7 urging companies to follow accounting standards that have been on the books for many years, Dow Jones reported.

    Based on the charges and restatement announcements that have come in the wake of the SEC letter it seems companies have failed for years to follow what regulators see as cut-and-dried lease-accounting rules. The SEC has yet to go so far as to accuse companies of wrongdoing, but it has led people to wonder why auditors hired to keep company books clean could have missed so many instances of failure to comply with the rule.

    "Where were the auditors?" J. Edward Ketz, an accounting professor at Pennsylvania State University, said to Dow Jones. "Where were the people approving these things? This doesn't seem like something that really requires new discussion. If we have to go back and revisit every single rule because companies and their professional advisers aren't going to follow the rules, then I think we're in very serious trouble in this country."

    Tom Fitzgerald, a spokesman for auditing firm KPMG, declined to comment. Representatives for Deloitte & Touche LLP, PricewaterhouseCoopers LLC, and Ernst & Young LLP, didn't return several phone calls, Dow Jones reported.

    The crux of the issue is that companies are supposed to book these "leasehold improvements" as assets on their balance sheets and then depreciate those assets, incurring an expense on their income statements, over the duration of the lease. Instead, companies such as Pep Boys-Manny Moe & Jack had been spreading those expenses out over the projected useful life of the property, which is usually a longer time period, Dow Jones reported.

    As a result, expenses were deferred and income was added to the current period. McDonald's Corp. took a charge of $139.1 million, or 8 cents a share, in its fourth quarter to correct a lease-accounting strategy that it says had been in place for 25 years, Dow Jones reported, adding that Pep Boys said it would book a charge of 80 cents a share, or $52 million, for the nine months through Oct. 30, 2004.

    Bob Jensen's threads on lease accounting are at http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#Leases 


    Bad audits are so common that multimillion settlements don't even make the front section, let alone the front page.
    "Ernst Pays $84 Million to Settle Suit Filed in 1993 by Bank Trustee," by Jonathan Weil and Diya Gullapalli, The Wall Street Journal, January 27, 2005, Page C3 --- http://online.wsj.com/article/0,,SB110679689916037687,00.html?mod=todays_us_money_and_investing 

    Ernst & Young LLP agreed to pay $84 million to settle a lawsuit in Boston over its audit work more than a decade ago for the defunct Bank of New England Corp.

    The settlement in the long-forgotten case, one of the largest Ernst has made, is a reminder of the litigation pressures on the Big Four accounting firms as they seek to restore public trust in their audit work.

    The accord, reached yesterday, came about two weeks after trial proceedings had begun in a federal district court in Boston, and a few days after Douglas Carmichael, chief auditor of the Public Company Accounting Oversight Board, testified in court as the plaintiff's lead expert witness. Mr. Carmichael had been retained as an expert in the suit before he was hired by the accounting board, and the board permitted him to conclude his work.

    Ernst denied liability. In a statement, an Ernst spokesman said: "We are pleased to have resolved this issue in a reasonable manner. We believe that it was in the best interest of all parties to resolve this matter to avoid continued litigation and legal costs."

    The suit, filed by the bank's bankruptcy trustee in 1993, accused Ernst of malpractice, among other things. Amid pressure from federal banking regulators, who began warning the bank about its deteriorating financial condition in early 1989, the bank in January 1990 announced it would report more than $1 billion in previously undisclosed losses on bad loans for its 1989 fourth quarter. Just four months earlier, the bank had raised $250 million through a public debt offering. The bank filed for Chapter 7 bankruptcy protection in January 1991.

    Bob Jensen's threads on the woes of Ernst and Young are at http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst 


     

    "These Stock Options Just Didn't Add Up," by Grechen Morgensen, The New York Times, January 30, 2005 --- 

    Top executives on the receiving end of munificent pay packages like to argue that their troughs full of stock options have no relationship to the improprieties that keep erupting across corporate America.

    But an episode last week involving Brocade Communications, a San Jose, Calif., company that makes switches for computer storage networks, suggests that every now and again there just might be a connection after all.

    Back in the bubble of 2000, you may recall, Brocade Communications was one heck of a stock. The shares went public in May 1999 at a split-adjusted $4.75. By October 2000, the stock had climbed to $133. It closed on Friday at $5.99.

    Last Monday, after the stock market closed, Brocade announced that its board had appointed a new chief executive to replace Gregory L. Reyes, its longtime chief; that it would be restating its results for the last six fiscal years; and that its annual financial report would not be filed on time to the Securities and Exchange Commission.

    Other than that, the company said, everything's going great.

    Financial restatements are distressingly common, of course. But Brocade certainly wins a prize for having to recompute its results for every one of the six years that it has existed as a public company.

    The amounts being restated are considerable. In fiscal 2004, for example, Brocade's net loss swelled to $32 million from $2 million as a result of the restatement. For 2003, its loss grew to $147 million from $136 million, and in 2002, its net income rose to $126 million from $60 million as a result of the new computations.

    The restatements, the company said, all had to do with errors in its option accounting. After a review, the audit committee of Brocade's board concluded that the company must record additional compensation charges relating to option grants from 1999 through the third quarter of 2003. What's more, the committee found "improprieties in connection with the documentation" of option grants given to a small number of employees before mid-2002 and concluded that the company's documentation related to certain option grants before August 2003 was unreliable.

    Exactly what went wrong with Brocade's options program is not clear; the company is not saying.

    An analysis last April by Glass Lewis & Company, an institutional advisory firm, found that Brocade had used unrealistic assumptions in calculating its option expense in its financial footnotes. The assumptions, related to the average life of its options and the underlying volatility in Brocade's stock, wound up understating the true costs of the grants, Glass Lewis said.

    Options have been the drug of choice for years at Brocade, as they have been at many Silicon Valley businesses. These companies have fought strenuously against the move last year by accounting rulemakers to require that the costs of this employee compensation be run through the profit-and-loss statement. Along with other companies, Brocade signed a letter to members of Congress in July 2003 that argued against the expensing of options.

    As is also typical at technology companies, Brocade's top management, especially Mr. Reyes, have been big recipients of options. In last year's proxy, Brocade noted that 4 percent of the total number of options granted to its employees in fiscal 2003 went to Mr. Reyes.

    Brocade's directors also receive stock options as part of their compensation: 80,000 options when they join the board and 20,000 options for each year they remain as members. They also receive annual cash compensation of at least $25,000.

    Under a new plan, which Brocade put to a shareholder vote last year, the company proposed a system by which a committee of the board would be free to determine how many options to dispense to directors, when to dispense them, their vesting provisions and terms. "An inflexible compensation structure limits our ability to attract and retain qualified directors," the company noted in its proxy last year. "The board of directors believes that the amended and restated 1999 Director Option Plan is necessary so that we can continue to provide meaningful, long-term equity-based incentives to present and future non-employee directors."

    Shareholders shouted down the plan. Fully two thirds of the shares that were voted rejected it.

    Many analysts who follow Brocade have concluded that Mr. Reyes's hasty departure was clearly related to the accounting improprieties. But in a conference call on Monday afternoon, David L. House, a Brocade director who is a former chief executive of Allegro Networks and a former president of Nortel Networks, refused to link the two events. Indeed, he told surprised listeners that even though Mr. Reyes would no longer run the company, he would stay on the board and have "a significant and important role" there.

    Mr. Reyes has been the body and soul of Brocade practically since the company was born. He became its chief executive in July 1998, before the company went public. He became chairman in May 2001.

    But why would Mr. Reyes still have a coveted place on Brocade's board, given the wall-to-wall restatements that occurred on his watch? Leslie Davis, a spokeswoman for the company, wrote in an e-mail message: "Greg has been a key contributor to the success of the company and will still add great value. Greg will advise on strategic and customer issues where he can continue to contribute to the success of Brocade." Ms. Davis declined to make any of the company's directors available.

    AT the end of Brocade's last fiscal year, Mr. Reyes had 1.7 million options with exercise prices of either $5.53 or $6.54 each. Ms. Davis said Brocade had not determined whether those options would become immediately exercisable now that Mr. Reyes has, to use the company's expression, passed the baton.

    Will the company also continue to reimburse Mr. Reyes for the use of his private plane, as it did when he was chief executive? For fiscal 2002 and 2003, he received $624,000 in such reimbursements. Not determined yet, Ms. Davis said.

    Brocade gets some credit for identifying the stock option improprieties. And it has instituted more restrictive policies in its option program recently. But its insistence on keeping Mr. Reyes shows how entrenched the obeisance to chief executives remains at some companies, even among directors who have a fiduciary duty to mind the store.

    Obviously, shareholders interested in reforming corporate America have a good deal more work to do.

    KMPG was and still is the independent auditor for these "options that just don't add up."

    Bob Jensen's threads on KPMG's good news and bad news are at http://faculty.trinity.edu/rjensen/Fraud001.htm#KPMG 

    Bob Jensen's threads on accounting for employee stock options are at http://faculty.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

     


    "Will Big Four Audit Firms Survive in a World of Unlimited Liability?," by Floyd Norris, The New York Times, September 10, 2004 

     

    RE the Big Four accounting firms members of an endangered species, destined to die from litigation?

    Within the accounting profession there has been growing fear ever since Arthur Andersen vanished in a sea of liability that it was only a matter of time before another firm followed. And then, the thought goes, the others would find it impossible to persuade partners to stay, lest their net worth be decimated as happened at Andersen.

    Perhaps the situation is not unlike the one that confronts the major airlines. Never has there been such need and demand for the service they provide, but as commercial ventures their viability is dubious at best. The difference is that there are a host of low-cost airlines willing to take up the slack if Alitalia or United should vanish, while it is not at all clear who could replace the Big Four.

    The alternative of government auditors is an unattractive one. The quality of the audits would be suspect, if only because of the difficulty in attracting good auditors at government pay, and political influence could be a problem. Consider the way technology companies got the House of Representatives to oppose reasonable accounting for stock options, or the fact that the European Commission is on the verge of overruling an international accounting rule on derivative accounting after heavy lobbying by banks.

    It is easier to understand how we got to the current situation than it is to figure out how to get out of it. Over time, the big accounting firms sought growth rather than excellence. Partners were rewarded for bringing in more business and penalized for offending clients with tough audits. There was no effective regulator.

    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.

    Now there are real reforms. The Public Company Accounting Oversight Board in the United States is watching over audit quality, and other countries are following suit.

    The firms appear tougher. ''We are turning down clients at an unprecedented rate,'' said James H. Quigley, the chief of Deloitte & Touche's American operations, in an interview. ''We are very rigorous in terms of who we become associated with in this world of unlimited liability.''

    But better audits now will not repair poor audits of the past, and the firms yearn for legal protection. In the United States, that is so unrealistic politically that no specific proposal is pending. In Britain, their plea for a cap on damage awards was rejected by the government this week.

    This may be a case of Catch-22. If auditors are doing a good job, they deserve to be protected from lawsuits that could put them out of business. But without the threat of such suits, will they do a good job?

    The probable outcome is that the firms will muddle through. Plaintiffs lawyers will temper their demands, knowing they need to keep the firms in business. If Big Four managements really appear to be determined to run quality firms, governments are not likely to bring criminal charges that will put them out of business, even if individual partners committed outrageous acts.

    Good auditing is essential to functioning capital markets, but in too many cases in the 1990's, auditors deemed it their job to help companies find ways to twist accounting rules and mislead investors. The reforms may have arrived just in time to save the Big Four.


    "Our study demonstrates that audit firms may lie to keep a profitable audit client if the expected benefits of keeping the client happy outweigh the expected costs of an audit failure if the firm gets caught," said Debra Jeter, co-author of the study and an associate professor of accounting at the Owen Graduate School of Management at Vanderbilt.

    "Federal Regulators Find Problems at 4 Big Auditors," by Floyd Norris, The New York Times, August 27, 2004

    The new regulatory body for the United States auditing industry said yesterday that its initial inspections of the Big Four accounting firms had found "significant audit and accounting issues" in work done by all four firms.

    It added that it had found problems in the quality control systems at each firm but said it retained confidence in all of them.

    Inspection reports on the four firms were released by the Public Company Accounting Oversight Board, which was established by Congress in 2002 in the wake of the failures of Enron and WorldCom and the collapse of Arthur Andersen, the auditing firm that had certified the books at both companies.

    The board reviewed the details of 16 audits in 2003 at each firm. The versions of the reports that were made public left out large parts of the actual reports because Congress ordered that the firms be given a year to clean up many problems before negative assessments could be made public.

    William J. McDonough, the board's chairman, tried to soften the blow on the firms by saying the "criticisms do not reflect any broad negative assessment of the firms' audit practices" and emphasizing that "our findings say more about the benefits of the robust, independent inspection process envisioned in the Sarbanes-Oxley Act of 2002 than they do about any infirmities in these firms' audit practices."

    He added that "none of our findings has shaken our belief that these firms are capable of the highest quality auditing."

    Nonetheless, the reports document cases where the four firms failed to apply one accounting rule, leading companies to understate the amount of their current liabilities - debts due within one year - and therefore overstate their working capital, an item that analysts often follow.

    That rule was issued in 1995 by the Emerging Issues Task Force, a part of the Financial Accounting Standards Board, and the fact that all of the top firms had been misapplying it raised issues of just how well they know the sometimes complicated rules.

    At Deloitte & Touche, the board said eight clients had restated their financial statements because of the error on the accounting rule. It said six clients of KPMG, three of Ernst & Young and three of PricewaterhouseCoopers had done the same.

    Some of the errors were found by the standards board, and others by the firms.

    The board also criticized Deloitte for signing agreements with one unidentified audit client that created close business relationships that seemed to violate Deloitte's own rules. It said the firm had concluded the contracts "included inappropriate language" but had not violated independence rules. Board officials said that most comments on independence issues were contained on the parts of the reports not made public.

    KPMG released some information on the part of its report that was not made public, saying the standards board had concluded that some contingent fee arrangements with audit clients violated independence rules. The firm said that it had complied with the rules as it understood them but had learned in May that the S.E.C. was taking a more restrictive stance. It said it had changed agreements to comply with that interpretation and that its independence had not been compromised.

    Applying accounting rules can be difficult, and in a number of other cases the staff disagreed with the way the auditing firms had applied the rules and companies ended up restating their financial statements. In one case, however, the board concluded that a client of KPMG had recorded a liability improperly, but KPMG disagreed and the staff of the Securities and Exchange Commission agreed with the accounting firm, although in the end it did force a change in the amount of the liability, according to the report.

    In its response to the report, KPMG said that it showed that "three knowledgeable informed bodies" - the firm, the board and the commission - had reached three different conclusions on proper accounting, "illustrating the complex accounting issues registrants, auditors and regulators all face."

    The delay on releasing some negative parts of reports has been controversial, Mr. McDonough said, but he added that he thought it was a good idea. "When it comes to quality control, any negative comments we make the firms have 12 months to correct. If they correct them, they remain confidential forever." Mr. McDonough said the delay "makes sense" because it encourages firms to improve promptly.

    The firms generally praised the board and said they were working to improve their audits. James S. Turley, the chief executive of Ernst & Young, said the board would "prove to be one of the best things that ever happened to the accounting profession."

    August 27, 2004 message from Ellen Glazerman

    I thought you might be interested in the open letter from Jim Turley, Ernst & Young Chairman and Chief Executive Officer, posted yesterday on our website, ey.com. In the letter, Jim shares our views on the PCAOB inspection process and observes that the PCAOB as "a tough, but fair and independent regulator, will make our firm and the entire profession better, while helping both to regain the confidence of the investing public..." A link to the text appears below.
     
    http://www.ey.com/global/download.nsf/US/PCAOB_Report/$file/PCAOB_Report.pdf
     
    Please feel free to contact me with any questions you may have. Have a wonderful semester!


    Ellen J. Glazerman
    Executive Director, Ernst & Young Foundation
    Americas Director, University Relations
    1285 Avenue of the Americas
    New York NY 10019
    212/773-5686
    212/773-6504 (fax)
    ellen.glazerman@ey.com
     

    ________________________________________________________________________

     


    "Behind Wave of Corporate Fraud: A Change in How Auditors Work:  'Risk Based' Model Narrowed Focus of Their Procedures, Leaving Room for Trouble,' " by Jonathan Weil, The Wall Street Journal, March 25, 2004, Page A1

    The recent wave of corporate fraud is raising a harsh question about the auditors who review and bless companies' financial results: How could they have missed all the wrongdoing? One little-discussed answer: a big change in the way audits are performed.

    Consider what happened when James Lamphron and his team of Ernst & Young LLP accountants sat down early last year to plan their audit of HealthSouth Corp.'s 2002 financial statements. When they asked executives of the Birmingham, Ala., hospital chain if they were aware of any significant instances of fraud, the executives replied no. In their planning papers, the auditors wrote that HealthSouth's system for generating financial data was reliable, the company's executives were ethical, and that HealthSouth's management had "designed an environment for success."

    As a result, the auditors performed far fewer tests of the numbers on the company's books than they would have at an audit client where they perceived the risk of accounting fraud to be higher. That's standard practice under the "risk-based audit" approach now used widely throughout the accounting profession. Among the items the Ernst & Young auditors didn't examine at all: additions of less than $5,000 to individual assets on the company's ledger.

    Those numbers are where HealthSouth executives hid a big part of a giant fraud. This blind spot in the firm's auditing procedures is a key reason why former HealthSouth executives, 15 of whom have pleaded guilty to fraud charges, were able to overstate profits by $3 billion without anyone from Ernst & Young noticing until March 2003, when federal agents began making arrests.

    A look at the risk-based approach also helps explain why investors continue to be socked by accounting scandals, from WorldCom Inc. and Tyco International Ltd. to Parmalat SpA, the Italian dairy company that admitted faking $4.8 billion in cash. Just because an accounting firm says it has audited a company's numbers doesn't mean it actually has checked them.

    In a September 2003 speech, Daniel Goelzer, a member of the auditing profession's new regulator, the Public Company Accounting Oversight Board, called the risk-based approach one of the key factors "that seem to have contributed to the erosion of trust in auditing." Faced with difficulty in raising audit fees, Mr. Goelzer said, the major accounting firms during the 1990s began to stress cost controls. And they began to place greater emphasis on planning the scope of their work based on auditors' judgments about which clients are risky and which areas of a company's financial reports are most prone to error or fraud.

    Auditors still plow through "high risk" items, such as derivative financial instruments or "related party" business dealings between a company and its executives. But ostensibly "low risk" items -- such as cash on the balance sheet or accounts that fluctuate little from year to year -- often get no more than a cursory review, for years at a stretch. Instead, auditors rely more heavily on what management tells them and the auditors' assessments of a company's "internal controls."

    Old and New

    A 2001 brochure by KPMG LLP, which claims to have pioneered the risk-based audit during the early 1990s, explained the difference between the old and new ways. Under a traditional "bottom up" audit, "the auditor gains assurance by examining all of the component parts of the financial statements, ensuring that the transactions recorded are complete and accurate." By comparison, under the "top down" risk-based audit methodology, auditors focus "less on the details of individual transactions" and use their knowledge of a company's business and organization "to identify risks that could affect the financial statements and to target audit effort in those areas."

    So, for instance, if controls over a company's sales and customer IOUs are perceived to be strong, the auditor might mail out only a limited number of confirmation requests to companies that do business with the audit client at the end of the year. Instead, the auditor would rely more on the numbers spit out by the company's computers.

    For inventory, the lower the perceived risk of errors or fraud, the less frequently junior-level accountants might be dispatched on surprise visits to a client's warehouses to oversee the company's procedures for counting unsold goods. If cash and securities on the balance sheet are deemed low risk, the auditor might mail out only a relative handful of confirmation requests to a company's banks or brokerage firms.

    In theory, the risk-based approach should work fine, if an auditor is good at identifying the areas where misstatements are most likely to occur. Proponents advocate the shift as a cost-efficient improvement. They also say it forces auditors to pay needed attention to areas that are more subjective or complex.

    "The problem is that there's not a lot of evidence that auditors are very good at assessing risk," says Charles Cullinan, an accounting professor at Bryant College in Smithfield, R.I., and co-author of a 2002 study that criticized the re-engineered audit process as ineffective at detecting fraud. "If you assess risk as low, and it really isn't low, you really could be missing the critical issues in the audit."

    Auditors can't check all of a company's numbers, since that would make audits too expensive, particularly in an age of sprawling multinationals. The tools at auditors' disposal can't ensure the reliability of a company's numbers with absolute certainty. And in many ways, they haven't changed much over the modern industry's 160-year history.

    Auditors scan the accounting records for inconsistencies. They ask people questions. That can mean independently contacting a client's customers to make sure they haven't struck undocumented side deals -- such as agreeing to buy more products today in exchange for a salesperson's oral promises of future discounts. They search for unrecorded liabilities by tracing cash disbursements to make sure the obligations are recorded properly. They examine invoices and the terms of sales contracts to check if a company is recording revenue prematurely.

    Auditors are supposed to avoid becoming predictable. Otherwise, a client's management might figure out how to sneak things by them. It's also important to sample-test tiny accounting entries, even as low as a couple of hundred dollars. An old accounting trick is to fudge lots of tiny entries that appear insignificant individually but materially distort a company's financial statements when taken together.

    Facing a crush of shareholder lawsuits over the accounting scandals of the past four years, the Big Four accounting firms say they are pouring tens of millions of dollars into improving their auditing techniques. KPMG's investigative division has doubled to 280 its force of forensic specialists, some hailing from the Federal Bureau of Investigation. PricewaterhouseCoopers LLP auditors attend seminars run by former Central Intelligence Agency operatives on how to spot deceitful managers by scrutinizing body language and verbal cues. Role-playing exercises teach how to stand up to a company's management.

    But the firms aren't backing away from the concept of the risk-based audit itself. "It would really be negligent" not to take a risk-based approach, says Greg Weaver, head of Deloitte & Touche LLP's U.S. audit practice. Auditors need to "understand the areas that are likely to be more subject to error," he says. "Some might believe that if you cover those high-risk areas, you could do less work in other areas." But, he adds, "I don't think that's been a problem at Deloitte."

    Mr. Lamphron, the Ernst & Young partner, and his firm blame HealthSouth's former executives for deceiving them. Mr. Lamphron declined to comment for this article. Testifying before a congressional subcommittee in November, he said he had looked through his audit papers and "tried to find that one string that, had we yanked it, would have unraveled this fraud. I know we planned and conducted a solid audit. We asked the right questions. We sought out the right documentation. Had we asked for additional documentation here or asked another question there, I think that it would have generated another false document and another lie."

    The pioneers of the auditing industry had a more can-do spirit. In Britain during the 1840s, William Deloitte, whose firm continues today as Deloitte & Touche, made a name for himself by helping to unravel frauds at the Great Eastern Steamship Co. and Great Northern Railway. A growing breed of professionals such as William Cooper, whose name lives on in PricewaterhouseCoopers, began advertising their services as an essential means for rooting out fraud.

    "The auditor who is able to detect fraud is -- other things being equal -- a better man than the auditor who cannot," wrote influential British accountant Lawrence Dicksee in his 1892 book, "Auditing," one of the earliest on the subject.

    But in the U.S., the notion of the auditor as detective never quite took off. The Securities and Exchange Commission in the 1930s made audits mandatory for public companies. The auditing profession faced its first real public test in 1937, when an accounting scandal broke open at McKesson & Robbins: More than 20% of the assets reported by the drug company were fictitious inventory and customer IOUs. The auditors had been fooled by forged documents.

    The case triggered some reforms. Auditing standards began requiring that auditors perform more substantive tests, such as contacting third parties to confirm customer IOUs and physically inspecting clients' warehouses to check inventories. However, the American Institute of Certified Public Accountants, the group that set auditing standards, repeatedly emphasized the limitations on auditors' ability to detect fraud, fearing liability exposure for its members.

    By the 1970s, a new force emerged to erode audit quality: price competition. For decades, the AICPA had barred auditors from publicly advertising their services, making uninvited solicitations to rival firms' clients or participating in competitive-bidding contests. The institute was forced to lift those bans, however, when the federal government deemed them anticompetitive and threatened to bring antitrust lawsuits.

    Bidding wars ensued. The pressures to hold down hours on a job "inadvertently discouraged auditors to look for" fraud, says Toby Bishop, president of the Association of Certified Fraud Examiners, a professional association.

    Increasingly, audits became a commodity product. Flat-fee pricing became common. The big accounting firms spent much of the 1980s and 1990s building more-lucrative consulting operations. Many audit clients soon were paying their independent accounting firms far more money for consulting than auditing. The audit had become a mere foot in the door for the consultants. Economic pressures also brought a wave of mergers, winnowing down the number of accounting firms just as the number of publicly traded companies was exploding and corporate financial statements were becoming more complex.

    Even before the recent rash of accounting scandals, the shift away from extensive line-by-line number crunching was drawing criticism. In an October 1999 speech, Lynn Turner, then the SEC's chief accountant, noted that more than 80% of the agency's accounting-fraud cases from 1987 to 1997 involved top executives. While the risk-based approach was focusing on information systems and the employees who fed them, auditors really needed to expand their scrutiny to include top executives, who with a few keystrokes could override their companies' systems.

    Looking back, the risk-based approach's flaws are on display at a variety of accounting scandals, from WorldCom to Tyco to HealthSouth.

    When WorldCom was a small, start-up telecommunications company, its outside auditor, Arthur Andersen LLP, did things the old-fashioned way. It tested the thousands of details of individual transactions, and it reviewed and confirmed the items in WorldCom's general ledger, where the company's accounting entries were first logged.

    But as WorldCom grew, Andersen shifted toward what it called a risk-based "business audit process." By 1998, it was incurring more costs to audit WorldCom than it was billing, making up the difference with fees for consulting and other work, according to an investigative report last year by WorldCom's audit committee. In its 2000 audit proposal to WorldCom, Andersen said it considered itself "a committed member of [WorldCom's] team" and saw the company as a "flagship client and a crown jewel" of the firm.

    Under the revised audit approach, Andersen used sophisticated software to analyze WorldCom's financial statements. The auditors gathered for brainstorming sessions, imagining ways WorldCom might cook its books. After identifying areas of high risk, the auditors checked the adequacy of internal controls in those areas by reviewing the company's procedures, discussing them with some employees and performing sample tests to see if the procedures were followed.

    'Maximum Risk'

    When questions arose, the auditors relied on the answers supplied by management, even though their software had rated WorldCom a "maximum risk" client, according to a January report by WorldCom's bankruptcy examiner, former U.S. Attorney General Richard Thornburgh.

    One question that Andersen auditors routinely asked WorldCom management was whether they had made any "top side" adjustments -- meaning unusual accounting entries in a company's general ledger that are recorded after the books for a given quarter had closed. Each year, from 1999 through 2002, WorldCom management told the auditors they hadn't. According to Mr. Thornburgh's report, the auditors conducted no testing to corroborate if that was true.

    They did check to see if there were any major swings in the items on the company's consolidated balance sheet. There weren't any, and from this, the auditors concluded that follow-up procedures weren't necessary. Indeed, WorldCom executives had manipulated its numbers so there wouldn't be any unusual variances.

    Had the auditors dug into specific journal entries -- the debits and credits that are the initial entries of transactions or events into a company's accounting systems -- they would have seen hundreds of huge entries of suspiciously round numbers that had no supporting documentation.

    The sole documentation for one $239 million journal entry, recorded after the close of the 1999 fourth quarter, was a sticky note bearing the number "$239,000,000," according to the WorldCom audit committee's report. Sometimes the "top side" adjustments boosted earnings by reversing liabilities. Other times they reclassified ordinary expenses as assets, which delayed recognition of costs. Other unsupported journal entries included one for precisely $334 million in July 2000, three weeks after the second quarter's books were closed. Another was for exactly $560 million in July 2001.

    Andersen signed its last audit report for WorldCom in March 2002, saying the numbers were clean. Three months later, WorldCom announced that top executives, including its former chief financial officer, had improperly classified billions of dollars of ordinary expenses as assets. The final tally of fraudulent profits hit $10.6 billion. WorldCom filed for Chapter 11 reorganization in June 2002, marking the largest bankruptcy in U.S. history. Now out of business, Andersen is appealing its June 2002 felony conviction for obstruction of justice in connection with its botched audits of Enron Corp.

    "No matter what kind of audit you do, it is virtually impossible for an auditor to detect purposeful fraud by management," says Patrick Dorton, an Andersen spokesman. "And that's exactly what happened at WorldCom."

    PricewaterhouseCoopers also fell prone to faulty risk assessments. In July, the SEC forced Tyco, the industrial conglomerate, to restate its profits, which it inflated by $1.15 billion, pretax, from 1998 to 2001. The next month, the SEC barred the lead partner on the firm's Tyco audits from auditing publicly registered companies. His alleged offense: fraudulently representing to investors that his firm had conducted a proper audit. The SEC in its complaint said that the auditor, Richard Scalzo, who settled without admitting or denying the allegations, saw warning signs about top Tyco executives' integrity but never expanded his team's audit procedures.

    Mr. Scalzo declined to comment. A PricewaterhouseCoopers spokesman declined to comment on the SEC's findings in the Tyco matter.

    Like Tyco and WorldCom, HealthSouth grew mainly by buying other companies, using its own shares as currency. So it needed to keep its stock price up. To do that, the company admitted last year, it faked its profits.

    In their audit-planning papers, Ernst & Young auditors noted HealthSouth executives' "excessive interest" in maintaining or increasing its stock price and earnings. Twice since the 1990s, the Justice Department had filed Medicare-fraud suits against HealthSouth.

    But none of that shook the Ernst & Young audit team's confidence in management's integrity, members of the team later testified. And at little more than $1 million annually, Ernst & Young's audits were fairly low cost. The firm charged slightly less to audit HealthSouth's financial statements than it did for one of its other services for HealthSouth: performing janitorial inspections of the company's 1,800 health-care facilities. The inspections, performed by junior-level accountants armed with 50-point checklists, included checking to see that the toilets and ceilings were free of stains, the magazine racks were neat and orderly, and the trash receptacles all had liners.

    Most of HealthSouth's fraud occurred in an account called "contractual adjustments." This is an allowance on the income statement that estimates the difference between the gross amount charged to a patient and the amount that various insurers, including Medicare, will pay for a specific treatment. The company manipulated the account to make net revenue and bottom-line earnings look higher. But for every dollar of illicit revenue, HealthSouth executives had to make a corresponding entry on the balance sheet, where the company listed its assets and liabilities.

    An Ernst & Young spokesman, Charlie Perkins, says the firm "performed appropriate procedures" on the contractual-adjustment account.

    At an April 2003 court hearing, Ernst & Young auditor William Curtis Miller testified that his team mainly had performed "analytical type procedures" on the contractual adjustments. These consisted of mathematical calculations to see if the account had fluctuated sharply overall, which it hadn't. As for the balance-sheet entries, prosecutors say HealthSouth executives knew the auditors didn't look at increases of less than $5,000, a point Ernst & Young acknowledges. So the executives broke up the entries into tiny pieces, sprinkling them across lots of assets.

    The company's ledger showed thousands of unusual journal entries that reclassified everyday expenses -- such as gasoline and auto-service bills -- as assets. Had the auditors seen those items, one congresswoman noted at a November hearing, they would have spotted that something was wrong. Mr. Lamphron conceded her point.

    Bob Jensen's threads on current scandals in the large auditing firms can be found at http://faculty.trinity.edu/rjensen/fraud.htm#others 

    Bob Jensen's summary of proposed auditing reforms is at http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm 


    "PwC: Accounting Irregularities Cause Most Class-Action Settlements," SmartPros, August 4, 2004 --- http://www.smartpros.com/x44644.xml 

    The number of securities litigation cases with accounting allegations remains well above historical averages, according to a PricewaterhouseCoopers Securities Litigation Study and a preliminary analysis of the first six months of 2004.

    Mega-settlements continue to drive average settlement values significantly higher than ever before. The involvement of the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) adds additional potency to the nature of securities litigation.

    Accounting-Related Cases

    The number of accounting-related cases remains high, totaling more than 60 percent of the 175 cases filed in 2003 and 57 percent of the 111 cases filed in the first seven months of 2004.

    The number one allegation made in accounting-related cases continues to be revenue recognition, alleged in over fifty percent of these cases in 2003.

    The study also finds two other allegations that are emerging in accounting-related cases: accounting estimates and internal controls. In 2003 each of these allegations appeared in over 40 percent of the accounting cases.

    Settlement Values Continue to Rise

    In 2003, average settlement values increased by 20 percent to $23.2 million. The increase was fueled in large part by six settlements topping $100 million each, including three settlements of $300 million or greater, with one of those settlements topping $500 million.

    Excluding several partial settlements, including the recent $2.65 billion partial Worldcom settlement, the average settlement in the first six months of 2004 surged to over $32 million. So far in 2004, 14 settlements have been announced for $30 million or greater, five of which settled for $100 million or more. The average accounting case, led by five case settlements over $100 million each, settled for over $38 million. While large settlements continue to lift settlement averages to new heights, the median 2004 settlement is approximately $6.3 million and the median accounting settlement is greater than $7 million, both up from the 2003 numbers.

    Triple Jeopardy Increases Potency of Cases

    The dynamic of securities litigation has changed dramatically in securities litigation class actions when the SEC and DOJ are also involved.

    This year for the first time, PricewaterhouseCoopers explored a phenomenon called "triple jeopardy," where companies are subject to securities class actions along with SEC and DOJ investigations. In 2002, there were an all-time high of over 40 such cases. In 2003 the study finds only 8 such instances which marks a return closer to historic norms. The preliminary 2004 research indicates that at least 13 companies are facing "triple jeopardy" this year, already surpassing the 2003 total.

    "The fines and penalties meted out in recent SEC and DOJ settlements with companies also facing securities litigation have risen dramatically, and criminal prosecutions and convictions for corporate fraud offenses are ratcheting up," said Charles Hacker, Investigations and Forensic Services partner, PricewaterhouseCoopers.

    Bob Jensen's threads on accounting fraud are at http://faculty.trinity.edu/rjensen/fraud.htm


    Surprise!  Surprise!
    I have long contended criticisms of auditing firm ethics due to consulting practices were are overblown relative to the much larger problem of local firm dependence on the proportion of revenue generated from their largest audit clients.  This is also implied in the by Jonathon Weil's 2001 article about Andersen's dependence upon the $1 million dollar per week fees from Enron.  See  http://faculty.trinity.edu/rjensen/fraud.htm#Professionalism 

    TITLE: Basic Principle of Accounting Tripped Enron 
    REPORTER: Jonathan Weil 
    DATE: Nov 12, 2001 
    PAGE: C1 in The Wall Street Journal
    LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB100551383153378600.djm 
    TOPICS: Accounting, Auditing, Auditing Services, Auditor Independence

    2003 Update
    You might take a look at a paper in the November/December issue of the Journal of Accounting and Public Policy --- http://www.elsevier.com/inca/publications/store/5/0/5/7/2/1/505721.pub.htt 

    From the AccountingWeb on October 28, 2003

    A study by Vanderbilt University researchers has found that audit firms are still likely to produce inaccurate audit opinions to benefit a big client — as long as company officials think they can get away with it.

    "Our study demonstrates that audit firms may lie to keep a profitable audit client if the expected benefits of keeping the client happy outweigh the expected costs of an audit failure if the firm gets caught," said Debra Jeter, co-author of the study and an associate professor of accounting at the Owen Graduate School of Management at Vanderbilt.

    However, the report also suggests that increased scrutiny over the auditing industry, brought about by the accounting scandals of the past two years, may help improve reporting as the possibility grows that wrongdoing will be discovered. Pressure brought by Securities and Exchange Commission enforcement and new rules set by the Public Company Accounting Oversight Board (PCOAB) could influence auditors’ decisions.

    "If the likelihood that the firms will get caught if using questionable accounting increases," Jeter added, "their auditors, in evaluating the costs of an audit failure, will think twice and realize that their best interest lies in insisting on fair reporting."

    Audit firms should rotate partners in charge of large audits, the study says, and audits should remain independent of consulting work by the same firm.

    For companies being audited, Jeter advised that companies must constantly improve the internal audit function. "Top management should require managers at various levels within the firm to certify the numbers they are responsible for. Companies should make sure that most — if not all — audit committee members are financially literate and that they meet more than once a year. This is vital."

    The study will be published in the November/December 2003 issue of the Journal of Accounting and Public Policy. "The Impact on the Market for Audit Services of Aggressive Competition by Auditors" is co-authored by Jeter; Paul Chaney, associate professor of accounting at the Owen School at Vanderbilt; and Pam Shaw of Tulane University.


    In case some of you did not notice, President Bush was not only on the Board of Directors of Harkin Energy, he was also on its Audit Committee at the same time.

    Loan Star State? The 1989 sale of a Harken Energy Company subsidiary to a related-party raises questions about President Bush's role as a member of Harken's audit committee . . . Pres. Bush was a member of the Harken audit committee at the time. But when reporters asked Bush to discuss Harken's accounting practices, the President dithered. Eventually, he noted that, in accounting, "Things aren't always black and white." Ronald Fink and Marie Leone, CFO.com, July 15, 2002 --- http://www.cfo.com/article/1,5309,7453,00.html 

    (The "black and white" quotation sounds like a feed to dubyaSpeak.com --- http://www.dubyaspeak.com/  This site is intended to be the most complete collection of George "Dubya" Bush quotes available anywhere on the Internet.)

    Actually accountants do not wear black or white eyeshades --- they're green! And they're green because most of the auditors of large corporations have almost no experience.  Those young auditors are mere puppies yapping at the accounts receivable. See "The Strategy of Low Cost Auditing using Articling Labor" in "The Transformation of the Accounting Profession: The History Behind the Big 5 Accounting Firms Diversifying into Law," by Colin Boyd, Professor of Management, University of Saskatchewan --- http://www.commerce.usask.ca/faculty/boyd/mpacc801/FinalCBAReport.htm 

    The sad thing is that most members of audit committees (like George Bush)  are not even accountants.  They, along with the boards of director members and our U.S. legislators, are the CEOs’ pet rocks.


    There are just too many reported bad audits to cling to any hopes that quality control has not become a systemic problem in modern times.  Many clients feel that their auditors are merely going through motions that add little value to discovering what is really going on in transactions around the world.  Many investors do not believe that auditors are doing a credible job.  The claim was made that Enron was a complex company, but what global company is not complex.

    Enron is not solely to blame for the crash in confidence in the auditing profession.  Enron simply brought the festering system to a head.  Some of the best summaries of auditor misdeeds are provided in the following reference:

    One of the best documents explaining the reasons for incompetent audits was written by Colin Boyd prior to the collapse of Enron.
    by Colin Boyd, Professor of Management, University of Saskatchewan 
    http://www.commerce.usask.ca/faculty/boyd/mpacc801/FinalCBAReport.htm#Executive
     

    Regional Mergers
    International Mergers and Industry Concentration --- decline in professionalism
    The Decline of Auditing --- unattractive, low profit activity among other accounting firm services
    Cutting Labor and Labor Costs --- reduce labor time and/or reduce skill level and experience of auditors
    The Strategy of Low Cost Auditing using Articling (Apprenticeship) Labor --- puppies yapping at accounts receivable
    Lower Quality Audits, Litigation, Insurance and Liability --- look at the scandals
    The Strategy of Horizontal Integration 
    • Audit, Accounting Services
    • Consulting, 
    • Tax, 
    • Risk Services, 
    • Business Valuations, 
    • Corporate Mergers & Acquisitions, 
    • Forensic Accounting & Litigation Support, 
    • Restructuring Advisory Services, 
    • Actuary Services
    • Elder Care
    • SysTrust

    The Resulting Changes in Power within the Big Firms --- Power follows sources of profits
    Is Horizontal Integration the same as "One-Stop Shopping"? (Auditing as a loss leader)

    The American Accounting Association recently published a monograph (with CD ROM) -- Studies in Accounting Research Volume No. 33. Empirical Research in Auditor Litigation: Considerations and Data 
    By Zoe-Vonna Palmrose Published 2000, 90 pages. Members $15.00 Nonmembers $20.00

    "THE NUMBERS CRUNCH After Enron, New Doubts About Auditors," by David S. Hilzenrath, The Washington Post,  December 5, 2001 

              Part 1 of 2 Washington Post Articles

              Part 2 of 2 Washington Post Articles 

    In a news release on January 17, 2002, (former) SEC Chairman Harvey Pitt admitted that the SEC will not seek the resources and power necessary to enforce ethics and conduct quality control investigations of audits beyond blatantly illegal activities.  He proposed that a private sector body of PCAOBs be formed for such purposes.  However, the complexities of creating such a body are immense and would never have a chance if it were not for the Enron scandal.   The firms themselves must make huge sacrifices to create an effective independent body, and their clients are the ultimate source of annual funds for such an expensive undertaking.  
    See http://faculty.trinity.edu/rjensen/fraud.htm#Pirr011702 

    The response of the Andersen accounting firm to Pitt's proposed oversight board are summarized at http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm#AndersenResponse 

    The SEC is a pussy cat in the sense that when it wants to become a tiger on big controversial issues, corporations and large accounting firms use vast resources when lobbying Congress to thwart the SEC.  Former SEC Chairman Arthur Levitt, in a nationally televised CSPAN program on January 15, claimed that his attempts to limit some types of consulting services of auditors failed because Big Five lobbying succeeded in beating him down.  His assertions were reiterated by former SEC Chief Accountant, Lynn Turner, in a January 17 CSPAN broadcast.

    The problem with the SEC is that it often has either too little or too much power.  It's own direct powers are very limited.  But the results of its investigations can become nuclear bombs on billion-dollar tort litigation going on in the courts.  For example, the SEC has to be extremely cautious in its investigation of the Andersen firm that audited Enron.  Andersen appears to be highly vulnerable amidst a flood of investor and employee lawsuits.  How many billions Andersen loses, including the possible implosion of this entire Big Five firm, rests heavily upon how SEC findings are used to bolster plaintiff claims of auditor negligence and fraud in the tort cases.

    Many other types of SEC actions are a big yawn.  On January 14, the SEC announced a severe censuring of KPMG, a Big Five auditing firm, due to conflicts of interest.  The world hardly noticed this SEC censuring act.  Those that noticed simply yawned.  There were no fines in this instance.  And if the SEC did impose what for it is a very big fine, say $10 million, KPMG would simply dip into petty cash to settle the claim.  To read about this censorship, go  http://www.sec.gov/news/digest/01-14.txt

    That is essentially what happened when KPMG agreed to pay a $9 million petty cash fine after the firm was accused of helping Columbia Hospital Corporation cheat Medicare and Medicaid out of over $1 billion. Columbia paid a fine of $840 million after nearly ten years of litigation.

    Andersen paid $7 million in June 2001 to settle federal charges for false filing and misleading audits in the mid-90's for Waste Management. And two years ago Andersen auditors made a $644 million mistake for a very important client -- the U.S. government.

    The problem with the SEC at this moment is that it does not have the resources and staff to do everything it is charged to do day in and day out.  Taking on any new task spreads responsibilities even thinner.  For example, no mention has even been made about making a major thrust in overcoming conflicts of interest problems among financial analysts.  

    At the moment, the SEC is talking tough, but in my viewpoint, I do not hold out much hope in having the SEC solve systemic problems.  On paper it has the power to take really powerful actions such as eliminating virtually all off-balance sheet debt or requiring auditing firms to reward whistle blowers, but anything that the firms and their clients do not want will be beaten down by the private-sector's friends in Congress.

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

    TITLE: Pitt's SEC Plan for Self-Regulation of Accountants May Have Pitfalls 
    REPORTER: Randall Smith and Michael Schroeder 
    DATE: Jan 18, 2001 PAGE: C15 
    LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1011306712421864080.djm  
    TOPICS: Auditing, Auditing Services, Regulation, Securities and Exchange Commission

    SUMMARY: SEC Chairman Harvey L. Pitt outlined a proposal for a new entity to regulate the accounting "industry."

    QUESTIONS: 
    1.) Why must the accounting and auditing profession be subjected to regulation? Explain the role of public confidence as a foundation for the value of accounting and auditing services.

    2.) Describe Chairman Pitt's proposal to establish new procedures in regulating the accounting and auditing profession. Compare and contrast these proposals to current practice.

    3.) Former chief accountant at the SEC, Lynn Turner, contend that Pitt's proposal doesn't go far enough. Explain Mr. Turner's suggestions for additional regulatory procedures.

    4.) This article and the related one describe concerns with the SEC's efforts to oversee Enron and the securities industry's own efforts at self-regulation. What is the inherent weakness when a profession regulates itself? On the other hand, what is the problem with allowing outsiders to establish regulations for the accounting profession?

    SMALL GROUP ASSIGNMENT: Draft a plan for a system to regulate the accounting and auditing profession. Be sure to address the public's concerns with a system that could allow a debacle like the case of Enron.

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

    --- RELATED ARTICLES --- 
    TITLE: Enron Reports Weren't Reviewed Fully by SEC for Several Years Before Collapse 
    REPORTER: Michael Schroeder 
    PAGE: C15 ISSUE: Jan 18, 2002 
    LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1011306791917364680.djm 

    "Unaccountable in Washington," by Michael Granof and Stephen A. Zeff, The New York Times, January 23, 2002 (if you cannot download this article, I am certain that Steve Zeff at Rice University will send you a copy via email.  His email address is  Stephen A. Zeff [sazeff@rice.edu

    The latter portion is quoted below:

    The story begins in the 1970's and 1980's, when members of Congress, most from oil-producing states, pressured the Financial Accounting Standards Board and the Securities and Exchange Commission not to demand tougher standards for financial reporting in the petroleum industry. At the time, it was clear that the lawmakers were serving corporate interests, not those of investors. Now it's clear that this was only a warm- up act.

    While the FASB is a private organization financed by industry, the board's authority comes from the S.E.C. requirement that corporations follow the standards its sets. If Congress is unhappy with an FASB standard, it can pass a law directing the S.E.C. to ignore it.

    From 1991 to 1994, members of Congress prevented the FASB from issuing a standard that would have forced companies to take a charge against earnings when they issue employee stock options. Congress persisted in this course of action even though investors like Warren Buffett and the S.E.C. itself supported the FASB's initiative, saying options should be counted as an expense on earnings statements in the same way other forms of compensation are.

    The driving forces behind the Congressional opposition were major industrial corporations and special-interest groups representing small, high-tech companies. If companies counted options as compensation, they argued, earnings would decline and stock prices would suffer. Members of both houses called for hearings and introduced bills that would have hamstrung the FASB in its attempt to bring clarity to this important issue. In fact, in 1994, 88 members of the Senate voted for a "sense of the Senate" resolution in which they informed the FASB that its proposed standard would have "grave economic consequences" for entrepreneurial ventures.

    At one point in the debate, Senator Joseph Lieberman, Democrat of Connecticut and now chairman of the committee that will convene tomorrow's first hearing, introduced a bill that would have effectively destroyed the FASB's authority to set standards for financial reporting. The bill, proposed as an amendment to the Securities Exchange Act of 1934, would have required the S.E.C. to vote on every statement issued by the board. In the face of this proposed legislation, the FASB had no choice but to drop its proposal to amend the way options are accounted for.

    In the 1997-1998 session, the FASB tried to rewrite the rules affecting derivatives, financial devices whose worth is determined by the value of another entity, whether it be government bonds, pork bellies or, as was the case with some of Enron's derivatives, the price of natural gas. Derivatives are complicated and risky, and the FASB in its new rules sought to ensure that corporate financial statements accurately reflected those risks. This time, in the face of opposition from members of both parties in Congress, the FASB was able to withstand the pressure. It issued its new standards in 1998.

    But adversity quickly followed this minor success. In the 1999-2000 session, members of Congress once again intervened, this time to place barriers in the path of proposed standards on mergers and acquisitions and the way corporations involved in them account for the value of intangible assets like good will. The FASB had wanted to change the way companies account for some costs in such deals, forcing them to write them off over a shorter period of time. Companies opposed the change, saying the increased costs would reduce their earnings, and lobbied Congress against the change. In the face of such opposition, once again the FASB was required to make a strategic retreat.

    Yet the true cost of all this Congressional meddling is even greater than the sum of its parts. Taken collectively, these proposed standards would have merely tweaked the existing accounting model. What is necessary is a comprehensive overhaul of the model itself. The model was designed for the industrial era. It worked fine when plants, equipment, inventories, accounts receivable — stuff you could see and touch — were what made a company tick. It fails miserably when the critical resources of a firm are software, intellectual capital, brand names and fiscal wizardry.

    Few accountants will deny that the FASB was unable to close accounting loopholes as rapidly as Enron and Andersen created them. And few will deny that fast and loose reporting practices are all too common in the corporate world.

    Yet Congress has not allowed even a modest tweaking. Imagine, then, the outcry if the FASB actually got serious about true reform of the current accounting model. Among the changes it might propose are restoring to the balance sheet many liabilities, like certain kinds of leases, that are now considered "off balance sheet"; adjusting reported earnings for changes in current prices of assets; and recognizing and amortizing the many intangible assets that are currently not even seen on balance sheets.

    Each of these changes could have helped regulators and investors see the Enron-Andersen debacle coming, or even helped to prevent it. By sending a message that such changes are not remotely welcome or politically possible, Congress paved the way for the current crisis. Congressional involvement in financial standard-setting has been pure politics, fueled by a system of campaign financing that distorts the pursuit of the nation's legislative agenda. If members of Congress are sincere about identifying and correcting weaknesses in the standards used for financial reporting, then they should investigate the old-fashioned way: follow the money. They are likely to find a trail that leads to the nearest mirror.


    Note:  Harvey Pitt resigned from the SEC following allegations that he was aiding large accounting firms in stacking the new Public Company Accounting Oversight Board (PCAOB) created in the Sarbanes-Oxley Act of 2002. 


    Any way you look at it, the audit business cannot continue much longer as it is. David Maister shares his thoughts about the Enron scandal and what is next for the profession. http://www.accountingweb.com/item/97016

    Any way you look at it, the audit business cannot continue much longer as it is. If years of "clean" audits are no guarantee that billions of dollars of previously reported profits are, in fact, illusory, then what value does an audit actually provide? Congress and the SEC are vigorously investigating this, but there is a grave danger that they may be focusing on the wrong problem.

    Auditing is a business full of paradoxes. The providers think they’re providing one thing (carefully phrased as "an attestation that financial accounts based on information provided by management are in accordance with generally accepted accounting principles"), and the investing public, the users of the service, continue to believe (despite the profession’s best efforts to tell them otherwise) that the service is something else: a protection against fraud, reliably affirming the financial health of the enterprise being audited.

    Many people seem to think that auditing's problems are due to the conflicts created by audit firms also providing consulting services. Legislators and regulators are today holding emergency hearings about whether auditors should be able to provide these additional services, and (in anticipation of their rulings) four of the Big 5 either have spun off their consulting divisions or have plans to do so. Amid all this activity, one point goes unrecognized: how irrelevant it all is!

    The problem of auditor independence is not, ultimately, about the provision of consulting services. The conflict is built into the auditing system itself. Auditors are supposed to be independent of management, providing a neutral "attestation" that financial reports are a fair reflection of the business. Yet, who hires the auditors? Who pays them? Who retains them? Who can fire them? Answer: Only the company they are supposed to be auditing, and no-one else. Even if they never did a dime's worth of consulting, auditors would be conflicted.

    The problem is made even worse by the way the output of an auditor's work is structured. They are permitted only, in reporting to the public, to issue a standardized letter with fixed language, basically saying one of two things: either "We concur" or "We have reservations" (usually with no elaboration or explanation.) Since the latter option is equivalent to dropping the guillotine, it's not used too often. There's not much else auditors are allowed to do.

    Imagine a management that is doing something questionable or on the edge. The auditor's choice is to go along, or to resign, causing a public scandal (and a loss of their own revenues.) How much ability do you think they have to influence that management team? All they've got is a threat to resign (or what is close to the same thing, issue a qualified opinion) and management knows that if they did that, they'd hurt their own business (i.e. lose substantial revenue.) What happens? Honorable, well-intentioned people try, with integrity, to get management to do the right thing, but unless they have incredible guts, they are forced to accept a lot of grey areas before they have to pull the trigger. If they are to do their job, auditors need more than these options in reporting their findings.

    It is readily understandable that auditing firms have historically looked for additional services to provide. The auditing "product line" is an unattractive business. It’s a low- (or no-) growth, declining margin, high-litigation-exposure business. Why would a firm that had options want to nurture this product line? True, it does have the virtue of providing an annuity, a good regular, dependable cash flow, year after year. And (here's the rub) firms view it as a base from which they can cross-sell their other services.

    Continued at http://www.accountingweb.com/item/97016


    What are the three main problems facing the profession of accountancy at the present time?

    One nation, under greed, with stock options and tax shelters for all.
    Proposed revision of the U.S. Pledge of Allegiance following a June 26, 2002 U.S. court decision that the present version is unconstitutional.

    On June 26, 2002, the SEC charged WorldCom with massive accounting fraud in a scandal that will surpass the Enron scandal in losses to shareholders, creditors, and jobs.  WorldCom made the following admissions on June 25, 2002 at http://www.worldcom.com/about_the_company/press_releases/display.phtml?cr/20020625 

    CLINTON, Miss., June 25, 2002 – WorldCom, Inc. (Nasdaq: WCOM, MCIT) today announced it intends to restate its financial statements for 2001 and the first quarter of 2002. As a result of an internal audit of the company’s capital expenditure accounting, it was determined that certain transfers from line cost expenses to capital accounts during this period were not made in accordance with generally accepted accounting principles (GAAP). The amount of these transfers was $3.055 billion for 2001 and $797 million for first quarter 2002. Without these transfers, the company’s reported EBITDA would be reduced to $6.339 billion for 2001 and $1.368 billion for first quarter 2002, and the company would have reported a net loss for 2001 and for the first quarter of 2002.

    The company promptly notified its recently engaged external auditors, KPMG LLP, and has asked KPMG to undertake a comprehensive audit of the company’s financial statements for 2001 and 2002. The company also notified Andersen LLP, which had audited the company’s financial statements for 2001 and reviewed such statements for first quarter 2002, promptly upon discovering these transfers. On June 24, 2002, Andersen advised WorldCom that in light of the inappropriate transfers of line costs, Andersen’s audit report on the company’s financial statements for 2001 and Andersen’s review of the company’s financial statements for the first quarter of 2002 could not be relied upon.

    The company will issue unaudited financial statements for 2001 and for the first quarter of 2002 as soon as practicable. When an audit is completed, the company will provide new audited financial statements for all required periods. Also, WorldCom is reviewing its financial guidance.

    The company has terminated Scott Sullivan as chief financial officer and secretary. The company has accepted the resignation of David Myers as senior vice president and controller.

    WorldCom has notified the Securities and Exchange Commission (SEC) of these events. The Audit Committee of the Board of Directors has retained William R. McLucas, of the law firm of Wilmer, Cutler & Pickering, former Chief of the Enforcement Division of the SEC, to conduct an independent investigation of the matter. This evening, WorldCom also notified its lead bank lenders of these events.

    The expected restatement of operating results for 2001 and 2002 is not expected to have an impact on the Company’s cash position and will not affect WorldCom’s customers or services. WorldCom has no debt maturing during the next two quarters.

    “Our senior management team is shocked by these discoveries,” said John Sidgmore, appointed WorldCom CEO on April 29, 2002. “We are committed to operating WorldCom in accordance with the highest ethical standards.”

    “I want to assure our customers and employees that the company remains viable and committed to a long-term future. Our services are in no way affected by this matter, and our dedication to meeting customer needs remains unwavering,” added Sidgmore. “I have made a commitment to driving fundamental change at WorldCom, and this matter will not deter the new management team from fulfilling our plans.”

    Actions to Improve Liquidity and Operational Performance

    As Sidgmore previously announced, WorldCom will continue its efforts to restructure the company to better position itself for future growth. These efforts include:

    Cutting capital expenditures significantly in 2002. We intend 2003 capital expenditures will be $2.1 billion on an annual basis.

    Downsizing our workforce by 17,000, beginning this Friday, which is expected to save $900 million on an annual basis. This downsizing is primarily composed of discontinued operations, operations & technology functions, attrition and contractor terminations.

    Selling a series of non-core businesses, including exiting the wireless resale business, which alone will save $700 million annually. The company is also exploring the sale of other wireless assets and certain South American assets. These sales will reduce losses associated with these operations and allow the company to focus on its core businesses.

    Paying Series D, E and F preferred stock dividends in common stock rather than cash, deferring dividends on MCI QUIPS, and discontinuing the MCI tracker dividend, saving approximately $375 million annually.

    Continuing discussions with our bank lenders.

    Creating a new position of Chief Service and Quality Officer to keep an eye focused on our customer services during this restructuring.

    “We intend to create $2 billion a year in cash savings in addition to any cash generated from our business operations,” said Sidgmore. “By focusing on these steps, I am convinced WorldCom will emerge a stronger, more competitive player.”

     

    Contrary to the optimism expressed above, most analysts are predicting that WorldCom will declare bankruptcy in a matter of months.  Unlike the Enron scandal where accounting deception was exceedingly complex in very complicated SPE and derivatives accounting schemes, it appears that WorldCom and its Andersen auditors allowed very elementary and blatant violations of GAAP to go undetected.

    This morning on June 27, 2002, I found some interesting items in the reported prior-year SEC 10-K report for WorldCom and its Subsidiaries:

      1999 2000 2001
    Net income (in millions) $4,013 $4,153 $1,501
    Taxes paid (in millions) $106 $452 $148

    The enormous disparity between income reported to the public and taxes actually paid on income are consistent with the following IRS study:

    An IRS study released this week shows a growing gap between figures reported to investors and figures reported for tax income. With all the scrutiny on accounting practices these days, the question is being asked - are corporations telling the truth to the IRS? To investors? To anyone? 
    http://www.accountingweb.com/item/83690
     

    Such results highlight the fact that audited GAAP figures reported to investors have lost credibility.  Three problems account for this.  One is that bad audits have become routine such that too many companies either have to belatedly adjust accounting reports or errors and fraud go undetected.  The second major problem is that the powerful corporate lobby and its friends in the U.S. Legislature have muscled sickening tax laws and bad GAAP. The third problem is that in spite of a media show of concern, corporate America still has a sufficient number of U.S. senators, congressional representatives, and accounting/auditing standard setters under control such that serious reforms are repeatedly derailed.  Appeals to virtue and ethics just are not going to solve this problem until compensation and taxation laws and regulations are fundamentally revised to impede moral hazard.

    One example is the case of employee stock options accounting.  Corporate lobbyists muscled the FASB and the SEC into not booking stock options as expenses for GAAP reporting purposes.  However, corporate America lobbied for enormous tax benefits that are given to corporations when stock options are exercised (even though these options are not booked as corporate expenses).  Following the Enron scandal, powerful investors like Warren Buffet and the Chairman of the Federal Reserve Board, Alan Greenspan, have made strong efforts to book stock options as expenses, but even more powerful leaders like George Bush have blocked reform on stock options accounting

    For more details, study the an examination that I gave to my students in April 2002 --- http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/ 
    Also see http://faculty.trinity.edu/rjensen/theory/sfas123/jensen01.htm

    For example, in its Year 2000 annual report, Cisco Systems reported $2.67 billion in profits, but Cisco managed to wipe out nearly all income taxes with a $2.5 billion benefit from the exercise of employee stock options (ESOs).  In a similar manner, WorldCom reported $585 million in 1999 and $124 million in 2000 tax benefits added to paid-in capital from exercise of ESOs.  The benefits would have been even more enormous if WorldCom’s stock price had not been declining since 1999.

    One nation, under greed, with stock options and tax shelters for all.
    Proposed revision of the U.S. Pledge of Allegiance following a U.S. June 26, 2002 court decision that the present version is unconstitutional.


    From The Wall Street Journal Accounting Educators' Review on July 15, 2002

    TITLE: Auditors' Methods Make It Hard to Catch Fraud by Executives 
    REPORTER: Ken Brown 
    DATE: Jul 08, 2002 
    PAGE: C1 
    LINK: http://online.wsj.com/article/0,,SB1026077052109691000.djm,00.html 
    TOPICS: Accounting, Audit Quality, Auditing, Auditing Services, Fraudulent Financial Reporting, Internal Controls

    SUMMARY: A recent published report indicates that the auditors' increased reliance on internal controls may have contributed to the auditors' failure to detect recent financial statement frauds. Questions focus on the auditors reliance on internal controls and the implications of the study for the profession.

    QUESTIONS: 
    1.) Discuss the results of the study by Sutton and Cullinan. Do you agree with the conclusions of the study? Support your opinion.

    2.) What are internal controls? Briefly discuss the auditing standards describing the auditors' responsibilities with respect to internal controls. How does reliance on internal controls affect the audit?

    3.) Why did the auditing profession increase reliance on internal controls? How does increasing reliance on internal controls change the cost of an audit?

    4.) Given the results of the study by Sutton and Cullinan and the growing number of audit failures, describe changes to the accounting profession that you believe are important.


    Additional Reading

    See http://faculty.trinity.edu/rjensen/fraud.htm#Fraud 

    The most notable activist is Abraham Briloff (emeritus from SUNY-Baruch) who for years wrote a column for Barrons that constantly analyzed breaches of ethics and audit professionalism among CPA firms. His most famous book is called Unaccountable Accounting.
    You might enjoy "The AICPA's Prosecution of Dr. Abraham Briloff: Some Observations," by Dwight M. Owsen --- http://accounting.rutgers.edu/raw/aaa/pi/newsletr/spring99/item07.htm  
    I think Briloff was trying in vain to save the profession from what it is now going through in the wake of the Enron scandal.

    Washington Post Summaries --- http://faculty.trinity.edu/rjensen/fraud.htm#WashingtonPostPart1 

    The accounting profession's self-regulatory system was caught in the cross-hairs of a GAO report issued this week at the request of Representative John Dingell. Limitations were highlighted in the report of "a system that is fragmented, is not well-coordinated, and has a disciplinary function that is widely perceived to be ineffective." http://www.accountingweb.com/item/83936 

    An IRS study released this week shows a growing gap between figures reported to investors and figures reported for tax income. With all the scrutiny on accounting practices these days, the question is being asked - are corporations telling the truth to the IRS? To investors? To anyone? http://www.accountingweb.com/item/83690 

    PricewaterhouseCoopers released the results of its 2001 securities litigation study on June 10. The results show a marked increase in the number of initial public offering lawsuits, along with record-breaking percentages and settlements for suits involving allegations of improper accounting. http://www.accountingweb.com/item/83117 

     

    The Future of Auditing

    "In Pari Delicto: Are Auditors Equally At Fault In The Big Fraud Cases?" by Francine McKenna, Re: The Auditors, March 9, 2010 ---
    http://retheauditors.com/2010/03/09/in-pari-delicto-are-auditors-equally-at-fault-in-the-big-fraud-cases/

    The phrase in pari delicto sounds like something dirty to me.  Maybe I’m still preoccupied with the accusation that I’m producing accounting pornography.

    “…the etymology of the term [pornography] is: “Etymology: Greek pornographos, adjective, writing about prostitutes, from porn prostitute + graphein to write; akin to Greek pernanai to sell, porosjourney “

    That implies accounting porn is writing about accounting prostitutes. That being the case, then Francine McKenna, Sam Antar, Tracy Coenen and Bob Jensen all engage in accounting porn. They write about the corporate executives and audit firm partners that prostitute their accounting reports in the search for fictitious profits and all too real unearned bonuses. In other words, accounting fraud is accounting prostitution…”

    In pari delicto, for those of you not lawyers or legal argument junkies like me, is “Latin for “in equal fault”. It’s a legal term used to indicate that two persons or entities are equally at fault, whether we’re talking about a crime or tort. The phrase is most commonly used by courts when relief is being denied to both parties in a civil action because of wrongdoing by both parties. The phrase means, in essence, that since both parties are equally at fault, the court will not involve itself in resolving one side’s claim over the other, and whoever possesses whatever is in dispute may continue to do so in the absence of a superior claim.”

    There are two active cases where this doctrine and defense is being employed by auditors trying to avoid liability for fraud.

    In Teachers’ Retirement System of Louisiana v. PricewaterhouseCoopers LLP, No. 454, 2009 (Del. March 4, 2010), one of many AIG suits that PwC is involved in directly or indirectly, the Delaware Supreme Court used a procedure provided for under the New York Rules of Court  to certify a question of law to New York’s highest court, the New York Court of Appeals.This matter involves an appeal from the Delaware Court of Chancery regarding the oft-cited AIG case which denied a motion to dismiss claims against the top officials of AIG for breach of fiduciary duty based on Delaware law. However, the claims against the auditor, PwC, were dismissed based on New York law. The Plaintiff’s are appealing the Chancery Court’ decision regarding PwC. (Summary borrowed for accuracy from Francis Pileggi at Delaware Litigation.com who alerted me to this most unusual move by the Chancery Court.)

    The Court of Chancery held that the claims against PwC were governed by New York law, and that based on the allegations of the Complaint, AIG’s senior officers did not “totally abandon[]” AIG’s interests—as would be required under New York law to establish the “adverse interest” exception to imputation.  Accordingly, the Court of Chancery held that the wrongdoing of AIG’s senior officers is imputed to AIG.3  The Court of Chancery concluded that, once the wrongdoing was imputed to AIG, AIG’s claims against PwC were barred by New York’s in pari delicto doctrine and by the related Wagoner line of standing cases in the United States Court of Appeals for the Second Circuit.

    This Court hereby certifies the following question to the New York Court of Appeals:

    Would the doctrine of in pari delicto bar a derivative claim under New York law where a corporation sues its outside auditor for professional malpractice or negligence based on the auditor’s failure to detect fraud committed by the corporation; and, the outside auditor did not knowingly participate in the corporation’s fraud, but instead, failed to satisfy professional standards in its audits of the corporation’s financial statements?

    The other case where the in pari delicto defense has tied the litigation into knots and caused some stops and starts is in Kirschner v. KPMG LLP et al., case number 09-2020, in the U.S. Court of Appeals for the Second Circuit which is about the Refco fraud. The Second Circuit certified the questions about an exception to the in pari delicto defense.  Now they have two high profile cases against auditors to consider. From Law360.com:

    Not one to go down easy, the bankruptcy trustee for Refco Inc. brought his suit implicating Mayer Brown LLP, KPMG LLP and other corporate giants in the massive Refco fraud to a federal appeals court…The U.S. Court of Appeals for the Second Circuit found Monday that trustee Marc S. Kirschner’s fight to revive his claims against the clutch of corporate insiders raised critical unresolved questions concerning the bankruptcy trustee’s standing under New York law to sue third parties for Refco’s fraud.

    The trustee alleges outside counsel Mayer Brown, auditors Ernst & Young LLP, [Grant Thornton] PricewaterhouseCoopersLLP, Banc of America Securities LLC and several other insiders are liable for defrauding Refco’s creditors, namely by helping the defunct brokerage conceal hundreds of millions of dollars in uncollectible debt.

    Steve Jakubowski, a local Chicago lawyer who writes the Bankruptcy Litigation Blog, sponsored a guest post in January by Catherine Vance, one of the fiercest critics of the “expansive” use of the in pari delicto defense.  He introduces her post this way:

    Whatever you may think about the fact that Refco’s outside corporate counsel, Joe Collins, was convicted on 5 criminal counts and sentenced today to 7 years in prison, one has to wonder how the system got so turned upside down on the civil side that while the law firm’s lead lawyer is torched in criminal court, his firm is summarily dismissed from a civil case for precisely the same conduct on a simple motion to dismiss (based on a theory that the Refco trustee lacked standing to bring suit to recover for damages arising from a fraudulent scheme devised and carried out by Refco’s own senior management).  One could argue that this result is unique to the Second Circuit (and the Seventh) because of the Wagoner decision and its progeny (which are not followed in the First, Third, Fifth, Eighth, or Eleventh Circuits).  Even in those circuits, however, management’s wrongful conduct has been imputed to the corporation under the in pari delicto doctrine to just as effectively knock the props out from civil actions involving some of the most spectacular commercial frauds of the century.

    Ms. Vance wrote an article entitled, In Pari Delicto, Reconsidered, in which she posited–as none had before–that the in pari delicto doctrine is being inappropriately used by federal courts to supplant traditional tort law defenses that derive from state, not federal, law.

    The way I see it, the in pari delicto doctrine is being used like a pair of needle nosed pliers by audit firm defense lawyers to diffuse a bomb – huge liability for some of the biggest frauds in history. The in pari delicto doctrine attempts to pull the auditors’ tails from the fire by excusing any of their guilty acts due to the approval of those acts by potentially equally guilty executives. The law allows these executives to continue to “stand in the shoes” of the shareholder plaintiffs even after their guilt has been determined. The theory is that the executives perpetrated the fraud for the benefit of the corporation and never “totally abandoned” it, as would be required for the “adverse interest” exception.

    Auditors who should otherwise be tested on their fulfillment of their public duty are instead getting reprieves because courts have been unwilling to impose the “adverse interest” exception as expansively as they have the in pari delicto defense itself.  How can executives who are successfully sued, been subject to regulatory sanctions or, in the case of the Refco executives, plead guilty to criminal activities, still be considered representatives of the corporation’s interests? They should forfeit the right to stand in the shoes of the corporation’s shareholders in derivative suits and therefore to shield other potentially guilty or negligent parties.

    The situation gets complicated in a bankruptcy case such as Refco since, traditionally according to Section 541 of a decision called In re PSA, Inc, “property of the bankruptcy estate consists of all legal or equitable interests of the debtor, including causes of action, as of the commencement of the bankruptcy case. A bankruptcy estate’s causes of action, therefore, as well as the attendant defenses thereto, transfer to the bankruptcy trustee frozen and fixed as they existed at the commencement of the bankruptcy case.  As a result, an “innocent” bankruptcy trustee “stands in the shoes” of the pre-petition debtor and may be unable to prevail on estate causes of action where the pre-bankruptcy debtor participated or was complicit in the wrongful acts upon which the estate attempts to sue.”

    A trustee in bankruptcy must have standing to sue anyone on behalf of the creditors and other injured parties.  Unfortunately, this habit of allowing guilty parties to continue to drive the bankruptcy bus by having the actions of the guilty officers “imputed” to the corporation and, therefore, in bankruptcy to the trustee potentially threatens the trustee’s ability to sue “co-conspirators.”

    It’s just nuts.

    Akin Gump summarizes critics of this line of reasoning this way:

    The purpose of the in pari delicto defense, they argue, is to prevent a party who is complicit in wrongdoing from prevailing against their joint actors.  In their view, the intercession of an innocent trustee whose duty it is to maximize the value of the estate for the debtor’s creditors purges the taint of the debtor’s wrongdoing, and that to hold otherwise would simply elevate the legal fiction of section 541 over the purpose of the in pari delicto defense.

    Ms. Vance reminds us in her treatise that in pari delicto was ushered into modern bankruptcy jurisprudence as a part of the deepening insolvency discussion. I’ve written about deepening insolvency many times as it relates to the auditors who, by continuing to provide false and negligent clean audit opinions, allow a company to go deeper and deeper into debt and ruin, thereby significantly diminishing any remaining value for stakeholders once the gig is up.

    The deepening insolvency arguments have been shot down by no less than Judge Posner whose pernicious pragmatism forces him to engage in the self-delusion that helping companies remain “viable” via fraud doesn’t hurt anyone.  This fantasy presupposes the company to be a person and not the embodiment of the goals and objectives, hopes and dreams, faith and trust of the shareholders, employees, creditors, and community that count on it to continue legally and honorably instead.   I suppose a Supreme Court that allows corporations to donate money to political campaigns in an exercise of their inalienable constitutional rights would not find this idea so strange.

    Continued in article

    Bob Jensen's threads on auditor fraud and negligence are at
    http://faculty.trinity.edu/rjensen/fraud001.htm


    January 25, 2006 message from Dennis Beresford [dberesfo@TERRY.UGA.EDU]

    The United States Chamber of Commerce has just released a report titled

    Auditing: A Profession at Risk. It is a short but interesting read.

    You can find it at

    http://www.uschamber.com/NR/rdonlyres/ewj43d74z5pemtshnkdi3fvko6azefuio2npyjeicyanm3hj4spkg7ivliac62faaieqewp4vdktk4ozqfv4ucilwpe/0601auditing.pdf

    Denny Beresford

    Jensen Comment
    I snipped the above link to http://snipurl.com/ChamberOfCommerceRep
     


    The accounting profession took great shocks when it was forced to divorce itself from many systems and tax consulting services of audit clients. Our profession was in trouble before that because audit core business in large firms was becoming less an less profitable even with cost cutting measures that led to declining audit quality and staggering lawsuits. Sarbanes-Oxley is restoring profitability to auditing and helping to restore audit quality. It is also adding stress to auditors. Of course auditing is only one of the lines of business of public accounting firms. Also there are many accountants who are employed outside public accounting.

    The following study might be viewed optimistically with 75% being satisfied with their jobs or pessimistically with 25% being dissatisfied with their current jobs. As in academe, a majority of accountants are unhappy one way or another with their compensation. Half are unhappy with workloads.

    But none of these negatives suggest that becoming accountants was a mistake, because the outlooks in other professions are about as bad or worse. Medical school applications are increasing but new physicians are not particularly happy with prospective workloads and their choices between working for HMOs or going out on their own in the face of enormous costs of malpractice insurance and the many years of added study required for credentials in lucrative specialties. Law school applications are way down in large measure due to oversupply of lawyers in the legal profession. As with most things in life, we must decide whether the glass is half full or half empty.

    "The Accounting Profession in 2006," AccountingWeb, February 14, 2006 ---
    http://www.accountingweb.com/cgi-bin/item.cgi?id=101774

    A new study shows about 25 percent of those in the accounting or finance profession are dissatisfied in their current jobs. Some 33 percent said they planned to find a new job in 2006. The survey, Job Forecast 2006 – Accounting/Finance was conducted in late 2005, by CareerBuilder.com.

    CareerBuilder.com collected survey responses from more than 150 accounting and finance workers between November 15 and December 6, 2005. Other metrics brought out in the survey exposed other dissatisfying situations in 2005:

     

    • About 66 percent did not receive a bonus
       
    • 33 percent did not receive raises
       
    • 37 percent of accounting and finance workers said they are dissatisfied with their pay
       
    • About 60 percent of those participating in the survey said their workloads increased
       
    • About 33 percent said they are unhappy with the balance between their work and home commitments
       
    • More than 50 percent said they are dissatisfied with their workload
       
    • 29 percent felt as though they were overlooked for past promotions
       
    • 35 percent said they were disappointed with the opportunities offered by their jobs
       
    • 33 percent felt their employers could offer improved training and professional development programs.

    “Financial services added 188,000 jobs in the United States in 2005, according to the Bureau of Labor Statistics. CareerBuilder.com sees more than 4.5 million job searches in accounting/finance every month as workers seek out the new opportunities that will provide them with the benefits they desire,” according to Arti Bedi, Finance Employment Expert at CareerBuilder.com.

    On the plus side of the profession, the DePaul University College of Commerce has seen the number of undergraduates majoring in accounting increase to 37 percent for the 2005-2006 academic school year, compared to the 2004-2005 school year, according to the DePaulia.com.

    Ray Whittington, the Interim Dean of the College of Commerce and director of DePaul’s Accounting Department, said to DePaulia.com, “There was a big piece of federal legislation written in 2002 which requires public companies to have their internal controls audited in addition to their financial statements,” explaining the increase in accounting majors. “It [Sarbanes-Oxley] has a lot of provisions, but the provisions that had the most effect on accountants is the one that requires management of the firms to certify or indicate that there is no material weaknesses in their internal control systems.” Whittington continued, “The increase has been going on for a little while, just kind of snowballing and getting quite a bit larger.”

    Eric Taylor, Campus Development manager for the Chicago office of KPMG, told DePaulia.com, that the Sarbanes-Oxley (SOX) Act of 2002 has not lead to DePaul’s increased enrollment, but instead the increased staffing demand has been created by SOX.

    Tess Nyka, DePaul’s associate director of Career Services, told DePaulia.com, “Thirty-eight companies recruited accounting students through On-Campus Interviewing (OCR) in Fall 2005, of the 75 companies participating in OCR. Accounting majors get hired as staff members of public accounting firms of varying sizes and specialties. Additionally, accounting majors are employed in business and industry, as well as government agencies, to name a few.” She also said that 130 accounting-related organizations work with the Career Center recruiting students.

    Eric Taylor, Campus Development manager for the Chicago office of KPMG, told DePaulia.com, “We believe the boost is, at least in part, due to the increased opportunities that exist for accounting students through internships and full-time jobs…in addition, the earning potential, variety and level of importance that all organizations are putting on accounting groups, have increased the prestige of the position, which will always lead to an increase in enrollment.”

    Looking at the larger employment picture, jobless claims rose less than expected last week, prompting Gary Thayer, chief economist at A.G. Edwards & Sons, to tell Reuters, “Claims are still suggesting that the economy started the year with a strong employment situation.” Thayer continued, “We still don’t know how much of this is weather-related…but if claims hold at these levels it would tell us that the job situation looks more favorable than a year ago.”

    Bob Jensen's threads on accountancy careers are at http://faculty.trinity.edu/rjensen/Bookbob1.htm#careers


    February 16, 2006 message from Brent Inman and Jean Wyer at PwC

    We hope your spring term is progressing nicely. There are a number of recent publications and surveys we wanted to share with you. We hope they provide you with relevant and timely information for use in your classes.

    World Watch Newsletter

    There is growing recognition of the importance of transparency and common business language for accounting and governance. This is particularly important in the current global business environment. Our most recent issue of World Watch contains new opinion articles and interviews. To help you understand the implementation of IFRS, World Watch includes a description of usage by country.

    Overall topics discussed in World Watch include:

    News on IFRS, audit, governance and sustainability Governance IFRS Hot Topics IFRS Pull Out Interviews

    http://www.pwc.com/worldwatchnewsletterdec

    9th Annual Global CEO Survey

    Our 9th Annual Global CEO Survey, featuring the perspectives of over 1,400 CEOs in 45 countries, takes a close look at globalization and complexity. The survey also features one-on-one interviews with five global business leaders. They bring in-depth, personal perspectives on how they and their organizations are meeting the challenges of globalization and complexity.

    Here are a few highlights:

    • 64% of CEO's cite over regulation as the chief challenge to globalization;
    • Nearly 80% of CEO's say that they have made reducing unnecessary complexity a personal priority;
    • More than three-quarters of CEO's surveyed say the level of complexity in their organization is higher than it was three years ago;
    • Among emerging market countries, CEO's are investing the most resources in China (55%).

    Please visit the following link for the full survey:

    http://www.pwc.com/9thannualglobalceosurvey

    PwC View

    Our executive publication, the view, is based on the idea that sharing thinking on challenging issues can help all of us. The view is about navigating in a complex world that requires difficult decisions. In this issue, we seek answers to "what if" questions, that could lead to out-of-the box thinking, crisis management, or a new way to look at a recurring challenge.

    The "what if" questions explored in this issue of the view are:

    What if the corporate reporting model were to change? This article discusses our belief that fundamental change in corporate reporting is needed to keep up with the evolving markets, investor needs, and technology. We discuss a possible alternative utilizing the internet and XBRL and explore ways to improve corporate reporting communications.

    What if a business is faced with a crisis and difficult decisions have to be made quickly? This section offers guidance on what should be done before, during, and after an unanticipated crisis. For advice from an experienced crisis leader, see the "Navigational Tips" provided by Robert P. May, interim CEO of HealthSouth.

    What if management wanted to provide information to the board, but the company could not provide it? Or, what if the board and management did not agree which information is most important? The corporate governance section explores how a board can be most effective by first being informed. We share findings from the 2005 What Directors Think survey including an interview with an experienced board recruiter focusing on ways to find good board members.

    Please visit the following link for the full publication:

    http://www.pwc.com/pwcviewmagazine 

    As always we welcome your feedback on these updates and appreciate hearing from you on how PwC can best support you as faculty members.

    Regards,

    Brent Inman and Jean Wyer

    Bob Jensen's threads on accountancy careers are at http://faculty.trinity.edu/rjensen/Bookbob1.htm#careers

    Bob Jensen's threads on the future of auditing are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing


    "Assessing and Responding to Risks in a Financial Statement Audit: Part II," Journal of Accountancy, January 2007 --- http://www.aicpa.org/pubs/jofa/jan2007/fogarty.htm

    Bob Jensen's threads on professionalism in auditing are at http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism


    From The Wall Street Journal Accounting Weekly Review, June 24, 2005

    TITLE: SEC Weighs a 'Big Three' World
    REPORTERS: Deborah Solomon and Diya Gullapalli
    DATE: Jun 22, 2005
    PAGE: C1 LINK:
    http://online.wsj.com/article/0,,SB111939468387765810,00.html
    TOPICS: Auditing, Auditing Services, Auditor Changes, Auditor Independence, Personal Taxation, Public Accounting, Regulation, Sarbanes-Oxley Act, Securities and Exchange Commission, Tax Shelters

    SUMMARY: As described in the related article, Justice Department officials are debating whether to seek an indictment of KPMG from a criminal case built by Federal prosecutors for the firm's sale of what the prosecutors consider to be abusive tax shelters. The Justice Department is concerned about competitiveness of the audit profession if KPMG collapses as did Arthur Andersen and only three large firms are left. As described in the main article covered in this review, the SEC already is considering relaxing some of the auditor independence rules because of the difficulties in implementing them with only four large firm auditing most publicly-traded companies.

    QUESTIONS:
    1.) What auditor independence rules have been implemented as a result of Sarbanes-Oxley? Hint: to help answer this question, you may refer to the AICPA's summary of this Act available at http://www.aicpa.org/info/sarbanes_oxley_summary.htm

    2.) What steps has the SEC taken to relax some standards for firms switching auditors? When did the SEC institute these allowances? What trade-offs do you think the commissioners considered in making these allowances to relax the standards?

    3.) Why is the SEC again concerned about what actions it may have to take to allow for firms to switch auditors?

    4.) What is the Public Company Accounting Oversight Board? What role can this entity play in establishing public policy because of the concerns with the shrinking number of large public accounting firms?

    5.) Refer to the related article. For what reason might KPMG LLP be indicted? Does this potential indictment have anything to do with the audit services provided by this firm?

    6.) How is the potential indictment affecting all aspects of KPMG's practice regardless of the culpability of the firm's audit partners? How do you think this potential indictment affects all firm employees' perception of the need for control procedures over the firms' activities in all practice areas?

    Reviewed By: Judy Beckman, University of Rhode Island

    --- RELATED ARTICLE ---
    TITLE: KPMG Faces Indictment Risk on Tax Shelters
    REPORTER: John. R. Wilke
    PAGE: A1
    ISSUE: Jun 16, 2005
    LINK: http://online.wsj.com/article/0,,SB111888827431261200,00.html

    Bob Jensen's threads on the two faces of KPMG are at http://faculty.trinity.edu/rjensen/fraud001.htm#KPMG

    Bob Jensen's threads on the future of auditing are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing


    "Auditors: Too Few to Fail," by Joseph Nocera, The New York Times, June 25, 2005 --- http://www.nytimes.com/2005/06/25/business/25nocera.html

    Yet the word now seems to be that the Justice Department will probably not indict the firm (KPMG). This is partly because KPMG has belatedly apologized, admitted the tax shelters were "unlawful," and cut adrift its former rising stars (and tried to shift the blame for the shelters to them). And it is working to come up with a deal with prosecutors that, however painful, will fall short of the death penalty.

    But it's also because the government is afraid of further shrinking the number of major accounting firms. Remember when people used to say that the major money center banks were "too big to fail"- meaning that if they ever got in real trouble the government would have to somehow ensure their survival? It appears that with only four big accounting firms left, down from eight 16 years ago, there are now "too few to fail." How pathetic is that?

    . . .

    "What infuriates me about the accounting firms is the enormous power they have," said Howard Shilit, president of the Center for Financial Research and Analysis. "You just can't compel them to do things they ought to do. And the fewer firms there are, the more concentrated their power." To my mind, the biggest problem is the hardest to change - that accounting firms are paid by the same managements they are auditing. Nobody really thinks about changing this practice mainly because it's been that way forever. But, "it's the elephant in the room," said Alice Schroeder, a former staff member at the Financial Accounting Standards Board who later became a Wall Street analyst. In the memorable phrase of Warren E. Buffett's great friend and the vice chairman of Berkshire Hathaway, Charles T. Munger - quoting a German proverb: "Whose bread I eat his song I sing."
     


    The long-awaited PCAOB auditor inspection reports

    We had a visiting accounting researcher in recently who claimed that the Big Four can charge more for audits because they do better audits than the second tier auditing firms.  There are some global advantages of the largest firms, but audit quality does not necessarily justify higher pricing.

    The following is sad, because Deloitte was once viewed as the auditors' auditor much like a skilled physician is viewed as the doctors' doctor.

    "Deloitte Receives Criticism in 2004 Inspections Report," SmartPros, October 7, 2005 --- http://accounting.smartpros.com/x50107.xml

    The U.S. audit overseer on Thursday rebuked Deloitte & Touche LLP for weaknesses in its audits of public companies, including an instance where the accounting firm allowed a company to gloss over an auditing error.

    The Public Company Accounting Oversight Board said that an inspection of the accounting giant from May through November 2004 found that "in some cases, the deficiencies identified were of such significance that it appeared to the inspection team that the firm had not, at the time it issued its audit report, obtained sufficient competent evidential matter to support its opinion on the issuer's financial statements."

    The U.S. audit oversight board also noted that Deloitte & Touche had improperly applied lease accounting standards in one audit and that it had come to an inaccurate conclusion about a company's ability to continue as a going concern.

    "We have taken appropriate action to address the matters identified by the inspection team for each of the instances identified," said Deborah Harrington, a spokeswoman for Deloitte & Touche. "We are supportive of this process and committed to work collectively to continuously improve the independent audit process."

    The audit board was created by Congress in 2002 following a spate of accounting scandals that rocked the U.S. stock markets. Under law, it must inspect the Big Four firms each year. It does not identify any of the public companies alluded to in its inspections reports.

    The PCAOB's report did not include details about the quality-control systems at Deloitte & Touche or the "tone at the top." Under law, that information must remain confidential for at least a year. If firms fail to address criticism about their quality controls within 12 months, then the PCAOB may make public its criticisms.

    KPMG also had troubles in its inspection report.  The following appeared in my September 30, 2005 edition of New Bookmarks --- http://faculty.trinity.edu/rjensen/book05q3.htm#093005

    The long-awaited PCAOB auditor inspection reports

    Denny Beresford clued me into the fact that, after several months delay, the Big Four and other inspection reports of the PCAOB are available, or will soon be available, to the public --- http://www.pcaobus.org/Inspections/Public_Reports/index.aspx
    Look for more to be released today and early next week.

    The firms themselves have seen them and at least one, KPMG, has already distributed a carefully-worded letter to all clients.  I did see that letter from Flynn.

    Denny did not mention it, but my very (I stress very) cursory browsing indicates that the firms will not be comfortable with their inspections, at least not some major parts of them.

    I would like to state a preliminary hypothesis for which I have no credible evidence as of yet.  My hypothesis is that the major problem of the large auditing firms is the continued reliance upon cheaper risk analysis auditing relative to the much more costly detail testing.  This is what got all the large firms, especially Andersen, into trouble on many audits where there has been litigation --- http://faculty.trinity.edu/rjensen/Fraud001.htm#others


    Bob Jensen’s threads on the future of auditing are at
     http://faculty.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing

    Bob Jensen’s threads on the weaknesses of risk-based auditing are at
     http://faculty.trinity.edu/rjensen/fraud001.htm#RiskBasedAuditing

    At the above site the first message is the following AECM message from Roger Debreceny

     April 27, 2005 message from Roger Debreceny [roger@DEBRECENY.COM]

    Hi,

    While doing some grading, I have been listening to the Webcast of the February meeting of the PCAOB Standing Advisory Group (see http://www.connectlive.com/events/pcaob/) (yes, I know, I have no life! <g>). There is an interesting discussion on the role/future of the risk-based audit. See http://tinyurl.com/8f5nt at 42 minutes into the discussion. A variety of viewpoints are expressed in the discussion. This refers back to an earlier discussion we had on AECM.

    Roger

    --
    Roger Debreceny
    School of Accountancy
    College of Business Administration
    University of Hawai'i at Manoa
    2404 Maile Way
    Honolulu, HI 96822, USA

    www.debreceny.com  

    "PCAOB Finds 18 KPMG Auditing Flaws," SmartPros, October 7, 2005 --- http://accounting.smartpros.com/x50018.xml

    A required report by the Public Company Accounting Oversight Board, released last week, uncovered flaws in 18 audits performed by KPMG LLP for publicly held companies.

    The PCAOB reviewed just 76 of KPMG's 1,900 publicly traded clients between June and October 2004. Some of the failures by KMPG, according to the PCAOB, include not thoroughly evaluating some known or likely errors, not keeping crucial documentation, and not backing up its opinion with "sufficient competent evidential matter."

    In a prepared statement, KPMG Chairman Timothy Flynn said, "KPMG is committed to the goal of continuous improvement in audit quality. We appreciate the constructive dialogue and consider it an important element in the process of improving our system of quality controls."

    The Sarbanes-Oxley Act, which established the oversight board, requires the inspections. The PCAOB may not make certain criticisms public, however, so some portions of the KPMG report remain undisclosed. This report is the first of four reports that will inspect the nation's top four accounting firms. KPMG is the fourth-largest accounting firm. The remaining reports are expected in the coming weeks.

    Bob Jensen's threads about troubles in the large accounting firms are at http://faculty.trinity.edu/rjensen/Fraud001.htm#others

    Bob Jensen’s threads on the weaknesses of risk-based auditing are at
     http://faculty.trinity.edu/rjensen/fraud001.htm#RiskBasedAuditing

    The Saga of Auditor Professionalism and Independence --- http://faculty.trinity.edu/rjensen/Fraud001.htm#Professionalism


    An accounting ethics blog --- http://www.accountingethics.blogspot.com/
    July 5, 2005 message from Art Berkowitz --- ArtBCPA@aol.com

    I thought you might be interested in my recent postings on accounting ethics at my new blog site:

    1. Can We Really Have Independent Auditors?

    2. The Innocence of Arthur Andersen? Nothing Could be Further from the Truth.


    Forwarded on November 24, 2004 by Dave Storhaug [storhaug@BTINET.NET

    Called to account - The future of auditing
    THE ECONOMIST via NewsEdge Corporation : ** NOTE: TRUNCATED STORY **

    The auditing industry has yet to recover from the damage inflicted by an era of corporate scandals

    NO ONE becomes an auditor because the job is adventurous. In recent years, however, the profession has been really rather racy. Auditors have been implicated in fraud after fraud. The Enron scandal brought down Arthur Andersen, which had been one of the profession's five giant firms. Now a scandal at Italy's Parmalat that was uncovered in late 2003 threatens Deloitte & Touche, another global giant, as well as Grant Thornton, an important second-tier firm. And new scandals are still emerging: most recently, financial manipulation was discovered at Fannie Mae, America's quasi-governmental mortgage lender, and at Nortel Networks, a telecoms-equipment group.

     Investors depend on the integrity of the auditing profession. In its absence, capital markets would lack a vital base of trust. So it is no surprise that scandals have triggered changes in the profession. In America it has seen self-regulation dissolved in favour of the Public Company Accounting Oversight Board (PCAOB), in effect, a new regulator. It has been deluged with new rules, restrictions and requirements as part of the Sarbanes-Oxley act. In Europe the Eighth Company Law Directive, which, among other things, deals with the auditing profession, is progressing, albeit slowly, towards enactment.

     Britain's Office of Fair Trading is in the midst of scrutinising its audit industry. One consequence of all this change is that audits have become tougher. The requirement introduced by Sarbanes-Oxley that auditors report to independent non-executive board directors rather than company management has reduced one overt conflict of interest. The certification of financial reports by chief executives and chief financial officers has focused minds. And the PCAOB has begun its inspections of audit quality and internal controls at auditing firms.  Its first, mostly reassuring, reports were published in August.

    Auditors themselves say they have toughened their standards and beefed up internal controls. And checks-and-balances in the financial system have been working better. Audit committees are taking their roles more seriously and asking tougher questions of management and auditors; activist shareholder groups, such as Calpers, are holding company auditors to standards that are higher even than those required by law, especially when it comes to their provision of non-audit services.

    Auditors even have more business, thanks to the new rules they must implement.  Yet despite this flurry of activity, behind the scenes there is  a feeling among auditors that they are still a long way from meeting all the challenges they face. True, there are promising solutions to, say, the problem of conflicts of interest. But leading auditors point to one central concern: what, if anything, can be done to reduce the industry's alarming concentration? That problem seems almost intractable.

    The world's biggest companies rely for their annual audits on a tight oligopoly of just four accounting firms. According to the General Accounting Office, a congressional watchdog, the Big Four - Deloitte & Touche, PricewaterhouseCoopers (PWC), Ernst & Young (E&Y) and KPMG audit 97% of all public companies in America with sales over $250m.  They audit more than 80% of public companies in Japan, two-thirds of those in Canada, all of Britain's 100-biggest public companies and, according to International Accounting Bulletin, they hold over 70% of the European market by fee income.

    > This dominance raises two concerns. Is concentration stifling competition and lowering the quality of audits? More alarming, if one of these firms were to buckle, could the system cope with only a Big Three? The dilemma is that these firms are too important to fail - but there are mechanisms by which they could fail, says Paul Danos, dean of Dartmouth College's Tuck Business School. These are shaky foundations for financial markets.

    The concentration of the audit industry is a relatively new phenomenon. Until the Great Depression, company audits were voluntary. But as part of the Securities Acts of 1933 and 1934, listed companies were required to disclose audited financial information to the public.  The franchise was given to the private sector, and so the auditing  industry was born.

    For several decades, hundreds of auditors plied their services to public companies without much ado. A big change came in the industry in the 1970s, when rules restricting auditors from advertising and competitive bidding were loosened, unleashing fierce competition - often on price as much as audit quality. Around this time, audit firms began to move more heavily into consulting, starting their transformation into multi-disciplinary conglomerates peddling everything from legal and strategic advisory services to the installation of computer systems.

    As listed companies grew bigger and more global, audit firms did too through a series of mergers and acquisitions. By the 1980s, eight firms dominated the American auditing industry. By 1998, this was down to five. After the SEC's criminal indictment of Andersen in 2002 for obstruction of justice in the Enron fiasco, the Big Five became the Big Four.

    Big, bigger, biggest

    There are arguments in favour of such scale, at least where the world's biggest companies are concerned. Unlike looser alliances of disparate accounting firms, which find it difficult to monitor audit quality across countries, the truly international audit firms spend piles of cash on common training, internal inspections and the like, spreading the substantial costs for these procedures across their relatively big capital bases.

    Also in theory, although this is perhaps more arguable in practice, big firms can be tougher auditors because they are not overly dependent on the profits they derive from a single client. They can also develop the specialised expertise needed to audit increasingly complicated clients - Citigroup and HSBC, for example, have banking activities spanning derivatives trading to syndicated loans, spread across dozens of jurisdictions.

    The question facing the industry is how few firms would be too few?  In 2003, after the implosion of Andersen, the General Accounting Office addressed this question at the behest of a worried Congress. It found  no evidence of collusion among the top firms.  Nor was there evidence that the audit profession's concentration hurt the quality of big-company audits (although this is an inexact exercise).

    The real concern is not so much that four firms are too few, but that four could fall to three. According to a report by Glass Lewis, a research consultancy specialising in corporate-governance issues, Andersen's collapse prompted approximately 1,300 firms to scramble to find new auditors. Today the Big Four already have their hands full dealing with the PCAOB's new rules. Cono Fusco, a partner with Grant Thornton in America, says that a further collapse could cause paralysis in financial markets, especially if it were to occur near the end of the year when companies file their financial reports.

    More importantly, a Big Three would almost certainly be too few to  ensure an adequate degree of competition in large-company audits. As it is, some firms are already finding it tricky to comply with the PCAOB's new rules, which restrict the provision of certain non-audit services by auditors. This is particularly the case because of Section 404, a new rule that requires public companies to have their internal controls, as well as their financial reports, checked by an independent auditor.

     Take Sun Microsystems, which has annual sales of $11 billion and operates in 100 countries. It uses KPMG, Deloitte and PWC for work on internal controls, valuation, tax and internal audit, while E&Y is its external auditor. Trying to juggle these relationships is a time-consuming pain, says Lynn Turner, a former SEC chief accountant who sits on Sun's audit committee. Yet Sun is too far-flung for it to be able to appoint a second-tier firm.

    This problem is especially acute in certain industries. According to the Public Accounting Report, an industry newsletter, the market share of three of the Big Four firms (E&Y, KPMG and PWC) in the oil and gas industry was 97.3% by revenue audited. In the casino industry, just two firms (Deloitte and E&Y) audited 88.2% of the industry by the same measure in 2004. Similar concentration exists in the air transportation, coal and other industries.

     Given this, regulators might feel constrained in how they respond to sloppy or unscrupulous behaviour on the part of the Big Four. Almost everyone agrees that Andersen's collapse made the financial system more vulnerable. So far, regulators have dealt with those improprieties that have come to light with narrow, targeted bans. For example, earlier this year E&Y was handed a six-month ban on taking on new, listed clients. It was found to have violated conflict-of-interest rules by forming a business partnership with PeopleSoft, a software firm that was also one of its audit clients.  But who can say that another scandal on the same scale as Enron or Parmalat will not surface? The reality is that the Big Four is very likely too big to fail. Regulators know this - and that is a huge moral hazard, says Jim Cox of Duke University.

     A naked option

    The mountain of litigation facing the profession as a whole, and the Big Four in particular, injects real bite into these concerns. Neil Lerner of KPMG says there is an estimated $50 billion in claims outstanding against the Big Four. Settlements can be enormous (see chart). And the worry is that even the likelihood of a big payout could trigger a mass exodus of accounting partners, followed by clients, then by more partners. Andersen didn't die because of the SEC's indictment per se, says Mr Lerner, but because its international network unravelled. It was a death spiral.

    The cost of litigation and size of claims have mounted steadily over decades, but in the post-Enron era both have spiked like a hockey stick, says Bill Parrett, boss of Deloitte in America. Some 10-20% of  the Big Four's audit revenues are routinely funnelled into litigation costs (settlements, insurance and the like), which are then passed on to consumers. The Big Four have huge problems getting insurance, particularly against unpredictable catastrophic risks. Ten years ago, there were 150 commercial insurers providing indemnity to the major auditors, says Tom McGrath, a senior partner at E&Y: Now there are ten.

    In theory, such pressure is a disciplining force on the profession.  The Big Four concede that they should pay something if they are to blame for their part in accounting fraud. But ultimately, they argue, fraud is perpetrated by company managers, not their auditors. Auditors claim they bear the brunt of any financial damages sought because they have deep pockets and are often the last man standing, says Sam DiPiazza, chief executive of PWC. In effect, auditors have become the insurers of financial statements, writing what Mr Fusco likens to a naked (ie, unhedged) option: You get unlimited exposure for a limited reward, he says. Critics see that as special pleading - after all, the whole point of auditing financial statements is to give some form of guarantee that they are credible.

    But the unintended consequence of litigation run amok, argues the profession, is that audit quality is worse. Accounting rules are increasingly interpreted prescriptively rather than based on broad principles that are seen as too fuzzy to hold up in court. Auditors themselves, fearful of lawsuits, are inclined to adopt a check-the-box approach, adhering strictly to accounting rules rather than exercising (necessarily subjective) judgment. And the looming threat of litigation, argues the profession, hurts the recruitment and retention of the best and brightest talent. Who wants to be a partner in a firm that faces billions of dollars in lawsuits? asks one company boss.

     The cap doesn't fit

    Arguably the litigation problem worsens the issue of industry concentration, because only auditors with deep pockets can afford to take on the risk of making a mistake with a large public company. The Big Four point out that some European countries have caps on auditor liability. As a consequence, they say, there is significantly less concentration in these markets, an outcome they seem willing to contemplate. In Germany, for example, where auditor exposure is capped at euro4m ($5.2m), 67 of the biggest 300 listed companies are audited by firms outside the ranks of the Big Four. In Greece, where the audit cap is set, bizarrely, at five times the salary of the president of the Supreme Court, 27 of the 60 companies listed on the Athens stock exchange are audited by firms outside the Big Four.

    >But these arguments have failed to sway regulators in America and Britain, where auditor-liability reform is most debated. Britain's Office of Fair Trading recently considered and rejected auditor caps, saying that it found little evidence that caps encouraged competition or would do anything to reduce the risk of the collapse of a Big Four firm. Indeed, caps might make concentration worse, since they would help the Big Four, who are already most exposed, more than smaller outfits. As for recruitment, figures show that, in America at least, the number of students taking accounting courses has risen sharply since the scandals at Enron and WorldCom were uncovered.

     Can anything be done to shore up the audit profession's latent instability? Ideally, the market would self-correct. Where profits are to be made, you should find new entrants, says Peter Wallison of the American Enterprise Institute, a think-tank. But the barriers to entry in the audit of the biggest companies are exceedingly high. Building huge international networks is difficult and expensive. And legal rules in many countries mean that audit firms have to be partnerships, so cannot raise funds on the capital markets.

     Regulation is another big barrier. The cost of doing public audits has increased dramatically, stretching capacity thin. As an indication of increased regulatory costs, E&Y's Mr McGrath says that so far this year, his firm has spent nearly 400,000 man-hours on training and education on Section 404 alone. Given how expensive it is to comply with the new regulations in order to do audits of public companies, and the significant downside from litigation, why would a smaller firm want to take this on? asks Mr Wallison.

    ** NOTE: This story has been truncated


    David Reilly and Alessandra Galloni, "Facing Lawsuits, Parmalat Auditor Stresses Its Disunity:  Deloitte Presented Global Face, But Says Arms Acted Alone; E-Mail Trail Between Units:  A Liability Threat for Industry,"  The Wall Street Journal, April 28, 2005; Page A1 --- http://online.wsj.com/article/0,,SB111464808089519005,00.html?mod=todays_us_page_one The Big Four accounting firms -- Deloitte, PricewaterhouseCoopers, KPMG and Ernst & Young -- have long claimed in court cases that their units are independent and can't be held liable for each other's sins. U.S. courts to date have backed that argument. The firms say the distinction is important -- allowing them to boost the efficiency of the global economy by spreading uniform standards of accounting around the world, without worrying that one unit's missteps will sink the entire enterprise. But Deloitte e-mails seized by Italian prosecutors and reviewed by The Wall Street Journal, along with documents filed in the court cases, show how the realities of auditing global companies increasingly conflict with the legal contention that an accounting firm's units are separate. The auditing profession -- which plays a central role in business by checking up on companies' books -- has become ever-more global as the firms' clients have expanded around the world. But that's creating new problems as auditors face allegations that they bear liability for the wave of business scandals in recent years.
    Bob Jensen's threads on Deloitte's legal woes are at http://faculty.trinity.edu/rjensen/fraud001.htm#Deloitte
    Bob Jensen's threads on the future of auditing are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing

     

    "GRANT THORNTON LLP ANNOUNCES FIVE STEPS TO INCREASED CHOICE AND COMPETITION FOR PUBLIC COMPANIES AND AUDITORS," by Andrew Priest, AccountingEducation.com, April 21, 2005 --- http://accountingeducation.com/news/news6097.html

    Calling on regulators, public company boards and executives, auditors and other capital markets influencers to take action to protect capital markets and investors, Grant Thornton LLP announced its Five Steps to Increased Choice and Competition for Public Companies and Auditors.

    "Sarbanes-Oxley - not to mention the numerous accounting failures leading up to it - has dramatically changed the audit environment," CEO Ed Nusbaum told members of The National Press Club in Washington on Friday. "But there is also another, less-reported factor in play, and that's the ongoing consolidation and resulting concentration in the accounting profession."

    Citing a Government Accountability Office (GAO) study, which found that 97 percent of public companies with sales between $250 million and $5 billion are audited by the Big Four, Mr. Nusbaum said that the high level of concentration in the accounting profession is the result of decades of consolidation, the fall of Andersen, and unchecked liability exposure that prevents smaller firms from competing. Misconceptions among capital markets influencers who believe only the four largest firms are capable of auditing public companies further limits company choice, he added.

    Managing Partner of Strategic Relationships Cono Fusco further explained that there is an array of firms capable of serving the varying and diverse needs of public companies. "Effectively matching company size and requirements with firm size and capabilities allows companies to find the best combination of quality, service, value and reach, and protects markets by spreading risk among a greater number of firms," he said.

    To accomplish this objective and to protect markets, Grant Thornton LLP proposes the following Five Steps to Increased Choice and Competition for Public Companies and Auditors: The SEC and our nation's stock exchanges must encourage, as a best practice, that public companies conduct a periodic review of their audit firm. As a matter of good governance and good business, companies should be encouraged to periodically evaluate their audit firm to be sure they are getting the best combination of quality, service, value and reach from their firm.

    Public company boards and audit committees must embrace the new market realities and "right-size" their audit firm.

    Matching company size, complexity and requirements with firm size and capabilities, companies may very well reaffirm their decision to continue working with their current audit firm. But, they also may find that another firm combines the same or better technical expertise with service, attention and market or industry expertise that makes for a better fit.

    Companies and other capital markets influencers - including investors, analysts, commercial and investment bankers, and attorneys - must recognize the new paradigm between companies and their external audit firms and open the door to more audit firm choices.

    There are more than four audit firms capable of serving public companies, but misconceptions in the capital markets preempt company choices. This cannot be allowed to continue. Influencers must reach out to the broader array of audit firm choices and conduct proper due diligence before discouraging a company from selecting a non-Big Four firm better suited to meet its needs. Auditors must facilitate this process by reaching out to and increasing their visibility with gatekeeper groups.

    The PCAOB and the audit profession must implement coordinated best practices for the audit process, and firms must periodically assess whether or not they have the requisite attributes to serve specific clients.

    Sharing best practices - including audit procedures, evaluation of fraud risk and possibly even audit software - among the leading audit firms would significantly enhance audit effectiveness and increase public confidence in quality audits.

    Because the best audits are completed when companies and audit firms are appropriately matched, auditors should also evaluate their resources in relation to client needs to determine if they are still appropriately matched in terms of size and service capabilities.

    A debate and discussion on the topic of caps on auditor liability exposure must begin.

    The possibility of being held responsible not only for the magnitude of an error but also for the current market psychology and valuation levers for an individual company creates what could become unlimited liability. This makes it difficult for smaller firms to compete.

    To eliminate this barrier to entry and promote competition in the accounting profession, the insurance industry, elected officials, the accounting profession, businesses and others in the capital markets must work together to implement liability caps. Firms should be accountable for their work, but not for the vagaries of market psychology.


    Question
    Why aren't accounting graduate programs competing high on the list of the brightest and most creative graduates from undergraduate programs? And why do some of our graduate students become unhappy on the job?

    February 18, 2006 message from Dennis Beresford [dberesfo@terry.uga.edu]

    Bob,

    If you haven't seen it already, I'm attaching a copy of an article from the January issue of The CPA Journal that provides excellent advice to students about to begin a career in accounting. We hear so much about the need for business schools to train "leaders" but the article provides the rest of the story.

    Denny

    The link to the article is "Public Accounting Needs Good Followers," by Barry P. Arlinghaus, The CPA Journal, January 2006 --- http://www.nysscpa.org/cpajournal/2006/106/perspectives/p6.htm

    The Structure of Accounting Firms

    Little public information is available about what really goes on in public accounting firms with regard to how decisions are made at each level and to what extent followers have any real input into the process. Most litigation is settled out of court, so deciphering the decision-making process that led to various high-profile cases is difficult. My perception is anecdotal and based on feedback from former students. However, I suspect that had the “partner model” been in place, the accounting firms would not have been the subject of much of the criticism and litigation noted above, however justified or unjustified. I have to believe that good followers would have provided constructive criticism, good leaders would have listened—the role of accounting firms in business failures, abusive tax shelters, and other such embarrassments to the profession would have been minimized under a “partner model.”

    The business model in public accounting and other personal service firms is based on leverage—the so-called pyramid. Staff are assigned to audits and consulting projects supervised by seniors or managers and, ultimately, partners. Those at the lower levels are billed out at fees that are significantly higher than what they are being paid themselves. The bulk of the hours on an engagement are worked by those at the lower levels of the organization. The difference between the fees charged and the compensation of those providing the service covers various overhead costs, such as administration, office space, and training, as well as litigation costs and a provision for a return to firm partners. This is the traditional business model, and there is nothing inherently wrong or immoral about it.

    Realistically, this business model will continue. To make the model work, firms think they need “implementers” at the lower levels. They need staff, and arguably seniors and managers, that the partners can count on to get the job done and not require much oversight or explanation. After all, they are not formulating strategy, establishing firm policies, or making business decisions for the firm. The partners, or at least some partners, do these things.

    But how can one grow from an “implementer” to a “partner” if the culture is to do but not to question? Managers and seniors in public accounting need to develop the ability to question in an appropriate manner at an appropriate level at an appropriate time, so they can do that as firm partners. Firms can no longer afford the “yes man” and groupthink. It is good business for seniors, managers, and partners to critically assess and, at times, constructively disagree with firm policy and strategy. And, in those hopefully rare situations when it is necessary, they must raise the cautionary flag when the firm appears headed down the wrong path on ethical issues.

    I also suspect it is difficult for an “implementer,” at whatever level within the firm, to question client behavior if the firm’s culture stresses getting the job done without explanation and holds that “clients are gods.” The extreme example occurred with Enron, where David Duncan was a leader with an implementer mindset and Carl Bass tried to be an exemplary follower. Duncan, the lead partner on the Enron engagement, colluded with the client and on numerous occasions overruled Andersen’s professional standards group. Bass, the partner in the Houston office in the professional standards group, insisted on proper accounting and was ultimately removed from the Enron engagement (see Mike McNamee, Amy Borus, and Christopher Palmeri, “Out of Control at Andersen,” Business Week Online, March 29, 2002).

    Moving Forward

    The pyramid business model will not change, and it does not necessarily need to. But the culture in accounting firms does need to change. Firms must cultivate good followers and create an environment conducive to good followership. This means an environment that encourages constructive criticism. It means partners and people at all levels who listen. This means really listening to critical ideas; it does not mean leaders with a supposed open-door policy that, via their verbal and nonverbal behavior, intimidate those who want to make suggestions or provide constructive criticism.

    From what I hear, firms are moving in this direction. But they need to go beyond mission statements and guiding principles, public interest councils, hotlines, and ethics courses. Whether a culture encourages good followers depends on what people actually do and how they treat each other. Firms should review and modify personnel evaluation practices, so those who provide constructive criticism or play the devil’s advocate are rewarded, not punished. They should establish and monitor mentorship programs that provide less-experienced personnel, at whatever level, with someone who really listens and not someone who has morphed into the “android” mentality. Yes, at whatever level, because just as staff need mentors, new partners need mentors. They should revise promotion criteria to encourage the development of good followers. Partners should be true partners, not implementers.

    There is more on the front part of this article not quoted above.

    February 19, 2006 reply from Bob Jensen

    In the process of looking up the link to the above article, I found a somewhat discouraging piece called "Give Me the Good and the Bright," by Michael K. Shaub, The CPA Journal, February 2006 --- http://www.nysscpa.org/cpajournal/2006/206/perspectives/p6.htm 

    Even with the string of financial frauds that led to the Sarbanes-Oxley Act of 2002 (SOX), some accounting professors continue to wring their hands not over the moral failures of the profession, but over attracting students who are “the best and the brightest.”

    A study by professors Thomas Frecka and William Nichols, published in Issues in Accounting Education, found that the best MBA programs are attracting students with significantly higher test scores than are the top graduate accounting programs.

    Changing the Curriculum to Attract New Recruits

    The proposed solution to this is, as always, improving the creativity and relevance of graduate accounting programs. Graduate accounting programs are seen as cookie-cutter curricula that point only toward the traditional role of CPAs as auditors. Graduates are perceived as having inadequate business savvy, and the implication is that they are no match for their MBA counterparts.

    Perhaps improving the relevance of graduate accounting programs is the solution to attracting the best and the brightest to the profession. Universities appear to be willing to do whatever is necessary to draw in targeted students, including classes any time of day or night (or online), hands-on experience, world travel, or an enviable lineup of guest speakers. So maybe more relevant and creative accounting programs will be enough to fix the problem

    Continued in article

    Jensen Comment
    The above article focuses on changing the accounting curriculum to attract better (in terms of test scores and creativity) students into accounting programs. It's not like we've ignored this problem or failed to experiment with curriculum alternatives. The AAA formed the Accounting Education Change Commission in 1989 with $4 million funding from the, then, Big Eight accounting firms. Grants were awarded to various universities who proposed experimenting with curriculum changes --- http://aaahq.org/facdev/aeccgsc.htm
    Links to AECC literature at the American Accounting Association's Website are at http://aaahq.org/facdev/aecc.htm

    I think articles like Shaub article that suggest more ethics in the curriculum miss the main point. The problem is timing of career choices and the enormously different sizes of candidate pools from which MBA and law schools draw graduate students versus the candidate pools for graduate schools of accountancy. Law schools and MBA programs draw from pools of students who majored in virtually anything from philosophy to engineering. Accounting programs draw from pools of students who majored in accounting after having made that career choice by the time they are sophomores or juniors. This in large measure is due to the many accounting courses that are prerequisites for graduate courses in accounting.

    The odds are much better for attracting bright and creative students from a pool of a million broad-skilled graduates than a pool of 50,000 students who by happenstance decided to major in accountancy before they were twenty years of age. We could change our graduate accounting curriculum so that a philosophy or engineering undergraduate could get into a two year program without having had a single accounting undergraduate course. Then we would have to decide whether the graduate accounting program is almost all comprised of accounting courses. No such graduate programs exist today, because to my knowledge no graduate accountancy program is designed to totally replace undergraduate accounting content plus add graduate content. Instead we make the philosophy and engineering graduates take a year or more of undergraduate accounting before eligible to take the graduate accounting courses. This adds a year or more of undergraduate study that is not required in MBA programs and law schools.

    What MBA programs do not face is licensure examinations that the curriculum must, at least in part, prepare them for in some of the courses. Law schools face the bar examinations, but law schools have three years of full time courses in their curricula.

    The bottom line is that we’re between the rocks of licensure examinations like the CPA examination and certification examination exams like the CMA and Internal Auditor examinations professional work that requires very technical expertise. At the other extreme there are hard places that require back-slapping personality and leadership skills and community involvement skills required for attracting clients.

    How do you design a curriculum for all that? Even law schools leave out a lot of the technical content like detailed tax courses because there is not enough time even in three years for all the technical content.

     




     

     

     

    Whistle Blowing is Often Not Rewarded But Times Are Changing

    Sometimes, but not usually, whistle blowing is rewarded

    Whistleblower --- http://en.wikipedia.org/wiki/Whistleblower

    From the CFO Journal's Morning Ledger on September 2, 2016

    Whistleblowing, career safety at odds
    In a perfect world, whistleblowing would be celebrated universally, but this ain’t a perfect world. That’s the message David Mayer, a professor of management and organizations at the University of Michigan business school. Those who speak out about wrongdoing in organizations often suffer retaliation, he writes for Harvard Business Review, both at their current organization and in their attempt to find future employment


    SEC:  More Than $16 Million Awarded to Two Whistleblowers ---
    https://www.sec.gov/news/press-release/2017-216

    Washington D.C., Nov. 30, 2017 —

    The Securities and Exchange Commission today announced awards of more than $8 million each to two whistleblowers whose critical information and continuing assistance helped the agency bring the successful underlying enforcement action.

    With this case, SEC enforcement actions involving whistleblower awards have now resulted in more than $1 billion in financial remedies ordered against wrongdoers.

    The first whistleblower alerted SEC enforcement staff of the particular misconduct that would become the focus of the staff’s investigation and the cornerstone of the agency’s subsequent enforcement action.  The second whistleblower provided additional significant information and ongoing cooperation to the staff during the investigation that saved a substantial amount of time and agency resources.   

    “Whistleblowers have played a crucial role in the progression of many investigations and the success of enforcement actions since the inception of the whistleblower program,” said Jane Norberg, Chief of the SEC’s Office of the Whistleblower.  “The value of whistleblowers can be seen in the more than $1 billion in financial remedies ordered against wrongdoers based on actionable information from whistleblowers, including more than $671 million in disgorgement of ill-gotten gains, much of which has been or is scheduled to be returned to harmed investors.” 

    The SEC’s whistleblower program has now awarded more than $175 million to 49 whistleblowers since issuing its first award in 2012.  All payments are made out of an investor protection fund established by Congress that is financed entirely through monetary sanctions paid to the SEC by securities law violators. No money has been taken or withheld from harmed investors to pay whistleblower awards. 

    Whistleblowers may be eligible for an award when they voluntarily provide the SEC with original, timely, and credible information that leads to a successful enforcement action.  Whistleblower awards can range from 10 percent to 30 percent of the money collected when the monetary sanctions exceed $1 million. 

    By law, the SEC protects the confidentiality of whistleblowers and does not disclose information that might directly or indirectly reveal a whistleblower’s identity.

    For more information about the whistleblower program and how to report a tip, visit www.sec.gov/whistleblower.

     


    IRS Whistleblower Awards Jump 322% ---
    http://taxprof.typepad.com/taxprof_blog/2017/01/irs-whistleblower-awards-jump-322.html


    This tidbit serves two major purposes.

    1. It shows the importance of testing for effectiveness of hedging contracts when hedge accounting under FAS 133 is utilized.

    2. It shows how not to treat employees who blow the whistle.

    Financial Firm Allegedly Hunted Down Whistleblowers ---
    http://blogs.wsj.com/riskandcompliance/2017/01/19/financial-firm-allegedly-hunted-down-whistleblowers-amid-sec-accounting-inquiry/

    A Seattle-based bank agreed to settle allegations from the Securities and Exchange Commission that it conducted improper accounting and later took steps to impede potential whistleblowers.

    HomeStreet, which primarily serves the western U.S. and Hawaii, agreed to pay a $500,000 penalty without admitting or denying wrongdoing.

    The bank, according to the SEC, made unsupported adjustments to its hedge effectiveness testing to ensure it could continue using favorable accounting treatment. The SEC also alleged that after HomeStreet employees reported concerns to management about accounting errors, the company concluded the adjustments to its effectiveness tests were incorrect. When the SEC contacted HomeStreet in April 2015 seeking documents related to hedge accounting, the bank assumed it was in response to a whistleblower complaint and it started trying to identify the tipster, the agency said.

    One person considered to be a whistleblower, the SEC said, was told that the terms of an indemnification agreement could allow the bank to deny payment for legal costs during an SEC investigation. And the bank required former employees to sign severance agreements waiving potential whistleblower awards, or risk losing their severance payments.

    “Companies that focus on finding a whistleblower rather than determining whether illegal conduct occurred are severely missing the point,” said Jina Choi, director of the SEC’s office in San Francisco, in a statement.

    In a press release, HomeStreet Chairman and Chief Executive Mark Mason said the company was pleased the SEC had not alleged intentional deception or fraud by the bank or its officers, but also took issue with the SEC’s press release on the settlement: “To the extent that the SEC’s press release implies that the treasurer and chief investment officer acted with anything other than a sincere belief that he was properly testing hedge effectiveness according to his understanding of the economic correlation of the loans and swap contracts, we believe that such an implication would be inconsistent with the allegations contained in the settlement agreement.”

     Continued in accounting


    Bradley A. Berkenfeld:  I Won $104 Million for Blowing the Whistle on My Company—But Somehow I Was the Only One Who Went to Jail ---
    https://melmagazine.com/i-won-104-million-for-blowing-the-whistle-on-my-company-but-somehow-i-was-the-only-one-who-went-to-7ed8a808d50c#.4rvzavrxp


    SEC's Relatively New Whistleblowing Rewards Program is a Game Changer

    The Securities and Exchange Commission's 5-year-old whistleblower program has obtained more than 14,000 tips, including nearly 4,000 in 2015. Officials call the program a game changer that has had a "transformative impact" on how the SEC pursues misconduct.
    Peter J. Henning, New York Times, September 6, 2016
    http://www.nytimes.com/2016/09/07/business/dealbook/whistle-blowing-insiders-game-changer-for-the-sec.html?_r=0

    Jensen Comment
    External auditors are not very good at detecting frauds. Typically insiders expose frauds, although whistle blowing is controversial and often more damaging to the whistleblower than rewarding

    "SEC Probes Companies’ Treatment of Whistleblowers:  Agency Officials Concerned About Corporate Backlash Against Whistleblowers," by Rachel Louise Ensign, The Wall Street Journal, February 25, 2015 ---
    http://www.wsj.com/articles/sec-probes-companies-treatment-of-whistleblowers-1424916002?tesla=y

    The Securities and Exchange Commission is probing whether companies are muzzling corporate whistleblowers.

    In recent weeks the agency has sent letters to a number of companies asking for years of nondisclosure agreements, employment contracts and other documents, according to people familiar with the matter and an agency letter viewed by The Wall Street Journal. The inquiries come as SEC officials have expressed concern about a possible corporate backlash against whistleblowers.

    Some of these types of documents sometimes include clauses that impede employees from telling the government about wrongdoing at the company or other potential securities-law violations, according to lawyers who handle whistleblower cases and some members of Congress. In some cases, the firms require employees to agree to forgo any benefits from government probes, effectively removing the financial incentive for participating in the SEC program.

    In a separate January letter to Rep. Maxine Waters (D., Calif.) that was reviewed by the Journal, SEC Chairman Mary Jo White said she was concerned about the agreements.

    The SEC has made a push to bring more whistleblower cases since the 2010 passage of the Dodd-Frank financial-reform bill, which created the agency’s whistleblower program.

    Whistleblowers have flocked to the SEC program, with the number of tips increasing each year. The agency fielded 3,620 tips on potential securities-law violations in the 2014 fiscal year, up 21% from two years before.

    As part of the program, tipsters can get between 10% and 30% of the sum of penalties collected if their information leads to an SEC enforcement action with sanctions of more than $1 million. The program handed out an award for more than $30 million last year to an undisclosed foreign tipster, which was its largest ever.

    Dodd-Frank regulations prohibit companies from interfering with employees reporting potential securities-law violations to the agency.

    An SEC spokesman declined to comment.

    Continued in article

    From the CFO Journal's Morning Ledger on February 20, 2015

    A whistleblower’s horror story
    Recent exposés of less than proprietary behavior in government and in business has led 
    Rolling Stone Magazine  to call this era the age of the whistleblower. As Matt Taibbi writes, “whistleblowers are becoming to this decade what rock stars were to the Sixties — pop culture icons, global countercultural heroes.” But today’s whistleblowers tend to partake in little of the spoils and almost none of the glamour. In fact their lives are very often almost destroyed in the process.

    Bob Jensen's threads on other whistleblower horror stories --- See Below


    From the CFO Journal's Morning Ledger on April 23, 2015

    Real Housewives’ whistleblower scores millions in payout
    http://www.wsj.com/articles/whistleblower-jim-marchese-scores-millions-in-payoutagain-1429695001?mod=djemCFO_h
    Bank of America Corp
    .’s multibillion-dollar settlement last year brought Jim Marchese, of “Real Housewives of New Jersey” fame, a rare second seven-digit award. In 2007, he received $1.6 million after reporting his former employer for allegedly defrauding Medicare.


     

     
       

    From the CFO Journal's Morning Ledger on December 18, 2014

    BofA whistleblower to get nearly $58 million
    http://www.wsj.com/articles/bofa-whistleblower-to-get-nearly-58-million-filing-1418858087
    Edward O’Donnell, the former Countrywide Financial Corp. executive who filed a whistleblower lawsuit against his former firm, will collect nearly $58 million. The U.S. Attorney’s Office in Manhattan used Mr. O’Donnell’s allegations as the basis of its $16.65 billion lawsuit against Bank of America Corp., which acquired Countrywide.

    SEC gives internal auditor $300,000 whistleblower award
    The Securities and Exchange Commission is giving a $300,000 whistleblower award to a corporate internal auditor who provided information that directly resulted in an enforcement action. The auditor had reported the wrongdoing internally, but when no action was taken within 120 days, the auditor turned to the SEC. Awards to whistleblowers range from 10% to 30% of the money collected from an enforcement action. CFO.com (8/29)


    "Auditors Can Be Whistleblowers: A Guest Post On Recent Developments In Whistleblower Case Law," by Francine McKenna, re:TheAuditors, January 5, 2015 ---
    http://retheauditors.com/2015/01/05/auditors-can-be-whistleblowers-a-guest-post-on-recent-developments-in-whistleblower-case-law/

    It’s rare but it does happen. Employees of the largest audit firms do occasionally step up and blow the whistle on potentially illegal and/or unethical activities at their firm or its clients.

    The Guardian writes about the whistleblower now formally charged in Luxemburg for leaking PwC’s copies of tax letter ruling documents:

    A 28-year-old former PricewaterhouseCoopers auditor charged with theft and violating trade secrets in Luxembourg in the wake of the LuxLeaks tax avoidance scandal has revealed his identity and claimed he acted out of conviction, in an interview with the French newspaper Libération.

    Antoine Deltour, who joined PwC from business school in 2008, resigned two years later. “Normally auditors are a bit like regulators. It is a useful profession, we verify the accounts of companies,” he told the newspaper. “But I wasn’t feeling at home in that environment [at PwC]. Bit by bit I discovered how extreme the system was in reality – it was a massive tax optimisation practice. I didn’t want to be part of that.

    The most interesting thing about Deltour’s admissions is that he believes he is not alone.

    Deltour, who said he had not passed information to the ICIJ, told Libération: “From the beginning, I acted out of conviction, for my ideas, not to appear in the media.”

    He added that he was part of “a broader movement” — a reference to the fact that the Guardian and other media working with the ICIJ had this month published more revelations and further confidential tax rulings secured by Ernst & Young, KPMG and Deloitte.

    It will be interesting to see if PwC and the other large firms can squelch this “movement” with threats and legal action or whether the cat is already out of the bag. If professionals in the US, UK or Australia become willing to act “out of conviction” and expose activities that their firms cover up on behalf of clients or that contravene public policy and the public good, we may witness a sea change return to the concept of the auditor’s “public duty” rather than the typical “pleaser” personality that is highly risk-averse, prone to group think,  and fears a black mark on his or her permanent record above all.

    Continued in article


    "Enron Revisited as Court Reviews Whistle-Blower Shield," by Greg Stohr, Bloomberg Businessweek, November 12, 2013 ---
    http://www.bloomberg.com/news/2013-11-12/sarbanes-oxley-whistle-blower-shield-scrutinized-by-high-court.html

    The U.S. Supreme Court revisited the Enron Corp. collapse as the justices debated whether whistle-blower protections in a 2002 law cover employees of auditors, law firms and other advisers to publicly traded companies.

    Hearing arguments today in the case of two former mutual-fund industry workers, the justices tried to sort out a law that represented Congress’s response to the accounting fraud behind Enron’s 2001 failure. The fast-paced session was laced with questions about a hypothetical butler working for the late Kenneth Lay, who was Enron’s chairman, and the role of the company’s accounting firm, Arthur Andersen LLP.

    The case will determine the scope of whistle-blower protections that watchdog groups say are important to prevent another Enron-like catastrophe. The dispute pits business groups against President Barack Obama’s administration, which is seeking a broad interpretation of the whistle-blower provision.

    “That’s what Congress intended to cover: these accountants, lawyers and outside auditors who were so central to the fall of Enron,” said Nicole Saharsky, a Justice Department lawyer. Enron, once the world’s largest energy trader, collapsed after using off-books partnerships to hide billions of dollars in losses and debt. That also brought down Arthur Andersen.

    Sarbanes-Oxley Law

    The dispute turns on a provision in the 2002 Sarbanes-Oxley law barring publicly traded companies and their contractors and subcontractors from discriminating against an “employee” who reports fraud or a violation of securities regulations. The central question is whether that provision allows retaliation lawsuits only by the employees of the public company, or by those of its contractors as well.

    The case is significant for the mutual fund industry. While the funds themselves are publicly traded, they typically have few if any employees, instead using privately held companies to conduct day-to-day activities.

    The suing employees, Jackie Hosang Lawson and Jonathan M. Zang, worked for units of privately held FMR LLC. The units provide investment advice and management services to publicly traded Fidelity mutual funds.

    The workers say they lost their jobs after reporting fraud. Lawson complained that expenses were being inflated and, ultimately, passed on to fund shareholders. Zang contended that a Fidelity statement filed with the Securities and Exchange Commission misrepresented how portfolio managers were compensated.

    Appeals Court

    FMR denies the allegations and says both employees had performance problems. Zang was fired in 2005 and Lawson resigned in 2007.

    A federal appeals court ruled that Lawson and Zang can’t sue for retaliation under Sarbanes-Oxley because they didn’t work for publicly traded companies.

    The workers’ lawyer, Eric Schnapper, said the lower court ruling “has the implausible consequence of permitting the very type of retaliation that we know Congress was concerned about, retaliation by an accountant such as Arthur Andersen.”

    Several justices suggested Schnapper’s interpretation of the law -- as protecting all the employees of a publicly traded company’s contractors and subcontractors -- would sweep too broadly.

    Justice Stephen Breyer asked whether Schnapper’s approach would allow lawsuits by employees of a gardening company that cuts the grass outside a company’s office building.

    ‘Mom-and-Pop Shop’

    Does the statute “make every mom-and-pop shop in the country, when they have one employee, suddenly subject to the whistle-blower protection for any fraud, even those frauds that have nothing to do with any publicly traded company?” Breyer asked Schnapper.

    Schnapper said his interpretation of the statute wouldn’t apply to employees of the company’s officers, including “Ken Lay’s butler.”

    Continued in article

    Bob Jensen's threads on Enron, including a timeline ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing


    October 27, 2010 message from Bob Jensen

    Hi David,

    I once had a professor who asserted in class that America was a land of cop haters who despised the scum that ratted to the cops for whatever reason --- a posted reward, a lighter sentence, media attention, book royalties, guilty conscience, religious guilt/fear, personal revenge, or whatever.

    American is also a land where it's often very difficult to detect perpetrators of crimes and to get convictions without despised scums that rat/snitch to the cops. The most important power of the police is that of being the place where whistleblowers/informants come forth to aid in detecting perpetrators of crimes and to help in gaining convictions in court.

    I would not say I'm such a huge fan of whistleblowers. I just don't despise them as much as dastardly criminals. And I'm a realist who genuinely feels that many more criminals would go scott free if it were not for whistleblowers/informants.

    I also think that we sometimes dwell on motives we don't respect (e.g., collecting rewards, book royalties, and revenge) and overlook the price paid by whistleblowers (ostracism, loss of friends, loss of job, loss of career, loss of savings, loss of respect, and fear of retaliation).

    Thus we are torn between hating whistleblowers and desperately needing them for the criminal justice system. I would assert that nearly all corporate frauds have been uncovered because of whistleblowers and not internal or external auditors acting without the help of some whistleblowers along the way. Of course, sometimes the whistleblowers are also auditors who sometimes see the need to bypass the chain of command.

    Trivia Questions
    Who were the famous whistleblowers working for Enron and WorldCom?
    How did they bypass the chain of command? (especially interesting in the case of Enron)

    Hint:  Both were women accountants!

    Bob Jensen's threads on Enron and WorldCom ---
    http://faculty.trinity.edu/rjensen/FraudEnron.htm

     


    Nine Famous Whistle-Blowers: Where Are They Now?

    This includes updates on Sherron Watkins (foul mouthed whistle blower who helped bring down Enron)
    This includes updates on Cynthia Cooper (persistent internal auditor whistle blower that helped bring down Worldcom)

    9 Famous Whistle-Blowers: Where Are They Now?
    http://www.businessinsider.com/9-famous-whistle-blowers-2013-6?op=1

    Bob Jensen's threads on Sherron (Smith) Watkins and Cynthia Cooper are at
    http://faculty.trinity.edu/rjensen/FraudEnron.htm

    Two types of speakers are popular on the convention circuit --- former whistle blowers and former fraudsters (after their prison years)
    Both types usually write top selling books as well.
    One problem with former fraudsters is that recidivism is somewhat high

    "Recidivism and Risk Management: Barry Minkow Goes Back to the Slammer," by Jim Peterson, re:Balance, March 2011 --- Click Here
    http://www.jamesrpeterson.com/home/2011/03/recidivism-and-risk-management-barry-minkow-goes-back-to-the-slammer.html

    Bob Jensen's threads on whistle blowing ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

    Can Ethics Be Taught?
    "Crazy Eddie Revisited: Old Lessons for Today's Accountants," by Anthony H. Catanach Jr., Grumpy Old Accountant, June 7, 2013 ---
    http://grumpyoldaccountants.com/blog/2013/6/7/crazy-eddie-revisited-old-lessons-for-todays-accountants

     


    SEC Ups the Rewards

    "SEC Whistleblower Fund Totals $450 Million," Huffington Post, October 29, 2010 ---
    http://www.huffingtonpost.com/2010/10/29/sec-whistleblower-fund-450-million_n_776397.html

    The Securities and Exchange Commission says it has set aside about $450 million for payments to outside whistleblowers whose information results in successful cases and penalties collected from companies or individuals.

    The SEC set up the program in accordance with the financial overhaul law enacted in July. It follows intense public criticism of the agency for the breakdown that allowed Bernard Madoff's multibillion-dollar fraud to go undetected for 16 years, despite numerous red flags raised by whistleblowers.

    A report issued Friday by the SEC shows it has put $451.9 million into a new fund to pay whistleblowers, which must have a minimum $300 million.

     


    A whistleblower should really wear a mask, ride a white horse, and have a native American partner to help track the piles of Kemosabi. The William Tell Overture also helps --- http://www.youtube.com/watch?v=qdQomfnCH_0

     

    If the SEC and/or Andersen offered high rewards at executive levels to whistle blowers in clients and in the local offices of their own firms, there never would have been an Enron implosion.  Andy Fastow would have never attempted such financial deceptions if it was almost certain from the beginning that somebody would become wealthy by blowing the whistle.  Enron would never have bet the farm amidst serious whistle blowers.

    Under our present systems, whistle blowers take huge gambles with their careers in spite of some minimal protections afforded by SEC rules.  Unrewarded whistle blowing does take place on occasion and is usually the most important move toward correcting serious problems.  But since systems highly discourage whistle blowing, whistle blowers generally do not come forth until late in the deceptions.

    Even if accounting firms highly rewarded whistle blowing, the rewards might not offset the physical dangers to families of whistle blowers who messed up some highly profitable ventures.  Whistle blowers might have to be willing to enter witness protection programs that separate them from former friends and family.  The same might apply to accounting firm executives who attempt to take action when alerted by whistle blowers.  There's  a mean world of high-stakes finance out there.


    February 5, 2010 message from Francine McKenna [retheauditors@GMAIL.COM]

    An interesting syllabus for a course at U Central Florida by Steve Sutton.http://www.bus.ucf.edu/ssutton/

     

    Ethics and Professionalism in Accounting and Auditing (ACG 6835)

    Spring 2010

    Course Schedule

    http://www.bus.ucf.edu/ssutton/A6835_syl_files/A6835_course_schedule.htm

     If anyone else includes my content in their syllabus, please let me know.  I am making a list of professors teaching using "non-traditional" sources.
     [retheauditors@GMAIL.COM]

    (I'd also love to visit!)

    Thanks.

    fm

    February 6. 2010 reply from Bob Jensen
    Hi Francine,

    Thank you for the heads-up.

    I think the (slow loading) Baylor University video should be included in the curriculum of every accounting program and possibly the curriculum of every high school in the U.S.

    June 15, 2009 message from Dennis Beresford [dberesfo@TERRY.UGA.EDU]

    I apologize if this is something that has already been mentioned but I just became aware of a very interesting video of former WorldCom Controller David Meyers at Baylor University last March - http://www.baylortv.com/streaming/001496/300kbps_str.asx 

    The first 20 minutes is his presentation, which is pretty good - but the last 45 minutes or so of Q&A is the best part. It is something that would be very worthwhile to show to almost any auditing or similar class as a warning to those about to enter the accounting profession.

    Denny Beresford


    Jensen Comment on Some Things You Can Learn from the Video
    David Meyers became a convicted felon largely because he did not say no when his supervisor (Scott Sullivan, CFO)  asked him to commit illegal and fraudulent accounting entries that he, Meyers, knew were wrong. Interestingly, Andersen actually lost the audit midstream to KPMG, but KPMG hired the same same audit team that had been working on the audit while employed by Andersen. David Myers still feels great guilt over how much he hurt investors. The implication is that these auditors were careless in a very sloppy audit but were duped by Worldcom executives rather than be an actual part of the fraud. In my opinion, however, that the carelessness was beyond the pale --- this was really, really, really bad auditing and accounting.

    At the time he did wrong, he rationalized that he was doing good by shielding Worldcom from bankruptcy and protecting employees, shareholders, and creditors. However, what he and other criminals at Worldcom did was eventually make matters worse. He did not anticipate this, however, when he was covering up the accounting fraud. He could've spent 65 years in prison, but eventually only served ten months in prison because he cooperated in convicting his bosses. In fact, all he did after the fact is tell the truth to prosecutors. His CEO, Bernard Ebbers, got 25 years and is still in prison.

    The audit team while with Andersen and KPMG relied too much on analytical review and too little on substantive testing and did not detect basic accounting errors from Auditing 101 (largely regarding capitalization of over $1 billion expenses that under any reasonable test should have been expensed).

    Meyers feels that if Sarbanes-Oxley had been in place it may have deterred the fraud. It also would've greatly increased the audit revenues so that Andersen/KPMG could've done a better job.

    To Meyers' credit, he did not exercise his $17 million in stock options because he felt that he should not personally benefit from the fraud that he was a part of while it was taking place. However, he did participate in the fraud to keep his job (and salary). He also felt compelled to follow orders the CFO that he knew was wrong.

    The hero is detecting the fraud was Worldcom's internal auditor Cynthia Cooper who subsequently wrote the book:
    Extraordinary Circumstances: The Journey of a Corporate Whistleblower (Hoboken, New Jersey: John Wiley & Sons, Inc.. ISBN 978-0-470-12429) http://www.amazon.com/gp/reader/0470124296/ref=sib_dp_pt#

    Meyers does note that the whistleblower, Cooper, is now a hero to the world, but when she blew the whistle she was despised by virtually everybody at Worldcom. This is a price often paid by whistleblowers --- http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

    Bob Jensen's threads on the Worldcom fraud are at http://faculty.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud

     

     

    Other possible source material for ethics, independence, and professionalism courses is available at
    http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism

    The above site begins with one of my all time favorite quotations (from Steve Samek) that indirectly suggests that no matter how much ethics and professionalism is beat into the heads of students/employees in college and CPE courses, it might help but probably is like trying to get obese people to lose 200 pounds by taking nutrition courses. Andersen had some of the best ethics and professionalism courses ever developed, including a very expense set of CDs.

    The day Arthur Andersen loses the public's trust is the day we are out of business.  
    Steve Samek, Country Managing Partner, United States, on Andersen's Independence and Ethical Standards CD-Rom, 1999

    If a man's poor and not a bad fellow, he's considered worthless; if he is rich and a very bad fellow, he's considered a good client.
    Attributed to Titus Maccius Plautus, 255 BC to 185 BC
    In spite of all the warning signs, Enron was considered to be a juicy client. Andersen billed Enron over $1 million per week.

    Business Ethics --- http://en.wikipedia.org/wiki/Business_ethics
    Lots of Good Links

    Business Ethics by Business Week --- http://bx.businessweek.com/business-ethics/news/

    Advancing Quality through Transparency Deloitte LLP Inaugural Report ---
    http://www.cs.trinity.edu/~rjensen/temp/DeloitteTransparency Report.pdf 

    In my opinion the best preventative for ethics, independence, and professionalism violations is a very intensive whistleblower program that is much more than a sham ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

    At Andersen it proved to be a sham!

    "Auditor Received Warning on Enron Five Months Ago," by Richard A. Oppel, Jr., The New York Times, January 17, 2002 ---
    http://faculty.trinity.edu/rjensen/FraudEnron.htm#Hoax  

    According to Congressional investigators, the Enron employee, Sherron S. Watkins, called a former colleague at Andersen on Aug. 20 and told him of her concerns about the energy company's accounting. About the same time, Ms. Watkins also laid out her doubts in a letter to Enron's chairman, Kenneth L. Lay, disclosed earlier this week by a Congressional committee, that warned that the company might be revealed as an "elaborate accounting hoax."

    Ms. Watkins's letter pointed to new questions about Enron's web of partnerships and raised the possibility that the company might have to reduce past earnings by $1.3 billion more than it already has.

    In an internal Andersen memorandum obtained by the House Energy and Commerce Committee, Ms. Watkins's former colleague at Andersen wrote that "based on our discussion I told her she appeared to have some good questions."

    On the next day, Aug. 21, four Andersen officials met to discuss Ms. Watkins's concerns, investigators said. They included David B. Duncan, the lead partner on the Enron account, whom Andersen fired this week after saying he ordered the destruction of Enron documents while the company's accounting was under investigation by the S.E.C.

    The officials then "agreed to consult with our firm's legal adviser about what actions to take in response to Sherron's discussion of potential accounting and disclosure issues," according to the memo.

    Investigators say Andersen began the destruction of Enron documents in September and that an e-mail message from an Andersen lawyer on Oct. 12 re-emphasized Andersen's policy on destroying documents and encouraged the activity in the firm's Houston office.

    Mr. Duncan, who is cooperating with authorities, spent hours in Washington today with government officials who are investigating the failure of Enron, the Houston company that pioneered energy deregulation and grew to be the nation's seventh-largest company before seeking bankruptcy protection last fall.

    He met for the second time this week with officials from the Justice Department, which is conducting a criminal investigation of Enron's collapse. On Monday — the day before Andersen fired him — Mr. Duncan met with Justice Department officials as well as staff members from the S.E.C. and agents from the F.B.I., according to people close to the inquiries.

    This afternoon, he spent more than four hours answering questions from eight investigators for the House Energy and Commerce Committee, one of several panels in Congress reviewing Enron's demise. Flanked by his lawyers, Mr. Duncan was not sworn, but he was warned not to give false statements to Congress. There was no discussion of giving him immunity for his testimony, investigators said.

    "He answered our questions and provided us with some valuable information, which we are pursuing," said Ken Johnson, a spokesman for Representative Billy Tauzin, a Louisiana Republican and chairman of the committee. Mr. Johnson declined to comment in detail about the interview but said that Andersen's shredding of documents and handling of the Enron account were discussed.

    Continued at http://www.nytimes.com/2002/01/17/business/17ENRO.html  


    "Bribery and the Gathering Storm Over Compliance," by Peter J. Henning, The New York Times (DealB%k), April 1, 2011 ---
    http://dealbook.nytimes.com/2011/04/01/bribery-and-the-gathering-storm-over-compliance/

    While insider trading cases have been attracting much of the financial headlines, there is another issue that will have a much greater impact on corporate bottom lines: bribery.

    The British Ministry of Justice has announced guidelines for the implementation of the far-reaching Bribery Act of 2010, which goes into effect on July 1. Meanwhile, while the Securities and Exchange Commission is set this month to announce rules required by the Dodd-Frank Act to encourage whistleblowers to disclose information about corporate misconduct, most likely including violations of the Foreign Corrupt Practices Act.

    The Bribery Act is sure to drive up the costs of compliance programs for American companies doing business in Britain, while the Dodd-Frank Act’s whistleblower provisions may well render those programs superfluous, even though they will still be required by the Sarbanes-Oxley Act.

    The Foreign Corrupt Practices Act prohibits individuals and companies from paying bribes to foreign officials to obtain or retain business in the country. It also requires corporations that file reports with the S.E.C. to maintain accurate books and records in accordance with the accounting rules. The law, first adopted in 1977, has grown in importance over the past decade as the Justice Department, working with the S.E.C., has brought a number of cases against multinational companies for corrupt payments, resulting in millions of dollars of fines and penalties.

    Britain’s Bribery Act is broader in some respects than the Foreign Corrupt Practices Act, most importantly applying to any type of bribery, not just payments to foreign officials. The Bribery Act makes a company liable for the actions of those “associated” with a “commercial organization,” including any employee or agent who acts on its behalf, and the organization is strictly liable for any failure to prevent the bribery.

    For American companies, a key facet of the Bribery Act is its application to any organization that “carries on a business” in Britain. The Ministry of Justice’s guidance is not particularly helpful on the scope of the law, noting that it would not apply to foreign company that did not have a “demonstrable business presence” in Britain, and that a company is not necessarily liable if it lists its shares on a British exchange or maintains a subsidiary in the country. Rather than explaining what the law does cover, the guidance simply describes what might fall outside the Bribery Act, while noting that the courts will finally decide the issue. This provides little clarity about the scope of the law.

    The Bribery Act provides a defense for a company accused of a violation if it can show it had in place “adequate procedures” to prevent an associated person from engaging in bribery, something the Foreign Corrupt Practices Act does not recognize as a basis to avoid liability. The Ministry of Justice outlined six principles for preventing bribery that should guide companies in adopting or expanding a compliance program to help establish a defense to a charge. The principles focus on adequately assessing the risks of a violation and implementing a sufficiently rigorous program of prevention and monitoring.

    While almost every publicly traded American company already has a compliance program in place, the potentially broad scope of the Bribery Act is likely to require companies doing any substantial amount of business in Britain to devote even greater resources to preventing bribery of any type, not just that involving foreign officials. Compliance is not cheap, of course, which means the lawyers, accountants and outside consultants who specialize in this field will see an uptick in business.

    Continued in article

    Bob Jensen's threads on Rotten to the Core are at
    http://faculty.trinity.edu/rjensen/FraudRotten.htm


    A New Global Code of Ethics

    "When Should Accountants Spill the Beans? A new code of ethics puts finance chiefs on the hook to report suspected fraud to corporate boards,"
    by Kathleen Hoffelder, CFO.com, September 6, 2012 ---
    http://www3.cfo.com/article/2012/9/auditing_international-federation-of-accountants-iesba-code-of-ethics

    Under proposed changes to a global ethics code for accountants, while auditors must report a suspected fraud to outside authorities, management accountants need only report their suspicions internally. At the same time, if corporate accountants spill the beans to CFOs, finance chiefs must report what they’ve learned to other senior executives and the audit committee of the board.

    As a matter of principle, corporate accountants have always maintained a degree of confidentiality about companies’ finances. But there has never been any guidance concerning when that confidentiality should be breached.

    In the case of suspected fraud or other illegal acts, however, the International Ethics Standards Board for Accountants (IESBA), an independent standard-setting board, is finally suggesting new steps that different accountants should take to disclose that information to management, the board, or external sources. Last month the IESBA issued an exposure draft on how professional accountants should disclose suspected illegal acts committed by a client or employer. The draft adds changes to the Code of Ethics for Professional Accountants, which was first revised in 2009.

    The IESBA exposure draft distinguishes between auditors and corporate and other professional accountants. If the suspected illegal act affects financial reporting or is within the expertise of the auditor, the auditor would be required to discuss the issue with management and the audit committee. If the response within the company is, in the auditor’s judgment, “not appropriate” and “of such consequence that disclosure would be in the public interest,” the auditor must disclose the suspected illegalities to “appropriate” external authorities, according to the proposal.

    For other professional accountants, including those who work for corporations, the approach would be similar except for one thing: while auditors are required to report to an appropriate authority, staff and other accountants serving the company would be only obliged to discuss it with management and the audit committee.

    “For accountants, it is not a requirement to disclose to an appropriate authority; it’s a right they are expected to exercise,” explains an official at the IESBA. “We recognize the fact there are accountants at all levels within the organization,” the official adds. “For an accountant in business to have a requirement to always report out might be going a little far, so that’s why we have that slightly different test.”

    All this added responsibility for accountants, however, is not expected to lessen the role CFOs must play in ensuring their company’s financial reporting runs as accurately as possible.

    If a finance chief is told by his or her staff accountant about a suspected illegal act, the CFO would be governed by the same code of ethics, since he or she is in the accounting reporting chain. “All professional accountants have a part to play here if they encounter a suspected illegal act. A distinguishing mark of the accounting profession is its responsibility of acting in the public interest,” says the IESBA official.

    CFO.com (http://s.tt/1mGcO)

    Continued in article

    Bob Jensen's threads on whistle blowing ---
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing


    "Silencing the Whistleblowers:  Financial reform won’t prevent another bubble if banks bulldoze their internal warning systems," by Michael W. Hudson, The Big Money (Slate), May 9, 2010 --- http://www.thebigmoney.com/articles/judgments/2010/05/07/silencing-whistleblowers

    In early 2006, Darcy Parmer began to worry about her job. She was a mortgage fraud investigator at Wells Fargo Bank. Her managers weren’t happy with her. It wasn’t that she wasn’t doing a good job of sniffing out questionable loans in the bank’s massive home-loan program. The problem, she said, was that she was doing too good a job.

    The bank’s executives and mortgage salesmen didn’t like it, Parmer later claimed in a lawsuit, when she tried to block loans that she suspected were underpinned by paperwork that exaggerated borrowers’ incomes and inflated their home values. One manager, she said, accused her of launching “witch hunts” against the bank’s loan officers.

    One of the skirmishes involved a borrower she later referred to in court papers as “Ms. A.” An IRS document showed Ms. A earned $5,030 a month. But Wells Fargo’s sales staff had won approval for Ms. A’s loan by claiming she made more than twice that—$11,830 a month. When Parmer questioned the deal, she said, a supervisor ordered her to close the investigation, complaining, “This is what you do every time.”

    Amid the frenzy of the nation’s mortgage boom, the back-of-the-hand treatment that Parmer describes wasn’t out of the ordinary. Parmer was one of a small band of in-house gumshoes at various financial institutions who uncovered evidence of corruption in the mortgage business—including made-up addresses, pyramid schemes, and organized criminal rings—and tried to warn their employers that this wave of fraud threatened consumers as well as the stability of the financial system. Instead of heeding their warnings, they say, company officials ignored them, harassed them, demoted them, or fired them.

    In interviews and in court records, 10 former fraud investigators at seven of the nation’s biggest banks and lenders—including Wells Fargo (WFC), IndyMac Bank, and Countrywide Financial—describe corporate cultures that allowed fraud to thrive in the pursuit of loan volume and market share. Mortgage salesmen stuck homeowners into loans they couldn’t afford by exaggerating borrowers’ assets and, in some cases, forging their signatures on disclosure documents. In other instances, banks opened their vaults to professional fraudsters who arranged millions of dollars in loans using “straw buyers,” bogus identities, or, in a few instances, dead people’s names and Social Security numbers.

    Corporate managers looked the other way as these practices flourished, the investigators say, because they didn’t want to crimp loan sales. The investigators discovered that they’d been hired not so much to find fraud but rather to provide window dressing—the illusion that lenders were vetting borrowers before they booked loans and sold them to Wall Street investors. “You’re like a dog on a leash. You’re allowed to go as far as a company allows you to go,” recalled Kelly Dragna, who worked as a fraud investigator at Ameriquest Mortgage Co., the largest subprime lender during the home-loan boom. “At Ameriquest, we were on pretty short leash. We were there for show. We were there to show people that they had a lot of investigators on staff.”

    Continued in article

    Bob Jensen's threads on the subprime sleaze --- http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze

    Bob Jensen's threads on how whistle blowing is not rewarded --- http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing


    At the SEC:  Madoff Déjŕ vu on Ignoring Whistleblowers

    "At SEC, the system can be deaf to whistleblowing," by Zachary A. Goldfarb, The Washington Post, January 21, 2010 ---
    http://www.washingtonpost.com/wp-dyn/content/article/2010/01/20/AR2010012005125.html?wpisrc=nl_pmtech

    Eric Kolchinsky was an executive at Moody's, the credit rating company, when he called a top official at the Securities and Exchange Commission in September to warn that his firm might be violating securities law. He reported that Moody's was blessing mortgage-backed investments that it knew were dangerous, according to a person familiar with the conversation. The SEC official assured Kolchinsky that someone from the agency would call him back shortly.

    But the call never came, Kolchinsky later told congressional investigators who were examining how the credit rating industry's failures contributed to the financial crisis. He had gone to Congress after losing patience with the SEC.

    Kolchinsky is one in a series of whistleblowers who in recent years tried to tip off the SEC to potential wrongdoing, only to be ignored, misunderstood or left to wonder whether they were being listened to. The SEC has no system in place to guide how officials should handle tips and complaints from outsiders, making it difficult for investigators to take advantage of an invaluable source of information.

    This failure helped to continue two of the most celebrated frauds of the last decade for several years, potentially costing unwitting investors millions of dollars. Countless others may have been left vulnerable to shysters because of warnings that went unheeded.

    Since SEC Chairman Mary L. Schapiro took office last year, she has said that fixing the holes in the process for handling tips and complaints has been a top priority. But improving the way hundreds of thousands of tips are analyzed and pursued has proven difficult.

    The SEC's enforcement division got back in touch with Kolchinsky about his allegations only after he told the story publicly to a congressional committee last fall, according to a person familiar with the matter.

    The SEC said it responded to Kolchinsky's concerns but declined to provide details or to say how fast it did so. Moody's said it examined his allegations and found nothing improper.

    The SEC has a haphazard, decentralized system for analyzing outsider information. Tips arrive by phone, mail and e-mail to officials throughout the agency -- investor education to enforcement divisions. A study commissioned by the SEC last year and conducted by Mitre, a nonprofit group that does research for the federal government, found that the SEC lacks technology to analyze tips and complaints, as well as cohesive policies for what officials should do when they get information.

    Whistleblower complaints are one of the main ways that investigators should be tipped to wrongdoing, SEC officials say, along with inconsistencies in financial filings and alerts from financial exchanges about suspicious trading patterns. But the SEC lags behind some other federal agencies in handling tips. The Internal Revenue Service, for instance, pays reward money to whistleblowers who provide credible information about tax fraud. The Federal Trade Commission has set up a call center for tips and complaints.

    On top of structural problems at the SEC, agency officials individually made mistakes in handling several recent cases, sometimes violating agency rules.

    Members of Schapiro's management team said they recognized problems with the system for handling whistleblowers shortly after taking over.

    "There was no uniformity to it. Every division and office had its own system of recording, tracking or handling tips and complaints. That system was pretty rudimentary," said Steve Cohen, the official tasked by Schapiro to overhaul the agency's tips, complaints and whistleblower program. "We're already working to acquire and deploy technology that centralizes all of the agency's tips and complaints so they can be sorted, reviewed, analyzed and tracked."

    Bob Jensen's threads on whistle blowing are at
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing


    "Whistleblowing in Public Accounting: Influence of Identity Disclosure, Situational Context, and Personal Characteristics," by Mary B. Curtis and Eileen Z. Taylor,  Accounting and the Public Interest 9 (1), 191 (2009) ---
    http://aaapubs.aip.org/getabs/servlet/GetabsServlet?prog=normal&id=APIXXX000009000001000191000001&idtype=cvips&gifs=Yes&ref=no

    ABSTRACT:
    Public accounting firms rely on effective reporting of unethical behavior (whistleblowing) as a form of corporate governance. This study presents results from a survey of 122 in-charge level auditors, who indicated their likelihood of internal whistleblowing under three forms of identity disclosure for three independent scenarios. Reporting likelihood was significantly lower under a disclosed identity format, while there was no significant difference in likelihood between anonymous and protected identity formats. Contrasts reveal a significantly higher likelihood of reporting audit standards violations than a professional code violation. Likelihood was also positively related to measures of trust that the firm would investigate and act on the reported incident. Personal characteristics (i.e., locus of control and ethical style) were significant antecedents to whistleblowing intentions. Findings should aid public accounting firms and organizational governance researchers in their understanding of the determinants of auditors' whistleblowing propensity. ©2009 American Accounting Association

    Bob Jensen's threads on whistle blowing are at
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing


    There are some huge snags in the SOX of whistle blower protection
    "First whisteblower unprotected by SOX," AccountingWeb, June 8, 2007 ---
    http://www.accountingweb.com/cgi-bin/item.cgi?id=103603

    June 12, 2007 reply from Randy Kuhn [jkuhn@BUS.UCF.EDU]

    Quite frankly, I would not bank on any whistleblower protection from SOX. The Act states protection only lasts until resolution of the issue. Well, what happens to the whistleblower after that point? One or more “poor” annual evaluations and the person is walked out the door with farcical support for termination. As for identifying the whistleblower … in most cases that is just simply too easy. For example, there are only so many accounts payable clerks and even fewer controllers. Executive management can more than likely deduce who issued the complaint. Unethical management will take advantage of that knowledge. The examples in Bob’s thread only further illustrate the point that whistleblower protection, more often than we would like to believe, is only lip service. Educating and attempting to instill strong moral business values in future executives is our best hope. I am glad to see the ever-increasing focus on ethics and forensics in accounting curriculum. Not much of that was around (that I was aware of) when I came through undergraduate and graduate school in the mid 90’s.

    Randy


    Question
    Why has whistleblower protection under the Sarbanes-Oxley Law failed so miserably?

    Sarbox's whistleblower provisions were intended "to prevent recurrences of the Enron debacle and similar threats to the nation's financial markets" by protecting those who report fraudulent activity that could damage innocent investors. That was the intent, at least. The reality is something else. About 1,000 whistleblowing claims have been filed under Sarbox. Only 17 were determined after federal investigation to have merit and only six of this group have kept their wins after full evidentiary hearings before administrative law judges. Nevertheless, the plaintiffs bar and others have ready answers for this extremely poor batting average. Critics assert that the 90-day statute of limitation for filing whistleblower claims is too short, the burden of proof placed on complaining employees is too high, that judges are reading the law too narrowly, or even that, as one law professor testified, the whistleblower provisions have "has failed to protect the vast majority of employees who file a Sarbanes-Oxley claim" because they rarely win.
    Michael Delikat, "Blowing the Whistle on Sarbox," The Wall Street Journal, August 23, 2007; Page A10 --- http://online.wsj.com/article/SB118783189154206113.html


    Tax Whistleblower 7623:  More Trouble for Ernst & Young Tax Shelter Clients
    The Ferraro Law Firm has submitted the first known $1 billion Tax Whistleblower submission to the newly created IRS Whistleblower Office. The IRS specifically created the Whistleblower Office to assist in identifying and capturing uncollected tax revenue from individuals and corporations typically assisted by clever law firms, accounting firms and banks. Tax whistleblower cases under section 7623 are a new arrow in the Commissioner's quiver to close the tax gap, which the GAO estimates to be approximately $345 billion each year. The submission involves a Fortune 500 company that entered into a series of transactions to improperly reduce its taxes by over $1 billion. The company was represented by Ernst & Young LLP, an established law firm and multiple name-brand banks. The identity of the whistleblower is strictly confidential to protect the individual and the identities of the law firm, banks and company are confidential at this stage to aid in the evaluation of the submission. This submission comes after an E&Y employee pled guilty to one count of conspiracy to commit tax fraud, and four E&Y tax partners have been indicted for their role in the sale of fraudulent tax shelters. "The tax law is not always black and white and taxpayers are all too often more than willing to use an extreme interpretation that drastically reduces taxes. There is not necessarily an element of fraud and people at these companies know the weak spots in their positions," said founding partner, James L. Ferraro. Given the recent modifications made to section 7623 of the Internal Revenue Code, the potential award in this case could exceed $300 million.
    Accounting Education, October 25, 2007 --- http://accountingeducation.com/index.cfm?page=newsdetails&id=145675

    Bob Jensen's threads on Ernst & Young are at http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst


    "Whistle-Blowers Say California State U. Fired Them for Questioning No-Bid Contracts," by  Kathryn Masterson, Chronicle of Higher Education August 17, 2008 --- Click Here

    Three senior employees at California State University say they lost their jobs after questioning whether the system’s chancellor, Charles B. Reed, misused public funds when he hired a labor-consulting firm without soliciting competitive bids, the San Francisco Chronicle reported.

    Two lawyers who worked in California State’s labor-relations office — Paul Verellen and Joel Block — said their firings were directly related to their questions over the hiring of C. Richard Barnes and Associates, a Georgia-based firm, to represent the university in negotiations with labor unions and in arbitration with faculty members.

    Mr. Verellen has filed a whistle-blower complaint with California’s Bureau of State Audits and said he plans to file a lawsuit against Mr. Reed and the university. A third dismissed employee has signed a legal settlement that prevents him from discussing the case, but others told the newspaper he too had lost his job after asking questions about the Barnes contracts.

    The Barnes firm, which is led by C. Richard Barnes, a former director of the Federal Mediation and Conciliation Service, has received more than $2-million so far, the newspaper reported. The university says the no-bid contracts were necessary and legitimate.

    Mr. Reed said that the former employees were let go in a staff reorganization, and that the Barnes contracts had been some of the office’s “best-spent resources.” The San Francisco Chronicle quoted him as saying: “I frankly got tired of all the labor-relations problems that we were having. I asked somebody who the very best labor person was in the country, and it turned out to be a guy in Atlanta who had worked in the Clinton administration. … And I asked him if he would help us with our labor problems.”


    WorldCom's head of internal auditing blew the whistle on the accounting fraud (over $1 billion) by the highest WorldCom executives and the worst Big Five accounting firm audit in the history of the world. She's now viewed as the "Mother of Sarbanes-Oxley Section 404."

    Recent Interview
    In February 2008, CFO Magazine did an article about her and her new book:
    "WorldCom Whistle-blower Cynthia Cooper: What she was feeling and thinking as she took the steps that, as it turned out, would change Corporate America," by . David M. Katz and Julia Homer, CFO Magazine, February 1, 2008, pp. 38-40.

    Blowing the Whistle on Cynthia Cooper (the Worldcom scandal's main whistleblower) in a critical review of her book
    Extraordinary Circumstances
    by Cynthia Cooper, former Internal Auditor of Worldcom
    Barnes and Noble --- http://search.barnesandnoble.com/booksearch/isbnInquiry.asp?z=y&EAN=9780470124291&itm=2
    Publisher: Wiley, John & Sons, Incorporated Pub. Date: February 2008 ISBN-13: 9780470124291 Sales Rank: 27,246

    ""Extraordinary Circumstances": Take it to the Beach ," by Tom Selling, The Accounting Onion, February 7, 2008 --- http://accountingonion.typepad.com/ 

    I decided to read "Extraordinary Circumstances" because I wanted to learn more about the major players at WorldCom, how the fraud was discovered, and how it was perpetrated. I was also curious to learn how the story of a fraud that was so simple at its core could take more than 350 pages to tell.

    As it turns out, the story I was expecting could have easily been told in about one hundred pages; even the chapter titles indicated that it would take me at least 200 pages to get where I thought I actually wanted to begin. But, as I was reading the book, impatient to get to the good stuff, I got hooked on the seeming mundaneness of how a smart but not brilliant, hardworking but not obsessed teenager, got hired and fired, married and divorced, have children, and marry again to a stay-at-home Dad. Much of this was skillfully interwoven with the history of WorldCom, along with the pathos of good corporate soldier accountants meeting their end, and the tragedy of the demigods of the telecommunications industry going to any extreme to avoid experiencing the consequences of their own fallibility.

    Continued in article

    Jensen Comment
    After reading Tom's full critical review I have the feeling that when he says "Take it to the Beach" he means throw it as far as possible into the water. Cynthia spoke at a plenary session a few years ago at an American Accounting Association annual meeting. I don't think the AAA got its money's worth that day. She seems to be exploiting this sad event year after year for her own personal gain as well as an ego trip.

    Bob Jensen's threads on the Worldcom fraud (read that the worst audit in the history of the world by a major international auditing firm) are at http://faculty.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud

    February 8, 2008 reply from Dennis Beresford dberesfo@uga.edu

    Bob, For a slightly different perspective, I bought copies for each of my MAcc students and gave the books to them this week. I'm not requiring the students to read the book but I told them it would be a good idea to do so. As Tom indicates, this is not a complete analysis of WorldCom's accounting. Interested parties can get that from the report of the special board committee that investigated the WorldCom fraud. That report is available through the company's filings in the SEC Edgar system.

    What the book is, however, is a highly personal story of how Cynthia courageously blew the whistle on what became the world's largest accounting fraud. I've plugged the book to students, audit committes, and others who can learn from her difficulties and be better prepared if ever faced with an ethical challenge of their own. There have been very few true heros of the accounting fiascos of the early 2000's, but Cynthia is definitely one of them.

    Rather than disparaging her efforts to educate others about her experiences, I think we should all glorify one who clearly did the right thing at immense cost to her personally.

    Denny Beresford

    February 8, 2008 reply from Bob Jensen

    Hi Denny

    My position is that Cynthia Cooper is indeed one of the three most courageous women that were featured on the cover of Time Magazine in 2002. I'll forward a second post about those three heroes.

    Indeed I agree with Denny that Ms. Cooper is a hero, but that does not mean we have to praise her book. Efforts to get rich (from speeches and books) after blowing the whistle push ethics to the edge, some far worse than these three heroes.

    You can read the following among my other whistle blower threads at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

    "Time Names Whistle-Blowers as Persons of the Year 2002", Reuters, December 22, 2002 --- http://www.reuters.com/newsArticle.jhtml?type=topNews&storyID=1948721 

    Time Magazine named a trio of women whistle-blowers as its Persons of the Year on Sunday, praising their roles in unearthing malfeasance that eroded public confidence in their institutions.

    Two of the women, Sherron Watkins, a vice president at Enron Corp., and Cynthia Cooper of WorldCom Inc., uncovered massive accounting fraud at their respective companies, which both went bankrupt.

    The third, Coleen Rowley, is an agent for the Federal Bureau of Investigation. In May, she wrote a scathing 13-page memo to FBI Director Robert Muller detailing how supervisors at a Minneapolis, Minnesota field office brushed aside her requests to investigate Zacarias Moussaoui, the so-called "20th hijacker" in the Sept. 11th attacks, weeks before the attacks occurred.

    "It came down to did we want to recognize a phenomenon that helped correct some of the problems we've had over the last year and celebrate three ordinary people that did extraordinary things," said Time managing editor Jim Kelly.

    Other people considered by the magazine, which hits stores on Monday, included President Bush, al Qaeda leader Osama bin Laden, Vice President Dick Cheney and New York attorney general Eliot Spitzer.

    Bush was seen by some as the front-runner, especially after he led his party to a mid-term electoral upset in November that cemented the party's majority in Congress.

    However, Kelly said "some of (Bush's) own goals: the capture of Osama bin Laden, the unseating of Saddam Hussein, the revival of a sluggish economy, haven't happened yet. There was a sense of bigger things to come, and it might be wise to see how things played out," he added.

    Watkins, 43, is a former accountant best known for a blunt, prescient 7-page memo to Enron chairman Kenneth Lay in 2001 that uncovered questionable accounting and warned that the company could "implode in a wave of accounting scandals."

    Her letter came to light during a post-mortem inquiry conducted by Congress after the company declared bankruptcy.

    Cooper undertook a one-woman crusade inside telecommunications behemoth WorldCom, when she discovered that the company had disguised $3.8 billion in losses through improper accounting.

    When the scandal came to light in June after the company declared bankruptcy, jittery investors laid siege to global stock markets.

    FBI agent and lawyer Rowley's secret memo was leaked to the press in May. Weeks before Sept. 11, Rowley suspected Moussaoui might have ties to radical activities and bin Laden, and she asked supervisors for clearance to search his computer.

    Her letter sharply criticized the agency's hidebound culture and its decision-makers, and gave rise to new inquiries over the intelligence-gathering failures of Sept. 11.

    My Foremost Whistle Blower Hero Who's Heads and Shoulders Above the Time Magazine Trio
    Cindy Ossias not only risked her job, she risked her law license to ever work again as an attorney. She also blew the whistle at the risk of going to jail.  Unlike the Time Magazine Women of the Year, Cindy Ossias knew there was no hope in blowing the whistle to her boss. Her boss was the big crook when she blew the whistle on him and the large home owner insurance companies operating in the State of California.
    http://www.insurancejournal.com/magazines/west/2000/07/10/coverstory/21521.htm 

    January 6, 2002 message form Hossein Nouri

    -----Original Message----- 
    From: Hossein Nouri [mailto:hnouri@TCNJ.EDU]  
    Sent: Monday, January 06, 2003 10:46 AM 
    To: AECM@LISTSERV.LOYOLA.EDU  
    Subject: Re: Time Magazine's Persons of the Year 2002 

    In the case of Enron, I remember I read (I think in US News) that the whistle-blower sold her Enron's shares before speaking out and made a significant profit. I do not know whether or not she returned that money to the people who lost their money. But if she did not, isn't this ethically and morally wrong?

    January 6, 2002 reply from Bob Jensen

    Hi Hossein,

    This is a complex issue. In a sense, she might have simply taken advantage of insider information for financial gain. That is unethical and in many instances illegal.

    She also may have acted in a manner only to ensure her own job security --- See "Sherron Watkins Had Whistle, But Blew It" http://www.forbes.com/2002/02/14/0214watkins.html That would be unethical.

    However, in this particular case, she allegedly believed that it was not too late to be corrected by Ken Lay and Andersen auditors. Remember that she did not whistle blow to the public. Whistle blowers face a huge dilemma between whistle blowing on the inside versus whistle blowing on the outside.

    Quite possibly (you will say "Yeah sure!") Watkins really had reasons to sell even if she had not detected any accounting questions? There are many reasons to sell, such as a timing need for liquidity and a need to balance a portfolio.

    Somewhat analogous dilemmas arise when criminals cooperate with law enforcement to gain lighter punishments. Is it unethical to let a criminal off completely free because that criminal testifies against a crime figure higher up the chain of command? There are murderers (one named Whitey from Boston) who got off free by testifying. Incidentally, Whitey went on to commit more murders!

    PS, I think Time Magazine failed to make a hero out of the most courageous whistle blower in recent years. Her name is Cindy Ossias --- http://www.insurancejournal.com/magazines/west/2000/07/10/coverstory/21521.htm 

    Cindy Ossias not only risked her job, she risked her law license to ever work again as an attorney. She also blew the whistle at the risk of going to jail.  Unlike Sherron Watkins, Cindy Ossias knew there was no hope in blowing the whistle to her boss. Her boss was the big crook when she blew the whistle on him and the large home owner insurance companies operating in the State of California.

    Bob Jensen

    Rick Telberg has a summary review in his CPA Trendlines ---
    http://cpatrendlines.com/2008/02/08/extraordinary-circumstances-stirs-debate-in-cpa-circles/

    You can read more about the WorldCom fraud and Cynthia Cooper at http://faculty.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud


    Bob Jensen has been receiving messages from a Halliburton whistle blower

    Sadly Persons Blowing the Whistle Do So at Their Own Peril
    "Whistleblowers on Fraud Facing Penalties," by Deborah Hastings, Forbes, August 24, 2007 --- http://www.forbes.com/feeds/ap/2007/08/24/ap4052736.html

    One after another, the men and women who have stepped forward to report corruption in the massive effort to rebuild Iraq have been vilified, fired and demoted.

    Or worse.

    For daring to report illegal arms sales, Navy veteran Donald Vance says he was imprisoned by the American military in a security compound outside Baghdad and subjected to harsh interrogation methods.

    There were times, huddled on the floor in solitary confinement with that head-banging music blaring dawn to dusk and interrogators yelling the same questions over and over, that Vance began to wish he had just kept his mouth shut.

    He had thought he was doing a good and noble thing when he started telling the FBI about the guns and the land mines and the rocket-launchers - all of them being sold for cash, no receipts necessary, he said. He told a federal agent the buyers were Iraqi insurgents, American soldiers, State Department workers, and Iraqi embassy and ministry employees.

    The seller, he claimed, was the Iraqi-owned company he worked for, Shield Group Security Co.

    "It was a Wal-Mart (nyse: WMT - news - people ) for guns," he says. "It was all illegal and everyone knew it."

    So Vance says he blew the whistle, supplying photos and documents and other intelligence to an FBI agent in his hometown of Chicago because he didn't know whom to trust in Iraq.

    For his trouble, he says, he got 97 days in Camp Cropper, an American military prison outside Baghdad that once held Saddam Hussein, and he was classified a security detainee.

    Also held was colleague Nathan Ertel, who helped Vance gather evidence documenting the sales, according to a federal lawsuit both have filed in Chicago, alleging they were illegally imprisoned and subjected to physical and mental interrogation tactics "reserved for terrorists and so-called enemy combatants."

    Corruption has long plagued Iraq reconstruction. Hundreds of projects may never be finished, including repairs to the country's oil pipelines and electricity system. Congress gave more than $30 billion to rebuild Iraq, and at least $8.8 billion of it has disappeared, according to a government reconstruction audit.

    Despite this staggering mess, there are no noble outcomes for those who have blown the whistle, according to a review of such cases by The Associated Press.

    "If you do it, you will be destroyed," said William Weaver, professor of political science at the University of Texas-El Paso and senior advisor to the National Security Whistleblowers Coalition.

    "Reconstruction is so rife with corruption. Sometimes people ask me, `Should I do this?' And my answer is no. If they're married, they'll lose their family. They will lose their jobs. They will lose everything," Weaver said.

    They have been fired or demoted, shunned by colleagues, and denied government support in whistleblower lawsuits filed against contracting firms.

    "The only way we can find out what is going on is for someone to come forward and let us know," said Beth Daley of the Project on Government Oversight, an independent, nonprofit group that investigates corruption. "But when they do, the weight of the government comes down on them. The message is, 'Don't blow the whistle or we'll make your life hell.'

    "It's heartbreaking," Daley said. "There is an even greater need for whistleblowers now. But they are made into public martyrs. It's a disgrace. Their lives get ruined."

    Continued in article

    If you see something suspicious, 'Shut up'
    Democrats favor lawsuits against anti-terrorist tipsters . . . That appears to be the way Senate Democrats want things. They're now pressuring a conference committee to remove language from the final homeland security bill that would confer civil immunity on citizens who "in good faith" report such suspicious behavior . . . The "John Doe provision" passed the House in March by a bipartisan vote that included every Republican and 105 Democrats. But in the Senate, opponents including Sen. Patrick Leahy, D-Vt., argue it "could invite racial and religious profiling." . . . Democrats expect Omar Shahin and his provocative pals to throw considerable new business to their most valued constituency -- our old friends, the trial lawyers.

    "If you see something suspicious, 'Shut up'," Las Vegas Review-Journal, July 24, 2007 --- http://www.lvrj.com/opinion/8677417.html 

     

    Bob Jensen has been receiving messages from a Halliburton whistle blower (See below)

    Bill-and-Hold Revenue Recognition Tale
    Anthony Menedez phoned me several times indicating that he thinks his tale would be interesting for accounting students to study. I think it would be an interesting series of events for a case writer to put into an educational case. The focus of the case, in my viewpoint, should be on a comparison of the KPMG article (quoted below) with the actual bill-in-hold transactions at Halliburton to force students to decide whether KPMG auditors and  Halliburton did or did not violate GAAP on these issues.

    A financial press article is also quoted below:
    Jonathan Weil, "Halliburton's Accounting Might Make You Wonder," Bloomberg News, July 21, 2007

    The case has two really interesting questions:

    1. What is the proper accounting (and auditing) for these transactions?
    2. Is "whistleblower protection" under the Sarbanes-Oxley law an oxymoron?

    June 24, 2007 message from Anthony Menendez [menendez.anthony@gmail.com]

    Professor Jensen-

    Hello. My name is Tony Menendez. I have enjoyed much of the information you have so generously provided on the web covering accounting issues and financial fraud. I thought you might find my Sarbanes-Oxley whistleblower case interesting. Just in case you have extra time and an interest, I am providing you with my contact information and links to some information concerning my case. I hope you are enjoying retirement but have not given up providing your insight into the ever so important area of accounting and financial fraud.

    Sincerely,

    Tony (713) 822 3764

    Here are a few links to information you can find on the web concerning my case:

    http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_weil&sid=am_McfuM6i4o 

    You can read Menendez's complaint in three parts (I, II, III) on the following website:
    http://www.tpmmuckraker.com/archives/003500.php

    Question
    In accounting, what do the following terms mean and in what context?
    bill-and-hold?
    Ship-in-Place?

    Answer
    "Bill-and-Hold Transactions in the Oilfield Services Sector," John C. Christopher, KPMG LLP --- http://faculty.trinity.edu/rjensen/BillandHold.pdf

    Determining and defining appropriate revenue recognition has been a primary focus of companies, regulators, standard setters, and auditors in recent years. Improper revenue recognition has been one of the leading causes of financial statement restatements. Perhaps no area of revenue recognition has received as much scrutiny as "bill-and-hold" transactions. Also known as "ship-inplace" transactions, these transactions generally refer to scenarios where revenue is recognized after a seller has substantially completed its obligations under an arrangement, but prior to the buyer, or a common carrier, taking physical possession of the goods.

    Background In a recent interview, former SEC Chairman Arthur Levitt referred to recognizing revenue on bill-and-hold transactions as "hocus pocus accounting." He said, "Companies try to boost revenue by manipulating the recognition of revenue. Think about a bottle of wine.You wouldn't pop the cork on that bottle until it was ready. But some companies are doing this with their revenue --- recognizing it before the sale is complete, before the product is delivered to the customer, or at a time when the customer still has options to terminate, void, or delay the sale.

    Although the bill-and-hold transaction is not a GAAP violation, unfortunately it has long been associated with incidents of financial fraud. In its October 2002 Report, the General Accounting Office (GAO) said that revenue recognition is the largest single issue involved in restatements. More than half of financial reporting frauds involve the overstatement of revenue, and restatements for revenue recognition have resulted in the largest drops in market capitalization compared with any other type of restatements. There remains an intense scrutiny around a company's revenue recognition principles for these types of transactions, and management and auditors should be unusually skeptical about the appropriateness of recording revenue for these transactions.

    Bill-and-hold scenarios frequently arise in the oilfield services sector. It is important to note that the form. of these transactions is neither illegal nor unethical. In fact, most have very good business or economic purposes. For example, there is currently a trend in the oil and gas industry towards developing fields in the deep waters toward the Gulf of Mexico or other more remote locations throughout the world. Development plans for these large deepwater offshore fields. as well as remote onshore fields throughout the world, will commonly have long timelines; therefore, the oilfield service companies have long lead times for delivery of equipment and products. As the development plan gets under way, many of the original timelines and milestones will change along the way as information about the reservoir becomes better. However, many of the products that the oilfield services companies manufacture and deliver are extremely capital intensive and will be manufactured and ready for their fixed delivery dates without regard to any changes in the development plan. These products are generally very large built-tosuit equipment such as wellhead connection equipment and completion products.

    There are certain criteria that companies must meet in order to recognize revenue on bill-and-hold transactions. These criteria relate to the risks of ownership. the commitment and request on the part of the buyer, the business purpose of the transaction, the delivery date, and the performance obligations, among others (these criteria are discussed in more detail in the next section). As an example, an oilfield services company may complete the manufacturing of the customer's requested products, have them shipped to a company-owned warehouse, determine a fixed delivery schedule to the customer's well site, obtain a legal acknowledgement from the customer that the risk of loss has been transferred, and have no additional obligations to perform such as installation of the equipment. All of this may take place prior to the particular point in the well development plan that calls for the installation of the product. In this example, the oilfield services company might (although only based on careful analysis of the SEC and FASB guidance related to bill-and-hold transactions) be able to recognize revenue immediately upon completing the manufacturing process and meeting all of the bill-and-hold revenue recognition criteria.

    SEC and FASB Guidance on Revenue Recog'nition and Bill-and-Hold Arrangements
    EITf- lssue 00.21: Multiple Elements in a bill-and-hold Arrangement

    Companies must first apply the separation model described in ElTF lssue 00-21 , Revenue Arrangements with Multiple Deliveries, to determine the number of units of accounting in the bill-and-hold arrangement. Bill-and-hold arrangements in this industry can include both the sale of products and the performance of certain services, such as warehousing for the product if it is shipped to a company-owned warehouse. If the SEC staff's revenue recognition criteria (discussed in the next section) are met for the product element in the bill-and-hold arrangement, revenue may be recognized on the product element when the company has completed the product only if it is a separate unit of accounting, or if there are any services involved in the transaction (e.g., warehousing), and those services are inconsequential or perfunctory to one unit of accounting. The company may need to consider whether the services are a separate unit of accounting, if they are inconsequential or perfunctory, and whether there are other performance obligations yet to be performed in determining the appropriate revenue recognition policy for the entire arrangement.

    Inconsequential or Perfunctory Element

    According to SAB No. 104, Revenue Recognition, if the-undelivered element is both inconsequential or perfunctory and not essential to the functionality of the delivered element, it would be appropriate to recognize revenue on the arrangement at the time of delivery and accrue the cost of providing the services related to the undelivered element. However, if the undelivered element is neither inconsequential nor perfunctory or is essential to the functionality of the delivered element, the revenue for the delivered element should be deferred and recognized based on the accounting requirements of the undelivered element. The SEC's guidance on the determination of whether an element is inconsequential or perfunctory is related to whether that element is essential to the functionality of the delivered products.

    In addition, remaining activities would not be inconsequential or perfunctory if failure to complete the activities would result in the customer receiving a full or partial refund or rejecting, or a right to a refund or to reject the products delivered. The SEC provided the following factors in SAB No.104, which are not all-inclusive, as indicators that a remaining performance obligation is substantive rather than inconsequential or perfunctory:

    • The seller does not have a demonstrated history of completing the remaining tasks in a timely manner and reliably estimating their costs.
    • The cost or time to perform the remaining obligations for similar contracts historically has varied significantly from one instance to another.
    • The skills or equipment required to complete the remaining activity are specialized or are not readily available in the marketplace.
    • The cost of completing the obligation, or the fair value of that obligation, is more than insignificant in relation to such items as the contract fee, gross profit, and operating income allocable to the unit of accounting.
    • The period before the remaining obligation will be extinguished is lengthy.
    • T he timing of payment of a portion of the sales price is coincident with completing performance of the remaining activity.

    . . .

    SEC Bill-and-Hold Criteria

    The SEC has established specific criteria codified in SAB No. 104 that a seller of goods or equipment must meet to recognize revenue for a bill-and-hold transaction, including:

    • The risks of ownership must have passed to the buyer.
    • The buyer must have a commitment to purchase, preferably in written documentation.
    •  The buyer, not the seller, must originate the request that the transaction be on a bill-and-hold basis.
    • The buyer must have a substantial business purpose for ordering the goods or equipment on a bill-and-hold basis.
    • Delivery must be for a fixed date and on a schedule that is reasonable and consistent with the buyer's purpose (this requirement will generally be difficult for an oilfield services company to meet due to the variable nature of the movement of timelines and milestones for oilfield development).
    • The seller must not retain any significant specific performance obligations under the agreement such that the earnings process is not complete. The goods or equipment must be segregated from the seller's inventory and may not be subject to being used to fill other orders.
    • The goods or equipment must be complete and ready for shipment.

    The SEC emphasized that that the above criteria are not a simple checklist. A transaction might meet all of the criteria and still fail the revenue recognition guidelines . . .

    Continued in article

    Jensen Comment
    Tony Menendez, while working for Halliburton, encountered what he considered a classic violation of GAAP for bill-an-hold transactions in Halliburton's oilfield operations. He says he first confronted his superiors in the company and then a KPMG auditor, who purportedly agreed with Tony on this issue. But Halliburton countered by saying that since "title passed," revenue could be recognized. The amount in terms of dollars was material in amount.

    Since Halliburton did not restate its financial statements, or purportedly, its subsequent accounting for these transactions, Tony then took the added step of blowing the whistle with the SEC. The SEC purportedly turned it back to Halliburton for further internal investigation. Soon thereafter Tony Menendez became an unemployed whistle blower

    Bill-and-Hold Revenue Recognition Tale
    Anthony Menedez phoned me several times indicating that he thinks his tale would be interesting for accounting students to study. I think it would be an interesting series of events for a case writer to put into an educational case. The focus of the case, in my viewpoint, should be on a comparison of the KPMG article (quoted above) with the actual bill-in-hold transactions at Halliburton to force students to decide whether KPMG auditors at Halliburton did or did not violate GAAP on these issues.

    By the way, Mr. Menedez is currently still unemployed and is considering applying for doctoral study in accountancy.

    August 8, 2007 message from Anthony Menendez [menendez.anthony@gmail.com]

    Please see attached. The very examples described by KPMG as bill-and-hold transactions at a company like Halliburton, were the same transactions, I also believed were bill-and-hold. Interestingly, Halliburton apparantly claims, that these transactions, are not, in fact bill-and-hold and thereby avoiding the bill-and-hold hold criteria which requires that the equipment is ready for its intended use, a fixed delivery date exists for the equipment, and that there are no ongoing obligations on the part of Halliburton ( e.g. installing the equipment and performing the necessary oilfield services, the typical services provided by an "oilfield service" company. Personally, I believe that Halliburton's claim is the most absurb argument I have ever seen and worse yet, I struggle to see how KPMG allows Halliburton to deviate from the very guidance it suggests to companies that are not "Halliburton" should apply. Enjoy.

    Best Regards,
    Tony


    The Sarbanes-Oxley Whistleblower Protection Clause and Anthony Menendez, former E&Y Auditor
    I received a message from Mr. Menendez telling me about his case of alleged bill-and-hold fraud.

    Anthony Menendez, who was Halliburton's director of technical accounting research and training, has accused the world's second-largest oilfield-services company of using so- called bill-and-hold accounting and other undisclosed practices to ``distort the timing of billions of dollars in revenue.'' In short, Menendez says this allowed Halliburton to book product sales improperly, before they occurred.
    Jonathan Weil, "Halliburton's Accounting Might Make You Wonder," Bloomberg News, July 21, 2007 --- Click Here

    The allegations are part of a 54-page complaint Menendez filed against Halliburton with a Labor Department administrative- law judge in Covington, Louisiana, who released the records in response to a Freedom of Information Act request. Menendez, who resigned last year and is seeking unspecified damages, says Halliburton retaliated against him in violation of the Sarbanes- Oxley Act's whistleblower provisions after he reported his concerns to the Securities and Exchange Commission and the company's audit committee.

    Halliburton has denied the allegations. A company spokeswoman, Cathy Mann, says Halliburton's audit committee ``directed an independent investigation'' and ``concluded that the allegations were without merit.'' She declined to comment on bill-and-hold issues, and Halliburton's court filings in the case don't provide any details about its accounting practices.

    Menendez, a 36-year-old former Ernst & Young LLP auditor, filed his complaint in December, shortly after a Labor Department investigator in Dallas rejected his retaliation claim. Mann says the company expects to prevail at trial.

    Cause of Concern

    Investors, of course, will care more about the reliability of Halliburton's numbers than whether Menendez wins. And a look at internal Halliburton documents Menendez filed with the court suggests there's reason for concern.

    Here's how Menendez, who reported to Halliburton's chief accounting officer, summed up the bill-and-hold issue in his complaint:

    ``For example, the company recognizes revenue when the goods are parked in company warehouses, rather than delivered to the customer. Typically, these goods are not even assembled and ready for the customer. Furthermore, it is unknown as to when the goods will be ultimately assembled, tested, delivered to the customer and, finally, used by the company to perform the required oilfield services for the customer.''

    If true, that would violate generally accepted accounting principles. For companies to recognize revenue before delivery, ``the risks of ownership must have passed to the buyer,'' the SEC's staff wrote in a 2003 accounting bulletin. There also ``must be a fixed schedule for delivery of the goods,'' and the product ``must be complete and ready for shipment,'' among other things.

    `Terribly Flawed'

    Shortly after joining Halliburton in March 2005, Menendez says he discovered a ``terribly flawed'' flow chart on the company's in-house Web site, called the bill-and-hold Decision Tree. The flow chart, a copy of which Menendez included in his complaint, walks through what to do in a situation where a ``customer has been billed for completed inventory which is being stored at a Halliburton facility.''

    First, it asks: Based on the contract terms, ``has title passed to customer?'' If the answer is no -- and here's where it gets strange -- the employee is asked: ``Does transaction meet all of the `bill-and-hold' criteria for revenue recognition?'' If the answer to that question is yes, the decision tree says to do this: ``Recognize revenue.'' The decision tree didn't specify what the other criteria were.

    At Odds

    In other words, Halliburton told employees to recognize revenue even though the company still owned the product.

    You don't have to be an accountant to see the problem.

    ``The policy in the chart is clearly at odds with generally accepted accounting principles,'' says Charles Mulford, a Georgia Institute of Technology accounting professor, who reviewed the court records. ``It's very clear cut. It's not gray.''

    Bill-and-hold was at the heart of Sunbeam Corp.'s collapse in the late 1990s, and later blowups at Qwest Communications International Inc. and Nortel Networks Corp.

    It is possible to use bill-and-hold and comply with the rules. But it's hard. The customer, not the seller, must request such treatment. The customer also must have a compelling reason for doing so. Customers rarely do.

    SEC Inquiry

    Menendez, who now works as a consultant, also accuses Halliburton of improper accounting for income taxes, off-balance- sheet entities and foreign-currency adjustments. Court records show he first alerted the SEC's enforcement division in November 2005, three months before he complained to Halliburton's audit committee.

    In a Jan. 3 court filing, Halliburton said the SEC had closed its inquiry into the company's accounting practices.

    Menendez told me, though, that he met with SEC investigators at the agency's Fort Worth, Texas, office as recently as March 28. He also shared a March 14 letter from an enforcement-division attorney there, which shows the travel itinerary the SEC arranged for him to attend that meeting. Mann, the Halliburton spokeswoman, declined to comment on whether the company has been notified of further SEC inquiries into Menendez's allegations.

    Halliburton seemed to quell doubts about its books back in August 2004, when it paid $7.5 million to settle a two-year SEC probe. The agency faulted Halliburton's disclosures, but not its accounting. As long as investors trust a company's profits, they generally don't care how the company earns them. If they begin to suspect they shouldn't, though, look out.

     

    You can read Menendez's complaint in three parts (I, II, III) on the following website: ---
    http://www.tpmmuckraker.com/archives/003500.php

    Bob Jensen's threads on whistle blowing are at
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

    Bob Jensen's threads on revenue reporting and frauds can be found at http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm

    Here's an older example of bill-and-hold fraud
    Death by Accounting

    To get companies to participate in a flu vaccine stockpile the government is dangling tons of new funding. Cash in hand is usually a very strong incentive. But a Clinton administration SEC policy prevents the vaccine makers from recognizing the revenue until the vaccine is delivered to the doctors, countering the very purpose of a stockpile. The Department of Health and Human Services' National Vaccine Advisory Committee concluded in early 2005 that for the stockpile program to be successful, "the revenue recognition issue must be resolved as soon as possible." It all began in late 1999, when the SEC issued "Staff Accounting Bulletin 101," which it painted as a modest clarification "not intended to change current guidance in the accounting literature." But in reality it was a radical change to the way companies could book revenue from "bill-and-hold" orders. This change would, at its least, lead to hindrances for innovative new companies. At its worst, it would discourage production of lifesaving products like vaccines.
    John Berlau, "Death by Accounting?" The Wall Street Journal, October 21, 2005 --- http://online.wsj.com/article/SB112985642561675193.html?mod=opinion&ojcontent=otep

    SEC SAB 101 "Revenue Recognition in Financial Statements" --- http://www.sec.gov/interps/account/sab101.htm

    Bob Jensen's threads on whistle blowing can be found at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing


    More workers than ever before have observed ethical misconduct in the workplace.
    According to a recent survey, more workers than ever before have observed ethical misconduct in the workplace. However, the same study reports that fewer employees are reporting the bad behavior they witness. David Gebler, President of Working Values, explains why corporate culture is the leading risk factor for compromising integrity and compliance today and how a cultural risk assessment can minimize those dangers. FAST FACT: Ethics guru Gebler acknowledges that there is often a gap or a 'disconnect' between the expectations that are created by the organization's leadership, and the way things are actually done in the trenches. He counsels companies to identify the types of pressures their employees face, in order to help people engage in ethical behavior, including reporting incidents of "bad" behavior.
    "Good People Do Bad Things: Is Your Culture a Risk Factor?" SmartPros, December 18, 2006 --- Click Here


    "The Hazards of Whistle Blowing," by Doug Lederman, Inside Higher Ed, October 5, 2006 --- http://www.insidehighered.com/news/2006/10/05/lansing

    Two weeks ago, Timothy N. Zeller did a potentially risky thing: He reported on alleged misspending by his boss, the interim president of Lansing Community College. Last week, the college lawyer appears to have paid a dear price, in the loss of his job.

    . . .

    Last month, Zeller sent a report to Michigan’s auditor general last month accusing Cunningham’s replacement, Interim President Judith Cardenas, with using institutional funds inappropriately. Among other things, he accused her of giving excessive overtime to her staff, handing out raises without following proper administrative procedures, and used college credit cards to give extravagant gifts to employees. Cardenas denied the charges in an article in the Lansing State Journal last month. “We’re all people of integrity,” she told the newspaper.

    Zeller alerted the chairman of the college’s Board of Trustees about the charges in a telephone call on the same day that he sent the report to the state auditor via e-mail, according to college officials. He was quickly suspended with pay, for reasons Lansing officials declined to explain.

    Tuesday, the college posted a message on its Web site saying that it had begun its own internal investigation of the charges contained in Zeller’s report. The college’s full-time internal auditor, who reports to the audit committee of the Board of Trustees, said in a letter to the campus that he would seek to determine if the colleges’ funds were misused or its policies violated.

    Zeller could not be reached for comment, but the Lansing newspaper reported that members of the Lansing board were upset that the lawyer had reported the accusations to the state rather than bringing them first to the board.

    According to the newspaper, Zeller said in an e-mail to the state auditor that he had contacted the state on the advice of a lawyer he had consulted, and that the fact that the allegations involved his superiors made them “awkward to handle.” Officials in the auditor general’s office did not return telephone calls seeking comment.


    "Combating Corporate Fraud," AccountingWeb, January 13, 2006 ---
    http://www.accountingweb.com/cgi-bin/item.cgi?id=101663

    The number of companies around the world that reported incidents of fraud increased 22 percent in the last two years, according to the 2005 biennial survey by PricewaterhouseCoopers (PwC), which interviewed more than 3,000 corporate officers in 34 countries. In England, a recent Ernst & Young survey of the Times Top 1000 indicated the average cost of each fraud exceeded $200,000. But fraud is not the only problem. There's also misconduct, unethical behavior, lying, falsification of records, sexual harassment, and drug and alcohol abuse.

    PwC found that “accidental” ways of detecting fraud, such as calls to hotlines or tips from whistleblowers, accounted for more than a third of the cases. Internal audits were responsible for detecting fraud about 26 percent of the time.

    Steven Skalak, Global Investigations Leader at PwC, told Reuters: "I think the investment in control systems is paying off and detecting more crime." The study found that companies with a larger number of controls could better determine the full impact of the fraud, uncovering three times as many losses as companies with fewer controls.

    Many of the new and increased controls were generated through the passage of The Sarbanes-Oxley (SOX) Act of 2002, which made having confidential, anonymous reporting mechanisms a legal requirement for any publicly traded company. But private, government and non-profit organizations would be well advised to also create and implement this important tool.

    While executives get the headlines, 43 percent of surveyed people admit to having engaged in at least one unethical act in the workplace in the last year, and 75 percent observed such an act and did nothing about it. Not spoken to the employee in question, not reported it, nothing. As much as we do not like to admit it, theft, fraud and malfeasance are common occurrences in companies. Unfortunately these practices exist in every level of the organization and irrespective of size or sector. Non-profits are stolen from in equal measure.

    The Association of Certified Fraud Examiners 2002 Report to the Nation indicates, "the most common method for detecting occupational fraud is by a tip from an employee, customer, vendor or anonymous source." It additionally comments, "the presence of an anonymous reporting mechanism facilitates the reporting of wrongdoing and seems to have a recognizable effect in limiting fraud and losses."

    The report concludes, "organizations with hotlines can cut their fraud losses by approximately 50 percent per scheme." To be effective, a confidential, anonymous reporting mechanism must be operated by an independent, third party. Employees are understandably hesitant and reluctant to report another employee. There is not only the fear of retaliation; there is the fear of retribution and of being ostracized by co-workers. In fact, in an independent survey, 54 percent gave this as the main reason for their silence.

    There is also a concern if the incident involves management, or the person required to take the report or initiate the investigation. Employees must be confident in knowing they can report an incident effectively, confidentially and anonymously. Furthermore, statistics prove that an internal hotline or reporting mechanism is rarely perceived as truly anonymous.

    You can become aware of and build upon the positive aspects of employee relations while proactively addressing and heading off potentially negative issues with Ethical Advocate’s confidential, anonymous reporting mechanisms and feedback system.

    Confidential, anonymous reporting mechanisms serves as an early warning system, enabling organizations to react quickly to investigate issues, and often resolve problems prior to increased malfeasance, costly stealing, litigation, or negative publicity. Spending a few dollars early on can save untold dollars and valuable time. It also creates a culture of ethical behavior that over time will diminish the prospects of these actions.

    When installed properly, confidential, anonymous reporting mechanisms can uncover a variety of information that can improve processes, resolve issues, and prevent catastrophic financial losses. Like a computer network and a website, an employee hotline was once just a good idea that top companies had adopted. Now it's a mandatory part of doing business.

    Bob Jensen's threads on fraud are at http://faculty.trinity.edu/rjensen/fraud.htm

    Bob Jensen's PowerPoint files on fraud are


    A Sad Day for Whistleblowers

    "AP Enterprise: 9/11 thefts not prosecuted," by Margaret Ebrahim, Yahoo News, June 16, 2006 --- http://news.yahoo.com/s/ap/20060616/ap_on_re_us/sept11_thefts

    Once-secret documents obtained by The Associated Press show a disaster supply management company went unpunished for Sept. 11 thefts after the government discovered FBI agents and other government officials had stolen artifacts from New York's ground zero. ADVERTISEMENT

    Kieger Enterprises of Lino Lakes, Minn., dispatched trucks to a Long Island warehouse and loaded hundreds of thousands of dollars worth of donated bottled water, clothes, tools and generators to be moved to Minnesota in a plot to sell some for profit, according to government records and interviews.

    Dan L'Allier said he witnessed 45 tons of the New York loot being unloaded in Minnesota at his company's headquarters. He and disaster specialist Chris Christopherson complained to a company executive, but were ordered to keep quiet. They persisted, going instead to the FBI.

    The two whistleblowers eventually lost their jobs, received death threats and were blackballed in the disaster relief industry. But they remained convinced their sacrifice was worth seeing justice done.

    They were wrong.

    As a result, most Americans were kept in the dark about a major fraud involving their donated goods even as new requests for charity emerged with disasters like Hurricane Katrina. And Christopherson and L'Allier were left disillusioned.

    "I wouldn't open my mouth again for all the tea in China," L'Allier said. Added Christopherson, a 34-year-old father of two: "I paid a big price."

    As firefighters searched for survivors after the Sept. 11 attacks, heat from the World Trade Center's smoldering ruins burned the soles off their boots. They needed new ones every few hours, and Christopherson made sure they got them. The moment that crushed Christopherson's faith was when his employer dispatched the trucks to the warehouse for those supplies, donated by Americans.

    The government ultimately gave the whistleblowers $30,000 each after expenses, their share in a civil settlement against KEI. They say the sum was hardly worth their trouble.

    Federal prosecutors eventually charged KEI and some executives with fraud, including overbilling the government in several disasters, but excluded the Sept. 11 thefts. Officially, the government can't fully explain why.

    KEI had worked for years for the government, providing disaster relief services during tornadoes, floods and other catastrophes. It was picked to manage the New York warehouse for the government's main Sept. 11 relief contractor.

    Thomas Heffelfinger, the former U.S. attorney in Minnesota who prosecuted KEI, said he never intended to charge the company for the ground zero theft, and instead referred that part of the case to prosecutors in New York.

    "At the heart of the KEI case was financial fraud," Heffelfinger said. "It was so bad we didn't need the theft."

    Heather Tasker, a spokeswoman for the U.S. attorney's office in New York, declined to discuss the KEI case. The whistleblowers, however, said they've never been contacted by New York prosecutors.

    FBI documents indicate the government, in fact, was preparing to charge KEI with Sept. 11 thefts.

    A March 2002 entry in the FBI's "prosecutive status" report states the U.S. Attorney's office in Minnesota intended "to prosecute individuals who were alleged to be involved in the transportation of stolen goods from New York City after the terrorist attack." A followup entry from Sept. 6, 2002 lists the specific evidence supporting such a charge.

    The lead investigators for the FBI and the Federal Emergency Management Agency told AP that the plan to prosecute KEI for those thefts stopped as soon as it became clear in late summer 2002 that an FBI agent in Minnesota had stolen a crystal globe from ground zero.

    That prompted a broader review that ultimately found 16 government employees, including a top FBI executive and Defense Secretary Donald H. Rumsfeld, had such artifacts from New York or the Pentagon.

    "How could you secure an indictment?" FEMA investigator Kirk Beauchamp asked. "It would be a conflict."

    While the globe's discovery had been widely reported, its impact on the Sept. 11 thefts had remained mostly unknown.

    Prosecutors "and the FBI were very conscious of the fact that if they proceeded in one direction, they would have to proceed in the other, which meant prosecuting FBI agents," said Jane Turner, the lead FBI agent. She too became a whistleblower alleging the bureau tried to fire her for bringing the stolen artifacts to light. Turner retired in 2003.

    The FBI declined to discuss Turner's allegation, saying it involved a personnel matter.

    "It's illogical" not to prosecute KEI because of the agents' stolen artifacts, said E. Lawrence Barcella, former chief of major crimes in the U.S. attorney's office in Washington. "The fact that FBI agents stole trinkets is an order of magnitude different than a company selling things they steal."

    Nick Gess, another former federal prosecutor, said the agents' actions shouldn't have precluded prosecuting the company.

    "DEA agents have been found to smoke pot occasionally," Gess said. "That doesn't mean they (the Drug Enforcement Administration) can't still work on drug cases."

    The government also didn't prosecute any of its employees for taking souvenirs, claiming it lacked a policy prohibiting such thefts.

    Ultimately, the FBI donated the stolen goods found at KEI's warehouse to the Salvation Army.

    Joe Friedberg, a lawyer who represented a KEI executive, dismissed the Sept. 11 thefts as "much ado about nothing." Friedberg said KEI took a few pallets of water and T-shirts because they had authorization from a FEMA official to take surplus items.

    But that FEMA official, Kathy McCoy, said she never gave Kieger such permission.

    Those who work near ground zero today are shocked to learn such thefts went unpunished.

    "To take advantage of people at a time of despair, it's probably one of the worst things human beings can do to another person," said Gregory Broms, Sr., a firefighter with Engine Company 10 at the foot of the former World Trade Center site. "It was morally wrong."

    Christopherson recalled receiving boxes of white T-shirts stolen from the Long Island warehouse sent back to him after KEI had embossed a Sept. 11 logo on the front. He was instructed by his boss to sell them to firefighters, police and volunteers for $12 a piece. Disgusted, he threw them in the corner and never sold them.

    Christopherson and L'Allier went to the FBI in fall 2001. On April 16, 2002, agents raided KEI, recovering at least 15,000 T-shirts and 18,000 bottles of bottled water. Because months had passed, the seized items were a fraction of the total the company had taken, the whistleblowers said.

    Both men were threatened and harassed, reporting it to the FBI's Turner. "We all experienced the death threats," L'Allier said. "We all experienced the phone ringing at three in the morning and no one being there. I'd come home and the house would be wide open."

    A few months after the raid, prosecutors drafted charges accusing the company of stealing the ground zero relief supplies, seeking an indictment on the one-year anniversary of the Sept. 11, 2001 attacks, Turner said.

    But Turner discovered in late August 2002 a cracked Tiffany & Co. globe — lifted from the World Trade Center ruins — on the desk of a colleague. The theft case against KEI sputtered.

    Eventually, KEI executives Edward Kieger Jr., Patrick Iwan and Joseph Dreshar were indicted in 2004 by a federal grand jury on charges of scheming to defraud the government. The former executives pleaded guilty, and Kieger and Iwan are serving prison terms. KEI has gone out of business.

    Christopherson and L'Allier were stunned when the indictment excluded the ground zero thefts. They spent two years unsuccessfully trying to find new work in disaster relief. Christopherson now runs a landscaping business; L'Allier works as a paramedic.

    For years, the two couldn't speak publicly because their whistleblower case remained under seal. They worried similar fraud might have occurred during Katrina.

    "If you donated, at your local supermarket, water or canned goods or cleaning supplies and a truck goes down there (to New Orleans), who knows where it is ending up," L'Allier.

    Today, the whistleblowers worry their fate might chill others from exposing wrongdoing.

    Continued in article


    Whistleblowers pay a heavy price
    While whistleblowers are protected under the Sarbanes-Oxley Act, the financial and emotional toll remains alarmingly high. Just ask David Windhauser, the former controller for Trane, the heating and cooling company. He was the first person to receive a U.S. Department of Labor order requiring his former employer to rehire him under Sarbanes-Oxley. He complained in 2003 that managers were committing fraud by recording fake expenses on financial statements. He was fired one month later. He and his wife, Jeanne, then filed a Sarbanes-Oxley complaint.
    AccountingWeb, August 3, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=101155


    Blowing the whistle on the top whistle blower cop
    Some government workers want to blow the whistle on the U.S. Office of Special Counsel -- the agency that is supposed to protect federal whistle-blowers. The independent agency, created by Congress in the wake of the Watergate scandal, is charged with protecting federal employees and deciding whether their complaints merit full-scale investigation -- a first line of defense against fraud and mismanagement in government. But current and former staffers as well as lawyers who practice before the agency say it is in turmoil following a series of actions by its chief, Special Counsel Scott Bloch.
    John R. Wilke, "Crying Foul at Whistle-Blower Protector:  Some Staff From U.S. Office of Special Counsel Claim Wrongdoing by the Agency's Chief ," The Wall Street Journal, March 31, 2005; Page A4 --- http://online.wsj.com/article/0,,SB111222969400193774,00.html?mod=todays_us_page_one


    A New Law to Encourage Whistle Blowing

    "At Hospitals, Lessons in Detection of Fraud," by Robert Pear, The New York Times, December 24, 2006 --- http://www.nytimes.com/2006/12/24/us/24fraud.html?_r=1&oref=slogin

    Most of the nation’s hospitals and nursing homes will have to teach their employees how to ferret out fraud and report it to the government under a federal law that takes effect next month.

    The law encourages people in the health care industry to blow the whistle on their employers. Many health care providers said this week that they were unaware of the requirement, and when informed of it, they described it as a burdensome, potentially costly federal mandate.

    But Senator Charles E. Grassley, Republican of Iowa, who drafted the law, said it would help ensure that “taxpayer dollars are used to provide care for the most vulnerable people and not to line the pockets of those who seek to defraud the government.”

    Starting Jan. 1, companies that do at least $5 million a year in Medicaid business must educate all employees and officers on how to detect fraud, waste and abuse. Moreover, health care providers must tell employees that if they report fraud, they will be protected against retaliation and may be entitled to a share of money recovered by the government.

    Under the federal False Claims Act, some whistle-blowers have received millions of dollars in rewards for disclosing large-scale fraud.

    Health care providers must also establish policies to make sure that their contractors investigate and report fraud. A large hospital system, whether run by a Fortune 500 company or a group of Roman Catholic nuns, typically has hundreds of contracts with doctors, billing agents and other vendors.

    The new requirement will also apply to many pharmacies, health maintenance organizations, home care agencies, suppliers of medical equipment, physician groups and drug manufacturers.

    Continued in article


    Fraud detection can only improve with diligent auditors combined with whistleblowers who are unafraid of retaliation because their rights are protected. According to a survey of members of the Association of Certified Fraud Examiners, less than 20 percent of fraud that is caught is turned up by internal controls versus 40 percent for inside tipsters, the Seattle Times reported.
    "Fighting Fraud Calls for Assertive Auditors, Whistleblowers," AccountingWeb, October 4, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99860 
    Bob Jensen's updates on fraud detection are at http://faculty.trinity.edu/rjensen/FraudUpdates.htm 


    Some federal doctors and medical researchers do not enjoy the same protections to blow the whistle on wrongdoing as other government employees, an administrative law judge has ruled.  The whistle-blower law was enacted more than a decade ago to strengthen federal workers' protections when they make accusations of government wrongdoing. It gives them outlets like the board to seek legal protection.
    Associated Press, "Judge Limits Protections Allowed to Federal Whistle-Blowers," The New York Times, December 25, 2004 --- http://www.nytimes.com/2004/12/25/politics/25whistle.html?oref=login 


    "DaimlerChrysler Is Named In Second Whistleblower," The Wall Street Journal, November 19, 2004 --- http://online.wsj.com/article/0,,SB110087841886279303,00.html?mod=home%5Fwhats%5Fnews%5Fus

    A second former employee of DaimlerChrysler AG has filed a federal lawsuit against the auto maker, accusing it of firing her after it ignored reports of accounting fraud.

    Christine Holtzmann filed the whistleblower lawsuit Thursday in U.S. District Court in Detroit. She claimed she was fired in December 2003 after working 18 years at DaimlerChrysler and its predecessor unit in the U.S., Chrysler Corp.

    Ms. Holtzmann claims in court documents that during an 18-month period ending in September 2003, DaimlerChrysler neither conducted preliminary investigations nor disclosed a dozen complaints to the auto maker's audit committee.

    Ms. Holtzmann at the time was administrator of Chrysler's Business Practices Office, which reviews allegations of improper business practices and is responsible for filing reports to DaimlerChrysler's audit committee about its activities.

    "There were some high-level cases that were being kept in a separate file cabinet," Laura Fentonmiller, a Royal Oak, Mich., lawyer representing Ms. Holtzmann, told the Detroit News. Some complaints were falsely backdated as closed years before they were actually opened, she said. "These cases were intentionally being removed from the radar," Ms. Fentonmiller said. "Shareholders needed to know that."

    The Securities and Exchange Commission is investigating Ms. Holtzmann's allegations and those of a second former Chrysler employee, David Bazzetta.

    Mr. Bazzetta, a former company auditor fired in January after 21 years with the company, filed a similar whistleblower lawsuit on Sept. 28. He claimed DaimlerChrysler maintained at least 40 secret bank accounts to bribe government officials in South America in violation of U.S. securities laws, and was fired after he notified senior company officials about the accounts.

    Continued in the article


    Who is most likely to commit a fraud within a corporation?

    I found this KPMG study outcome most interesting.

    The fact that most of fraudsters are males from the "Finance Department" (which probably includes accounting) does not surprise me.  What surprised me at first was their seniority and age, but then perhaps the internal controls are weaker at the higher levels of management.  

    What may be a surprise to you is the fact that many persons who knew enough to blow the whistle did not blow the whistle.  This didn't surprise me, however, since whistle blowing has few rewards relative the trouble it can get you into.  Since Sarbanes-Oxley, however, there will be greater opportunities for anonymous whistle blowing.  However, Sarbanes-Oxley is not likely to change the corporate culture overnight (if ever?) as long as whistle blowing is not rewarded --- http://faculty.trinity.edu/rjensen/fraudconclusion.htm#CrimePays 

    "Long-Serving, Male Execs Most Likely to Commit Company Fraud," AccountingWEB, April 27, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99078 

    A study conducted by by KPMG has revealed some interesting information about the typical perpetrator of a fraud, why they steal and who they target. Seventy-two percent of cases involve men only. Over half of company fraud involves two to five people. Forty percent of fraud involves employees from the finance department.

    The analysis examines 100 of the fraud cases that KPMG has been called in to investigate over the past two years, from which a profile of a fraudster has been created. Alex Plavsic, national head of fraud investigations at KPMG, said: “One of the alarming findings from the study was the seniority of the perpetrators - we found that directors or senior managers committed almost two thirds of the 100 cases surveyed." “Fraud can have a devastating effect on a business, both from a financial and reputational perspective, which is why most companies try to keep the discovery of fraudulent activity as quiet as possible.”

    Who? The analysis found that many of the perpetrators were long serving employees - 32 percent of them had been working for their companies for between 10 and 25 years. And they were not operating alone - in more than half of all the cases (51 percent) two to five parties were involved in the fraud, compared with only one in three cases carried out solely by the perpetrator. The number of people involved in some of the cases (more than five people in ten percent of them) is indicative that fraud can be endemic within some departments and consequently more difficult for outsiders to detect. In one case analysed, 207 individuals were involved in a single fraud.

    In 72 percent of cases, the fraudsters were found to be male-only. Female-only fraudsters were identified in seven percent of cases and both male and females were involved together in some 13 percent of cases. In the remainder of cases, no perpetrator was identified. The age of the principal fraudster was typically between 36 and 45 (41 percent of cases). 29 percent of cases involved those aged between 46 and 55. Those aged between 18 to 25 made up only one percent of perpetrators.

    The finance department is the most likely business area that the fraudster targeted or was responsible for (40 percent of cases). Procurement was the next most likely area (12.5 percent), while one in ten frauds occurred in the sales area.

    How? A weak control environment was the primary reason. In half of the cases surveyed, this was the weakness exploited by the fraudster. In nearly one in three incidents it was the perpetrator abusing their key authorities. Just over one in ten frauds were achieved by the fraudster operating in alliance with others to circumvent controls. While the finance department is often perceived as guardian of control, it remains the top opportunity and target for fraudsters.

    And if company directors are hoping that their internal controls are robust enough to pick up fraud they are likely to be disappointed - only one in four were detected by a management review. 31 percent of frauds were discovered following an employee blowing the whistle, an anonymous tip-off or a report by an external third party. Whistle-blowing is an important weapon in the fight against fraud, despite this, the survey found that while four in ten employees were aware of or suspected that a fraud was occurring, they took no action.

    Why? Personal gain was the most likely reason (41 percent) for committing fraud. External pressures were also a trigger for fraudulent activity with one in eight cases caused by the perpetrator getting into financial difficulties. In nearly 33 percent of the cases the amount stolen was more than Ł1 million while in 26 percent of the cases, it was more than Ł100,000.

    How do companies respond? Dismissal of the perpetrator was the most common response with 55 percent of the fraudsters being fired. However, in just under one in five cases no sanction was taken and this may be because of concerns about the reputational impact of fraud becoming known.

    This is borne out by the fact that in 69 percent of cases there was no publicity surrounding the investigation or subsequent sanction, while only six percent of companies chose to publicise the fraud.

    On a positive note, in a third of cases, businesses had recovered or were taking action to recover cash or assets following a fraud. Alex Plavsic adds: “This study has highlighted some worrying findings, and particularly demonstrates the need for companies to continually review their internal controls. Regular testing of key controls against the risk of fraud will identify any weaknesses in the system, which could easily be exploited by potential fraudsters."

    “Internal controls can only be effective if companies have the right culture in place. A breakdown in the control framework and the integrity of individuals, is when fraud is most likely to be perpetrated.”

    Bob Jensen's threads on corporate fraud are at http://faculty.trinity.edu/rjensen/Fraud.htm 


    Most Companies Get an "F" in Fraud Prevention http://www.accountingweb.com/item/98709 

    Enron had a code of conduct. Enron had a hotline. And in the end, Enron had fraud. Today, companies operate with a false sense of security because they either don't have a fraud prevention program or the program they have is a legal, yet ineffective "fig leaf." "One key to fraud prevention is to create an atmosphere where employees feel confident in reporting wrongdoing without being victimized, even if executives appear to be involved," explains Toby Bishop, president & CEO of the Association of Certified Fraud Examiners (ACFE), the largest anti-fraud association in the world. "If companies don't have effective fraud prevention programs, they are at risk of failure," says Bishop.

    Years ago, working as a consultant, Bishop tested the effectiveness of an existing fraud prevention program for a major utility company. Management thought their program was working and wanted confirmation. Bishop's firm surveyed a statistical sample of employees to assess their feelings about management's commitment only to discover that employees in one division did not believe management wanted to "do the right thing," says Bishop.

    "If employees perceive their company's fraud controls to be weak or if they think management is only giving lip service to ethical behavior, fraud is inevitable," Bishop warns.

    In 2002 fraud prevention was one of the goals addressed in the Sarbanes-Oxley Act (SOX), legislation that affects how public organizations and accounting firms deal with corporate governance, financial reporting and public accounting. The effect of SOX has been far reaching, leading to voluntary changes in private companies and mandatory changes in public companies. But is it preventing fraud? "It may not be as effective as people expected," Bishop answers.

    Over the past 18 months Bishop has taught several thousand participants how to use the ACFE's Fraud Prevention Check-Up, a tool that identifies major gaps in organizations' fraud prevention processes. None of the participants thought their organization would pass the test, which means they are at significant risk of fraud.

    Bishop says while Sarbanes-Oxley invokes a basic framework for internal controls, including anti-fraud controls, additional specifics are needed to address controls to prevent fraud. "There is a definite gap in the standards used to establish fraud prevention controls, if companies use them at all."


    Three former employees of Duke Energy Corp. were arrested after a federal grand jury indictment was unsealed in Houston that accused the trio of 18 counts of racketeering and defrauding their onetime employer through a false energy-trading and accounting scheme.
    Rebecca Smith, "Former Employees Of Duke Charged Over Wash Trades," The Wall Street Journal, April 22, 2004 --- http://online.wsj.com/article/0,,SB108257549068489537,00.html?mod=home%5Fwhats%5Fnews%5Fus 

    For an account of how badly a whistle blower on accounting fraud at Duke Energy was treated, see "Duke Whistle-Blower Goes Public," by Ted Reed,  The Charlotte Observer, August 19, 2002 --- http://dukeemployees.com/audit3.shtml


    Whistle-Blower Woes
    "Many companies think the whistle-blower provisions of Sarbanes-Oxley will spark nuisance suits by disgruntled employees. The truth is far more complex," by Alix Nyberg, CFO Magazine, October 01, 2003 --- http://www.cfo.com/article/1,5309,10790||BS||181,00.html?f=insidecfo 

    When Matthew Whitley was laid off from his job last March as a finance manager at The Coca-Cola Co., along with about 1,000 other employees, he didn't take it lying down. Two months later, Whitley approached his former employer seeking a whopping settlement—$44.4 million—on the grounds that he had been fired in retaliation for raising concerns about accounting fraud. When Coke balked, Whitley turned for relief to a new ally: the Sarbanes-Oxley Act of 2002. He filed for whistle-blower protection under the act's Section 806 provisions, and initiated federal and state lawsuits that charged seven Coke executives, including CFO Gary Fayard, with crimes ranging from racketeering to mail and wire fraud.

    "This disgruntled former employee has made a number of allegations accompanied by an ultimatum: that the company pay him almost $45 million or he would go to the media," said Coke in a May statement announcing the claims. Since then, a Georgia state court judge has dismissed most of the charges, including those related to racketeering and breaches of fiduciary responsibility. While Coke may still have to defend itself against claims related to wrongful termination, "we are confident we will prevail once the facts are presented in a court of law," said Coke in a statement.

    One of Whitley's allegations, however, has already had some effect. His contention that Coke falsified a marketing test of Frozen Coke at Burger King restaurants in Virginia led the company to make a public apology and an offer to pay Burger King $21 million. In July, the Department of Justice (DoJ) announced it was launching a criminal investigation of the alleged fraud.

    CFOs may be forgiven for fearing that cases like Whitley's are a harbinger of things to come—that, thanks to the protections afforded by Sarbanes-Oxley, irate workers will accuse their employers of financial wrongdoing in order to wring large settlements from them. Indeed, on August 27, a federal judge refused to dismiss a whistle-blower lawsuit accusing TXU Corp., an energy company, of earnings manipulation; unless the case is settled, it will become the second suit filed under Section 806 to reach a federal court (the first involved JDS Uniphase Corp.).

    But it remains to be seen whether Sarbanes-Oxley will have a significant impact on whistle-blower litigation. Although the number of such filings has increased, most will probably be dismissed as lacking merit. And even with the new protections of Section 806, would-be whistle-blowers still face a painful cost-benefit decision: whether a lawsuit with uncertain chances of success is worth the professional and personal sacrifices that will assuredly be required.

    Continued in the article


    Employees who try to bring to light unethical or illegal practices by their employers are often criticized, treated like outcasts, fired, or worse.
    CFO.com --- http://www.cfo.com/article/1,5309,7778,00.html 

    Lawsuits: I Wouldn't Cook Books So I Got Fired --- http://www.smartpros.com/x35618.xml

    Oct. 15, 2002 (USA TODAY) — As the crackdown on corporate fraud continues, some executives are suing their former companies, saying they were fired after refusing to cook the books.


    There's no nationwide tally of such lawsuits. But with so much shady accounting and pressure to meet Wall Street numbers in recent years, attorneys say more corporate executives and whistle-blowers are striking back and not taking the fall for higher-ups.

    Some cases are pending in:

    * Silicon Valley. Ronald Sorisho, a former vice president at high-tech contractor Solectron in Milpitas, Calif., says in a lawsuit filed last week that he was canned because he believed the firm should have written down $45 million in obsolete inventory.

    But executives refused to allow the write-down, saying it would hurt the firm's earnings and stock price, the lawsuit alleges.

    Solectron spokesman Kevin Whalen denies the allegations, calling them "baseless" and "sour grapes." Sorisho was let go for poor performance, he says.

    * Hollywood. A former executive hired by fallen super-agent Michael Ovitz sued him last week, alleging she was let go because she told auditors that Ovitz's Artists Management Group was misusing $4 million in annual funds from partner Vivendi.

    Cathy Schulman, who ran Ovitz's film-production unit, charges that Ovitz fired her "in a rage" and engaged in a "public smear campaign" against her.

    Ovtiz's attorney, Terry Sanchez of Munger Tolles & Olson in Los Angeles, declined to comment Friday.

    * Texas. Bradley Farnsworth, the former controller at Dynegy, sued the Houston energy firm in August. He alleges he was dismissed because he would not manipulate natural-gas trading data and earnings.

    Dynegy spokesman John Sousa says the company will investigate the allegations and prove them false.

    Dynegy says Farnsworth never raised red flags with the company's board or audit committee, and he signed off on financial statements for fiscal 2000.

    Dynegy's accounting practices are under investigation by the Justice Department and the Securities and Exchange Commission.

    In recent months, former executives and managers at Xerox, WorldCom and Global Crossing have filed similar lawsuits alleging wrongful termination.

    A new federal law may encourage more whistle-blowers to speak up. It requires companies to set up confidential procedures for employees who suspect fraud, and it allows workers to sue if they are harassed, demoted or fired for reporting allegations.

    "This gives employees a decent weapon," says Jonathan Ben-Asher, an attorney at the law firm of Beranbaum Menken Ben-Asher & Fishel in New York. "We're going to see many more of these cases."

    "Year of the Whistleblower:  The personal costs are high, but a new law protects truth-tellers as never," Business Week, December 16, 2002 --- http://www.businessweek.com/magazine/content/02_50/b3812094.htm 

    When Martin L. Grass, the former Rite Aid Corp. (RAD ) chairman and CEO, was indicted in late June along with three other company managers, prosecutors tipped their hats to Joe Speaker--a little-known executive at the drugstore chain. Soon after becoming acting chief financial officer at Rite Aid in 1999, Speaker uncovered numerous errors in the company's accounts. He told Grass that the problems were serious enough to require a major restatement but feared the CEO would brush them aside. At the time, the Camp Hill (Pa.) company desperately needed to raise capital to pay debt from an acquisition spree. Grass was pleading with banks to extend a line of credit while trying to persuade the Securities & Exchange Commission to stop holding up a share offering. 

    What the then 40-year-old Speaker did next went beyond the call of duty. He contacted and personally hired Ralph C. Ferrara, a former SEC general counsel recommended by his brother Pete, a lawyer. Ferrara arranged a private meeting with Rite Aid's audit committee, led by Loews Corp. (LTR ) Co-Chairman Preston R. Tisch. Days later, the brothers drove to a secret Manhattan meeting.

    Over the next several hours, the acting CFO nervously relayed an incredible story of accounting chicanery. Inventories had been overvalued, bills were being paid out of reserves set aside to close stores, and millions in expenses had not been properly booked. According to one person present, he warned: "I'm in over my head." Stunned, Tisch and other board members, including former Primerica Corp. Chairman Gerald Tsai Jr. and Hartz Group Inc. Chairman Leonard N. Stern, authorized him to hire whatever help he needed to dig into Rite Aid's books. In the end, $541 million in earnings over the previous nine quarters became $1.6 billion in losses.

    Speaker will be a main government witness when Grass and three lieutenants go on trial early next year. All four have pleaded not guilty. A Rite Aid spokeswoman declines to comment. Speaker, son of a former Pennsylvania attorney general, also won't discuss his role in stopping what prosecutors say was one of the most audacious capers in corporate history. "Joe is an ordinary man who was put in an extraordinary position," says his lawyer, Philip S. Khinda. "And he responded in just the way we all hope we would."

    This year, dozens of ordinary people have been put in extraordinary positions throughout Corporate America, and like Joe Speaker, they blew the whistle. Some are now familiar names, such as Enron Corp.'s Sherron S. Watkins (page 110) and WorldCom Inc.'s Cynthia Cooper. But most are middle managers who want to avoid the limelight. Behind the scenes, they have all played a critical role in providing enforcers with virtual road maps around complex accounting maneuvers. "Whistleblowers give us an insider's perspective," says Linda Chatman Thomsen, the SEC's deputy director for enforcement, "and have advanced our investigations immeasurably."


    Continued at  http://www.businessweek.com/magazine/content/02_50/b3812094.htm  

     


    One section of the (Sarbanes-Oxley) act also provides federal protection to would-be whistleblowers. As a result, warnings about accounting problems are reaching boardrooms at an unprecedented rate.
    "Accounting Leads Rise, Making Boards Edgy," SmartPros, July 30, 2004 --- http://www.smartpros.com/x44556.xml 


    Discount retailer Kmart is under investigation for irregular accounting practices. In January an anonymous letter initiated an internal probe of the company's accounting practices. Now, the Detroit News has obtained a copy of the letter that contains allegations pointing to senior Kmart officials as purposely violating accounting principles with the knowledge of the company's auditors, PricewaterhouseCoopers. http://www.accountingweb.com/item/82286 

    Bankrupt retailer Kmart explained the impact of accounting irregularities and said employees involved in questionable accounting practices are no longer with the company. http://www.accountingweb.com/item/90935 

    Kmart's CFO Steps up to Accounting Questions

    AccountingWEB US - Sep-19-2002 -  Bankrupt retailer Kmart explained the impact of accounting irregularities in a Form 10-Q filed with the U.S. Securities and Exchange Commission (SEC) this week. Chief Financial Officer Al Koch said several employees involved in questionable accounting practices are no longer with the company.

    Speaking to the concerns about vendor allowances recently raised in anonymous letters from in-house accountants, Mr. Koch said, "It was not hugely widespread, but neither was it one or two people."

    The Kmart whistleblowers who wrote the letters said they were being asked to record transactions in obvious violation of generally accepted accounting principles. They also said "resident auditors from PricewaterhouseCoopers are hesitant to pursue these issues or even question obvious changes in revenue and expense patterns."

    In response to the letters, the company admitted it had erroneously accounted for certain vendor transactions as up-front consideration, instead of deferring appropriate amounts and recognizing them over the life of the contract. It also said it decided to change its accounting method. Starting with fourth quarter 2001, Kmart's policy is to recognize a cost recovery from vendors only when a formal agreement has been obtained and the underlying activity has been performed.

    According to this week's Form 10-Q, early recognition of vendor allowances resulted in understatement of the company's fiscal year 2000 net loss by approximately $26 million and overstatement of its fiscal year 2001 net loss by approximately $78 million, both net of taxes. The 10-Q also said the company has been looking at historical patterns of markdowns and markdown reserves and their relation to earnings.

    Kmart is under investigation by the SEC and the Justice Department. The Federal Bureau of Investigation, which is handling the investigation for the U.S. Attorney, said its investigation could result in criminal charges. In the months before Kmart's bankruptcy filing, top executives took home approximately $29 million in retention loans and severance packages. A spokesperson for PwC said the firm is cooperating with the investigations.


    "Whistleblower Says He Just Wanted Coke to Listen," SmartPros, September 17, 2003 --- http://www.smartpros.com/x40589.xml 

    Matthew Whitley wanted to work for Coca-Cola Co. so much he submitted his resume 15 times. After being hired, the auditor and finance manager drank nothing but water and Coke and decorated a room in his house with company trinkets.

    Eleven years later, Whitley is drinking only water. His wife sold the Coke plates, glasses and memorabilia at a garage sale. He is out of his $140,000-a-year job after accusing officials of the world's largest soft drink maker of shady accounting and fraudulent marketing practices.

    Whitley, 37, was fired March 26, five days after sending his allegations to the company's top lawyer, although Coke said he was dismissed as part of a restructuring and not because he spoke up. Whitley demanded $44.4 million from Coke in exchange for his silence, but was refused, and is now suing the company for unspecified damages, charging Coke with wrongful termination, fraud, slander and intentional infliction of emotional distress.

    "I'm the last one who wanted any of this to happen," Whitley said. "I wanted somebody to take what I was saying seriously."

    In some ways, he's gotten his wish. Federal prosecutors are conducting a criminal investigation of claims in his suit, including allegations that Coke rigged a marketing test of Frozen Coke, a slush drink, at Burger King restaurants in Virginia in 2000. Coke has offered to pay Burger King $21 million as part of an apology.

    A Superior Court judge earlier this month dismissed more than half of Whitley's claims, including allegations that Atlanta-based Coke sought to hide fraud, but ruled the lawsuit may continue. The suit also is filed in federal court; that case was not affected by the judge's decision.

    E. Christopher Murray, an employment law expert in Garden City, N.Y., said the fact that the suit survived a motion to dismiss, even if it is a scaled-down version, is a victory for Whitley, who will now be able to depose Coke executives and obtain documents from the company. Most such cases are thrown out, he said.

    Because the judge left intact Whitley's claims of intentional infliction of emotional distress and slander, he will be able to delve into the fraud allegations to show Coke had a motive for its actions, Murray said.

    But legal tactics Coke is likely to use could prolong the case, he said.

    "With the larger companies, what they normally do is fight you tooth and nail, file thousands of discovery motions, put you through the wringer, until they wear you out," Murray said. "I'm sure that's what Coca-Cola will do."

    Coke has denied most of the charges but conceded that some employees improperly influenced the marketing test.

    Continued in the article.


    It is important to encourage whistle blowing.
    The AccountingWeb now provides a free report can help with your training process by providing you with crucial legal information and perspectives on whistle blowing and how it can be both a godsend and a curse to your business. http://www.accountingweb.com/item/96760 

    Free Whistle Blower Hotlines from TeleSentry (all hours seven days per week) --- http://telesentry.org/hotline.htm 

    We have designed our toll free reporting service specifically to provide employees an anonymous communication channel to bring forth Code of Conduct concerns and establish a protected platform for on-going communications with your company.

    The Sarbanes-Oxley Act of 2002 now requires that companies have some formalized procedure for encouraging whistle blowing.  One of the most effective procedure is to make an outside firm (such as a law firm or a CPA firm) available to all employees 24 hours a day as an opportunity to blow the whistle anonymously.

    "Accounting Leads Rise, Making Boards Edgy," Greg Farrell, SmartPros, July 30, 2004 --- http://www.smartpros.com/x44556.xml 

    Two years after passage of the Sarbanes-Oxley Act, forensic accountants, corporate lawyers and the Securities and Exchange Commission are reporting a sharp increase in whistleblower complaints about accounting problems at publicly traded companies.

    --------------------------------------------------------------------------------

    The law requires public companies to add costly controls in their accounting departments and holds top executives responsible for any misleading information in financial statements.

    One section of the act also provides federal protection to would-be whistleblowers. As a result, warnings about accounting problems are reaching boardrooms at an unprecedented rate.

    "There is increased whistle-blowing activity," said Harvey Kelly, a forensic accountant who heads fraud investigation at law firm Alix Partners. "There's an increased awareness on the part of people that Sarbanes-Oxley gives protection to individual whistleblowers."

    Kelly says it's difficult to quantify the increase in whistleblower complaints. He says his firm has received a steady stream of calls from boards of directors about internal allegations of accounting fraud.

    "Whistle-blowing has become almost a common feature of corporate life," said Michael Young of Willkie Farr & Gallagher, a law firm that investigated accounting fraud at Cendant. "I've been hearing it and living it."

    Young says the increase in complaints has put boards of directors in a difficult spot. "In this environment, every eruption has to be seriously considered," he said. "What if somebody writes on the back of a candy wrapper that your bad debt is underfunded? Do you take it seriously? Do you have to launch an investigation?"

    Kelly says that's happening at many companies. Boards are asking him to determine which complaints are unfounded grumblings from disgruntled employees and which are legitimate claims of accounting fraud.

    "The concept of audit committees not wanting to get second-guessed is creating a much more robust volume of internal investigations," he said.

    The SEC receives tips about possible violations of securities laws through its email complaint service ( www.sec.gov/complaint.shtml ). Complaints jumped from 77,000 in 2001 to 180,000 last year. The SEC has received nearly 250,000 complaints this year.

    More than 1,300 email complaints arrive each day, says John Stark of the SEC's enforcement division. The majority tend to be tips about accounting problems at public companies.

    "It's a tremendous source of leads," Stark said.

    August 3, 2004 reply from John L. Rodi [jrodi@IX.NETCOM.COM

    Bob,

    Did anyone else find this statement disheartening? I would have thought that the board would welcome information regarding the activities of individuals who are suspected of wrongdoing. After all isn’t safeguarding the assets of the corporation one of the responsibilities of the board of directors and anyone misappropriating assets or recording assets that don’t exist would be creating future havoc for the company.

    The other thing that caught my attention is the line stating that the act was requiring the implementation of “costly controls”! Has any attempt been made to compare these costs to the billions of dollars that have been lost because of the malfeasance of officers of various corporations that have been in the news? I am reminded of the owners who use to say that they were too small to have internal controls. Subsequent defalcations made the implementation of those controls miniscule.

    John Rodi

     

    "Time Names Whistle-Blowers as Persons of the Year 2002", Reuters, December 22, 2002 --- http://www.reuters.com/newsArticle.jhtml?type=topNews&storyID=1948721 

    Time Magazine named a trio of women whistle-blowers as its Persons of the Year on Sunday, praising their roles in unearthing malfeasance that eroded public confidence in their institutions.

    Two of the women, Sherron Watkins, a vice president at Enron Corp., and Cynthia Cooper of WorldCom Inc., uncovered massive accounting fraud at their respective companies, which both went bankrupt.

    The third, Coleen Rowley, is an agent for the Federal Bureau of Investigation. In May, she wrote a scathing 13-page memo to FBI Director Robert Muller detailing how supervisors at a Minneapolis, Minnesota field office brushed aside her requests to investigate Zacarias Moussaoui, the so-called "20th hijacker" in the Sept. 11th attacks, weeks before the attacks occurred.

    "It came down to did we want to recognize a phenomenon that helped correct some of the problems we've had over the last year and celebrate three ordinary people that did extraordinary things," said Time managing editor Jim Kelly.

    Other people considered by the magazine, which hits stores on Monday, included President Bush, al Qaeda leader Osama bin Laden, Vice President Dick Cheney and New York attorney general Eliot Spitzer.

    Bush was seen by some as the front-runner, especially after he led his party to a mid-term electoral upset in November that cemented the party's majority in Congress.

    However, Kelly said "some of (Bush's) own goals: the capture of Osama bin Laden, the unseating of Saddam Hussein, the revival of a sluggish economy, haven't happened yet. There was a sense of bigger things to come, and it might be wise to see how things played out," he added.

    Watkins, 43, is a former accountant best known for a blunt, prescient 7-page memo to Enron chairman Kenneth Lay in 2001 that uncovered questionable accounting and warned that the company could "implode in a wave of accounting scandals."

    Her letter came to light during a post-mortem inquiry conducted by Congress after the company declared bankruptcy.

    Cooper undertook a one-woman crusade inside telecommunications behemoth WorldCom, when she discovered that the company had disguised $3.8 billion in losses through improper accounting.

    When the scandal came to light in June after the company declared bankruptcy, jittery investors laid siege to global stock markets.

    FBI agent and lawyer Rowley's secret memo was leaked to the press in May. Weeks before Sept. 11, Rowley suspected Moussaoui might have ties to radical activities and bin Laden, and she asked supervisors for clearance to search his computer.

    Her letter sharply criticized the agency's hidebound culture and its decision-makers, and gave rise to new inquiries over the intelligence-gathering failures of Sept. 11.

    My Foremost Whistle Blower Hero Who's Heads and Shoulders Above the Time Magazine Trio
    Cindy Ossias not only risked her job, she risked her law license to ever work again as an attorney. She also blew the whistle at the risk of going to jail.  Unlike the Time Magazine Women of the Year, Cindy Ossias knew there was no hope in blowing the whistle to her boss. Her boss was the big crook when she blew the whistle on him and the large home owner insurance companies operating in the State of California.
    http://www.insurancejournal.com/magazines/west/2000/07/10/coverstory/21521.htm 

    January 6, 2002 message form Hossein Nouri

    -----Original Message----- 
    From: Hossein Nouri [mailto:hnouri@TCNJ.EDU]  
    Sent: Monday, January 06, 2003 10:46 AM 
    To: AECM@LISTSERV.LOYOLA.EDU  
    Subject: Re: Time Magazine's Persons of the Year 2002 

    In the case of Enron, I remember I read (I think in US News) that the whistle-blower sold her Enron's shares before speaking out and made a significant profit. I do not know whether or not she returned that money to the people who lost their money. But if she did not, isn't this ethically and morally wrong?

    January 6, 2002 reply from Bob Jensen

    Hi Hossein,

    This is a complex issue. In a sense, she might have simply taken advantage of insider information for financial gain. That is unethical and in many instances illegal.

    She also may have acted in a manner only to ensure her own job security --- See "Sherron Watkins Had Whistle, But Blew It" http://www.forbes.com/2002/02/14/0214watkins.html That would be unethical.

    However, in this particular case, she allegedly believed that it was not too late to be corrected by Ken Lay and Andersen auditors. Remember that she did not whistle blow to the public. Whistle blowers face a huge dilemma between whistle blowing on the inside versus whistle blowing on the outside.

    Quite possibly (you will say "Yeah sure!") Watkins really had reasons to sell even if she had not detected any accounting questions? There are many reasons to sell, such as a timing need for liquidity and a need to balance a portfolio.

    Somewhat analogous dilemmas arise when criminals cooperate with law enforcement to gain lighter punishments. Is it unethical to let a criminal off completely free because that criminal testifies against a crime figure higher up the chain of command? There are murderers (one named Whitey from Boston) who got off free by testifying. Incidentally, Whitey went on to commit more murders!

    PS, I think Time Magazine failed to make a hero out of the most courageous whistle blower in recent years. Her name is Cindy Ossias --- http://www.insurancejournal.com/magazines/west/2000/07/10/coverstory/21521.htm 

    Cindy Ossias not only risked her job, she risked her law license to ever work again as an attorney. She also blew the whistle at the risk of going to jail.  Unlike Sherron Watkins, Cindy Ossias knew there was no hope in blowing the whistle to her boss. Her boss was the big crook when she blew the whistle on him and the large home owner insurance companies operating in the State of California.

    Bob Jensen

     

    Sharing Videos of the Week from CCPA Whistleblower Public Forum --- http://www.workingtv.com/whistleblower.html 

    "Accounting scandals, interference in scientific research, environmental cover-ups... From Enron to BC's fish farm, whistleblower protections are needed to keep governments and corporations accountable. Why are there so few protections for people who find the courage to speak out in the public interest?"
    From promotional material for the March 27, 2003 Whistleblower Public Forum at the Vancouver Public Library sponsored by the BC Office of the Canadian Centre for Policy Alternatives

    Download the videos from  http://www.workingtv.com/whistleblower.html  
    ( You can also speed up things by downloading only the audio files.)

    • Introduction: Erica Johnson, CBC Television host of "Marketplace" RT: 5:00
    • Jamie Court, Foundation for Taxpayer and Consumer Rights (California) RT: 16:36
    • Duff Conacher, Co-ordinator Democracy Watch, Ottawa RT: 14:12
    • Dr. Gordon Hartman, Director, Public Service Employees for Environmental Ethics RT: 20:26
    • Mae Burrows, Labour Environmental Alliance RT: 17:08

    A U.S. Department of Labor (DOL) administrative law judge recently issued what is believed to be the first ruling on whistleblower protections under The Sarbanes-Oxley Act. The DOL ruled that a bank's former CFO was unlawfully terminated after protesting suspected insider trading.
    FERF Newsletter on April 6, 2004 

     

     

    Cost Cutting Pressures Create Moral Hazards

    An elaborate game created last year by the McCombs School of Business at the University of Texas at Austin teaches students about handling the delicate balance of business and ethics, and the sometimes high moral price of too much cost cutting.

    "A Delicate Balance," by Scott McCartney, The Wall Street Journal, May 10, 2004, Page R7 --- http://online.wsj.com/article/0,,SB108379356955403126,00.html?mod=gadgets%5Fprimary%5Fhs%5Flt 

    For one business-school class, a simulation game provided
    a painful lesson in the price of obsessive cost cutting

    For the young executives at computer-maker InfoMaster Ltd., the company budget was on the line. Terrorism threats were swirling in Jakarta, Indonesia, and the company had to either shut down production there for one quarter and harden security or keep churning out hot-selling products.

    The executives opted for production over protection. Soon after, a bomb exploded at the plant.

    "I just killed 350 people," said a dazed David Marye, InfoMaster's 25-year-old chief ethics officer. "I made a bad call, and people died. It's going to be hard to sleep tonight."

    Luckily for Mr. Marye, both InfoMaster and the terrorist attack were fictitious, part of an elaborate game created last year by the University of Texas at Austin's McCombs School of Business. Three made-up student-run companies competed in the cutthroat computer-hardware industry, all trying to maximize revenue, keep costs down and beat back competitors. But the prizes -- $11,000 and the chance to perform in front of a high-level, real-world executive panel -- were real.

    While the Sim City for the business world appeared to be about the bottom line, the real intent was to teach students about handling the delicate balance of business and ethics, and the sometimes high moral price of too much cost cutting. The results were eye opening -- and painful. Idealistic students, who started the game preaching virtue, succumbed to the everyday challenges of making their numbers and whipping the competition. Buying cheaper components or hiring cheaper workers would allow more production. Not spending resources on training or quality control would let them get new products to markets faster, but there might be a price to pay down the road. The game proved so realistic that some students were stunned that, under pressure, they readily chose corner-cutting paths they had vowed never to take.

    The Texas program was created after the WorldCom scandal broke, as officials looked for ways to teach better behavior to M.B.A. students. The academics knew that while students talk like angels in ethics classes, they behave avariciously in finance classes. "Ethical issues aren't being addressed in financing, marketing and accounting classes," says Steve Salbu, the associate dean for graduate programs and founder of the school's business-ethics program. "We needed to try to do something we think might be effective."

    Applying Pressure

    Steven Tomlinson, a finance lecturer who has a background in theater, pushed to put students under pressure and throw choices at them. He hired Allen Varney, an Austin-based designer of video and board games, and consulted with a soap-opera scriptwriter and corporate executives. Scripts were written, rules devised and software created to track decisions.

    The result was the Executive Challenge, a three-day game played late last year, where teams of about two dozen students were divided into three companies, with each given a limited amount of production capacity and a set of workers with varying skills. A company could borrow money, and it could spend cash to increase capacity or add products or workers. But it also had to take care of existing projects and decide whether to spend precious resources on corporate-culture projects such as diversity training and quality programs.

    A three-month financial quarter typically lasted 30 minutes, forcing companies to communicate and make decisions in rapid-fire fashion. The game offered both individual and corporate shortcuts and lures. Early on, players might get away with ignoring problems and postponing expenses, but then the problems grew like weeds. A team could opt for lower quality for a quarter or two, only to discover later that its computer batteries exploded -- a scenario taken from Dell Inc.'s history.

    "The game is all about temptation," Mr. Varney says. "Business-school students, as a breed, are overconfident, and the game really plays to that."

    Going in, students suspected that the game would likely test their ethics since they had just come off a week of traditional ethics training. On the first day, all three made-up companies -- InfoMaster, General Data Machines Inc. and Starr Computing Co. -- spent money on corporate-culture initiatives at the expense of new products, surprising Mr. Varney, the game designer. "All those goody-goodies are doing the corporate-culture initiatives," he said, "which makes no sense in dollars and cents."

    Textbook Traits

    Indeed, the teams created their companies around textbook traits like collaborative decision making and promises to share prize money equally. Fearful of repercussions, executives decided to pay themselves little if any salary. "They were remarkably socialistic," Dr. Tomlinson says.

    InfoMaster even created an ethics team with leaders from different departments, headed by Mr. Marye, who worked as an analyst for Houston-based Enron Corp. before seeking a master's degree.

    Yet as the revenue race tightened, behavior changed. On the second day, each company learned that it had hired an employee who had stolen software from a competitor and that the stolen code was now used in the company's highest-margin products. General Data and Starr both opted to turn themselves in and try to negotiate licenses. InfoMaster, despite its ethics team, took the path of least resistance, hoping not to get caught.

    General Data proved consistent with its choices -- for the most part. Faced with a toxic-waste issue at a river near one of its plants, it opted to dredge the river and make the issue public, even though it didn't believe it was responsible for the pollution. But doing the right thing came at a price. The company was in last place in revenue after the first day.

    "Ben and Jerry would not do well at this game," Mr. Varney says, referring to the socially concerned ice-cream entrepreneurs.

    Much as the game's creators expected, student executives began routinely opting for less-expensive options by the end of the second day. General Data was hit with a sexual-harassment complaint against its vice president of sales, and it chose to postpone action while investigating the allegation. At the time, the company was short of cash and was trying to aggressively ramp up product development to catch competitors. Besides, a previous complaint had turned out to be unfounded.

    This time, though, the investigation discovered that the complaint was credible, and major. "We thought we did the right thing," said Jay Manickam, a former consultant for Andersen and Deloitte & Touche who was General Data's chief executive. "But this is apparently going to be a hit."

    Continued in the article

    Bob Jensen's threads on edutainment and learning games are at http://faculty.trinity.edu/rjensen/000aaa/thetools.htm#Edutainment 


    Will some clients be relegated to risk pools that reluctant auditing firms must serve?  High risk drivers are now assigned to a risk pool that insurance companies must serve (due to state laws requiring insurance) at higher rates even though they would rather not serve at any rate.  The same may happen with high risk clients of accounting firms.

    "Big Four Accounting Firms Steering Clear of Risky Business," AccountingWeb, December 14, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100202 

    Statistics from research firm Audit Analytics indicate that the Big Four firms are dropping clients at record rates, and the trend is increasing. Since the auditing nightmares at Enron were exposed three years ago, audit firm resignations among the Big Four have increased from 18% of all departures from auditing assignments in 2001 to 34% in 2004. Just in the first three quarters of this year, the Big Four firms have resigned from a total of 157 U.S. audits.

    The firms are attributing the resignations to a variety of factors, with limited resources as a result of Sarbanes-Oxley legislation being the most prominent reason. The Sarbanes-Oxley Act of 2002 placed additional burdens on auditors and is leaving accounting firms in a position of having to be more selective in choosing the clients whose audits can be performed most efficiently.

    In addition, firms are weeding out clients with risk factors that can affect the reliability of financial statement information. Earlier this fall, PricewaterhouseCoopers resigned from the audit of Pegasus Communications Corp., citing "material weaknesses in the application of accounting principle and policies that led to the restatement of the Company's financial statements," as the reason for the resignation.

    A side effect of the Big Four's paring down of its clients is the boon to second tier national firms such as Grant Thornton, BDO Seidman, and McGladrey & Pullen. USA Today reports that many of the companies being booted by the Big Four are turning to these smaller firms and finding a benefit in lower costs and better access to top accounting professionals.

    In order to meet the added demands of Sarbanes-Oxley, the Big Four and the smaller accounting firms are scrambling to find and hire talent, which is good news for accountants seeking jobs. It's reported that both the types of jobs available for accountants and the starting salaries are improving. "More of [the accounting graduates] are getting jobs with the better firms than in the past few years," said Edward Ketz, an accounting professor at Penn State's Smeal College of Business. And Robert Half International anticipates starting salaries for auditors to increase from 5 percent to 13.4 percent in 2005.


    From Bob Jensen's Enron Quiz at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

    Why do auditors often lose professionalism?

    For auditors the problem is more complicated, especially for those in charge of major local-office audits or those in charge of their entire firms of tens of thousands of employees around the world.  Think of David Duncan who had the honor as a relatively young man to take charge of Andersen's audit of the huge Enron Corporation in 1997.  David was not a shareholder in Enron and, unlike Andy Fastow, did not have greedy hands in the air while Enron's billions were swirling over his head. 

    David Duncan was torn apart by classical auditor conflicting responsibilities.  On one side he had a huge responsibility to see that Enron abided by Generally Accepted Accounting Principles (GAAP) intended for fairness of information released to the investing public.  He also was responsible for maintaining both internal and external public perceptions of Andersen's professionalism.  On the other side he inherited hundreds of Andersen's Houston Office auditors and consultants working on Enron, some of whom were my former students.  David Duncan was responsible for meeting the huge monthly payroll of his audit and consulting teams.  Enron was a problematic client because there were higher than usual threats about taking Enron's business elsewhere if Andersen became too problematic in Enron's eyes.  I might add that financial institutions like Citibank and Merrill Lynch faced similar problems of losing enormous cash flows from Enron if they did not overlook some of Andy Fastow's financial misdeeds.

    Hundreds upon hundreds of Andersen's Houston Office professionals would've been fired if David Duncan lost Enron as a client.  And these people were much closer to Duncan than unknown faces in the investing public.  David Duncan violated GAAP responsibilities in favor of keeping Enron as a client.  Not all Andersen auditors would've done the same.  Carl Bass, who worked at a high level on the Enron audit,  most certainly paid more homage to GAAP than David Duncan.   But the buck stopped at Duncan's desk, and this is why Duncan forced Bass off the Enron audit.

    What is discouraging is how the CEOs at both Enron and Andersen preferred to remain in the dark about accounting irregularities instigated by executives beneath themselves.  Ken Lay at Enron preferred not to hear about accounting book cooking that helped to keep Enron share prices soaring.   Several succeeding CEOs at Andersen resisted putting in quality controls on large audits around the world --- even when there were signs of bad auditing dating back to audit failures such as Waste Management.  Art Wyatt, a former high-level executive partner with Andersen, captured the sentiment in his paper entitled "ACCOUNTING PROFESSIONALISM --- THEY JUST DON'T GET IT" --- http://aaahq.org/AM2003/WyattSpeech.pdf

    I attribute many audit failures in every large large CPA firm to the growth in size of the clients themselves.  The U.S. auditing process is flawed in design by having CPA auditors both responsible to the public and beholding to fees paid to them by clients being audited.  The potential for conflict of interest is self evident since huge clients can destroy local offices of large CPA firms by changing auditors.

    The problem was not so huge years ago when firms had many small clients and could afford to lose a client in favor of standing on principles of professional responsibility.  The problem is huge today because local offices of these firms often have a single enormous client like Enron, Exxon, Fannie Mae, or General Electric upon which the future of the entire office resides.  Enron was paying Andersen's Houston office $1 million per week for auditing and consulting services.  Imagine any single local office losing cash flow of $1 million per week!

    Many theorists claim that the U.S. auditing model is so flawed that auditing should be put in the hands of the government.  My response is that this would be even worse given the track record as U.S. government being the source of the biggest frauds in world history. 

    No auditing system will ever be perfect.  All we can do is struggle to constantly make our profession better and increasingly ethical.  We do have some help from the tort lawyers nipping at our heels (actually our heads).  You can read more about the Future of Auditing at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing

    The day Arthur Andersen loses the public's trust is the day we are out of business.
    Steve Samek, Country Managing Partner, United States, on Andersen's Independence and Ethical Standards CD-Rom, 1999.

    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, "Will Big Four Audit Firms Survive in a World of Unlimited Liability?," The New York Times, September 10, 2004

    Kurt Eichenwald, Conspiracy of Fools (Broadway Books, 2005, pp. 666-667) --- http://www.bookreporter.com/reviews2/0767911784.asp 
     

    Andersen sought to settle but fumbled.  The government demanded an admission of criminal liability, and at one point the two sides seemed close to a deal.  But in the end Andersen balked, and the government walked away from the negotiating table.

    By that time a top prosecutor on the Enron Task Force, Andrew Weissmann, had secured a secret weapon: David Duncan.  After mulling the matter for months, Duncan acknowledged that he must have destroyed documents with the knowledge that he would be keeping them away from the SEC.  He agreed to plead guilty to one count of obstruction, and to serve as the chief witness against his former employer.

    The Andersen indictment for obstruction of justice ended the company's last hope of survival.  Clients fled in droves, unwilling to allow a firm charged with a crime to serve as their financial watchdog.  Around the globe, Andersen partners jumped to competing firms.  By the time of Andersen's conviction in June, only a small shell of the once great firm remained, and it announced that it would cease auditing public companies.
     

    See the Future of Auditing at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing

     

     

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

    "The Devil Is in the E-Mail;" by Alex Salkever, Business Week, April 23, 2002 --- 
    Once, brokerages could bury prosecutors in mountains of irrelevant paper. Now, as Merrill Lynch is learning, e-dirt is much easier to dig.

    In computer-security circles, Wall Street is considered a premier customer. Each major brokerage and investment-banking house spends huge sums to ensure that no one, but no one, breaks into its computer systems. It's money well spent. Trust is the stock in trade of brokers and investment bankers. Investors must feel that their money is safe from a slick cybercrook. And the threat is real. It's entirely conceivable that a sophisticated hacker could empty a bank's coffers of millions of dollars with some simple keystrokes. 

    LOOSE USE. 

    Now, it turns out that the biggest digital-security threat facing giant brokerage houses and investment banks may have nothing to do with firewalls, intrusion detection, and security engineers. It may lie with the loose use of e-mail and instant messaging by employees, who write things they would never dare to say out loud. Witness the disturbing case that New York State Attorney General Eliot Spitzer is building against Merrill Lynch, the largest brokerage and investment bank in the U.S. Spitzer's probers have uncovered scads of e-mail implying that Merrill employees, including star Internet analyst Henry Blodget, privately disparaged companies they were publicly promoting. Blodget called at least two of the companies a "piece of sh-t" at the same time that Merrill was recommending them to investors, according to documents released by the New York AG's office. Spitzer alleges that Merrill fudged research calls to please investment-banking clients, namely, publicly traded companies that Merrill analysts were following. Skeptics have doubted a separation between banking and research The AG still hasn't declared whether the case he's building against Merrill will be civil or criminal. That alone has the Street on edge. And Spitzer has already made it clear that Merrill is only the first in what could be a long list of targets. Should his allegations of misconduct hold up in court, Merrill could face millions in settlement payouts.

     

    Additional Reading

    INSTITUTE FOR THE ADVANCED STUDY OF INFORMATION WARFARE --- http://www.psycom.net/iwar.1.html 

    IWS Information Warfare Site --- http://www.iwar.org.uk/ 

    Georgetown University and The Terrorism Research Center.
    Information Warfare Database --- http://www.terrorism.com/iwdb/ 

    INFORMATION WARFARE, by Randall Whitaker --- http://www.informatik.umu.se/~rwhit/IW.html 

    Threads on e-Commerce --- http://faculty.trinity.edu/rjensen/ecommerce.htm 

    Opportunities of E-Business Assurance & Security: Risks in Assuring Risk --- http://faculty.trinity.edu/rjensen/ecommerce/assurance.htm#SpecialSection 

     

     

    Collision of Security and Privacy and Freedom Criteria
    From http://www.justice.org.uk/ourwork/privacy/main.html#top 

    The EU, through its Justice and Home Affairs Committee, is working towards greater co-operation between member states for combating serious cross-border crime. JUSTICE has monitored and commented on the human rights implications of proposals, including those involving databases and issues of data protection and privacy.

    Our 2000 report, The Schengen Information System: a human rights audit, put Europe's largest database under scrutiny for human rights compliance for the first time. We highlighted serious criticisms of the adequacy of data protection controls and their supervision.

    Additional Reading

    From the University of Toronto --- http://www.innovationlaw.org/lawforum/pages/workingpaper_series.htm 

    From Rosemary Horton in Australia --- http://www.alia.org.au/~rhorton/it/fact.htm 

     

     

    Investment Banking and Security Analysis Professions Are Rotten to the Core
    The SEC leadership is often on the side of the crooks!
    SEC Staff Wants to End "Short Seller Wars" --- http://www.smartpros.com/x37167.xml 

    Feb. 21, 2003 (FinancialWire) — The Financial Times is reporting that the SEC staff had wanted to propose "sweeping changes" to rules governing "short selling," but was rebuffed by Chairman Harvey Pitt. Naming three NYSE companies that have claimed manipulation -- Allied Capital, MBIA and mortgage lender Federal Agricultural Mortgage Corp. "Farmer Mac" -- FT says the staff plans to take its case before new SEC Chief William Donaldson as early as next week.

    Also, Wednesday's entry of InternetStudios, Inc. into the fray now brings the number of companies associated with short selling, mostly of the naked variety, to a whopping 57 varieties.

    FT's reporter John Labate said that "regulators around the world are under pressure to tighten rules on short-selling, in which traders bet a stock price will fall, amid concern that it is used by professional traders to manipulate share prices, particularly of smaller companies."

    Among the proposals could be "rules forcing traders to borrow stock to cover their short positions. Under current rules, traders can take out 'naked' short positions over an unlimited number of shares, putting huge downward pressure on an illiquid stock.

    FT said regulators are less concerned about short-selling in the most liquid stocks and may even consider loosening the rules for large companies; and that officials want a consistent set of rules across all US markets. For example, it said, traders are forbidden from shorting a stock quoted on the New York Stock Exchange when the price is falling but Nasdaq stocks operate under a separate rule that does not apply to small stocks in the over-the-counter market.

    The staff said it has been lobbied by politicians who complain that small companies and shareholders in their constituencies are being hurt -- perhaps unlawfully. A rule proposal by Georgetown University Associate Professor James J. Angell, presented to the CEO Council last fall, is at http://www.investrend.com/default.asp?level=137 

    Continued in the article.


    "In Search Of the Last Honest Analyst," by David Rynecki, Fortune, June 10, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208085 

    During the boom the analyst's job was to cozy up to the company brass, not to question them. Or so the evidence would suggest. Recent disclosures of Merrill Lynch e-mails, in which allegedly independent researchers hyped stocks to the public while privately trashing them, are only the latest exhibits. The pumped-up stocks--no surprise--were those of companies with which Merrill had a lucrative investment-banking relationship. In a settlement with New York State's attorney general, the securities firm has agreed to pay a $100 million civil penalty, reform its analyst-compensation system, and apologize for failing to address the obvious conflicts of interest. But as FORTUNE and others have pointed out, the numbers have long illustrated the failure of Wall Street research. Last June, during the height of the recession--when even the most optimistic CEOs were unable to hide the bad news--investment analysts couldn't find a stock they couldn't tout. Of 26,451 buy, hold, and sell recommendations, only 213 were sells.

    Too many financial analysts and investment bankers do no analysis and have conflicts of interests that are rotten to the core.  Their professions are in marketing rather than analysis.  Their research reports about such firms as Enron are really written by those same firms.  Aside from a few independents like David Tice and Jim Chanos, most financial analysts and investment bankers really believed Enron was still a good buy almost up to the day it imploded, and if they knew otherwise, they were keeping quiet about it until they and some of their buddies sold their own stock in Enron.

    For an example, see the following:
    Credit Suisse First Boston -- the investment bank that managed some of the most hyped stock offerings of the Internet boom era -- agrees to pay a $100 million fine for improperly pumping up share prices --- http://www.wired.com/news/business/0,1367,49930,00 

    Probably the biggest investment banking scandal in the Year 2002, was the Merrill Lynch scandal in which its brokers were forced to promote overpriced securities that the investment banking division knew were really bad investments.  But there were similar scandals at Payne Webber, Lehman Brothers, Morgan Stanley, and other investment firms.

    "In Search Of the Last Honest Analyst," by David Rynecki, Fortune, June 10, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208085 

    During the boom the analyst's job was to cozy up to the company brass, not to question them. Or so the evidence would suggest. Recent disclosures of Merrill Lynch e-mails, in which allegedly independent researchers hyped stocks to the public while privately trashing them, are only the latest exhibits. The pumped-up stocks--no surprise--were those of companies with which Merrill had a lucrative investment-banking relationship. In a settlement with New York State's attorney general, the securities firm has agreed to pay a $100 million civil penalty, reform its analyst-compensation system, and apologize for failing to address the obvious conflicts of interest. But as FORTUNE and others have pointed out, the numbers have long illustrated the failure of Wall Street research. Last June, during the height of the recession--when even the most optimistic CEOs were unable to hide the bad news--investment analysts couldn't find a stock they couldn't tout. Of 26,451 buy, hold, and sell recommendations, only 213 were sells.

    The government is doing virtually nothing new that I know of to correct huge conflicts of interest among securities dealers and investment bankers.   Scott Cleland did a marvelous job summarizing how these professions are rotten to the core, but his proposed solution seems to me to be hopeless.  He suggests that Congress snarl at financial analysts and investment bankers.  Unless Congress actually bites off some heads, little is to be gained from snarling.

    See http://faculty.trinity.edu/rjensen/fraud.htm#Cleland 

    On April 12,  I reported on the Merrill Lynch indictment by the State of New York --- http://faculty.trinity.edu/rjensen/fraud041202.htm 

    Nice Going Merrill Lynch:  To Hell With the Widows and Orphans
    The pressures put on the Merrill Lynch internet group to appease both investment bankers and clients led the group to ignore the bottom two categories of the five-point rating system (“reduce” and “sell”) and to use only the remaining ratings (“buy”, “accumulate” and “neutral”). The absence of clear guidance from Merrill Lynch management on how to resolve the conflicts created by these pressures led respondent Henry Blodget, the head of the internet group, in a moment of candor, to threaten to “start calling the stocks (stocks, not companies)... like we see them, no matter what the ancillary business consequences are."
    Chief of the Investment Protection Bureau of the New York State Department of Law and am of counsel to Eliot Spitzer, Attorney General of the State of New York before the Supreme Court of the State of New York, April 2002 
    (Dan Gode from NYU sent me this Merrill Lynch Indictment as an email attachment.)
    Bob Jensen's similar "Go to Hells" from Investment Bankers are listed at http://faculty.trinity.edu/rjensen/fraud.htm#Cleland  
    Bob Jensen's April 12, 2002 updates on the Enron/Andersen scandals are at http://faculty.trinity.edu/rjensen/fraud041202.htm 

    On April 25, we learned that the "rotten to the core" investment banking and security analyst scandals are gaining national criminal investigation levels and that the Enron/Andersen scandals are being overshadowed by a much larger and more rotten cancer investment markets.

    "Stock Hyping Under The Microscope," CBS Evening News, April 25, 2002 --- http://www.cbsnews.com/stories/2002/04/25/eveningnews/main507282.shtml

    (CBS) When George Zicarelli, a videotape editor at CBS News, invested his life savings with Salomon Smith Barney in 1999, the firm recommended a hot new fiber optic company called Global Crossing.

    "And then the stock starts dropping," said Zicarelli. As the stock, which Zicarelli first bought at $50 a share, began to swan dive, Salomon's star tech analyst, Jack Grubman, stuck to his "buy" rating and said he was "still bullish."

    "I constantly asked my broker to reassure me. And he constantly reassured me," said Zicarelli. In the end, Zicarelli said, he lost more than $450,000 on Global Crossing.

    "Close to half a million dollars altogether."

    But after learning that analyst Grubman was making millions in investment banking deals from the very companies whose stocks he was recommending, Zicarelli is now seeking damages from Grubman and Salomon Smith Barney.

    Zicarelli isn't unique in his experience. On Thursday, New York Attorney General Eliot Spitzer announced that his office and the Securities and Exchange Commission are heading a multi-agency investigation of investment analysts with conflicts of interest.

    The inquiry will be conducted by the SEC, the New York Stock Exchange, the National Association of Securities Dealers, Spitzer, the North American Securities Administrators Association and several states, according to a statement released by Spitzer and the SEC.

    "I think there is a crisis of accountability right now," Spitzer told CBS News Correspondent Anthony Mason before Thursday's announcement of the inquiry.

    It's possible that Zicarelli could get some settlement resulting from the inquiry. He has also hired an attorney, Jacob Zamansky, to pursue matters directly.

    "Jack Grubman and Salomon Smith Barney have misled investors with thoroughly conflicted stock research," said Zamansky. Zamansky has already won $400,000 in damages for another client from Merrill Lynch. He says the two cases are similar.

    "Absolutely," said Zamansky. "It's the same issue."

    The issue is the credibility of Wall Street's investment advice and potential charges of criminal fraud. And it's not just burned investors out for blood. Wall Street hasn't faced this kind of legal scrutiny in decades.

    "It may only be the tip of the iceberg," said Spitzer, who has been investigating Merrill Lynch.

    After subpoenaing company e-mails, Spitzer revealed that Merrill's former Internet analyst Henry Blodget, while publicly touting a stock called Infospace, was privately ridiculing it as a "powder keg" and "a piece of junk."

    Spitzer said that across the entire investment industry there is "a desire and an urge to push the boundaries in a way that means fraud on almost a daily basis. And that can't be permitted."

    SEC Chairman Harvey L. Pitt said the disclosures that resulted from Spitzer's investigation, as well as practices uncovered by the SEC, the New York Stock Exchange and the National Association of Securities Dealers, "reinforced the commission's conclusion that further inquiry is warranted."

    Salomon Smith Barney has refused to comment. Merrill Lynch's chief financial officer, according to the Wall Street Journal, has called its analyst's actions "inappropriate." That may not be enough, said Spitzer, who wants both reform and an admission of wrongdoing.

    "If they continue to maintain that what happened was inappropriate, but wasn't illegal, then there will be no settlement. Then there will be much tougher sanctions. There could be criminal charges. And the fate of the company is in their hands."

    Among ordinary investors like George Ziccarelli, Wall Street's credibility has already taken a beating.

    "I believed 'em," he said. "I know it sounds dumb now. But I did."

    On May 22, 2002, Merrill Lynch announced a controversial $100 million settlement that has not been approved by all 50 states and does not prevent huge civil lawsuits.  The settlement itself will be paid out of petty cash and the suggested reforms do not go far enough in the eyes of most investor protection groups.


    Business Week Cover Story on May 2, 2002
    Spitzer: "My Job Is to Protect Investors" New York's Attorney General explains why he released the Merrill Lynch e-mail and why the Street may need cleaning now more than ever
     http://www.businessweek.com/bwdaily/dnflash/may2002/nf2002052_2194.htm 

    New revelations about brokers and analysts who push iffy stocks--without pointing out, say, their investment banking relations with the company--have investors hopping mad. Lawsuits and investigations have plunged Wall Street into crisis, and the implications are huge.


    Nice going Lehman:   To Hell With the Widows and Orphans
    Richard Gross, an analyst at Lehman Bros., maintains a "strong buy" rating on Enron as the stock declines from $81 to $0.75. A Lehman spokesperson helpfully explains to the New York Times that the firm was advising Dynegy on its purchase of Enron's pipeline, and it is Lehman's policy not to change the firm's rating on any company involved in a deal in which Lehman is an adviser.
    Number 55 among the 101 Dumbest Moments in Business reads as follows at http://www.business2.com/dumbest/

    Nice Going Paine Webber:   To Hell With the Widows and Orphans
    "The Man Who Paid the Price for Sizing Up Enron," by Richard A. Oppel, Jr., The New York Times, March 27, 2002, Page C1 ---  http://www.nytimes.com/2002/03/27/business/27ENRO.html 

    Enron (news/quote) executives pressed UBS PaineWebber to take action against a broker who advised some Enron employees to sell their shares in August and was fired by the brokerage firm within hours of the complaint, according to e-mail messages released today by Congressional investigators.

    The broker, Chung Wu, of PaineWebber's Houston office, sent a message to clients early on Aug. 21 warning that Enron's "financial situation is deteriorating" and that they should "take some money off the table."

    . . .

    The episode illustrates just how easily Enron appears to have thrown its weight around at a Wall Street firm, which may have satisfied a big corporate customer at the expense of some retail customers. PaineWebber managed Enron's stock option program for employees and handled brokerage accounts for many company executives. It also did substantial investment banking work for Enron, which generated fees for the firm. PaineWebber said that Mr. Wu was fired because he had violated policies by sending unauthorized e-mail messages to more than 10 clients and by failing to disclose that PaineWebber's research analyst had rated Enron a "strong buy."

    But the day that Mr. Wu was fired was the day that Enron's chairman, Kenneth L. Lay, was both shedding some of his own shares and talking up the stock. On Aug. 21, Mr. Lay sold $4 million of stock to the company. He also sent an e-mail message to employees saying that one of his highest priorities was to restore investor confidence, adding that that "should result in a significantly higher stock price."

    The message complaining to PaineWebber about Mr. Wu was sent by Aaron Brown, an Enron official who PaineWebber said helped oversee the stock option program. Mr. Brown could not be reached for comment. A switchboard operator at Enron said today that Mr. Brown no longer worked at the company, and a spokesman did not respond to questions.

    Mr. Wu, who declined to comment through his lawyer today, previously asserted that Enron was behind his dismissal, but today's disclosure was the first to show pressure was applied by Enron officials. Mr. Wu now works for A. G. Edwards.

    A PaineWebber spokesman declined to elaborate on the matter involving Mr. Wu but pointed to a letter sent to Congress last week.

      Continued at http://www.nytimes.com/2002/03/27/business/27ENRO.html 


    JP Morgan – whose lawyers must be working overtime – is refuting any wrongdoing over credit default swaps it sold on Argentine sovereign debt to three hedge funds. But the bank failed to win immediate payment of $965 million from the 11 insurers it is suing for outstanding surety bonds.
    Christopher Jeffery Editor, March 2, 2002, RiskNews http://www.risknews.net 
    Note from Bob Jensen: The above quotation seems to be Year 2002 Déjŕ Vu in terms of all the bad ways investment bankers cheated investors in the 1980s and 1990s.  Read passage from Partnoy's book quoted at http://faculty.trinity.edu/rjensen/book02q1.htm#022502 


    In fairness, there are many honest brokers and security analysts.  In their defense, you may read the following:
    "Here Comes the Lynch Mob,"  by Patty Enrado. Upside, June 2002, Page 12 --- http://www.upside.com/Upshot/3ced28c51.html 


    Additional Reading

    The Professions of Investment Banking and Security Analysis are Rotten to the Core --- http://faculty.trinity.edu/rjensen/FraudRotten.htm  

     

     

    Dawning of the Age of Unaccountable Contracting
    Accounting standard setters worldwide have attempted to develop "conceptual frameworks" to draw upon so that standards are internally consistent and that they conform to an established framework.   In the new economy, some types of contracting defy definition and linking to concepts.  For example, the FASB cannot give a precise definition of a derivative financial instrument and must virtually ignore conceptual frameworks when setting accounting standards for derivatives.

    The most troublesome contracts entail revenue and liabilities.  Complicated instruments are issued that do not fit established concepts of liabilities or equity.  Clauses in these contracts create a maze of contingencies that often confuse sophisticated analysts.  In many instances the main purpose of the confusion is to complicate the accounting.

    Sometimes it is extremely difficult to measure something that meets a given concept.  For example, frequent flyer awards by airlines map conceptually to the definition of a "liability."  But assigning a meaningful number to amount of liability is exceedingly complex given that it is not known if or when the passenger will seek an award.  Awards are sometimes assigned at virtually no cost if the seat would otherwise be empty on an awarded ticket.   However, airlines that attempt to limit the awards to only empty seats are subject to massive class-action lawsuits of violating the spirit of the awards.  Since airlines are now cutting back on flights in an effort to make all flights nearly full, the "liability" of frequent flyer awards is much more troubling than when there were more flights having empty seats available.  Awards carry into a future where the costs of fuel, security, and labor are very hard to forecast. 

    Particularly sticky have been issues of risk versus liability.  Diamond structures are particularly interesting where three or more partners enter a venture with little or no investment.  However, their long-term purchase or throughput (in the case of a pipeline) commitments are all that is needed for the venture to borrow millions.  The originating partners are not liable for the venture's debt, and no partner has "control."  However, this is not a risk free deal for the partners due to their enormous unbooked purchase or throughput commitments.

    The major problem that exploded the accounting firm of Andersen was its approval of the way Enron accounted for hundreds of offshore SPEs.  Special purpose entities (SPEs) also create special problems due to the fact that one originator may form an SPE, but the originator is not obligated to pay the SPE's debt if the SPE becomes insolvent.  Nor can the creditors of the originator lay claim to the assets of the SPE.  And yet there is risk involved such as when the originator has a lease (often a synthetic lease) commitment with the SPE.  The lease is typically worded so that it will not have to be booked as debt.

    Bob Jensen's explanations of the arguments for and against current SPE accounting are given at http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm 


    Let me close by citing Harry S. Truman who said, "I never give them hell; I just tell them the truth and they think its hell!"
    Great Speeches About the State of Accountancy

    "20th Century Myths," by Lynn Turner when he was still Chief Accountant at the SEC in 1999 --- http://www.sec.gov/news/speech/speecharchive/1999/spch323.htm

    It is interesting to listen to people ask for simple, less complex standards like in "the good old days." But I never hear them ask for business to be like "the good old days," with smokestacks rather than high technology, Glass-Steagall rather than Gramm-Leach, and plain vanilla interest rate deals rather than swaps, collars, and Tigers!! The bottom line is—things have changed. And so have people.

    Today, we have enormous pressure on CEO’s and CFO’s. It used to be that CEO’s would be in their positions for an average of more than ten years. Today, the average is 3 to 4 years. And Financial Executive Institute surveys show that the CEO and CFO changes are often linked.

    In such an environment, we in the auditing and preparer community have created what I consider to be a two-headed monster. The first head of this monster is what I call the "show me" face. First, it is not uncommon to hear one say, "show me where it says in an accounting book that I can’t do this?" This approach to financial reporting unfortunately necessitates the level of detail currently being developed by the Financial Accounting Standards Board ("FASB"), the Emerging Issues Task Force, and the AICPA’s Accounting Standards Executive Committee. Maybe this isn’t a recent phenomenon. In 1961, Leonard Spacek, then managing partner at Arthur Andersen, explained the motivation for less specificity in accounting standards when he stated that "most industry representatives and public accountants want what they call ‘flexibility’ in accounting principles. That term is never clearly defined; but what is wanted is ‘flexibility’ that permits greater latitude to both industry and accountants to do as they please." But Mr. Spacek was not a defender of those who wanted to "do as they please." He went on to say, "Public accountants are constantly required to make a choice between obtaining or retaining a client and standing firm for accounting principles. Where the choice requires accepting a practice which will produce results that are erroneous by a relatively material amount, we must decline the engagement even though there is precedent for the practice desired by the client."

    We create the second head of our monster when we ask for standards that absolutely do not reflect the underlying economics of transactions. I offer two prime examples. Leasing is first. We have accounting literature put out by the FASB with follow-on interpretative guidance by the accounting firms—hundreds of pages of lease accounting guidance that, I will be the first to admit, is complex and difficult to decipher. But it is due principally to people not being willing to call a horse a horse, and a lease what it really is—a financing. The second example is Statement 133 on derivatives. Some people absolutely howl about its complexity. And yet we know that: (1) people were not complying with the intent of the simpler Statements 52 and 80, and (2) despite the fact that we manage risk in business by managing values rather than notional amounts, people want to account only for notional amounts. As a result, we ended up with a compromise position in Statement 133. To its credit, Statement 133 does advance the quality of financial reporting. For that, I commend the FASB. But I believe that we could have possibly achieved more, in a less complex fashion, if people would have agreed to a standard that truly reflects the underlying economics of the transactions in an unbiased and representationally faithful fashion.

    I certainly hope that we can find a way to do just that with standards we develop in the future, both in the U.S. and internationally. It will require a change in how we approach standard setting and in how we apply those standards. It will require a mantra based on the fact that transparent, high quality financial reporting is what makes our capital markets the most efficient, liquid, and deep in the world.


    From The Wall Street Journal Accounting Educators' Reviews on June 20, 2002

    TITLE: Frequent-Flier Programs Get an Overhaul 
    REPORTER: Ron Lieber 
    DATE: Jun 18, 2002 
    PAGE: D1 LINK: http://online.wsj.com/article/0,,SB1024344325710894400.djm,00.html  
    TOPICS: Frequent-flier programs, Accounting

    SUMMARY: Many frequent-flier programs are offering alternative rewards in exchange for frequent-flier miles. Questions focus on accounting for frequent-flier programs and redemption of miles.

    QUESTIONS: 
    1.) What is a frequent-flier program? List three possible ways to account for frequent-flier miles awarded to customers in exchange for purchases. Discuss the advantages and disadvantages of each accounting method.

    2.) Why are companies offering alternative rewards in exchange for frequent-flier miles? How is the redemption of miles reported in the financial statements? Discuss accounting issues that arise if the miles are redeemed for awards that are less costly than originally anticipated.

    3.) The article states that the 'surge in unredeemed points is causing bookkeeping headaches.' Why would unredeemed points cause bookkeeping headaches? Would companies be better off if the points were never redeemed? If a company created a liability for awarded points, in what circumstances could the liability be removed from the balance sheet?

    4.) Refer to the related article. Describe Jet Blue's frequent-flier program. How does stipulating a one-year expiration on frequent-flier points change accounting for a frequent-flier program?

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

    --- RELATED ARTICLES --- 
    TITLE: JetBlue Joins the Fray But With Big Caveat: Miles Expire in a Year 
    REPORTER: Ron Lieber 
    PAGE: D1 
    ISSUE: Jun 18, 2002 
    LINK: http://online.wsj.com/article/0,,SB102434443936545600.djm,00.html 

    Bob Jensen's threads on accounting theory are at http://faculty.trinity.edu/rjensen/theory.htm 


    Other particularly troublesome issues include the Baker's listing discussed in
    Financial Accounting Issues --- http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm 

    Revenue Issue: Gross versus Net

    Issue 01: Should a company that acts as a distributor or reseller of products or services record revenues as gross or net?

    Issue 02: Should a company that swaps website advertising with another company record advertising revenue and expense?

    Issue 03: Should discounts or rebates offered to purchasers of personal computers in combination with Internet service contracts be treated as a reduction of revenues or as a marketing expense?

    Issue 04: Should shipping and handling fees collected from customers be included in revenues or netted against shipping expense?

    Definition of Software

    Issue 07: Should the accounting for products distributed via the Internet, such as music, follow pronouncements regarding software development or those of the music industry?

    Issue 08: Should the costs of website development be expensed similar to software developed for internal use in accordance with SOP 98-1?

    Revenue Recognition

    Issue 9: How should an Internet auction site account for up-front and back-end fees?

    Issue 10: How should arrangements that include the right to use software stored on another company’s hardware be accounted for?

    Issue 11: How should revenues associated with providing access to, or maintenance of, a website, or publishing information on a website, be accounted for?

    Issue 12: How should advertising revenue contingent upon “hits,” “viewings,” or “click-throughs” be accounted for?

    Issue 13: How should “point” and other loyalty programs be accounted for?

    Prepaid/Intangible Assets vs. Period Costs

    Issue 14: How should a company assess the impairment of capitalized Internet distribution costs?

    Issue 15: How should up-front payments made in exchange for certain advertising services provided over a period of time be accounted for?

    Miscellaneous Issues

    Issue 16: Does the accounting by holders for financial instruments with exercisability terms that are variable-based future events, such an IPO, fall under the provisions of SFAS 133?

    Issue 17: Should Internet operations be treated as a separate operating segment in accordance with SFAS 131?

    Issue 18: Should there be more comparability between Internet companies in the classification of expenses by category?

    Issue 19: How should companies account for on-line coupons?

     


    Additional Reading

    See Bob Jensen's threads on accounting theory at http://faculty.trinity.edu/rjensen/theory.htm 

    Baruch Lev's Home Page --- http://www.stern.nyu.edu/~blev/main.html 

     

     

    Failed Education Systems In the Early Years Leave Weak Foundations to Build Upon
    At least 55% are being "honest."
    In a speech to an audience of business leaders, students and the media at the Millenium Biltmore, Quigley
    (Deloitte and Touche CEO) said compliance with the new laws and regulations is required but will not be enough. The new age demands "principle-centered leadership and a values-based approach to individual action." Quigley summarized a survey of high school students conducted in conjunction with Junior Achievement. In the survey, students were asked "would you act unethically if you were sure you would never be caught?" Fifty-five percent of the students responded "yes," or "they were not sure."
    SmartPros, "Deloitte CEO Outlines Direction for 'New Age of Accountability'," November 18, 2004 --- http://www.smartpros.com/x45888.xml 

    Most professors in colleges and universities lament the decline in educational quality in the K-12 schools that feed into the higher education systems.  This fact underlies the increasing difficulty in finding talented and educated inputs to the post-secondary education systems that, in turn, feed professions like accountancy.

    "A Nation Still at Risk," by William J. Bennett, Willard Fair, Chester E. Finn Jr., Rev. Floyd Flake, E.D. Hirsch, Will Marshall, Diane Ravitch, et al., Policy Review, July 1998 --- http://www.policyreview.org/jul98/nation.html 

    Fifteen years ago, the National Commission on Excellence in Education declared the United States a nation at risk. That distinguished citizens’ panel admonished the American people that "the educational foundations of our society are presently being eroded by a rising tide of mediocrity that threatens our very future as a Nation and a people." This stark warning was heard across the land.

    A decade and a half later, the risk posed by inadequate education has changed. Our nation today does not face imminent danger of economic decline or technological inferiority. Much about America is flourishing, at least for now, at least for a lot of people. Yet the state of our children’s education is still far, very far, from what it ought to be. Unfortunately, the economic boom times have made many Americans indifferent to poor educational achievement. Too many express indifference, apathy, a shrug of the shoulders. Despite continuing indicators of inadequacy, and the risk that this poses to our future well-being, much of the public shrugs and says, "Whatever."

    The data are compelling. We learned in February that American 12th-graders scored near the bottom on the recent Third International Math and Science Study (TIMSS): U.S. students placed 19th out of 21 developed nations in math and 16th out of 21 in science. Our advanced students did even worse, scoring dead last in physics. This evidence suggests that, compared to the rest of the industrialized world, our students lag seriously in critical subjects vital to our future. That’s a national shame.

    Today’s high-school seniors had not even started school when the Excellence Commission’s report was released. A whole generation of young Americans has passed through the education system in the years since. But many have passed through without learning what is needed. Since 1983, more than 10 million Americans have reached the 12th grade without having learned to read at a basic level. More than 20 million have reached their senior year unable to do basic math. Almost 25 million have reached 12th grade not knowing the essentials of U.S. history. And those are the young people who complete their senior year. In the same period, more than 6 million Americans dropped out of high school altogether. The numbers are even bleaker in minority communities. In 1996, 13 percent of all blacks aged 16 to 24 were not in school and did not hold a diploma. Seventeen percent of first-generation Hispanics had dropped out of high school, including a tragic 44 percent of Hispanic immigrants in this age group. This is another lost generation. For them the risk is grave indeed.

    To be sure, there have been gains during the past 15 years, many of them inspired by the Excellence Commission’s clarion call. Dropout rates declined and college attendance rose. More high-school students are enrolling in more challenging academic courses. With more students taking more courses and staying in school longer, it is indeed puzzling that student achievement has remained largely flat and that enrollment in remedial college courses has risen to unprecedented levels.

    The Risk Today

    Contrary to what so many seem to think, this is no time for complacency. The risk posed to tomorrow’s well-being by the sea of educational mediocrity that still engulfs us is acute. Large numbers of students remain at risk. Intellectually and morally, America’s educational system is failing far too many people.

    Academically, we fall off a cliff somewhere in the middle and upper grades. Internationally, U.S. youngsters hold their own at the elementary level but falter in the middle years and drop far behind in high school. We seem to be the only country in the world whose children fall farther behind the longer they stay in school. That is true of our advanced students and our so-called good schools, as well as those in the middle.

    Remediation is rampant in college, with some 30 percent of entering freshmen (including more than half at the sprawling California State University system) in need of remedial courses in reading, writing, and mathematics after arriving on campus. Employers report difficulty finding people to hire who have the skills, knowledge, habits, and attitudes they require for technologically sophisticated positions. Silicon Valley entrepreneurs press for higher immigration levels so they can recruit the qualified personnel they need. Though the pay they offer is excellent, the supply of competent U.S.-educated workers is too meager to fill the available jobs.

    In the midst of our flourishing economy, we are re-creating a dual school system, separate and unequal, almost half a century after government-sanctioned segregation was declared unconstitutional. We face a widening and unacceptable chasm between good schools and bad, between those youngsters who get an adequate education and those who emerge from school barely able to read and write. Poor and minority children, by and large, go to worse schools, have less expected of them, are taught by less knowledgeable teachers, and have the least power to alter bad situations. Yet it’s poor children who most need great schools.

    If we continue to sustain this chasm between the educational haves and have-nots, our nation will face cultural, moral, and civic peril. During the past 30 years, we have witnessed a cheapening and coarsening of many facets of our lives. We see it, among other places, in the squalid fare on television and in the movies. Obviously the schools are not primarily responsible for this degradation of culture. But we should be able to rely on our schools to counter the worst aspects of popular culture, to fortify students with standards, judgment, and character. Trashy American culture has spread worldwide; educational mediocrity has not. Other nations seem better equipped to resist the Hollywood invasion than is the land where Hollywood is located.

    Delusion and Indifference

    Regrettably, some educators and commentators have responded to the persistence of mediocre performance by engaging in denial, self-delusion, and blame shifting. Instead of acknowledging that there are real and urgent problems, they deny that there are any problems at all. Some have urged complacency, assuring parents in leafy suburbs that their own children are doing fine and urging them to ignore the poor performance of our elite students on international tests. Broad hints are dropped that, if there’s a problem, it’s confined to other people’s children in other communities. Yet when attention is focused on the acute achievement problems of disadvantaged youngsters, many educators seem to think that some boys and girls—especially those from the "other side of the tracks"—just can’t be expected to learn much.

    Then, of course, there is the fantasy that America’s education crisis is a fraud, something invented by enemies of public schools. And there is the worrisome conviction of millions of parents that, whatever may be ailing U.S. education in general, "my kid’s school is OK."

    Now is no time for complacency. Such illusions and denials endanger the nation’s future and the future of today’s children. Good education has become absolutely indispensable for economic success, both for individuals and for American society. More so today than in 1983, the young person without a solid education is doomed to a bleak future.

    Good education is the great equalizer of American society. Horace Mann termed it the "balance wheel of the social machinery," and that is even more valid now. As we become more of a meritocracy the quality of one’s education matters more. That creates both unprecedented opportunities for those who once would have found the door barred—and huge new hurdles for those burdened by inferior education.

    America today faces a profound test of its commitment to equal educational opportunity. This is a test of whether we truly intend to educate all our children or merely keep everyone in school for a certain number of years; of whether we will settle for low levels of performance by most youngsters and excellence only from an elite few. Perhaps America can continue to prosper economically so long as only some of its citizens are well educated. But can we be sure of that? Should we settle for so little? What about the wasted human potential and blighted lives of those left behind?

    Our nation’s democratic institutions and founding principles assume that we are a people capable of deliberating together. We must decide whether we really care about the debilitating effects of mediocre schooling on the quality of our politics, our popular culture, our economy and our communities, as dumbing-down infiltrates every aspect of society. Are we to be the land of Jefferson and Lincoln or the land of Beavis and Butthead?

    Continued at http://www.policyreview.org/jul98/nation.html  


    Yer Publik Skools At Werk 
    More than 3,000 Nevada high school seniors are in danger of not graduating this June because they can&rsquo;t pass the math proficiency test. ... In math, 65 percent of the 4,955 who took the most recent examination failed.  In reading, 50 percent of 1,955 taking the test failed. ... Tom McIntosh, director of standards, curricula and assessment for the Education Department, said he has no explanation why students haven&rsquo;t improved this year.An estimated 3,200 seniors haven&rsquo;t passed, about 900 more than last year at this time.  The test is no harder,&rsquo; McIntosh said. ... The skills required are not anything a kid shouldn't know
    --- http://www.dittohead.org/school.html 

     

     

     

    Career Passed Away --- An Excerpt from http://faculty.trinity.edu/rjensen/cpaaway.htm 
    Dr. Robert E. Jensen
    Department of Business Administration
    Trinity University
    715 Stadium Drive
    San Antonio, TX  78212

    Dear Professor Jensen:

    It has been a long time since we last communicated.  Since the demise of the CPA examination, we have not hired a CPA.  It is my understanding that accounting majors are now part of your Computer Science Department.  However, legacy SEC rules require that public accounting firms have at least one old-style CPA, and therein lies our problem.  We need to make contact with former students having old-style CPA credentials.  None of the accounting graduates in the past decade could become CPAs.  What also makes it difficult is our firm's policy requiring that applicants have a graduate degree in penmanship.  If you can think of any qualified applicants, please forward their names to us.

    Each of the Big 5 public accounting firms has one CPA.  He's called the Signer.  On the occasion of his 100th birthday on June 14, our Signer named Ebenezer Overhill will retire.  Since he only gets $5 for each signed audit report, he could not afford to retire until this year.  Mr. Overhill takes great pride in his signature and can only manage two per hour.  We are very proud of our Mr. Overhill.  Last year the entire membership of the AICPA met in a restaurant to honor him.  He received the AICPA Lifetime Signer Award.  Our firm strives to carry on the signature TQM that is a tradition due to our wonderful Mr. Overhill.

    You may wonder who conducts the audits and generates the reports that the SEC requires Mr. Overhill to sign.  Our auditor's name is HAL EVERY.  HAL's a massive parallel processor capable of tracking every transaction of every worldwide client during every hour of every day.  Ironically, our prospering Consulting Division was sold in Year 2000 due to SEC concerns about audit independence.  Now we outsource all HAL design and operation duties to our former Consulting Division.  But the SEC requires that our CPA sign each and every audit report.  Mr. Overhill does not have clue about HAL.  Just between us, he can't even remember HAL's name.  But nobody in public accounting has a finer signature than our Mr. Overhill.

    I do miss the days when our home office was on the top floor of a New York skyscraper.  Leasing such luxurious space is no longer necessary since Mr. Overhill and I are the only employees of the firm.  Mr. Overhill used to dictate all the letters that I typed.  Alas, a stroke on July 7, 2016 made his speech incoherent.  But he will sign this letter.  He still likes to sign all correspondence going out of this office.  Thus far this year, there were five letters typed and mailed the old fashioned way.  We have not had to worry about client correspondence since the 2014 SEC ruling that all domestic and international clients  must be randomly assigned to the Big 5 firms.  Our clients communicate directly with HAL.  We do see their names on the tops of the audit reports that must be signed.

    There's plenty of room in Mr. Overhill's garage for our office since his old car was sold.  The State of New York refused to renew his driving license after he became blind.  But at his advanced age, it is nice that his desk is only 12 feet from the bedroom door and 23 feet from the commode.  With help, he can make it more than half the time without wetting himself.  And I only have to run over here from my house next door. 

    Even though Mr. Overhill will sign this letter, please remember that my name is Barbara Pawalski if you telephone our office.  Please address all mail to Mr. Overhill.  I read every letter aloud  to him, although there have been no letters in the past two years.  He would so enjoy getting a letter. I regularly read parts of HAL's audit reports to Mr. Overhill until he dozes off.

    Very truly yours,

    Ebenezer Overhill, CPA

    Continued at http://faculty.trinity.edu/rjensen/cpaaway.htm  

     

    June 11 message from Lisa Young at Ernst & Young

    Maintaining our valued campus relationships is something that we refuse to lose sight of at Ernst & Young-despite the many distractions in the industry. In order to communication with you on topics that may be of interest to accounting educators, we have created the Ernst & Young Faculty Connection-an electronic newsletter.

    We believe that a fresh influx of talent-and free and open dialog between you and the big firms-is crucially important to the professional accounting business-probably more so now than at any time in our history. Maintaining a supply of bright, prepared people is a year-round job for you and for us.

    We invite you to launch your first issue by simply clicking the link below, or copying and pasting the link in your browser:

    http://www.ey.com/GLOBAL/content.nsf/US/Careers_-_Faculty_Connection_Newsletter 

    Accentuate the Positive
    One of the early responders was Dennis Beresford from the University of Georgia (and former Chairman of the FASB)

    In this section each issue we will invite one of your colleagues to write an editorial. For the first issue, we thank Denny Beresford, Executive Professor from the University of Georgia, for his insightful words on the profession during this very unique time.

    "Twenty-six years at E&Y, ten years at the FASB, and five years at the University of Georgia should have prepared me for the extraordinary events of the past six months. Yet the meltdowns of both Enron and Andersen have made this period quite different than any other in my professional lifetime. Hardly a day has passed without my receiving at least a couple of calls from reporters, versus only a few calls a month while at the FASB. And the opportunities to testify to Congress, appear on national television, and make numerous other presentations have made this a truly exciting period. But, rather than focusing on these personal activities, I try to keep the professional big picture in mind.

    At least some changes in accounting standards, regulation of auditing, and corporate governance are needed and will occur. These changes no doubt will influence the content of many accounting courses. I know that some accounting professors already are including some of the Enron/Andersen lessons into their classes, and other will have to do so soon.

    Beyond those subject matter challenges, however, is the overall impression of accounting as a vocation. It is here, I believe, where educators have the greatest opportunity to make a positive contribution.

    I've already seen evidence of some professors making a very pessimistic assessment. They note that Enron/Andersen "proves" that the accounting profession is fundamentally flawed with too many unethical practitioners. This kind of cynical attitude will almost certainly reinforce concerns about accounting as a career choice in the minds of current and potential accounting majors.

    I prefer to take a more optimistic view. I believe the current situation demonstrates that high-quality financial reporting and high-quality auditing are critical to our capital markets and overall economy. The market can extract huge penalties for inadequate performance, and it also can reward those who do the right thing. With the recent supply of accounting graduates declining, and the tremendous opportunities for well-educated individuals in the profession, this is a great time to be entering the profession.

    A very old song made a lasting impression on my life. It said we should "accentuate the positive, and eliminate the negative." Current events show that we'll never be 100% successful with the latter. However, if we remember to "accentuate the positive" in all of our communications with students, we'll help ensure an even better profession in the future."

    Continued at http://www.ey.com/GLOBAL/content.nsf/US/Careers_-_Faculty_Connection_Newsletter 

     

     

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

    Prospects for Public Company Accounting Oversight Board (PCAOB) created in the Sarbanes-Oxley Act of 2002.

    Note:  Harvey Pitt resigned from the SEC following allegations that he was aiding large accounting firms in stacking the new Public Company Accounting Oversight Board (PCAOB) created in the Sarbanes-Oxley Act of 2002. The following module was written by Bob Jensen over a year before he resigned.

    In spite of the resounding of trumpets ushering in a new quasi-independent body that enforces ethics of auditors and investigates auditing system quality controls, the proposal sounds to me more like a rearranging of deck chairs and the building of a facade over a system that will change little after the Enron scandal dies down in the media. former SEC Chairman Harvey Pitt called for an oversight board that I will refer to here as the PCAOB or the Lone Ranger Board.  The PCAOB would, in theory, ride into virtually every bad audit situation where there is gross incompetence and/or fraud and clean up the mess like the Lone Ranger on a silver horse.

    As far as riding in like the the Lone Ranger and Tonto to save the employees and investors from bad local-office audits, I do not have a whole lot of hope in the new quality control PCAOB.  A few serious quality control investigations of a few complex audits may be all that an outside board can launch each year.  There are enormous startup costs to any such investigation.  Imagine being charged with doing a quality control investigation of a company almost as complex as Enron.  The audit firms themselves spend millions trying to train auditors for highly varied industries and complicated contracts.  There are just too many companies and too much correspondence to investigate month in and month out. 

    The best and the brightest accounting graduates aspire to go to work for the large auditing firms.  They have hopes of becoming rich as partners in large firms or beneficiaries of  huge offers from audit clients.  All the PCAOB can offer is kemosabe for breakfast, lunch, and dinner.  The FASB hires some pretty good short-term staff, because the FASB needs only a small number of staff members.   The PCAOB  quality control investigation system will need hundreds or possibly thousands of staff members (recall that the Houston office of Andersen alone had around 1,800 employees working on a relatively small number of audits).

    A major portion of each audit is now devoted to what went on inside the black boxes called computers and networked databases.  Auditing firms must hire and train specialists for particular audits who can cope with the unique features of each client's computer system.  Any quality control investigation should entail an investigation of the competencies of the auditors in dealing with very complex information systems.  This means that PCAOB must also hire highly technical specialists in information systems as well as investigators trained in accounting and auditing.  What I am saying is that the expense of creating a competent PCAOB and staff boggles my mind.  The cost of the FASB is miniscule compared to what the body proposed by Harvey Pitt on January 17, 2002 will cost, at least as how I envision a quality control inspection system.

    When 99.5% of tax returns do not get audited, the effectiveness of tax audits in deterring errors and fraud is substantially reduced from the days when nearly half the returns were audited (if there ever was such an era).   The same will hold for audit quality control investigations, and if a large accounting firm gets charged $10 million for negligence, the fine will be paid out of petty cash.

    I just cannot imagine worries of the PCAOB (like the Lone Ranger and Tonto) whisking briefly into town will instill nearly as much fear as gut-wrenching worries about being sued for $50 billion by unhappy investors and the client's employees. 

    Other Alternatives

    The cheapest and most effective way to prevent fraud from taking place initially is to seriously reward whistle blowing.  Enron could never have created such complex accounting deceptions in the midst of employees and auditors seeking to become rich for exposing deceptive acts.  But an organization where virtually every employee wants to blow the whistle may lead to dysfunctional organizations and paranoia to such an extreme that there is no incentive to manage and innovate.  In short, business firms just may not function in a whistle blowing world that is not inhabited by an entire population of saints.  Another worry is that whistle blowing may be so successful that Mafia-style contracts are let on whistle blowers to discourage whistle blowing.

    Probably the most serious deterrent to bad audits, aside from a whistle blowing society, is already in place in the United States.  Auditing firms live in fear of tort litigation in the magnitudes of millions or billions of dollars.  Someday one or more of the firms may implode due to enormous judgments against the auditors.  Big Five firms are survivors because, until Enron, there has never been a case where there were not enough resources and insurance to survive.  

     

    Conclusion

    What it boils down to is incentives for internal quality controls within auditing firms.  The PCAOB  might add some incentives for auditing ethics and quality, but I doubt that the PCAOB will have a major impact.  The PCAOB will have a bigger impact if there are  incentives  for whistle blowers to report in to the PCAOBs.  For example, the mere promise to do something when auditors and clients do nothing after the whistle is blown becomes an incentive to blow whistles.  After Sherron Watkins blew the whistle internally, neither the CEO of Enron nor the National Office of Andersen did anything of note to stop Enron's double-dealing CFO, Andy Fastow, from borrowing more money off balance sheet and creating more complicated accounting deceptions. 

    To the extent that Sherron Watkins could have expected more positive reactions of a PCAOB-type board to her whistle blowing, she and her fellow-employees might have blown the whistle much earlier than August 20, 2001 when there was still time to save the farm.

    In parting, I conclude that all new audit quality control the PCAOB in and of themselves will not have much impact unless they work more closely with whistle blowers in finding what to investigate among the mind-boggling number of audits that could be investigated. 

    • My proposed solution is to annually rotate the partners in charge of all audits --- with such rotations for large audits coming from partners and managers in other cities.   Destruction of records should be prohibited.

    • My proposed solution is to provide greater incentives to whistle blowers within audit firms and their clients.  

    • My proposed solution is to make the white collar punishment match the crime and never to allow any serious white collar criminal a choice other than a prison sentence followed by closely-monitored remaining life in a minimum wage job.

    • My proposed solution is to reduce some of the due process red tape of the FASB and let standard setters get on with eliminating SPEs and other gimmicks allowing firms to hide financial risk.  I have more faith in the FASB than the SEC in this regard due to the lobbying powers of industry and big accounting firms.

    • I don't think the benefits of the quality control investigating board proposed by the SEC on January 17 justify the tremendous costs of setting it up and maintaining it month after month with really qualified specialists.  

    EY's Turley: How Accounting Can Get Back Its Good Name In the Wall Street Journal, EY Chairman Jim Turley outlines a series of reforms to help the accounting profession respond to challenges in the post-Enron business environment. Included in the recommendations: a ban on the sale of IT consulting services to audit clients and the attempt to make financial statements more understandable

    "How Accounting Can Get Back Its Good Name," by Jim Turley, Chairman, Ernst & Young

    Never before has the accounting profession faced what it faces today. The fundamental underpinning of our profession -- our integrity -- is being challenged. What started as a problem for Enron and its auditor has become a problem for all auditing firms. Part of it is perception. But much is quite real. We have to deal with both.

    I have been asked repeatedly what the profession should do to get back its good name. The reasons behind business failures and accounting restatements are quite complex, and it is important to bring balance to the issue.

    First, let's deal with some outstanding issues. Two years ago, Arthur Levitt, then chairman of the Securities and Exchange Commission, proposed regulations that would largely ban the delivery of information technology consulting services to audit clients of the firms. It's time to adopt these restrictions. Ernst & Young supported the proposals then, and our position hasn't changed today. Recently other firms have joined our position. So let's just get it done.

    I know some cynics will say that we've sold our consulting practice and therefore wouldn't be giving up much. But that's missing the point. We sold our practice because we thought it was the right and strategic thing to do. And Ernst & Young, as the leader in internal audit services, will be the firm most impacted by the restriction on internal audit services. But again, we think it's the right thing to do.

    Second, we should create a new regulatory body for the profession. It should have its own funding, offices and staff. It should have direct power over the profession's disciplinary and audit quality control programs, replacing the current "peer review" process in which firms review each other. To ensure maximum public credibility, this oversight should come from a body other than the American Institute of Certified Public Accountants, because many believe it has not maintained its historic focus on professional responsibility.

    While auditor independence and professional discipline are critically important, reforms in those areas alone won't prevent another Enron. We need to address other issues as well.

    Financial disclosure needs to be more forthright and understandable. SEC Chairman Harvey Pitt placed this on the top of his agenda even before the current crisis. The problems with financial statements are well-known: They focus on historical information instead of current and trend information; are hard to understand; and haven't kept pace with modern corporate complexities. Additionally, companies report a single earnings per share number, as if their results were that precise. Investors might be better served by a range that reflects the reality of business uncertainties.

    We need new rules, new standards, new disclosures. The Financial Accounting Standards Board, which has responsibility for rulemaking in this area, must move more quickly and with more foresight.

    There are other steps that should be considered. Let's strengthen audit committees' independence to ensure they provide oversight of management's actions. Let's make it clear that auditors are to be hired and fired by the audit committee, not management. Let's make it a criminal offense to lie to the outside auditor.

    Another idea to consider is the formation of a multi-disciplinary National Transportation Safety Board-like organization, which would immediately investigate the causes of a corporate "crash" and recommend steps needed to prevent a recurrence. Like the NTSB, this group's sole focus would be on prevention, not discipline.

    These are all good ideas. But some changes being discussed would do more harm than good.

    For instance, there is no need to ban all non-audit work for audit clients. Many so-called non-audit services are so closely linked to the audit that as a practical matter only the auditor can provide them. Another service -- tax -- has always been provided by auditors to their clients. I have yet to see one client facing a business issue that didn't have both accounting and tax ramifications.

    Mandatory auditor rotation -- that is, a requirement that clients periodically switch their audit firm -- is being urged by some. That would likely reduce audit quality in both the early and late years of an audit "term." A better approach, if change is really needed: a staggered rotation of all partners and staff on the engagement -- providing a continuous flow of new eyes and objectivity, while maintaining the institutional knowledge that helps ensure audit quality.

    A client recently asked me what I thought to be the worst possible outcome of the current situation. I told him it would be the implosion of Arthur Andersen, which would create an immediate supply/demand mismatch in the audit profession, coupled with legislation by Congress that unduly restricted the profession -- making it unappealing for students to enter the profession or long-time auditors to stay in it. Add to this the imposition of too many requirements on audit committees, and we could end up with nobody wanting to do audits and nobody wanting to serve on audit committees.

    That's my nightmare. The client looked at me, concerned, and said, "This could happen."

    But people who know me say I'm an undying optimist. I am. And I believe that with all the people looking at my profession, people who are searching for solutions, we won't make the mistakes that would lead to my nightmare, but instead will take the right steps to ensure a stronger profession, better financial reporting and stronger capital markets. ____

    Mr. Turley is chairman of Ernst & Young.

    Bob Jensen's Conclusion
    In spite of Mr. Turley's reminder that Ernst & Young supported Arthur Levitt's failed SEC "proposed regulations that would largely ban the delivery of information technology consulting services to audit clients of the firms" and, thereby, took a position opposite of most other large accounting firms, I still have to argue that retrenchment of accounting firms into audit services apart from consultancy is not the solution to restoring the image of accountancy.  Auditing by and of itself is neither a dynamic nor a very profitable industry.  I still argue for both consultancy and auditing coupled with warranties (like insurance) on the liabilities backing those services.  Thus, buyers of services could then purchase various warranty options that would pay either the clients or shareholders/creditors for failed consultancy and/or audit services.  

     
    Will CPA Auditing Survive?  Insurance Versus Assurance?

    Why Not Eliminate Public Accounting Firm Audits? SmartPros, January 2, 2003

    Jan. 2, 2003 (Thomson Media) — The latest accounting debacle is shaking up not only the financial industry, with bankers probed about loans to corporate miscreants, but also our political environment with the White House being maneuvered toward reforms. The question on the minds of everyone from executives to the President to the SEC is, how do we fix the audit system? The real question, however, should be, is the audit system even necessary?

    In the name of full disclosure, I received my CPA well over 10 years ago working for the accounting firm KPMG. I did not keep up my certification programs and no longer practice as a CPA. My current mission of improving corporate value via productivity makes me passionate about efficiency.

    My fervent recommendation is to eliminate the entire public auditing industry. In this new world, sans the auditing industry, auditors would still have a vital role in ensuring compliance, but not through an artificially forced extra layer, such as is currently in place. Half of the auditors would work for the SEC to reinforce interpretation and opinion. The rest of the auditors would work directly for the companies who file their financial statements with the SEC. The companies themselves would provide the sole and detailed opinion on their financial statements. Checks and balances would occur directly between the company and the SEC -- which would remain an unbiased and financially independent compliance organization.

    The auditing perspective is based on principles of public auditing that I learned at KPMG in my early years. The perception of conflict of interest is to be avoided as much as the realities of it. In the case of the audit profession, the fact that the firms are "for profit" partnerships paid by clients is the fundamental conflict of interest issue -- not specifically the payments made for the consulting work. Too many control points dilute rather than reinforce accountability. This is the problem in almost all of the current situations. Auditors blame management, which is ultimately accountable. But management blames the auditors upon whom it relies. One proposed solution is to implement an overseeing body to supervise the auditors-adding even more layers of theoretical control. This is a true waste of resources and puts us in a vicious cycle. Bad business models create bad business judgment.

    The value of public auditing is difficult even for auditors to justify. If the company is reporting according to principles defined by the SEC, then the public audit provides little additional value. Though there are certainly mistakes caught inside an audit that are fixed and never make it to the public's attention, a strong internal audit group could likely provide the same level of value. If the company has financial and management issues and is not reporting correctly, then the role of the outside auditor is conflicted. It is clear current audit methods often do not go far enough. For external audits to provide real value, they would likely need to be significantly deeper and less influenced than they are today.

    From the productivity point of view, our economic system can provide just so many resources for overseeing company accounting activities. If they are spread unevenly across internal auditors, internal accountants and finance departments, internal compliance, external auditors, external auditor review boards, and the SEC, we are likely to continue to get the results we have seen in the last nine months: too many touch points with too little assurance. The redundancy is ineffective and expensive. Eliminating the public system altogether and putting the onus on the company to report correctly and directly with the SEC makes the most sense.

    So what would this change really look like and will anyone take it seriously? CPAs would continue to be trained on SEC regulations, but wouldn't be required to work at a public firm to receive their licenses. Instead of working for audit firms, they'd work directly for companies. Internal auditors and these SEC-trained auditors would work together to ensure the company followed correct accounting procedures. Direct corporate repercussions from the SEC would alleviate concerns about management influence over their audit employees.

    The reality is we'll probably just add another layer of governing to the already cumbersome public auditing industry. But just for a moment, wouldn't it be nice to imagine efficiency and responsibility winning over wasted resources, additional red tape, and continued finger-pointing?

    -- Thomson Media

     

    Questions
    Will public accounting external audit services survive?  
    What are the alternatives to financial assurance by public accounting firms?  

    Answers
    My first answer is that the public accounting auditors will probably survive.  However, if they survive they may have to add more value and less costs to most audits.  One way to add value is to insure rather than assure the quality of audit services.  This was first proposed by me in this document in March 2002.

    My answers, albeit naive, begin with a recommendation that auditing firms "warrant" or "insure" their services much like insurance companies insure against liability with limits as to what they will pay such as limits to liability in automobile accidents.  Clients should decide how much auditing liability insurance they are willing to purchase as a component of the total audit fee.  The insured liability limit  should be publicized on Page 1 of a corporate annual report and in stock price listings in newspapers and on the Internet.  Accordingly, the amount of insured audit liability would then become an important input into investor and creditor decisions.  Firms paying for lower audit liability would then pay the price by having a higher cost of capital.   This does not mean that all audits should not be held accountable to identical high auditing standards or that audit insurance claims can be filed for stock price declines.  Claims should only be filed when there is evidence of audit negligence and/or fraud.
    Bob Jensen at http://faculty.trinity.edu/rjensen/damages.htm 

    Audit service warranties may also reduce the cost of some audits and lead to more efficient resource allocations.  Two factors work toward inefficient and ineffective allocation of resources in audits.  

    • Need to Put in the Time
      The first factor is the need to put in the time to justify the billings for audit services.  This motivates auditors to perform tasks even when they know they are just spinning their wheels on tasks that add little or no value for some clients.  Audit service (warranty) insurance would no longer have to justify billings based upon task times.  Instead the billings could be based upon a combination of the audit risk and the level of insurance.

    • High Litigation Costs
      The second factor is the high cost of litigation that must be factored into billing rates for all clients.  If assurance was replaced by insurance, litigation costs could be eliminated much like casualty insurers avoid litigation costs with a combination of damage estimation, insurance, and arbitration to avoid enormous amounts of litigation in claims settlements.

    I wrote first recommended that insurance replace assurance appeared in March 2002.  Subsequently, Joshua Ronen took a more radical stance by recommending a Financial Statement Insurance (FSI) alternative in "Policy Reforms in the Aftermath of Accounting Scandals," Journal of Accounting and Public Policy, Volume 21, Winter 2002, Page 284 --- http://www.elsevier.nl/inca/publications/store/5/0/5/7/2/1/

    The threat of legal liability is not at present properly crafted to eliminate the incentive to do management's bidding.  Moreover, the expected cost of litigation and other penalties is recouped in the aggregate from the auditees, but not in such a way that each of the auditees defrays the expected cost it imposes: high-quality auditees subsidize lower-quality auditees.  This results in an inefficient allocation of risk and resources.  Furthermore, the recoupment is made out of the client-corporation's resources, diminishing the wealth of the shareholders, who purchased the shares at prices potentially inflated as a result of misrepresentations.  Thus, instead of being protected, the shareholders end up partially shouldering the costs.  Only severing the agency relation between the client-management and the auditors can remove the inherent conflict of interest.  We need to create instead an agency relationship between the auditor and an appropriate principal--one whose economic interests are aligned with those of investors, who are the ultimate intended beneficiaries of the auditor's attestation.  Insurance carriers are eminently reasonable candidates.

    Financial statement insurance (FSI) would change the principal-agent relationship.  Instead of appointing and paying auditors, companies would purchase insurance that provides coverage to investors against losses suffered as a result of misrepresentation in financial reports.  The insurance coverage the companies obtain would be publicized, along with the premiums paid for the coverage.  The insurance carriers would appoint--and pay-- the auditors, who would attest to the accuracy of the financial statements of the insurance company's prospective clients.

    Companies announcing higher limits of coverage and smaller premiums would distinguish themselves in the eyes of the investors as companies with higher-quality financial statements.  In contrast, those with smaller or no coverage or higher premiums would reveal themselves as those with lower quality financial statements.  Every company would be eager to avoid this characterization.  A sort of Gresham's law in reverse would be set in operation, resulting in a flight to quality.

    The FSI scheme effectively eliminates the conflict of interest that came to light in the aftermath of Enron.  But financial statement insurance has other important benefits: the credible signaling of financial statement quality and the consequent improvement of such quality, the decrease in shareholder losses, and the better channeling of savings to socially desirable projects.

    This solution can be complemented and reinforced by GAAP and GAAS reforms, resulting in significant additional indirect benefits.  If implemented, FSI would facilitate an accounting approach based on underlying principles rather than detailed rules.  It has been argued in this journal that the US model of specifying rules that must be applied has allowed or encouraged firms such as Andersen to accept procedures that, while they conformed to the letter of the rules, violated the basic objectives of GAAP accounting.  For example, although SPEs in Enron usually appeared to have the minimum required three percent of independent equity.  Enron in fact bore most of the risk.  The contention is that general principles such as UK GAAP, which require auditors to report a "true and fair view" of an enterprise, are preferable to the over-specified US model, and that the US model encourages corporate officers to view accounting rules as analogous to the Tax Code.1


    1    "ENRON: what happened and what we can learn from it," by George J. Benston and Al L. Hartgraves, Journal of Accounting and Public Policy, 2002, pp. 105-127 

    "The Evolving Accounting Standards for Special Purpose Entities and Consolidations," by Al L. Hartgraves and George J. Benston, Accounting Horizons, September 2002, pp. 245-258.

    Neither FSI nor audit service warranty insurance proposals have been worked out in any kind of detail by Professor Ronen or me. Two components that I would like to include are as follows:

    1. A whistle blowing incentive scheme that will help disclose breakdowns in the services.

      Reply from Kevin O'Brien [kobrien@du.edu
      Kevin made an excellent presentation on CPA whistle blowing obligations.

      Bob, thanks for the feedback; I have had several CPAs come up and tell me your presentation was very thought provoking!

      My Powerpoint related to the presentation is on my website at the following URL: http://www.du.edu/~kobrien/whistleblowing.ppt 

      You can also access it at www.du.edu/~kobrien  and follow the link to "CPA Ethics".


      I highly recommend Kevin's proposed solutions.


    2. For claims to be adjudicated in an "accounting court" very similar to the "court" proposed by the most famous managing partner (Leonard Spacek) in the history of Arthur Andersen --- Spacek, L., "The Need for an Accounting Court", The Accounting Review, l958, pp. 368-379.  Whereas Spacek was more concerned with the setting of accounting principles and resolving disputes between auditors and clients, my vision would expand upon this concept. I think what I envision is both a an accounting justice system that would review the merits of claims and press charges for wrongful acts in the accounting court.

      I envision the "accounting court" of the future to operate with both arbitration and mediation schema much like labor arbitration and mediation systems have evolved to keep labor disputes out of the courts.  The accounting court would attempt to keep disputes between investors and auditors out of the legal system and arbitrate claims of auditor errors, incompetence, and frauds.  Each auditing firm would charge clients for audit insurance and the accounting court would attempt to settle claims that the auditing firm did not voluntarily settle.

    Leonard Spacek was the most famous and most controversial of all the managing partners of the accounting firm of Arthur Andersen. It is really amazing to juxtapose what Spacek advocated in 1958 with the troubles that his firm having in the past decade or more.

    In the link below, I quote a long passage from a 1958 speech by Leonard Spacek. I think this speech portrays the decline in professionalism in public accountancy. What would Spacek say today if he had to testify before Congress in the Enron case.

    What I am proposing today is the need for both an accounting court to resolve disputes between auditors and clients along with something something like an investigative body that is to discover serious mistakes in the audit, including being a sounding board for whistle blowing. Spacek envisioned the "court" to be more like the FASB. My view extends this concept to be more like the accounting court in Holland combined with an investigative branch outside the SEC.

    You can download the passage below from http://faculty.trinity.edu/rjensen/FraudSpacek01.htm 

    My   proposal differs somewhat from the "Investigative Body" proposal of Deloitte and Touche CEO Jim Copeland in that Copeland's investigative body would look only at financial failures.  My proposal is intended to help investors not be mislead by bad accounting before the failures transpire.  It is intended to weaken the powers of large clients when trying to force auditors to compromise on representational faithfulness and adherence to accounting and auditing rules.  This does not eliminate the need Copeland's Investigative Body.  See http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm#InvestigativeBody 

     


    In a landmark vote, Disney shareholders voted to reject the proposal that would have prohibited the company from using the same firm to provide auditing and consulting services. In spite of the shareholder vote giving the company the right to seek auditing and consulting services from the same firm, Disney Chairman and Chief Executive Michael Eisner announced company plans to separate audit and consulting services among outside providers. http://www.accountingweb.com/item/72840


    What will the U.S. accounting business look like when the dust settles on Arthur Andersen? http://faculty.trinity.edu/rjensen/fraud041202.htm#Future 



    "The Truth Behind the Earnings Illusion:  The profit picture has never been so distorted. The surprise? Things aren't as ugly as they look" by Justin Fox, Fortune, July 22, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208677 

    Question:  
    Where are the major differences between book income and taxable income that favor booked income reported to the investing public?

    Answer according to Justin Fox:

    What the heck happened? The most obvious explanations for the disconnect are disparities in accounting for stock options and pension funds. When a company's employees exercise stock options, the gains are treated for tax purposes as an expense to the company but are completely ignored in reported earnings. And while investment gains made by a company's employee pension fund are counted in reported earnings, they don't show up in tax profits.

    Analysts at Standard & Poor's are working to remove those two distortions by calculating a new "core earnings" measure for S&P 500 companies that includes options costs and excludes pension fund gains. When that exercise is completed in the coming weeks, most of the profit disconnect may disappear. Then again, maybe not. In struggling to deliver the outsized profits to which they and their investors had become accustomed in the mid-1990s, a lot more CEOs and CFOs may have bent the rules than we know about. "There was some cheating around the edges," says S&P chief economist David Wyss. "It's just not clear how big the edges are."

    While conservative accounting is now back in vogue, it's impossible to say with certainty that reported earnings have returned to reality: Comparing the earnings per share of the S&P 500 with the tax profits of all American corporations, both public and private (which is what the Commerce Department reports), is too much of an apples and oranges exercise. But over the long run reported earnings and tax earnings do grow at about the same rate--just over 7% a year since 1960, according to Prudential Securities chief economist Richard Rippe, Wall Street's most devoted student of the Commerce Department profit numbers. So the fact that Commerce says after-tax profits came in at an annualized rate of $615 billion in the first quarter--a record-setting pace if it holds up for the full year--ought to be at least a little reassuring to investors. "I do believe the hints of recovery that we're seeing in tax profits will continue," Rippe says.

    That does not mean we're due for another profit boom. Declining interest rates were the biggest reason profits rose so fast in the 1990s, says S&P's Wyss. Rates simply don't have that far to fall now. So even when investors start believing again what companies say about their earnings, they may still be shocked at how slowly those earnings are growing.

    Continued at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208677 

    Reply by Bob Jensen:

    For a technical explanation of the stock option accounting alluded to in the above quotation, go to one of my student examinations at http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/Exam02VersionATeachingNotes.htm 

    The exam02.xls Excel workbook answers can be downloaded from http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/ 

    The S&P revised GAAP core earnings model alluded to in the above quotation can be examined in greater detail at http://www.standardandpoors.com/Forum/MarketAnalysis/coreEarnings/index.html 

    Question:
    Where are the major differences between book income and economic income that understate book income reported to the investing public?

    Answer:
    This question is too complex to even scratch the surface in a short paragraph.  One of the main bones of contention between the FASB and technology companies is FAS 2 that requires the expensing of both research and development (R&D)  even though it is virtually certain that a great deal of the outlays for these items will have economic benefit in future years.  The FASB contends that the identification of which projects, what future periods, and the amount of the estimated benefits per period are too uncertain and subject to a high degree of accounting manipulation (book cooking) if such current expenditures are allowed to be capitalized rather than expensed.  Other bones of contention concern expenditures for building up the goodwill, reputation, and training "assets" of companies.  The FASB requires that these be expensed rather than capitalized except in the case of an acquisition of an entire company at a price that exceeds the value of tangible assets less current market value of debt.  In summary, many firms have argued for "pro forma" earnings reporting such that companies can make a case that huge expense reporting required by the FASB and GAAP can be adjusted for better matching of future revenues with past expenditures.

    You can read more about these problems at http://faculty.trinity.edu/rjensen/theory.htm 


    Independence Rules

    Corporate Reform: The New SEC Auditor Independence Rules (from Ernst & Young) --- 

    http://www.ey.com/global/download.nsf/US/Corporate_Reform_SEC_Auditor_Independence_Rules/$file/CorporateReformSECAuditorIndependenceRules.pdf 

     


    See http://faculty.trinity.edu/rjensen/cpaaway.htm 

    Also see http://faculty.trinity.edu/rjensen/damages.htm 

    You might enjoy "The AICPA's Prosecution of Dr. Abraham Briloff: Some Observations," by Dwight M. Owsen --- http://accounting.rutgers.edu/raw/aaa/pi/newsletr/spring99/item07.htm  
    I think Briloff was trying to save the profession from what it is now going through in the wake of the Enron scandal.

     

    Bob Jensen's other threads are at http://faculty.trinity.edu/rjensen/threads.htm 

    Bob Jensen's homepage is at http://faculty.trinity.edu/rjensen/

    Updates following the Enron Scandal

    Bob Jensen's Threads on Accounting Fraud, Forensic Accounting, Securities Fraud, and White Collar Crime 
    http://faculty.trinity.edu/rjensen/fraud.htm
     



     
    Bob Jensen's Commentary on the Above Messages From the CEO of Andersen
         (The Most Difficult Message That I Have Perhaps Ever Written!)
    http://faculty.trinity.edu/rjensen/fraud.htm#Andersen120401 


    My paper on "Damages" at http://faculty.trinity.edu/rjensen/damages.htm


    Suggested Reforms (Including those of Warren Buffet and the Andersen Accounting Firm)    
    http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm


    Bottom-Line Commentary of Bob Jensen:  Systemic Problems That Won't Go Away  
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm

     

    Six ways to crack down on corporate crooks
    "More Reform and Less Hot Air," by Daniel Eisenberg, Time, July 14, 2002 --- http://www.time.com/time/magazine/article/0,9171,1101020722-320777,00.html 

    1. More Orange Jumpsuits 
    President Bush last week called for doubling the maximum prison term for mail and wire fraud to 10 years. But the problem isn't the length of the sentence handed down for corporate malfeasance; it's winning a criminal conviction in the first place. Financial misdeeds are often difficult to explain to juries, and proving intent is even harder. More money for investigators would help, but the new $100 million that Bush pledged for the Securities and Exchange Commission is not nearly enough for the underfunded agency.

    There is similar posturing in Congress but also some substantive proposals. An amendment introduced by Senator Patrick Leahy of Vermont would make it a felony to defraud shareholders — making it easier to prosecute executives — and also provide more protection to whistle-blowers. Another proposed law would make CEOs liable for the accuracy of their firm's financial statements, a measure supported by nearly 90% of those surveyed in a new TIME/CNN poll.

    2. Get Rid of Pet-Rock Boards 
    Even with the improvements of recent years, too many corporate boards of directors still serve as little more than puppets of management. Bush only briefly touched on this in his speech, calling for a majority of each board — and for all members of its audit, nominating and compensation committees — to be "truly independent" and to "ask tough questions." But this should be spelled out further. Independent should mean more than someone who doesn't work for the company; it should exclude anyone who has a consulting gig or supplier deal or who has recently left the company — as the New York Stock Exchange recently proposed.

    Board members also need to stop spreading themselves thin on five or 10 boards at a time. They should be subject to 10-year term limits and annual elections. The terms should not be staggered, so shareholders can throw out all board members at once if they wish. Companies should be required to give shareholders election materials about rival candidates; as it stands, small investors who want to wage upstart campaigns don't stand a chance.

    To avoid getting too cozy with management, directors need to meet regularly by themselves and with auditors without any of the company's top executives present. They should appoint a lead independent director to balance the power of — or even serve as — the chairman, who these days too often happens to be the CEO. (That should not be allowed.) Finally, directors should be paid primarily with long-term grants of stock, rather than collect a check for showing up occasionally. At AutoZone, a $5 billion-a-year parts-supermarket chain, each board member must invest at least $100,000 in company stock within three years of joining.

    3. Price the Options 
    Executive pay is out of control. the proposal from President Bush and Congress to bar company loans to executives would help address the problem. Another good idea is letting shareholders approve every grant of stock options. But it's the kind of compensation — in the form of stock options — and the perverse incentives that come with it that pose the biggest concern. Because most corporations do not deduct the cost of options from their bottom line, CEOs have no reason not to stuff their pockets with options. So far, Bush has declined to address this crucial accounting issue, and Arizona Senator John McCain's attempts to push it were blocked last week. But in an encouraging development, West Coast real estate firm AMB Property just became one of the few U.S. companies (along with Boeing and Winn-Dixie Stores) to deduct the expense.

    One reason options are troubling is that they encourage executives to expose the company to more risk than they would otherwise; executives have much to gain from reckless or shortsighted tactics and little to lose. Paying top executives mostly in restricted stock would force CEOs to "ride it up and down," says Charles Elson, director of the Center for Corporate Governance at the University of Delaware. And prohibiting CEOs from selling their company stock until after their tenure has ended would remove the incentive to manage earnings for the short term. McCain has called for such a restriction, which 70% of TIME/CNN poll respondents support.

    4. Stop Bribing Auditors 
    Much of the mischief by accounting firms stems from the dual role they often play: as auditors sworn to serve shareholders and as consultants paid much more to please management. Several bills in Congress take aim at the accounting industry, promising increased oversight. None yet propose the full separation that is needed between auditing and consulting firms, as McCain called for last week, but the bills at least stipulate that public companies should not be allowed to have the same firm do both its auditing and its accounting — a proposal endorsed by more than 70% of those polled by cnn and TIME. Auditing firms — or, at the very least, their employees — should be rotated from client to client every few years. Most important, auditors should give detailed statements explaining how aggressive or conservative their client's accounting is, rather than simply signing off on it.

    5. End Stock Pimping 
    One had only to witness the grilling that Salomon Smith Barney analyst Jack Grubman endured at the congressional WorldCom hearing last week to get a sense of how low Wall Street analysts have sunk. Too many stopped providing objective stock research to investors long ago, instead spending the bulk of their time helping woo investment-banking business. New York State attorney general Eliot Spitzer has made some small progress toward cleaning up the industry: increasing disclosure of conflicts of interest and separating analysts' compensation from specific investment-banking deals. But those are half measures. The best solution would be to separate investment-banking businesses completely from research, as McCain has proposed. But the financial firms and their pet lawmakers will probably block such a reform. Still, analysts' pay should be based entirely on the performance of their stock picks, and investment banking divisions should have their own, separate army of analysts to work on deals.

    6. Unlock Those 401(K)S 
    One way to help potential victims of corporate crime is to give employees more power to diversify their 401(k) plan and not get stuck with a rotten nest egg. The Senate is considering legislation that would allow workers to sell company stock after being at a firm for three years. It would also require companies to disclose any planned insider stock sales.

    Continued at http://www.time.com/time/magazine/article/0,9171,1101020722-320777,00.html


    "The three Cs of fraudulent financial reporting"
    Source: The Internal Auditor
    October 10, 2002
    Web Link --- http://infobrix.yellowbrix.com/pages/infobrix/Story.nsp?story_id=33655472&ID=infobrix&scategory=Accounting+%26+Audit&

    Assessing an organization's conditions, corporate structure, and the choices it makes can help reveal the motivations, opportunities, and rationalizations behind the commission of financial statement fraud.

    FRAUDULENT FINANCIAL REPORTING IN THE UNITED States has cost investors more than sioo billion over the past two years. In its "2002 Report to the Nation on Occupational Fraud and Abuse," the Association of Certified Fraud Examiners estimates that about 6 percent of revenues, or $600 billion, will be lost this year as a result of occupational fraud and abuse (see related story, "The High Cost of Occupational Fraud," page 13). This report also indicates that financial statement fraud is the most costly type of occupational fraud, with median losses of $425 million per scheme. The other two types of occupational frauds are asset misappropriations and corruption schemes.

    Fraudulent financial reporting occurs for many reasons, which can be grouped into three broad categories - conditions, corporate structure, and choice, or the "3Cs." Internal auditors can use the 3Cs model to predict and uncover financial statement fraud, consistent with 11A Attribute Standard 1210.A2, which clearly states that "The internal auditor should have sufficient knowledge to identify the indicators of fraud ... ." 11A Practice Advisory 1210.A2-I: Identification of Fraud, and Practice Advisory 1210.A2- 2: Responsibilities for Fraud Detection, further detail the auditor's role in fraud investigations and suggest that auditors should 1) identify symptoms - conditions - that indicate a fraud may have been perpetrated; 2) search for opportunities - corporate structure - that may allow fraud to occur; and 3) evaluate the need for further investigation, notify the appropriate individuals within the company about the possibility of financial statement fraud, and take the actions necessary to reduce or minimize its likelihood of occurrence - choice.

    DEFINING THE 3CS

    The 3Cs model helps explain motivations, opportunities, and rationalizations for the commission of financial reporting fraud.

    CONDITIONS
    The motivations and pressure to engage in financial statement fraud are the conditions. Pressures on corporations to meet analysts' earnings forecasts play an important role in the commission of this type of fraud. In recent corporate cases, executives deliberately committed illegal actions to mislead users of financial statements - investors and creditors - about their poor or less-than-favorable financial performance.

    CORPORATE STRUCTURE
    An organization's corporate structure can create an environment that increases the likelihood that fraudulent financial reporting will occur. Given that management usually is the perpetrator of this type of fraud, it is not surprising that most incidences occur in an environment characterized by irresponsible and ineffective corporate governance.

    Attributes of the corporate governance structure most likely to be associated with financial statement fraud are aggressiveness, arrogance, cohesiveness, loyalty, blind trust, control ineffectiveness, and gamesmanship. Aggressiveness and arrogance can play a part in the organization's attitude and motivations toward being a leader in the field or exceeding analysts' earnings expectations. Cohesiveness, gamesmanship, and loyalty attributes increase the likelihood of cooking the books and subsequent cover- up attempts and decrease the probability of whistle-blowing. Blind trust and ineffective controls can cause monitoring mechanisms - such as audit functions and the internal control structure - to be less effective in preventing and detecting fraud.

    CHOICE 
    Management must choose between using ethical business strategies to achieve continuous improvements in both quality and quantity of earnings and engaging in illegitimate earnings management schemes to show earnings stability or growth. Management may choose to engage in financial statement fraud when: 1) its personal wealth is closely associated with the company's performance through profit sharing, stock-based compensation plans, and other bonuses; 2) management is willing to take personal risk - such as risking indictment or civil or criminal penalties - for corporate benefit; 3) opportunities for the commission of financial statement fraud are present; 4) there is a substantial internal and external pressure to either create or maximize shareholder value; and 5) the probability of the fraud being detected is perceived to be very low.

    The presence of any one of the 3Cs can signal the possibility of fraud, whereas the combination of two or more factors at any one time increases the likelihood that fraud has occurred.

     

     


    Although there is nothing new below, some of you might be interested in my shoot from the hip answers to a reporter’s questions on fraud prevention.

    -----Original Message----- 
    From: Jensen, Robert 
    Sent: Tuesday, February 17, 2004 9:03 AM 
    To: XXXXX 
    Subject: RE: request for intervie

    I will be happy to help you out.

    My brief answers to your questions are as follows:

    * How did the Enron, Worldcom, et al scandals raise general awareness of fraud as a significant business issue?

    Enron had an enormous impact because it was so huge, so sudden, and most importantly the straw that broke its auditor’s back. Andersen emerged through a series of scandals (Waste Management in particular) as arrogant as ever and did not really change its ways in audit quality control. Enron collapsed because Andersen’s clients at last realized that having Andersen as a auditor was more of a negative than a positive in the eyes of investors.

    The Worldcom scandal surfaced later on and was even a worse mess. Andersen could be somewhat forgiven in the Enron case because the SPE transactions and other complicated deals made the accounting a nightmare. Worldcom was a huge and simple failure of Auditing 101 on Andersen’s part.

    Both scandals plus the others that have emerged (Tyco, Adelphia, etc.) called the attention of the public to the fact that top corporate executives were seeking to loot their companies by treating these companies as their own private pińatas. They also demonstrated in some cases that CEOs were willing to bet the farm by taking great risks with corporate assets with little heed to the stewardship responsibilities of their offices. See http://faculty.trinity.edu/rjensen/FraudUpdates.htm 

     

    * Sarbanes-Oxley created a new standard of oversight for public companies. What's in place to help prevent/deter fraud in privately-held firms?

    Many privately held firms still must have or elect to have external audits by CPA firms. These audits will be much more in line with the requirements of SOX even if SOX is not legally in effect for such firms. Of course a much larger deterrent is are the tort liability laws of the land that can make civil awards in court much more painful that the rather toothless criminal statutes. There are more fraud prevention controls that can be put into place. See http://www.cfenet.com/home.asp  and in particular note http://www.cfenet.com/resources/resources.asp 

     

    * For business owners, are traditional accounting controls enough to prevent fraud? If not, what can they do to protect better themselves?

    Business owners should not rely upon external audits to deter fraud. External audits were never intended to deter internal fraud except in the case of huge fraud that significantly impacts upon the audited financial statements. Many internal frauds are too small to have a material impact on the bottom line. But that does not mean that such frauds should not be prevented.

    Probably the biggest deterrents to fraud are solid internal controls coupled with a whistle blower reward system. Business owners can have a fraud prevention check up as described at http://www.cfenet.com/resources/resources.asp 

     

    * Do small to medium size business owners face different challenges in fraud prevention than, say, Fortune 500 firms? Explain.

    There are obvious differences. Most Fortune 500 companies are multinational and have to worry about fraud prevention around the world. Small business owners have less to look over. Also, shareholders of Fortune 500 companies must worry about fraud and waste perpetrated by top management. Small business owners generally are the top managers and therefore need only worry about fraud and waste at lower levels of the company.

    What we find is that the most important thing about corporate ethics is the “tone at the top.” Small business owners can sing their own tunes. But what we are finding with large corporations is that top managers are out of tune. And they still don’t get it.

    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 --- http://online.wsj.com/article/0,,SB107584886617919763,00.html?mod=home%5Fpage%5Fone%5Fus 

    You can read more about this at http://faculty.trinity.edu/rjensen/fraud033104.htm 

     

    · What's working in business fraud prevention, and what still needs improvement?

    SOX is very expensive to implement and probably won’t have benefits that exceed the costs (although the auditors will make fortunes because of SOX). The one feature of SOX that holds out the most hope is Section 404 which now makes auditors more accountable for internal control audits.

    What is beginning to work in SOX and holds out great potential is the enhancements of whistle blowing. This is probably the number one means of fraud prevention and detection (just as police and courts would be helpless without informants).

    What is failing the U.S. and the entire world is the fact that white collar crime pays. Even if you know you will get caught stealing $100 million, it's good business to steal the money, hide much of it away offshore and with friends and relatives, confess to your crime in exchange for leniency, and serve you five years in a Club Fed prison. You can them come out and live a life of luxury in Switzerland on your yacht.

    You will never find Charles Keating, Andy Fastow, Jeff Skilling, and Dennis Kowalski working at convenience stores after being released from Club Fed.

    Couple that with the odds of never getting caught, and you've got soaring white collar crime that will never really be prevented until we lock perpetrators up in a Bastille-like hell hole and throw away the key.  This would be too bad for the ones who got caught, but it would be the best preventative medicine for corporate fraud.

     


    My new and updated documents the recent accounting and investment scandals are at the following sites:

    Fraud Detection and Reporting --- http://faculty.trinity.edu/rjensen/FraudReporting.htm
    Bob Jensen's threads on the Enron/Andersen scandals are at  http://faculty.trinity.edu/rjensen/fraud.htm  
    Bob Jensen's Enron Quiz (with answers) --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm
    Bob Jensen's SPE threads are at http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm  
    Bob Jensen's threads on accounting theory are at http://faculty.trinity.edu/rjensen/theory.htm  

    Bob Jensen's Summary of Suggested Reforms --- http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm 

    Bob Jensen's threads on ethics and accounting education are at 
    http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation
     

    The Saga of Auditor Professionalism and Independence --- 
    http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism
     

    Incompetent and Corrupt Audits are Routine --- 
    http://faculty.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits
     

    Bob Jensen's Bottom Line Commentary --- http://faculty.trinity.edu/rjensen/FraudConclusion.htm 

    The Virginia Tech Overview:  What Can We Learn From Enron? --- http://faculty.trinity.edu/rjensen/fraudVirginia.htm 

    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 ---

     

    Bob Jensen's homepage --- http://faculty.trinity.edu/rjensen/