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 Threads Frauds at Andersen, Enron, and Worldcom
Bob Jensen at Trinity University
 


Table of Contents
FBI Corporate Fraud Hotline (Toll Free) 888-622-0177

My fraud.htm file became too large for my HTML editor software, so that I had to divide it into fraudEnron.htm and a fraud.htm files.  This is the fraudEnron.htm file. 
The fraud.htm file is at
http://faculty.trinity.edu/rjensen/fraud.htm

Bob Jensen's Enron Quiz is at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

The Andersen, Enron, and Worldcom Scandals 

Enron/Andersen Fraud Introductory Quotations 

Books and Other References on the Andersen and Enron Scandals  

Enron Fraud Updates and Timeline of Key Events in the History of the Enron Scandal

Andersen Partners in the Aftermath of Enron:  Protiviti and Huron in Particular

Other Fraud Updates and Other Updates to the Accounting and Finance Scandals --- 
http://faculty.trinity.edu/rjensen/FraudUpdates.htm
 

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

Risk-Based Auditing Under Attack  --- http://faculty.trinity.edu/rjensen/Fraud.htm#RiskBasedAuditing  

What's Right and What's Wrong With (SPEs), SPVs, and VIEs --- 
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.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.

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

Bob Jensen's threads on accounting scandals are in various documents:

Accounting Firms --- http://faculty.trinity.edu/rjensen/Fraud001.htm

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

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

 

What are some of the main lessons learned from the Enron scandal? 
What major problems remain?

I especially like "Suggestions for Reform" listed at http://www.citizenworks.org/corp/reforms.php

A pretty good summary of lessons learned is provided at http://www.law.northwestern.edu/professionaled/documents/Ruder_Lessons_Enron.pdf

How did energy deregulation became a tangled mess? How did Enron exploit this mess?
Click Here for Question 11 and its answer --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.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 ---

 

 

Links Related to Andersen, Enron, Worldcom, and Other Frauds

Bob Jensen's Enron Quiz With Answers --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm
 

Enron History --- http://en.wikipedia.org/wiki/Enron_scandal

Enron Fraud Updates and Timeline of Key Events in the History of the Enron Scandal

Enron/Andersen Fraud Introductory Quotations 

Books and Other References on the Andersen and Enron Scandals  

ENRON'S CAST OF CHARACTERS AND THEIR STOCK SALES
You can read more about how much the Directors and Officers made from Enron share sales at Enron's financial meltdown wiped out tens of billions in shareholder wealth at http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales 

The Famous Enron Video on Hypothetical Future Value (HFV) Accounting --- HFV

What was the total of Jeff Skilling's Enron stock sales and how much was he fined in 2006?
Ken Lay's secret recipes for looting $184,494.426 from the corporation you manage

Ken Lay's Defense

Online Videos About Enron and Other Frauds

Google, Microsoft and Yahoo are quietly developing new search tools for digital video, foreshadowing a high-stakes technology arms race in the battle for control of consumers' living rooms. Google's effort, until now secret, is arguably the most ambitious of the three. According to sources familiar with the plan, the search giant is courting broadcasters and cable networks with a new technology that would do for television what it has already done for the Internet: sort through and reveal needles of video clips from within the haystack archives of major network TV shows. The effort comes on top of Google's plans to create a multimedia search engine for Internet-only video that it will likely introduce next year, according to sources familiar with the company's plans. In recent weeks, Mountain View, Calif.-based Google has demonstrated new technology to a handful of major TV broadcasters in an attempt to forge alliances and develop business models for a TV-searchable database on the Web, those sources say.
GeekNik, December 5, 2004 --- http://www.geeknik.net/?journal,594 
The full story is at http://news.com.com/Striking+up+digital+video+search/2100-1032_3-5466491.html?tag=nefd.lede 
You can test Yahoo now.  Search for Enron at http://video.search.yahoo.com/ 
Bob Jensen's search helpers are at http://faculty.trinity.edu/rjensen/searchh.htm 

Frontline (from PBS) videos on accounting and finance regulation and scandals in the U.S. --- http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/

Note that one of the Frontline videos in about the Enron scandal --- http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/

Rebecca Mark's Secret Recipes for Looting $100 million from corporations you manage

Can you detect when Jeff Skilling lied just by studying his face?

Enron's E-mail (Email) messages are now part of the public record

Confessions of Andy Fastow

They do it because they can get away with it!  Even if they get caught they either live lavishly in a country that will not extradite them or they serve a few years in a country club called a prison.

Free Market Myths by Agency Theorists  

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

Andersen Audits of NASA Were Audit Failures 

The Worldcom/Andersen Scandal  

Worldcom Fraud   

What's Right and What's Wrong With (SPEs), SPVs, and VIEs --- 
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm

Risk-Based Auditing Under Attack   

What's Right and What's Wrong With SPEs, SPVs, and VIEs --- http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm

The Enron/Andersen Scandal on Creative Accounting and My Messages to Students 

Fast Acting Texas State Board of Accountancy

I think it's spelled Andersen, but why quibble years later?
"Anderson Accountants Facing Disciplinary Actions," AccountingWeb, November 10, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=101466

The Texas State Board of Public Accountancy has filed a complaint against seven former Arthur Anderson accountants who were involved in audit operations for Enron and its subsidiaries. The Houston Chronicle reports that they failed to adequately examine and report financial events leading to Enron’s implosion according to the filed complaint. The complaint was filed with the State Office of Administrative Hearings. The complaint reads that the seven accountants audited a portion of Enron’s 1997 financial statements and allegedly did not follow proper accounting procedures that specified they consolidate the statements of the two subsidiaries named for Star Wars characters, Chewco and Jedi. After notification by the Securities and Exchange Commission, these statements were changed by Enron according to the Houston Chronicle.

The Houston Chronicle reports that actions leading from the complaint include suspension or revocation of their state accounting licenses. Arthur Anderson’s accounting license was revoked in 2002. The seven accountants may also receive fines of $1000 for each violation alleged in the complaint according to the Associated Press. There has been no date specified for their hearing.


November 11, 2005 message from Clikeman, Paul [pclikema@RICHMOND.EDU]

Can somebody please help me understand this news item?

 David Duncan, who pleaded guilty to a felony, is not one of the seven AA auditors named in the complaint. Has he already been disciplined by the Texas Board?

 And Carl Bass is named in the current complaint. The media portrayed Bass as a “hero” in 2002 for objecting to Enron’s SPE accounting. Joseph Berardino claimed in a television interview that Bass was removed from the Enron audit because Enron’s executives complained about Bass’s refusal to cooperate. Is Bass not as innocent as earlier news items indicated?

 Paul M. Clikeman, Ph.D.
Associate Professor of Accounting
Robins School of Business
University of Richmond
Richmond, VA 23173

pclikema@richmond.edu

November 11, 2005 reply from Bob Jensen

If you read Page 426-427 (especially the bottom of Page 427) of Conspiracy of Fools by Kurt Eichenwald, you get the idea that Carl Bass was made a fall guy, by Andersen executives, in Braveheart, Fishtail, and Raptor.

Bass seemed all along to argue with Duncan about accounting for derivatives and SPEs, which is why Duncan himself had Bass removed from the Enron audit.  Some might argue that Bass could have done more early on in reporting his side of things with John Stewart in Chicago.  In some ways I agree with this.  Carl Bass seemed to be a good auditor who just did not blow the whistle effectively until it was too late.  I think he had ample evidence that Duncan was not going to listen to reason and buck Rick Causey at Enron.

Bob Jensen

 


 

Enron: A Message to My Students in the Wake of Recent Auditing Scandals

Accounting Education Shares Some of the Blame --- http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation 

The SEC will not tolerate a pattern of growing restatements, audit failures, corporate failures and massive investor losses," Pitt said in a news conference. "Somehow we have got to put a stop to the vicious cycle that has now been in evidence for far too many years."

 

Enron is Yet Another Example of a Typical Audit Committee Failing
My Gut Wrenching Memo About My Former Professor and Mentor


What were Enron's Accounting Tricks?
The best and most concise summary of tricks is Frank Portnoy's Senate Testimony --- http://faculty.trinity.edu/rjensen/fraudEnron.htm#FrankPartnoyTestimony

The starting draft about some of the tricks --- http://faculty.trinity.edu/rjensen//theory/00overview/AccountingTricks.htm 

 

Suggested Reforms
Suggested Reforms (Including those of Warren Buffet and the Andersen Accounting Firm)    
http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm

Major New Law in the Wake of the Accounting and Finance Scandals
SARBANES-OXLEY ACT OF 2002 --- http://faculty.trinity.edu/rjensen/fraud082002.htm 

Bottom-Line Commentary of Bob Jensen
Bottom-Line Commentary of Bob Jensen:  Systemic Problems That Won't Go Away  
http://faculty.trinity.edu/rjensen/FraudConclusion.htm

 

Books and Other References on the Andersen and Enron and Related Scandals  


Related Documents in the Accounting, Finance, and Corporate Governance Scandals and Frauds

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

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 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 

Future of Auditing --- http://faculty.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing

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

Bob Jensen's threads on how to detect and report frauds --- http://faculty.trinity.edu/rjensen/FraudReporting.htm 

 

 

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

 

 


Introductory Quotations 

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.


 

One time I posed a question to the, then, Editor of The Wall Street Journal Editorial Page (my former fraternity brother Bob Bartley) about why the WSJ on that very day was attacking Mike Milken as a felonious thief on Page 1 and praising Milken as a creative capitalist on the Editorial Page. Bob Bartley's truthful response was that the WSJ, more than any other newspaper, is really two newspapers bundled into one copy. The Editorial Page is an unabashed advocate of free-reining capital markets (Damn the Torpedoes). The rest of the newspaper reports the facts (and I think the WSJ reporters are among the best in the world, especially when they commenced to prickle Ken Lay and Jeff Skilling about hidden related party transactions at Enron). See Question 22 at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm
It's interesting that WSJ reporters discovered related party transactions when Enron's auditors pleaded ignorance about such fraudulent dealings. But then Andersen was becoming notorious at that time for bad audits.

 


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


In his eulogy for Arthur Andersen, delivered on January 13, 1947 the Rev. Dr. Duncan E. Littlefair closed with the following words:

Mr. Andersen had great courage.  Few are the men who have as much faith in the right as he, and fewer still are those with the courage to live up to their faith as he did...For those of you who worked with him and carry on his company, the meaning is clear.  Those principles upon which his business was built and with which it is synonymous must be preserved.  His name must never be associated with any program or action that is not the highest and the best.  I am sure he would rather the doors be closed than that it should continue to exist on principles other than those he established.  To you he has left a great name.  Your opportunity is tremendous; your responsibility is great.


The most serious problems in our profession are caused by our own self-indulgence.
LEONARD SPACEK, CEO of the major accounting firm of Arthur Andersen, 1956
Loren Steffy, "Sage of ethical accounting foretold Andersen demise," The Houston Chronicle, January 13, 2005 (I thank Paul Bjorklund for pointing this article out to me.)


It is not too much to expect that principles have a place in business today.  They do.  It's too late for this once-great Firm, but there's still time for the rest of us.
As quoted from pp. 253-254 in Final Accounting, by Barbara Ley Toffler (Broadway Books, 2003).  I might  note that the main message at the start of Barbara Ley Toffler’s book is that Andersen adopted a policy of overcharging for services or in her words “padding the bill.”  This perhaps was the beginning of the end!
You can read about Arthur Andersen at http://fisher.osu.edu/acctmis/hall/members-chrono.htm 


Nothing wrong with overcharging, so long as everyone else is doing it, right?
Gretchen Morgenson"The Mutual Fund Scandal's Next Chapter," The New York Times, December 7, 2003
(For threads on the mutual fund scandals, see Rotten to the Core below.)

So what's a little business deal among friends?  It's trouble, if the friends are college or college-foundation trustees who benefit personally from the decisions they make on behalf of the institutions they serve.  
Julianne Basinger, "Boars Crack Down on Members' Insider Benefits," The Chronicle of Higher Education, February 6. 2004, Page A1.


The open-access method of distributing scientific journals, says John E. Cox, a publishing-industry consultant, "is the most articulate and serious threat to the conventional publishing market that we've seen."
Lila Gutterman, "The Promise and Peril of 'Open Access,'" The Chronicle of Higher Education, January 30, 2004, Page A10.
See The Biggest Academic Rip-off of All Time by Publishing Monopolists --- http://faculty.trinity.edu/rjensen/fraud033104.htm#MonopolyJournals


Conspiracy of Fools

Sometimes the key mover in Enron's shady dealings, CFO Andy Fastow, was portrayed by the media as a financial genius.  This may not be the case.
Somebody called in Kaminski.  He was soft-spoken yet excitable, a man who quickly assessed colleagues' brainpower --- and Fastow had never made it high on his list of high-voltage intellects.  Long ago, when Fastow had incorrectly boasted that his business was unaffected by interest rate, Kaminski had concluded the man was a lightweight . . . Kaminski smiled to himself.   "How could a man like this be in charge of a business?" A hedge could only offset declines in an asset's value, not operating losses from a failing business.  The only hedge for a money-losing business was a moneymaking business---and one of those certainly wasn't going to be coming out of this meeting.
Kurt Eichenwald, Conspiracy of Fools (Broadway Books, 2005, pp. 9394).
 

Nor are Andersen's managing partners on the Enron audit portrayed as rocket scientists.
Kurt Eichenwald, Conspiracy of Fools (Broadway Books, 2005, pp. 138-139).

Since 1990, Stephen Goddard at Andersen had overseen Enron--meeting the board, reviewing deals, auditing financials.  Goddard wasn't Hollywood's idea of an accountant; this was no boring technocrat with green eyeshades.  He was a specialist in client services, a backslapper who maintained a close relationship with the managers whose numbers his team reviewed.

Thanks in part to that familiarity, Andersen and Enron developed an unusually close relationship.  The firm was both its auditor and its consultant.  Veterans of Andersen's Houston office jumped to Enron as internal auditors; even Rick Causey, Enron's top accounting guru, had been an Andersen manager.  The relationship couldn't have been cozier.

But by February 1997, things had to change.  Andersen rotated partners on accounts every seven years, and Goddard's time was up.  Some partners lobbied to move up Tom Bauer, a top-notch accountant, who audited Enron's trading operations.  But Goddard thought there was only one candidate--David Duncan, a thirty-six-year-old who had worked on Enron for years.  With Goddard's support, Duncan got the nod.

Duncan rarely impressed anyone as a towering intellect, and his background was unremarkable.  Born in Lake Charles, Louisiana, and raised in Beaumont, Texas, Duncan attended Texas A&M, where he studied accounting.  In college he had been something of a party boy; he and a group of friends had formed what amounted to a co-op for illicit drugs, purchasing large quantities of marijuana that they divided among themselves.  Often, Duncan and his pals could be found around campus laughing it up, stoned.

In 1981, straight out of college, Duncan joined Andersen's Houston office but didn't change his ways.  For years, he and his friends kept up their mass drug buying.  Several days a week he would leave the staid accounting world and head home to toke up; sometimes he branched out to cocaine.  But a few years after starting on the Enron engagement, Duncan straightened up.  He didn't used illegal drugs since.

Enron seemed the ideal assignment.  In his early days at Andersen, Duncan struck up a friendship with Causey, then just another accountant in the Houston office.  The two became close, often lunching, golfing, or going out with their wives.  Now his buddy was Enron's top accountant.

Clearly, Duncan was no accounting whiz, but nobody worried about that; like most partners, he would rely on the experts in the firm's Professional Standards Group to rule on tough issues.  But he stuck some partners as top-flight where it mattered--his familiarity with Enron and a close relationship with its executives.  His good looks and disciplined organization didn't hurt, either.

In early February, Goddard and Duncan had an appointment with Lay, to notify him of the coming change.  Lay was polite, if not particularly interested; he vaguely knew Duncan and thought he seemed competent enough.

"I'm very excited about the opportunity to work more closely with Enron," Duncan said.  "It's really an honor."

Lay smiled.  "We'll have a lot of fun," he said.

By any measure, Duncan seemed a man on the precipice of big things.  But it was not to be; the great opportunity at Enron would be his last high-profile accounting job.

 

Jensen Comment:
It was Enron CEO Jeff Skilling who really got Enron into its illegal trading practices, although in fairness he did not view them as illegal when he came up (while a consultant to Enron from McKinsie) with some very clever ideas for getting Enron into the energy trading business.  Skilling is portrayed as the smartest of Enron's dim-light bulb executives but he also became the least mentally and emotionally stable.  He was great when things were rolling well but collapsed badly under pressures and pending bad news. 


The Causey of It All --- At Long Last

Of all the Enron accounting executives (Fastow was the CFO who knew epsilon about accounting) I wanted Rick Causey sent up river. Causey was the Chief Accounting Officer who worked out most of the accounting fraud and was the closest conspirator with David Duncan, Andersen's manager of the less-than-independent audit. Causey mysteriously was not called on to testify in the trials of Lay and Skilling, purportedly because he was "not a rat." It appears that he was a bit more of a rat than previously reported.

"Ex-Enron Officer Given 5˝ Years in Prison," The New York Times, November 16, 2006 --- http://www.nytimes.com/2006/11/16/business/16enron.html

Richard A. Causey, the last of the top Enron executives to learn his punishment, was sentenced Wednesday to five and a half years in prison for his role in the corporate accounting scandal.

Mr. Causey, 46, the company’s former chief accounting officer, pleaded guilty in December to securities fraud, two weeks before he was to be tried along with the founder of Enron, Kenneth L. Lay, and the former chief executive, Jeffrey K. Skilling, on conspiracy, fraud and other charges related to the company’s collapse.

Mr. Causey had agreed to serve seven years in prison. Prosecutors said they could have recommended it be reduced to five if they were pleased with his cooperation.

Mr. Causey also agreed to pay $1.25 million to the government and to forfeit a claim to about $250,000 in deferred compensation as part of his plea deal. Unlike some others at Enron, he did not skim millions of dollars for himself.

Prosecutors dropped their plan to seize Mr. Causey’s home, a $950,000 two-story red-brick house in a Houston suburb.

Mr. Causey had faced more than 30 counts of conspiracy, fraud, insider trading, lying to auditors and money laundering.

In his guilty plea, made in Federal District Court, he admitted making false public findings and statements.

He did not testify in the Lay-Skilling trial this year, though he was on the defense witness list.

Mr. Skilling and Mr. Lay were convicted in May of conspiracy and fraud. Mr. Lay’s convictions were wiped out with his July death from heart disease. Mr. Skilling was sentenced last month to more than 24 years in prison.

Andrew S. Fastow, Enron’s former chief financial officer, whose schemes helped doom the company, was sentenced in September to six years.

Mark E. Koenig, Enron’s former director of investor relations, and Michael J. Kopper, an Enron managing director and Mr. Fastow’s top aide, are scheduled to be sentenced Friday.

Enron collapsed into bankruptcy in December 2001 after years of accounting tricks could no longer hide billions in debt or make failing ventures appear profitable.

Bob Jensen's threads on Rick Causey are at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

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.

 


"Enron’s Lasting Influence," AccountingWeb, January 10, 2006 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=101647

With the former Enron executives finally coming to trial, we are reminded again of the long shadow cast by the implosion of the company that helped enact the Sarbanes-Oxley (SOX) Act of 2002. Section 404 has added teeth to SOX, making regulation more expensive and staff intensive and the Public Company Accounting Oversight Board (PCAOB) has been created to aid in the governance and enforcement of the accounting industry. Audit committees have attained more important positions in corporate structures and are more attuned to avoid the conflicts of being both auditor and consultant for the same company. At the same time, with the collapse of Arthur Andersen, the consolidation of the Big Five to the Big Four now have four accounting firms doing the work for more than 90 percent of publicly traded companies, according to the New York Times.

“We certainly have seen some improvements in governance, but we’ve also seen some areas of no improvement, and some areas where things have gone backwards,” said Lynn E. Turner, speaking to the New York Times. Turner is the former chief accountant at the Securities and Exchange Commission (SEC) and now managing director of research at Glass, Lewis & Company.

The outright accounting scandals of Worldcom, Tyco, and Adelphia have now morphed into companies making financial restatements. Glass, Lewis & Company reports that earnings restatements numbered 1,031 through the end of October 2005, compared with 650 for 2004 and 270 in 2001, according to the New York Times. John C. Coffee, speaking in the Los Angeles Times, said the restatements were not necessarily evidence of fraud but shows the tighter focus of accountants.

Also, more than 1,250 public companies, out of around 15,000 in total, reported material weaknesses in their internal corporate controls in October 2005. Some 232 other companies reported less serious, but significant deficiencies in their internal controls, according to the New York Times.

In contrast, a new study shows that the number of securities class-action suites has come down 17 percent in 2005. The 176 filed in 2005 is the lowest since 1997, according to Cornerstone Research and Stanford Law School. 1998 saw 239 suites, the highest number in recent years, according to the Los Angeles Times.

Christopher Cox, chairman of the SEC, said in a late December interview with the New York Times, that he agreed that more should be done, disclosing his intention to lead a commission effort to rewrite rules forcing companies to provide more financial details concerning executive pay.

Tighter accounting and disclosure rules enacted to enhance the transparency of financial information have lead to an industry-lead backlash. Cox said to the New York Times that it “would be a mistake” to retract major provisions of SOX.

“The shocks were so big that no director could miss the lesson and if they did miss somehow, the significant changes in the law made it absolutely certain that they are now more focused,” Cox added. “With just a few years of Sarbanes-Oxley under their belts, most companies are begrudgingly admitting that the exercise is producing benefits.”

SOX has sincere proponents though, institutional and pension investor groups being the most vocal. Alan G. Hevesi, New York comptroller of one of the nation’s largest institutional investors, has been leading the effort to increase corporate accountability. Speaking with the New York Times, Hevesi said, “We’ve had some successes in corporate governance reform. In other words – such as giving a greater voice to shareholders to elect independent directors and curbing excessive executive compensation – we haven’t been as successful. I worry about whether the necessary reforms have really been institutionalized.”

Executives say that restatements are healthy signs of change according to the New York Times although, “The general impression of the public is that accounting rules are black and white. They are often anything but that, and in many instances the changes in earnings came after new interpretations by the chief accountant of the S.E.C.," said Steve Odland, Office Depot’s CEO and head of a corporate governance task force at the Business Roundtable.

Accounting scandals are more often settled with the SEC or actions filed by the agency now. For example, AcAfee, the Internet security company, has agreed to settle charges made by the SEC that they inflated revenues by some $622 million between 1998 and 2000. Their penalty will be $50 million. The settlement is awaiting court approval.

The SEC filed a civil lawsuit against six former executives then employed by an unnamed transfer-agent unit of Putnam Investments last week. They allegedly defrauded mutual funds and clients out of some $4 million in 2001. Also the judge has ruled that SEC testimony will be allowed into the trials of former Enron executives Jeffrey Skilling and Kenneth Lay.

What are some of the main lessons learned from the Enron scandal? 
I especially like "Suggestions for Reform" listed at http://www.citizenworks.org/corp/reforms.php

A pretty good summary of lessons learned is provided at http://www.law.northwestern.edu/professionaled/documents/Ruder_Lessons_Enron.pdf

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

Bob Jensen's Enron Quiz is at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm


KPMG’s “Unusual Twist”
While KPMG's strategy isn't uncommon among corporations with lots of units in different states, the accounting firm offered an unusual twist: Under KPMG's direction, WorldCom treated "foresight of top management" as an intangible asset akin to patents or trademarks.
 
See  http://faculty.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud

Punch Line
This "foresight of top management" led to a 25-year prison sentence for Worldcom's CEO, five years for the CFO (which in his case was much to lenient) and one year plus a day for the controller (who ended up having to be in prison for only ten months.) Yes all that reported goodwill in the balance sheet of Worldcom was an unusual twist.

 


Professional Fees in Enron Bankruptcy Top $780 million (as of December 2004) --- http://www.accountingweb.com/item/100263 
Guess who pays the next time you pay your power bill?


A jury has convicted four former Merrill Lynch executives and a former Enron finance executive for helping push through a sham deal to pad the energy company's earnings
"5 Executives Convicted of Fraud in First Enron Trial," The New York Times, November 3, 2004 --- http://www.nytimes.com/aponline/business/03WIRE-ENRON.html 

Update on October 2007

Then how come Merrill Lynch is on the verge of escaping the wrath of investors because of its involvement in some of Enron's corporate and accounting frauds? The Securities and Exchange Commission lays out the facts in various documents such as Litigation Release No. 20159 and Accounting and Auditing Enforcement Release No. 2619, and in the related Complaint in the U.S. District Court.
"The Accounting Cycle:  The Merrill Lynch-Enron-Government Conspiracy," by: J. Edward Ketz, SmartPros, October 2007 --- http://accounting.smartpros.com/x59129.xml 

In a 2004 trial, a jury found these four Merrill executives guilty of participating in a fraudulent scheme. The former Merrill managers appealed the verdicts, and amazingly the Fifth Circuit tossed them out. The appellate court held that those bankers provided "honest services" and that they did not personally profit from the deal.

That argument assumes that getaway drivers supply honest services to bank robbers; after all, an oral agreement to repurchase the investment at 22 percent return is a strong signal that something is amiss with the transaction. The argument also shows a lack of understanding how managers profit in the real world. Investment bankers advance their careers by bringing in business that generates income for the bank; Merrill Lynch's executives did that with the Enron barge transaction, thereby promoting their careers, their promotions, and their salaries and bonuses, even if in an indirect fashion.

 

 


Enron documentary will be available soon
For the preview screening in Houston last week of the documentary " Enron: The Smartest Guys in the Room," two indicted executives from the company, Kenneth L. Lay and Jeffrey K. Skilling, were not in the room - even though their multimillion-dollar homes were just a few blocks from the theater. "We invited them, but we didn't hear back," Alex Gibney, the documentary's director, said with a straight face. Hundreds of former Enron employees, however, did attend the screening. Many groaned and shook their heads at archival clips in which top-level management appeared arrogant, dishonest and greedy. "Try 'em and fry 'em," said Michael Ratner, who was a manager in Enron's pipeline division and now works for an investment bank. But in the same breath, he said wistfully: "It was a great place to work. You could do anything if you proved that you could make money."
Kate Murphy, "Mr. Skilling, Come On Over," The New York Times, April 24, 2005 --- http://www.nytimes.com/2005/04/24/business/yourmoney/24suits.html


Sherron Watkins' whistle blowing Memo2 to Enron CEO Ken Lay as quoted on Page 366 of her book  Power Failure (Doubleday, 2003):

Summary of Raptor oddities: 

1.  The accounting treatment looks questionable. 

a. Enron booked a $500 mm gain from equity derivatives from a related party. 
b. That related party is thinly capitalized, with no party at risk except Enron. 
c. It appears Enron has supported an income statement gain by a contribution of its own shares.

One basic question: The related party entity has lost $500 mm in its equity derivative transactions with Enron. Who bears that loss? I can't find an equity or debt holder that bears that loss. Find out who will lose this money. Who will pay for this loss at the related party entity?


Scandals Are a Hot Topic in College Courses --- http://www.smartpros.com/x42201.xml


The Lawyers and Accountants Hit'em Hardest When Their Down
Executives from failed energy giant Enron say its total legal and accounting costs since declaring bankruptcy may top $1 billion by 2006, according to a newspaper report.

SmartPros, November 14, 2003 --- http://www.smartpros.com/x41372.xml 


Enron had done its homework in Washington. Help came largely from the husband-and-wife team of economists Senator Phil Gramm and his wife, Wendy. Before joining the Enron board, Wendy Gramm had exempted energy futures contracts from government oversight in 1992; her husband now pushed for the Commodity Futures Modernization Act in December 2000, which would deregulate energy trading. There was strong opposition to Phil Gramm's bill in the House, mainly from the President's Working Group on Financial Markets, who included Secretary of the Treasury Lawrence Summers; Alan Greenspan, the chairman of the Federal Reserve; and Arthur Levitt, chairman of the SEC. But Enron spent close to $2 million lobbying to combat that opposition, while Gramm kept the bill from floor debate in the waning days of the Clinton administration. He reintroduced it under a new name immediately after Bush assumed office and got his bill passed. Enron, in turn, got the opportunity to trade with abandon. No one needed to know--or could find out--how much power Enron owned and how or why the company moved it from place to place.
Power Failure: The Inside Story of the Collapse of Enron, by Mimi Swartz, Sherron Watkins, Page 227.  See "What was Enron getting for its political bribes?"


"Who Will Fastow Implicate? Enron's ex-CFO is a loose cannon who could shoot in several directions, at a string of Enron execs, bankers, and lawyers," Business Week, January 15, 2004 --- http://www.businessweek.com/bwdaily/dnflash/jan2004/nf20040115_1433_db035.htm 

It's a safe bet that a lot of people in Houston probably had trouble falling asleep last night. Now that former Enron (ENRNQ ) Corp. Chief Financial Officer Andrew S. Fastow has joined forces with the Justice Dept., he could potentially implicate dozens of execs, bankers, and lawyers for contributing to the company's downfall (see BW Online, 1/8/04, "From the Fastows to the Bigger Fish?"). Unlike Worldcom (WCOEQ ), Tyco (TYC ) HealthSouth, (HLSH ), and many other recent corporate scandals, where the circle of accused wrongdoers is small, the Enron case involved "large groups of officers and employees, representing such diverse functions as finance, accounting, tax, and legal," according to a report filed last year by bankruptcy examiner R. Neal Batson.

Continued in the article


Does all of this add up to a convincing indictment against the market? No. Even those economists like MIT's Paul Joskow who are most convinced that illegal market manipulation played a major role in the California meltdown continue to support the introduction of (better designed) markets to the electricity sector. Other economists are of the opinion that market design ought to be left to trial and error in the context of more complete deregulation rather than to some template drafted by experts who think they can know a priori how electricity markets could best be organized.
Jerry Taylor (See below.)


A paragraph form Page 360 of Pipe Dreams:  Greed, Ego, and the Death of Enron, by Robert Bryce (Public Affairs, 2002):

On June 17, Enron filed documents in bankruptcy court that showed total cash payments of $309.8 million to a group of 144 top Enron executives during 2001. In addition, those same executives cashed in stock options worth $311.7 million. There were lots of other perquisites that haven't been made public. According to one Enron insider, since the bankruptcy the company has been canceling club memberships all over Houston. When Enron filed for bankruptcy, the insider said, the company was paying for twenty-nine different country club memberships, each of which were costing the company an average of $28,000 per year.


The secret of success is sincerity. Once you can fake that, you've got it made!
Arthur Bloch  (although Chris Nolan says it should be attributed to Daniel Schorr)


New York State Attorney General Eliott Spitzer's charges of improper trading practices by several leading mutual fund families are another blow to public trust in financial institutions. Mutual funds have been the place you would advise the most unsophisticated investors to go: Mutual funds were designed for grandpa and grandma, and repeatedly recommended to them by all kinds of benevolent authorities. Thus scandals in the mutual fund sector are potentially much more damaging to public trust in our financial institutions than are scandals in other sectors -- such as the one playing out in the New York Stock Exchange right now.
See Robert Shiller's article below under "Rotten to the Core"


Good accounting serves as a check on speculation.  Good accounting challenges the pyramid scheme that bubbles perpetuate.  Bad accounting perpetuates pyramid schemes.  Bad accounting creates false earnings momentum that feeds price momentum.  GAAP , unfortunately, does have features that can be used to perpetuate bubbles. 
Stephen H. Penman, Financial Statement Analysis and Security Valuation (McGraw-Hill, 2004, Page 48).


Off Balance Sheet Financing Lives On
"Creative Deal or Highflying Pork?" by Leslie Wayne, The New York Times, April 28, 2003

The plan — in which Boeing and the Air Force propose to employ the kind of off-the-books financing made infamous by the Enron scandal — could provide Boeing up to $30 billion in fresh military contracts. The proposal would lease 100 planes — Boeing 767 airborne refueling tankers — to the Air Force. To critics, it is a perfect example not only of creative accounting but also of the political pork that has crept into government spending since the terrorist attacks of Sept. 11, 2001. Senator John McCain, Republican of Arizona and an influential member of the Senate Armed Services Committee, has called the Boeing proposal "cockamamie" and has vowed "to do everything I can to see the taxpayers of America are protected from this military-industrial rip-off." But what is a rip-off to Senator McCain, who has thrown one roadblock after another in front of the proposal, is portrayed by Boeing and the Air Force as a cost-effective way to provide a new link in the military supply chain as the Air Force begins to face the issue of replacing aging air refueling tankers. Some of the tankers date back to the Eisenhower administration, and many are now in use refueling Air Force military jets over Iraq and Afghanistan. "New tankers are a critical need," said Marvin R. Sambur, assistant secretary of the Air Force for acquisitions. "But we don't have that money to put out front." The lease proposal, he said, "gives us the ability to leverage the total amount of money the Air Force has. It's a super lease deal." But studies from the General Accounting Office, the Office of Management and Budget and the Congressional Budget Office, some ordered by Senator McCain, conclude that the Boeing-Air Force lease option is more costly than buying the planes outright. The studies also say the lease plan is far more expensive than simply overhauling the existing tanker fleet, an option the Air Force calls unrealistic, given the fleet's age. Now Mr. Rumsfeld must choose between the two sides. At a news conference last month, he declined to tip his hand as the Pentagon budget begins to move through Congress. He said that the issue was complex and that he had asked for more information. "And it's something that I guess I'll decide when I decide," he said. "But I don't need to set arbitrary deadlines as to when that might be."


QWEST EX-CEO JOSEPH NACCHIO soon may face civil charges over improper accounting. The telecom firm agreed to a preliminary $250 million settlement with the SEC.
Deborah Solomon et al, The Wall Street Journal, September 13, 2004, Page A3 --- http://online.wsj.com/article/0,,SB109483441282814794,00.html?mod=technology_main_whats_news 


Iwan Lost
Qwest executives massaged a deal with the Arizona School Facilities board to book the sale early and misled auditors about their actions, former Arthur Andersen auditor Mark Iwan testified Thursday.  Iwan said Grant Graham, a former Qwest finance executive, assured him the transaction would comply with accounting standards necessary to book the $33.6 million in the second quarter of 2001.

Tom McGhee, The Denver Post, March 19, 2004 --- http://www.denverpost.com/Stories/0,1413,36%257E26430%257E2027537,00.html


At least they will spend a little time in prison
A federal judge in Houston gave two former Merrill Lynch & Co. officials substantially shorter prison sentences than the government was seeking in a high-profile case that grew out of the Enron Corp. scandal. In a separate decision yesterday, another Houston federal judge said that bank-fraud charges against Enron former chairman Kenneth Lay would be tried next year, immediately following the conspiracy trial against Mr. Lay, which is set for January. Judge Sim Lake had previously separated the bank-fraud charges from the conspiracy case against Mr. Lay and his co-defendants, Enron former president Jeffrey Skilling and former chief accounting officer Richard Causey. The government had been seeking to try Mr. Lay on the bank-fraud charges within about the next two months . . . Judge Ewing Werlein, Jr. sentenced former Merrill investment banking chief Daniel Bayly to 30 months in federal prison and James Brown, who headed the brokerage giant's structured-finance group, to a 46-month term. The federal probation office, with backing from Justice Department prosecutors, had recommended sentences for Messrs. Bayly and Brown of about 15 and 33 years, respectively. Mr. Brown had been convicted on more counts than Mr. Bayly.
John Emshwiller and Kara Scannell, "Merrill Ex-Officials' Sentences Fall Short of Recommendation," The Wall Street Journal, April 22, 2005, Page C3 ---
http://online.wsj.com/article/0,,SB111410393680013424,00.html?mod=todays_us_money_and_investing
Jensen Comment:  I double dare you to go to my "Rotten to the Core" threads and search for every instance of "Merrill" --- http://faculty.trinity.edu/rjensen/FraudRotten.htm

Update on October 2007

Then how come Merrill Lynch is on the verge of escaping the wrath of investors because of its involvement in some of Enron's corporate and accounting frauds? The Securities and Exchange Commission lays out the facts in various documents such as Litigation Release No. 20159 and Accounting and Auditing Enforcement Release No. 2619, and in the related Complaint in the U.S. District Court.
"The Accounting Cycle:  The Merrill Lynch-Enron-Government Conspiracy," by: J. Edward Ketz, SmartPros, October 2007 --- http://accounting.smartpros.com/x59129.xml 

In a 2004 trial, a jury found these four Merrill executives guilty of participating in a fraudulent scheme. The former Merrill managers appealed the verdicts, and amazingly the Fifth Circuit tossed them out. The appellate court held that those bankers provided "honest services" and that they did not personally profit from the deal.

That argument assumes that getaway drivers supply honest services to bank robbers; after all, an oral agreement to repurchase the investment at 22 percent return is a strong signal that something is amiss with the transaction. The argument also shows a lack of understanding how managers profit in the real world. Investment bankers advance their careers by bringing in business that generates income for the bank; Merrill Lynch's executives did that with the Enron barge transaction, thereby promoting their careers, their promotions, and their salaries and bonuses, even if in an indirect fashion.

 


 

From SmartPros on April 17, 2003 --- http://www.smartpros.com/x37911.xml 

According to the Wall Street Journal, more than 60% of the money paid to auditors by companies last year was for nonaudit services.

The huge amount is partly due to the new definition of "audit fees", which now covers services that were previously considered nonaudit.

The Securities and Exchange Commission is seeking to limit nonaudit services to preserve the independence of accountants and protect investors.

Hypocrisy of an unusual purity is on display as union leaders try to avoid disclosing truthful financial information to their members.
George Will 

Cooking the Books --- See http://faculty.trinity.edu/rjensen/fraudFirms.htm#Cooking    

References

Frontline (from PBS) videos on accounting and finance regulation and scandals in the U.S. --- http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/ Note that one of the Frontline videos in about the Enron scandal --- http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/


March 31, 2008 message from rock musician larry@mightymoonmen.com

I just found your Enron links and stories from 2002...brings up bad memories
I wrote a song based loosely on Jeff skilling ... "Medicine Man"
You can listen to the song and read the lyrics ---
www.mightymoonmen.com 
thanx

 


July 13, 2006 message from Linda Kidwell, University of Wyoming [lkidwell@UWYO.EDU]

The AccountingWeb.com weekly news service gave a link to a company that helped the SEC explain the case against Waste Management's Koenig. If you visit the site, at http://www.thefocalpoint.com/news/recent-cases_sec.htm,

you will find a pretty interesting series of power points that boil the issues down to basics.

Linda Kidwell


Risk-Based Auditing Under Attack   

Quotations for the Enron/Andersen scandals were moved to http://faculty.trinity.edu/rjensen/FraudEnron.htm#Quotations

Selected works of FRANK PARTNOY
Bob Jensen at Trinity University

 

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?


I begin with the following document the best thing I ever read explaining fraud at Enron.
Testimony of Frank Partnoy Professor of Law, University of San Diego School of Law Hearings before the United States Senate Committee on Governmental Affairs, January 24, 2002 --- http://www.senate.gov/~gov_affairs/012402partnoy.htm 

The following selected quotations from his Senate testimony speak for themselves:

 

  • Quote:  In other words, OTC derivatives markets, which for the most part did not exist twenty (or, in some cases, even ten) years ago, now comprise about 90 percent of the aggregate derivatives market, with trillions of dollars at risk every day.  By those measures, OTC derivatives markets are bigger than the markets for U.S. stocks. Enron may have been just an energy company when it was created in 1985, but by the end it had become a full-blown OTC derivatives trading firm.  Its OTC derivatives-related assets and liabilities increased more than five-fold during 2000 alone.

     
  • Quote: And, let me repeat, the OTC derivatives markets are largely unregulated.  Enron’s trading operations were not regulated, or even recently audited, by U.S. securities regulators, and the OTC derivatives it traded are not deemed securities.  OTC derivatives trading is beyond the purview of organized, regulated exchanges.  Thus, Enron – like many firms that trade OTC derivatives – fell into a regulatory black hole.

     
  • Quote:  Specifically, Enron used derivatives and special purpose vehicles to manipulate its financial statements in three ways.  First, it hid speculator losses it suffered on technology stocks.  Second, it hid huge debts incurred to finance unprofitable new businesses, including retail energy services for new customers.  Third, it inflated the value of other troubled businesses, including its new ventures in fiber-optic bandwidth.  Although Enron was founded as an energy company, many of these derivatives transactions did not involve energy at all.


     
  • Quote:  Moreover, a thorough inquiry into these dealings also should include the major financial market “gatekeepers” involved with Enron: accounting firms, banks, law firms, and credit rating agencies.  Employees of these firms are likely to have knowledge of these transactions.  Moreover, these firms have a responsibility to come forward with information relevant to these transactions.  They benefit directly and indirectly from the existence of U.S. securities regulation, which in many instances both forces companies to use the services of gatekeepers and protects gatekeepers from liability.


     
  • QuoteRecent cases against accounting firms – including Arthur Andersen – are eroding that protection, but the other gatekeepers remain well insulated.  Gatekeepers are kept honest – at least in theory – by the threat of legal liability, which is virtually non-existent for some gatekeepers.  The capital markets would be more efficient if companies were not required by law to use particular gatekeepers (which only gives those firms market power), and if gatekeepers were subject to a credible threat of liability for their involvement in fraudulent transactions.  Congress should consider expanding the scope of securities fraud liability by making it clear that these gatekeepers will be liable for assisting companies in transactions designed to distort the economic reality of financial statements.


     
  • QuoteIn a nutshell, it appears that some Enron employees used dummy accounts and rigged valuation methodologies to create false profit and loss entries for the derivatives Enron traded.  These false entries were systematic and occurred over several years, beginning as early as 1997.  They included not only the more esoteric financial instruments Enron began trading recently – such as fiber-optic bandwidth and weather derivatives – but also Enron’s very profitable trading operations in natural gas derivatives.


     
  • Quote:  The difficult question is what to do about the gatekeepers.  They occupy a special place in securities regulation, and receive great benefits as a result.  Employees at gatekeeper firms are among the most highly-paid people in the world.  They have access to superior information and supposedly have greater expertise than average investors at deciphering that information.  Yet, with respect to Enron, the gatekeepers clearly did not do their job.

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 U.S. Treasury bonds.

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)

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.

 

 


Conspiracy of Fools by Kurt Eichenwald

Product Details:
ISBN: 0767911784
Format: Hardcover, 768pp
Pub. Date: March 2005
Publisher: Broadway Books

 Description --- http://www.randomhouse.com/broadway/conspiracyoffools/about_the_book.html

From an award-winning New York Times reporter comes the full, mind-boggling story of the lies, crimes, and ineptitude behind the spectacular scandal that imperiled a presidency, destroyed a marketplace, and changed Washington and Wall Street forever...

It was the corporate collapse that appeared to come out of nowhere. In late 2001, the Enron Corporation—a darling of the financial world, a company whose executives were friends of presidents and the powerful—imploded virtually overnight, leaving vast wreckage in its wake and sparking a criminal investigation that would last for years. But for all that has been written about the Enron debacle, no one has yet to re-create the full drama of what has already become a near-mythic American tale.

Until now. With Conspiracy of Fools, Kurt Eichenwald transforms the unbelievable story of the Enron scandal into a rip-roaring narrative of epic proportions, one that is sure to delight readers of thrillers and business books alike, achieving for this new decade what books like Barbarians at the Gate and A Civil Action accomplished in the 1990s.

Written in the roller-coaster style of a novel, the compelling narrative takes readers behind every closed door—from the Oval Office to the executive suites, from the highest reaches of the Justice Department to the homes and bedrooms of the top officers. It is a tale of global reach—from Houston to Washington, from Bombay to London, from Munich to Săo Paulo—laying out the unbelievable scenes that twisted together to create this shocking true story.

Eichenwald reveals never-disclosed details of a story that features a cast including George W. Bush, Dick Cheney, Paul O’Neill, Harvey Pitt, Colin Powell, Gray Davis, Arnold Schwarzenegger, Alan Greenspan, Ken Lay, Andy Fastow, Jeff Skilling, Bill Clinton, Rupert Murdoch, and Sumner Redstone. With its you-are-there glimpse into the secretive worlds of corporate power, Conspiracy of Fools is an all-true financial and political thriller of cinematic proportions.

One of the interesting outcomes is why top executives Rebecca Mark (stock sales of $8 million) and Lou Pai (stock sales of $270 million) escaped with fortunes and no legal repercussions like other top executives.  You can read about what they hauled home at http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales

I've commented about Rebecca Mark previously at http://faculty.trinity.edu/rjensen/FraudEnron.htm#RebeccaMark

Lou Pai seems to be the biggest winner of all the "fools" in the Conspiracy of Fools.  Why he escaped is largely a matter of what seemed like bad luck that turned into good luck.  Although married, Lou became addicted to strip tease clubs.  He ultimately became involved and impregnated one of the young entertainers.  His messy divorce settlement called for him to sell his Enron stock holdings when the stock price was very high and appeared to have a great future.  That looked like his bad luck.  However, he actually cashed in at near the high point for reasons other than clairvoyance regarding the pending collapse of share prices.  In other words he cashed in at a high.  That was his good luck, because he cashed in early for reasons other than inside information.

Lou Pai became so wealthy at Enron that he managed to purchase a Colorado ranch larger than the State of Rhode Island.  The ranch even has a mountain which he named Pai Mountain that was actually a bit higher than his pile of cash from Enron stock sales and other compensation from Enron.  To make matters worse, the operation that he actually managed while at Enron was a big money loser for the company.  Who says sin doesn't pay?


I accidentally stumbled on Julian Pye's Photo Diary --- http://www.photodiary.org/index.html 

At this point the diary contains 1741 entries, most of the earlier are done with Nikon Coolpixes (N950, N995, N4500), a Canon S110, and most of the later ones with a Canon D30 and a Canon 10D. Thereally old ones have been scanned in from older photos, mostly taken with my Nikon 801 SLR, even earlier ones with my dad's Canon F1 and my first own camera, a Minolta AF-1.... And I'll just add more and more as time goes along..... Please check back from time to time and also leave lots of comments if you want ;-)

Note the keywords at http://www.photodiary.org/keywords.html 

Actually I was looking for Websites on Enron's scandalous Rebecca Mark --- http://www.photodiary.org/ph_c_4837.shtml 

What eventually happened to Rhyolite and its past glory is similar to what happened to ENRON in 2001. Peter Cooper is now the administrator of the Houston based company which was headed by former Navy veteran Ken Lay, a swindler. Skilling made a killing. Remember Rebecca Mack.

Rebecca Mark's timely selling of her Enron shares yielded $82,536,737.  You can read 1997  good stuff about her in http://www.businessweek.com/1997/08/b351586.htm and bad stuff about her (with pictures) at http://www.apfn.org/enron/mark.htm 

Rebecca Mark-Jusbasche has held major leadership positions with one of the world's largest corporations.  She was chairman and CEO of Azurix from 1998 to 2000.  Prior to that time, she joined Enron Corp. in 1982, became executive vice president of Enron Power Corp. in 1986, chairman and CEO of Enron Development Corp. in 1991, chairman and CEO of Enron International in 1996 and vice chairman of Enron Corp. in 1998.  She was named to Fortune's "50 Most Powerful Women in American Business" in 1998 and 1999 and Independent Energy Executive of the Year in 1994.  She serves on a number of boards and is a member of the Young President's Organization.

She is a graduate of Baylor University and Harvard University.  She is married and has two children.
http://superwomancentral.com/panelists.htm

If Mark had taken a bitter pleasure in Skilling’s current woes—the congressional grilling, the mounting lawsuits, the inevitable criminal investigation—no one would have blamed her. And yet she was not altogether happy to be out of the game. Sure, she had sold her stock when it was still worth $56 million, and she still owns her ski house in Taos. Her battle with Skilling, however, had been a wild, exhilarating ride.
TIME TABLE AND THE REST OF THE STORY:
http://www.msnbc.com/news/718437.asp

Rebecca P. Mark-Jusbasche, now listed as a director, bagged nearly $80 million for her 1.4 million shares. Rebecca was just Rebecca P. Mark without the hyphenated flourish in 1995, though I shouldn't say "just" because she was also Enron's CEO at the time, busily trying to smooth huge wrinkles in the unraveling Dabhol power project outside Bombay. That deal, projected to run to $40 billion and said to be the biggest civilian deal ever written in India, hinged on a power purchase agreement between the Maharashtra State Electricity Board (MSEB) and Enron's Dabhol Power Corp. (a JV led with project manager Bechtel and generator supplier GE).

There had been a lot of foot-dragging on the Indian side and Becky was there to light a fire. A memorandum of understanding between Enron and the MSEB had been signed in June '92 – only two weeks, as it happened, before the World Bank said it couldn't back the project because it would make for hugely expensive electricity and didn't make sense.

According to the state chief minister's account given two years later, the phase-one $910 million 695 MW plant was to run on imported distillate oil till liquefied natural gas became available. By the time the phase-two $1.9 billion 1320 MW plant was to be commissioned, all electricity would be generated by burning LNG – a very sore point with World Bank and other critics, given the availability of much cheaper coal.

In the event, by December '93, the power purchase agreement was signed, but with an escape clause for MSEB to jump clear of the second, much bigger plant.

State and union governments in India came and went, and for every doubt that surfaced, two were assuaged long enough for Indian taxpayers to sink deeper into Enron's grip.

Soon they were bound up in agreements to go ahead with the second phase of the project -- which now promised electricity rates that would be twice those levied by Tata Power and other suppliers. Unusually for this kind of project, the state government, with Delhi acting as a back-up guarantor, backed not just project loans but actually guaranteed paying the monthly power bill forever -- all in U.S. dollars – in the event the electricity board, DPC's sole customer, defaulted.

"The deal with Enron involves payments guaranteed by MSEB, Govt. of Maharashtra and Govt. of India, which border on the ridiculous," noted altindia.net on its Enron Saga pages. "The Republic of India has staked all its assets (including those abroad, save diplomatic and military) as surety for the payments due to Enron."
http://www.asiawise.com/mainpage.asp?mainaction=50&articleid=2389 

Key Lay and Rebecca Mark attempted to strong arm President Bush and Vice President Cheney into holding back on U.S. Aid payments to India if India defaulted on payments to India for the almost-useless power plant built by Enron (because it was gas in coal-rich India).  However, about the same time, the Gulf War commenced.  The U.S. needed all the allies it could get, including India.  Hence, the best laid political strong arm intentions of Lay and Mark failed.



Book Reviews by Nancy Bagranoff
JOURNAL OF INFORMATION SYSTEMS
Vol. 18, No. 2
Fall 2004
pp. 127-131

BETHANY MCLEAN AND PETER ELKIND, The Smartest Guys in the Room (New York, NY: Penguin Group, 2003).

Many books describe the Enron scandal.  This book's special niche is twofold.  First, it focuses on the cast of characters responsible--these are the smartest guys, or perhaps the greediest guys, on the planet.  Second, the authors provide a detailed explanation of the finance and accounting issues behind the company's downfall.  They can do so because McLean, in addition to her reporting skill, was also a Goldman Sachs analyst who was among the first to question Enron's business model and practices (see McLean's [March 5, 2001, pages 122-125] Fortune article: "Is Enron Overpriced?").

The scandal cast is large, so large that the book includes a guide to people and their jobs.  The cast includes insiders, accountants at Arthur Andersen, and the lawyers, bankers, and analysts at affiliated firms.  Ken Lay is the charismatic leader who set the tone at the top--the culture of greed.  Jeffrey Skilling is the brilliant Harvard M.B.A. who was an intellectual purist and gambler.  These qualities may have helped him to overlook the reality behind his ideas and take enormous risks.  The accountants in the story include Andy Fastow, the CFO who plea-bargained for a reduced sentence in return for ratting out the rest of the group; Rick Causey, the Chief Accounting Officer; and David Duncan, Enron's engagement partner at Arthur Andersen, best known for being a "yes man" to Enron management.  Every reader will have a favorite villain.  Mine is Andy Fastow, who the book portrays as the guy who came up with the schemes to juggle the numbers, while robbing the company like a common thief.

The Smartest Guys in the Room details Fastow's creative accounting "Structured financing" is the term used to describe the inventive measures Fastow's team used to find Enron's too-good-to-be-true growth.  One of the tools employed was a by-product of "securitization" (i.e., bundling a bunch of loans and getting investors to purchase them--like factoring accounts receivable) that allowed independent entities to purchase one or more securitized assets.  The independent entity set up to do this is the now infamous special purpose entity (SPE).  Enron became enamored with SPEs.  Fastow set up SPEs to bear risk and improve Enron's financial picture by supplying cash flows and earnings.  SPEs are not necessarily illegal and Enron's creative accounting began as just a stretch of the rules.  But Enron needed capital to continue its growth.  This pressured the financial team to increase cash flow and earnings.  Additionally, Fastow started thinking he should grab more profits for himself.  Some of his early SPEs were named after Star Wars characters (JEDI and Chewco, for example), but later entities that Fastow himself controlled were named for his family.  For example, the LJM funds are an acronym representing Fastow's wife and children's first names.  The chutzpah of some of Fastow's deals is breathtaking.  Accountants will love reading about them and wondering how anyone who took Accounting 101 could fail to see through them.

Jeffrey Skilling brought his consulting experience in the financial services industry to Enron where he introduced the concept of trading natural gas contracts, thereby creating a complex and hard-to-understand business model.  He insisted that Enron value its energy trade transactions using mark-to-market accounting.  The Smartest Guys in the Room explains that Skilling wanted this accounting method to be used at Enron so badly that it was "make or break" to get him to join the company.  Perhaps his motives were pure and he genuinely thought this was the best accounting method for these transactions.  He's been indicted, so the courts will decide.  Regardless of his intent, we now know the dangers of applying mark-to-market to difficult-to-value assets, such as energy contracts.  The book returns to the concept of mark-to-market many times in describing Enron's escalating financial woes.  It illustrates accounting method abuse, offering instructors rich fodder for classroom debates over principles- versus rules-based standards and conventional versus riskier accounting methods.

This book articulates Enron's undoing of Arthur Andersen.  In Andersen's culture, auditors saw themselves as enablers rather than as protectors of the public interest.  Andersen's auditors did, of course, question the financials and much of Andy Fastow's creative accounting.  The trouble is that they bent under management pressure and continued to issue clean opinions.  Even worse, anyone within the firm who objected, such as Carl Bass from Andersen's Professional Standards Group, was ignored or removed from the Enron account.  Exacerbating Andersen's lack of independence was the fact that many of the Enron's accountants were former Andersen employees.  For example, Rick Causey and David Duncan were close friends who began their careers together at Andersen.  The book explains, "The problem, of course, wasn't merely that Duncan was going to the Masters with Causey; it was that he saw things the way the client wanted him to see them and gave his assent to Enron accounting treatments that bore little relationship to economic reality" (p. 147).  Of course, the accountants were not the only ones who stood by and let Enron happen.  McLean and Elkind appropriately take the lawyers, bankers, and analysts to task, too.

The Enron story is likely to appear in accounting classrooms for years, much as Equity Funding's scandal did throughout the 1970s and beyond.  Enron's downfall contains many useful lessons and this book may be the best at detailing them for accounting and auditing students.  It is also a great morality play with important ethical lapses and lessons.  Interestingly, the book begins with a Statement of Values reprinted from Enron's 1998 annual report.  It also describes the Code of Ethics at Enron and how Lay often touted the integrity of the company's leaders.  Amazing.

Accounting Information Systems faculty might use the book to spark debates among students about how IT controls or continuous auditing might have helped to protect investors.  They can also discuss how much Andersen's reliance on consulting revenues might have helped them to turn a blind eye.  No matter how a faculty member uses it, faculty and students will enjoy a good read.

NANCY A. BAGRANOFF
Old Dominion University


"Sage of ethical accounting foretold Andersen demise," by Loren Steffy, The Houston Chronicle, January 13, 2005 

''The most serious problems in our profession are caused by our own self-indulgence."
LEONARD SPACEK, 1956

Spacek was the chief executive of Arthur Andersen from 1947 to 1973, when Andersen was the moral voice of public accounting, and the ironic truth of his comments lingers even as the Supreme Court decided last week to consider overturning the accounting firm's conviction for obstruction of justice.

The court will review whether U.S. District Judge Melinda Harmon's jury instructions were too vague when it came to determining whether Andersen employees knew it was a crime to shred documents related to Enron.

The Supremes' decision, though, doesn't really involve the particulars of Andersen's demise. Regardless of how they rule, it won't bring the firm back, and it won't change the fact that Andersen was a victim of its own self-indulgence.

After all, jury foreman Oscar Criner told the Chronicle's Mary Flood that Harmon's instructions pertaining to the document destruction didn't affect the panel's decision. He said the nail in Andersen's coffin was a memo written by in-house attorney Nancy Temple advising colleagues to alter documents that discussed Enron's finances.

The government showed how Andersen's previous transgressions motivated Temple in urging others to cover their Enron-related tracks, Criner said.

Make no mistake, the government's decision to indict Andersen was harsh, and prosecutors knew it would kill the firm. Andersen, though, was a recidivist. It was the third time in a year that the firm was mired in a major accounting scandal, each bigger than the last. Seven months before Enron's bankruptcy, Andersen had been hit with the biggest fine ever for an audit failure because it approved bogus financial statements at Houston-based Waste Management.

Punishment didn't change the firm's behavior. Andersen's role as Enron's shredder-in-chief wasn't a fluke, and it wasn't a mistake. It was inevitable given the firm's track record.

Record-setting fines The tragedy of Andersen's collapse is that thousands of good, honest accountants were caught in the vortex of its failure. As too often happens in corporate malfeasance, the innocent bore the penalty.

The legions of loyal Andersen partners didn't deserve to be put out on the street, and they didn't deserve a leadership that kept the firm on the wrong side of too many blown audits.

Between 1997 and 2001, the year Enron collapsed, Andersen paid more than $500 million to settle claims of blown audits, including four of the five largest settlements. In May 2001, it settled claims that it had approved fraudulent audits at Sunbeam for $110 million, and a month later it shelled out $95 million more to settle similar claims involving Waste Management.

Look the other way In the Waste Management case in particular, internal SEC documents show that Andersen's senior executives knew the company was overstating earnings as far back as 1993, yet the auditors continued to sign off on Waste Management's financial statements. Year after year, the company promised to change its ways. Andersen acquiesced.

Continued in the article


"If the Auditors Sign Off, Does That Make It Okay?" by Lawrence Weiss, Harvard Business Review Blog, May 1, 2012 --- Click Here
http://blogs.hbr.org/cs/2012/05/if_the_auditors_sign_off_on_it.html?referral=00563&cm_mmc=email-_-newsletter-_-daily_alert-_-alert_date&utm_source=newsletter_daily_alert&utm_medium=email&utm_campaign=alert_date

Andrew Fastow, the former chief financial officer of Enron, recently completed a six-year prison sentence for his part in the scandalous deception that hid Enron's financial troubles from investors. After I was quoted late last year in an article on the 10th anniversary of the Enron debacle, Fastow contacted me and offered to speak to the Financial Statement Accounting class I teach at Tufts University's Fletcher School of Law and Diplomacy.

Last month, Fastow made good on his offer. Why did he commit fraud? Why did a bright, aspiring, stereotypical MBA cross the line and misrepresent the true financial picture of Enron? According to Fastow, greed, insecurity, ego, and corporate culture all played a part. But the key was his proclivity to rationalize his actions through a narrow application of "the rules."

Fastow's message, an important one for all managers and potential managers, has two key points. First, the rules provide managers with discretion to be misleading. Second, individuals are responsible for their actions and should not justify wrongful actions simply because attorneys, accountants, or corporate boards provide approval.

After his guilty plea for fraud, Fastow forfeited $23.8 million in cash and property. He has helped the Enron Trust recover over $27 billion, of which $6 billion has gone to shareholders. (And he was not compensated for his presentation to my class.)

He began the presentation by admitting he committed fraud and taking full responsibility for his actions. He made a heartfelt detailed apology and expressed remorse for having hurt so many people. He admitted making technical violations and taking wrongful actions that, while approved, were misleading. He said he knew what he was doing was wrong. But he rationalized those actions in his mind at the time, because the result was higher leverage, a higher return on equity, and a higher stock price. Further, he convinced himself that his actions were acceptable because they had been signed off by the firm's lawyers, accountants, and board and were disclosed in the financial reports. He told himself his actions were systemic, it is the way the game is played. All who cared to know knew. As Fastow rhetorically asked my students:

"If the internal and external auditors and lawyers sign off on it, does that make it okay?"

The problem is that attorneys, accountants, managers, boards, and bankers are not gatekeepers; rather, they are there to help businesses execute deals. They are enablers. In the case of Enron, these outside advisers played an active role in structuring and disclosing the deals, and the board approved them, but managers were still responsible for their own actions. Thus, technically following the rules as interpreted by these advisers, even if theirs is the best expertise money can buy, does not make a given action "right." Fastow emphasized that enablers are not an excuse: each individual is his or her own and only gatekeeper.

Fastow suggested that to avoid falling into an ethical trap he should have asked himself the right questions: Am I only following the rules or am I following the principles? If this were a private partnership, would I do the same deal?

Regulation has not prevented fraud. In fact, it may have exacerbated the problem. Enron viewed the complexity or ambiguity of rules as an opportunity to game the system.

Compare Enron's deals with the structured finance innovations we've seen since the passage of the Sarbanes-Oxley Act: Enron's prepays (circular commodity sales which moved debt off the balance sheet and generated funds flow) look very similar to Lehman's Repo 105s (short-term loans secured with a transfer of securities treated as a sale of securities). The mispriced investments and derivatives at Enron look similar to mortgage-backed securities at banks or companies with a disproportionate amount of Level 3 fair-value assets (illiquid assets with highly subjective estimated values). Enron's $35 billion in off-balance sheet debt looks puny compared to the $1.1 trillion of off-balance sheet debt at Citi in 2007. Enron did not pay income taxes in four of its last five years, and GE pays little today. Banks are now engaging in "capital relief" deals that inflate regulatory capital in advance of the new Basel standards. Are these deals true risk transfers or are they cosmetic?

Continued in article

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

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

 


From Smart Stops on the Web, Journal of Accountancy, January 2004, Page 27 --- 

Accountability Resources Here
www.thecorporatelibrary.com
CPAs can read about corporate governance in the real world in articles such as “Alliance Ousts Two Executives” and “Mutual Fund Directors Avert Eyes as Consumers Get Stung” at this Web site. Other resources here include related news items from wire services and newspapers, details on specific shareholder action campaigns and links to other corporate governance Web stops. And on the lighter side, visitors can view a slide show of topical cartoons.

Cartoon archives --- http://www.thecorporatelibrary.com/cartoons/tcl_cartoons.htm

Cartoon 1:  Two kids competing on the blackboard.  One writes 2+2=4 and the other kid writes 2+2=40,000.  Which kid as the best prospects for an accounting career?

Cartoon 36:  Where the Grasso is greener (Also see Cartoon 37)

 

Show-and-Tell
www.encycogov.com
This e-stop, while filled with information on corporate governance, also features detailed flowcharts and tables on bankruptcy, information retrieval and monitoring systems, as well as capital, creditor and ownership structures. Practitioners will find six definitions of the term corporate governance and a long list of references to books, papers and periodicals about the topic.

Investors, Do Your Homework
www.irrc.org
At this Web site CPAs will find the electronic version of the Investor Responsibility Research Center’s IRRC Social Issues Reporter, with articles such as “Mutual Funds Seldom Support Social Proposals.” Advisers also can read proposals from the Shareholder Action Network and the IRRC’s review of NYSE and Sarbanes-Oxley Act reforms, as well as use a glossary of industry terms to help explain to their clients concepts such as acceleration, binding shareholder proposal and cumulative voting.

 

SARBANES-OXLEY SITES

Get Information Online
www.sarbanes-oxley.com
CPAs looking for links to recent developments on the Sarbanes-Oxley Act of 2002 can come here to review current SEC rules and regulations with cross-references to specific sections of the act. Visitors also can find the articles “Congress Eyes Mutual Fund Reform” and “FBI and AICPA Join Forces to Help CPAs Ferret Out Fraud.” Tech-minded CPAs will find the list of links to Sarbanes-Oxley compliance software useful as well.

Direct From the Source
www.sec.gov/spotlight/sarbanes-oxley.htm
To trace the history of the SEC’s rule-making policies for the Sarbanes-Oxley Act, CPAs can go right to the source at this Web site and follow links to press releases pertaining to the commission’s involvement since the act’s creation. Visitors also can navigate to the frequently asked questions (FAQ) section about the act from the SEC’s Division of Corporation Finance.

PCAOB Online
www.pcaobus.org
The Public Company Accounting Oversight Board e-stop offers CPAs timely articles such as “Board Approves Registration of 598 Accounting Firms” and the full text of the Sarbanes-Oxley rules. Users can research proposed standards on accounting support fees and audit documentation and enforcement. Accounting firms not yet registered with the PCAOB can do so here and check out the FAQ section about the registration process.


Bank of America will pay $69 million to settle a class-action suit alleging it was among top U.S. financial firms that participated in a scheme with Enron's top executives to deceive shareholders.

"Bank of America Settles Suit Over the Collapse of Enron," by Rick Brooks and Carrick Mollekamp, The Wall Street Journal, July 4, 2004 --- http://online.wsj.com/article/0,,SB108879162283854269,00.html?mod=home_whats_news_us 

Bank of America Corp. became the first bank to settle a class-action lawsuit alleging that some of the U.S.'s top financial institutions participated in a scheme with Enron Corp. executives to deceive shareholders.

The Charlotte, North Carolina, bank, the third-largest in the U.S. in assets, agreed to pay $69 million to investors who suffered billions of dollars in losses as a result of Enron's collapse amid scandal in 2001. In making the settlement, Bank of America denied that it "violated any law," adding that it decided to make the payment "solely to eliminate the uncertainties, expense and distraction of further protracted litigation," according to a statement.

The settlement with Bank of America raises the possibility that it could cost other banks and securities firms still embroiled in the suit much more to settle the allegations against them, should they decide to do so. Bank of America had relatively small-scale financial dealings with Enron compared with other banks, and was sued only for its role as an underwriter for certain Enron and Enron-related debt offerings.

In contrast with other financial institutions being pursued by Enron shareholders, led by the Regents of the University of California, which lost nearly $150 million from Enron, Bank of America wasn't accused of defrauding the energy company's shareholders. Other remaining defendants in the class-action suit, filed in 2002 in U.S. District Court in Houston, are alleged to have helped Enron with phony deals to inflate the energy company's earnings, potentially exposing those banks and securities firms to much steeper damages.

William Lerach, the lead attorney representing the University of California, predicted that the $69 million payment from Bank of America "will be the precursor of much larger ones in the future, especially with the banks that face liability for participating in the scheme to defraud Enron's common stockholders."

Still, it won't be clear until additional settlements are reached or the suit goes to trial whether Bank of America was able to negotiate a better agreement because of its willingness to strike a deal with Enron shareholders before other defendants. Bank of America's payment to settle the claims against it represents more than half its potential exposure, Mr. Lerach added.

Citigroup Inc. and J.P. Morgan Chase & Co., still defendants in the suit, declined to comment. Enron shareholders also sued Merrill Lynch & Co.; Credit Suisse First Boston, a unit of Credit Suisse Group; Deutsche Bank AG; Canadian Imperial Bank of Commerce; Barclays PLC; Toronto-Dominion Bank; and Royal Bank of Scotland PLC. Named as defendants in the class-action suit before it was amended to include the banks and securities firms were several Enron officers and directors and its former outside auditor, Arthur Andersen LLP.

The only other firm to settle allegations against it in the class-action suit is Andersen Worldwide SC, the Swiss organization that oversees Andersen Worldwide's independent partnerships. In 2002, it reached a $40 million deal with the University of California that released Andersen Worldwide from the suit. That agreement also raised questions among some other Enron claimants about whether they would recover anything more sizable from Enron's accounting firm.

The University of California's board of regents, a 26-member supervisory panel, is expected to give final approval to the settlement agreement with Bank of America later this month. A trial in the Enron class-action suit is set to start in October 2006.

Enron also triggered huge losses for Bank of America shortly after the energy company collapsed. Bank of America incurred a charge of $231 million related to its lending relationship with Enron Corp. The bulk of that stemmed from $210 million in loans that were charged off, which essentially means the bank declared them worthless. Four Bank of America employees tied to the bank's relationship with Enron left the bank in January 2002, a week after Bank of America took the Enron-related charge.


Where are some great resources (hard copy and electronic) for teaching ethics?

"An Inventory of Support Materials for Teaching Ethics in the Post-Enron Era,” by C. William Thomas, Issues in Accounting Education, February 2004, pp. 27-52 --- http://aaahq.org/ic/browse.htm

ABSTRACT: This paper presents a "Post-Enron" annotated bibliography of resources for accounting professors who wish to either design a stand-alone course in accounting ethics or who wish to integrate a significant component of ethics into traditional courses across the curriculum.  Many of the resources listed are recent, but some are classics that have withstood the test of time and still contain valuable information.  The resources listed include texts and reference works, commercial books, academic and professional articles, and electronic resources such as film and Internet websites.  Resources are listed by subject matter, to the extent possible, to permit topical access.  Some observations about course design, curriculum content, and instructional methodology are made as well.

Bob Jensen's threads on resources for accounting educators are at http://faculty.trinity.edu/rjensen/000aaa/newfaculty.htm#Resources 


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.

 


24 Days: How Two Wall Street Journal Reporters Uncovered the Lies that Destroyed Faith in Corporate America, by John R. Emshiller and Rebecca Smith (Haper Collins, 2003, ISBN: 0060520736) 

Here's a powerful Enron Scandal book in the words of the lead whistle blower herself:
Power Failure: The Inside Story of the Collapse of Enron
by Mimi Swartz, Sherron Watkins

ISBN: 0385507879
Format: Hardcover, 400pp
Pub. Date: March 2003
Publisher: Doubleday & Company, Incorporated
Edition Description: 1ST

“They’re still trying to hide the weenie,” thought Sherron Watkins as she read a newspaper clipping about Enron two weeks before Christmas, 2001. . . It quoted [CFO] Jeff McMahon addressing the company’s creditors and cautioning them against a rash judgment....


Related Books


February 1, 2005 message from Boyd, Colin [boyd@commerce.usask.ca

Hi Bob,

I note that you have some of my stuff on one of your excellent web sites. You may be interested in 2 more articles that I had published in July of last year.

Here are the URLs to get to the articles – you can click a link on each of the two web sites so as to get pdf copies of the original published articles. I suspect that you may be particularly interested in some of the analysis I offer in my review of Toffler’s book, which is the second piece below.

Colin Boyd

http://www.commerce.usask.ca/faculty/boyd/StructuralOrigins.html 

http://www.commerce.usask.ca/faculty/boyd/LastStraw.html 

Colin Boyd, Professor of Management, 
Department of Management and Marketing, 
College of Commerce, 
University of Saskatchewan, 
25 Campus Drive, Saskatoon, Sask., Canada S7N 5A7

February 1, 2005 reply from Bob Jensen

Thank you so much for these highly informative papers.

I will add your entire message to the February 18 forthcoming edition of New Bookmarks --- http://faculty.trinity.edu/rjensen/bookurl.htm 

Since your first paper deals with auditor professionalism, I will also add your message to my module on auditor professionalism at http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism 

Since your second paper is an excellent Enron reference, I will add it to my Enron references at http://faculty.trinity.edu/rjensen/FraudEnron.htm#References 

Thanks again, 

Bob Jensen


Chronicling the inner workings of Andersen at the height of its success, Toffler reveals "the making of an Android," the peculiar process of employee indoctrination into the Andersen culture; how Androids - both accountants and consultants--lived the mantra "keep the client happy"; and how internal infighting and "billing your brains out" rather than quality work became the all-important goals. Final Accounting should be required reading in every business school, beginning with the dean and the faculty that set the tone and culture." - Paul Volker, former Chairman of the Federal Reserve Board.
The AccountingWeb, March 25, 2003.

Barbara Ley Toffler is the former Andersen was the partner-in-charge of 
Andersen's Ethics & Responsible Business Practices Consulting Services.

Title:  Final Accounting: Ambition, Greed and the Fall of Arthur Andersen 
Authors:  Barbara Ley Toffler, Jennifer Reingold
ISBN: 0767913825 
Format: Hardcover, 288pp Pub. 
Date: March 2003 
Publisher: Broadway Books

Book Review from http://www.amazon.com/exec/obidos/tg/stores/detail/-/books/0767913825/reviews/002-8190976-4846465#07679138253200 

Book Description A withering exposé of the unethical practices that triggered the indictment and collapse of the legendary accounting firm.

Arthur Andersen's conviction on obstruction of justice charges related to the Enron debacle spelled the abrupt end of the 88-year-old accounting firm. Until recently, the venerable firm had been regarded as the accounting profession's conscience. In Final Accounting, Barbara Ley Toffler, former Andersen partner-in-charge of Andersen's Ethics & Responsible Business Practices consulting services, reveals that the symptoms of Andersen's fatal disease were evident long before Enron. Drawing on her expertise as a social scientist and her experience as an Andersen insider, Toffler chronicles how a culture of arrogance and greed infected her company and led to enormous lapses in judgment among her peers. Final Accounting exposes the slow deterioration of values that led not only to Enron but also to the earlier financial scandals of other Andersen clients, including Sunbeam and Waste Management, and illustrates the practices that paved the way for the accounting fiascos at Worldcom and other major companies.

Chronicling the inner workings of Andersen at the height of its success, Toffler reveals "the making of an Android," the peculiar process of employee indoctrination into the Andersen culture; how Androids—both accountants and consultants--lived the mantra "keep the client happy"; and how internal infighting and "billing your brains out" rather than quality work became the all-important goals. Toffler was in a position to know when something was wrong. In her earlier role as ethics consultant, she worked with over 60 major companies and was an internationally renowned expert at spotting and correcting ethical lapses. Toffler traces the roots of Andersen's ethical missteps, and shows the gradual decay of a once-proud culture.

Uniquely qualified to discuss the personalities and principles behind one of the greatest shake-ups in United States history, Toffler delivers a chilling report with important ramifications for CEOs and individual investors alike.

From the Back Cover "The sad demise of the once proud and disciplined firm of Arthur Andersen is an object lesson in how 'infectious greed' and conflicts of interest can bring down the best. Final Accounting should be required reading in every business school, beginning with the dean and the faculty that set the tone and culture.” -Paul Volker, former Chairman of the Federal Reserve Board

“This exciting tale chronicles how greed and competitive frenzy destroyed Arthur Andersen--a firm long recognized for independence and integrity. It details a culture that, in the 1990s, led to unethical and anti-social behavior by executives of many of America's most respected companies. The lessons of this book are important for everyone, particularly for a new breed of corporate leaders anxious to restore public confidence.” -Arthur Levitt, Jr., former chairman of the Securities and Exchange Commission

“This may be the most important analysis coming out of the corporate disasters of 2001 and 2002. Barbara Toffler is trained to understand corporate ‘cultures’ and ‘business ethics’ (not an oxymoron). She clearly lays out how a high performance, manically driven and once most respected auditing firm was corrupted by the excesses of consulting and an arrogant culture. One can hope that the leaders of all professional service firms, and indeed all corporate leaders, will read and reflect on the meaning of this book.” -John H. Biggs, Former Chairman and Chief Executive Officer of TIAA CREF

“The book exposes the pervasive hypocrisy that drives many professional service firms to put profits above professionalism. Greed and hubris molded Arthur Andersen into a modern-day corporate junkie ... a monster whose self-destructive behavior resulted in its own demise." -Tom Rodenhauser, founder and president of Consulting Information Services, LLC

"An intriguing tale that adds another important dimension to the now pervasive national corporate governance conversation. -Charles M. Elson, Edgar S. Woolard, Jr., Professor of Corporate Governance, University of Delaware

“You could not ask for a better guide to the fall of Arthur Andersen than an expert on organizational behavior and business ethics who actually worked there. Sympathetic but resolutely objective, Toffler was enough of an insider to see what went on but enough of an outsider to keep her perspective clear. This is a tragic tale of epic proportions that shows that even institutions founded on integrity and transparency will lose everything unless they have internal controls that require everyone in the organization to work together, challenge unethical practices, and commit only to profitability that is sustainable over the long term. One way to begin is by reading this book. –Nell Minow, Editor, The Corporate Library

About the Author Formerly the Partner-in-Charge of Ethics and Responsible Business Practices consulting services for Arthur Andersen, BARBARA LEY TOFFLER was on the faculty of the Harvard Business School and now teaches at Columbia University's Business School. She is considered one of the nation's leading experts on management ethics, and has written extensively on the subject and has consulted to over sixty Fortune 500 companies. She lives in the New York area. Winner of a Deadline Club award for Best Business Reporting, JENNIFER REINGOLD has served as management editor at Business Week and senior writer at Fast Company. She writes for national publications such as The New York Times, Inc and Worth and co-authored the Business Week Guide to the Best Business Schools (McGraw-Hill, 1999).

Also see the review at  http://www.nytimes.com/2003/02/23/business/yourmoney/23VALU.html 


March 8, 2004 message from neil glass [neil.glass@get2net.dk
Note that you can download the first chapter of his book for free.  The book may be purchased as an eBook or hard copy.

Dr. Jensen,

I just came across your website and was pleased to find you talk about some of the frauds and other problems I reveal in my latest book. If you had a moment, you might be amused to look at my website only-on-the-net.com where I am trying to attract some attention to my book Rip-Off: The scandalous inside story of the Management Consulting Money Machine.

best wishes

neil glass

The link is http://www.only-on-the-net.com/ 


The AICPA's Prosecution of Dr. Abraham Briloff, Some Observations --- http://accounting.rutgers.edu/raw/aaa/pi/newsletr/spring99/item07.htm 


Art Wyatt admitted:
"ACCOUNTING PROFESSIONALISM: THEY JUST DON'T GET IT" ---
http://aaahq.org/AM2003/WyattSpeech.pdf 


Here is some earlier related material you can find at http://faculty.trinity.edu/rjensen/fraudVirginia.htm 

Lessons Learned From Paul Volker:  
The Culture of Greed Sucked the Blood Out of Professionalism
In an effort to save Andersen's reputation and life, the top executive officer, Joe Berardino, in Andersen was replaced by the former Chairman of the Federal Reserve Board, Paul Volcker.  This great man, Volcker, really tried to instantly change the culture of greed that overtook professionalism in  Andersen and other public accounting firms, but it was too little too late --- at least for Andersen.

The bottom line:

I have a mental image of the role of an auditor. He’s a kind of umpire or referee, mandated to keep financial reporting within the established rules. Like all umpires, it’s not a popular or particularly well paid role relative to the stars of the game. The natural constituency, the investing public, like the fans at a ball park, is not consistently supportive when their individual interests are at stake. Matters of judgment are involved, and perfection in every decision can’t be expected. But when the “players”, with teams of lawyers and investment bankers, are in alliance to keep reported profits, and not so incidentally the value of fees and stock options on track, the pressures multiply. And if the auditing firm, the umpire, is itself conflicted, judgments almost inevitably will be shaded. 
Paul Volcker (See below)

"Volcker says "new Andersen" no longer possible," by Kevin Drawbaugh, CPAnet, May 17, 2002 --- http://www.cpanet.com/up/s0205.asp?ID=0572

WASHINGTON, May 17 (Reuters) - Former Federal Reserve Board Chairman Paul Volcker, who took charge of a rescue team at embattled accounting firm Andersen (ANDR), said on Friday that creating "a new Andersen" was no longer possible.

In a letter to Sen. Paul Sarbanes, Volcker said he supports the Maryland Democrat's proposals for reforming the U.S. financial system to prevent future corporate disasters such as the collapse of Enron Corp. (ENRNQ).

"The sheer number and magnitude of breakdowns that have increasingly become the daily fare of the business press pose a clear and present danger to the effectiveness and efficiency of capital markets," Volcker said in the letter released to Reuters.

"FINALLY, A TIME FOR AUDITING REFORM" 
REMARKS BY PAUL A. VOLCKER  
AT THE CONFERENCE ON CREDIBLE FINANCIAL DISCLOSURES 
KELLOGG SCHOOL OF MANAGEMENT 
NORTHWESTERN UNIVERSITY 
EVANSTON, ILLINOIS 
JUNE 25, 2002
http://www.fei.org/download/Volker_Kellogg_Speech_6-25-02.pdf 

How ironic that we are meeting near Arthur Andersen Hall with the leadership of the Leonard Spacek Professor of Accounting. From all I have learned, the Andersen firm in general, and Leonard Spacek in particular, once represented the best in auditing. Literally emerging from the Northwestern faculty, Arthur Andersen represented rigor and discipline, focused on the central mission of attesting to the fairness and accuracy of the financial reports of its clients. 

The sad demise of that once great firm is, I think we must now all realize, not an idiosyncratic, one-off, event. The Enron affair is plainly symptomatic of a larger, systemic problem. The state of the accounting and auditing systems which we have so confidently set out as a standard for all the world is, in fact, deeply troubled.

The concerns extend far beyond the profession of auditing itself. There are important questions of corporate governance, which you will address in this conference, but which I can touch upon only tangentially in my comments. More fundamentally, I think we are seeing the bitter fruit of broader erosion of standards of business and market conduct related to the financial boom and bubble of the 1990’s. 

From one angle, we in the United States have been in a remarkable era of creative destruction, in one sense rough and tumble capitalism at its best bringing about productivity-transforming innovation in electronic technology and molecular biology. Optimistic visions of a new economic era set the stage for an explosion in financial values. The creation of paper wealth exceeded, so far as I can determine, anything before in human history in relative and absolute terms. 

Encouraged by ever imaginative investment bankers yearning for extraordinary fees, companies were bought and sold with great abandon at values largely accounted for as “intangible” or “good will”. Some of the best mathematical minds of the new generation turned to the sophisticated new profession of financial engineering, designing ever more complicated financial instruments. The rationale was risk management and exploiting market imperfections. But more and more it has become a game of circumventing accounting conventions and IRS regulations. 

Inadvertently or not, the result has been to load balance sheets and income statements with hard to understand and analyze numbers, or worse yet, to take risks off the balance sheet entirely. In the process, too often the rising stock market valuations were interpreted as evidence of special wisdom or competence, justifying executive compensation packages way beyond any earlier norms and relationships. 

It was an environment in which incentives for business management to keep reported revenues and earnings growing to meet expectations were amplified. What is now clear, is that insidiously, almost subconsciously, too many companies yielded to the temptation to stretch accounting rules to achieve that result.

I state all that to emphasize the pressures placed on the auditors in their basic function of attesting to financial statements. Moreover, accounting firms themselves were caught up in the environment – - to generate revenues, to participate in the new economy, to stretch their range of services. More and more they saw their future in consulting, where, in the spirit of the time, they felt their partners could “better leverage” their talent and raise their income. 

I have a mental image of the role of an auditor. He’s a kind of umpire or referee, mandated to keep financial reporting within the established rules. Like all umpires, it’s not a popular or particularly well paid role relative to the stars of the game. The natural constituency, the investing public, like the fans at a ball park, is not consistently supportive when their individual interests are at stake. Matters of judgment are involved, and perfection in every decision can’t be expected. But when the “players”, with teams of lawyers and investment bankers, are in alliance to keep reported profits, and not so incidentally the value of fees and stock options on track, the pressures multiply. And if the auditing firm, the umpire, is itself conflicted, judgments almost inevitably

Continued at http://www.fei.org/download/Volker_Kellogg_Speech_6-25-02.pdf 

"We're The Front Line For Shareholders,"  by Phil Livingston (President of Financial Executives International), January/February 2002 --- http://www.fei.org/magazine/articles/1-2-2002_president.cfm 

At FEI's recent financial reporting conference in New York, Paul Volcker gave the keynote address and declared that the accounting and auditing profession were in a "state of crisis." Earlier that morning, over breakfast, he lamented the daily bombardment of financial reporting failures in the press.

I agree with his assessment. The causes and contributing factors are numerous, but one thing is clear: We as financial executives need to do better, be stronger and take the lead in restoring the credibility of financial reporting and preserving the capital markets.

If you didn't already know it and believe it deeply, recent cases prove the value of a financial management team that is ethical, credible and clear in its communications. A loss of confidence in that team can be a fatal blow, not just to the individuals, but to the company or institution that entrusts its assets to their stewardship. I think the FEI Code of Ethical Conduct says it best, and it is worth reprinting the opening section here. The full code (signed by all FEI members) can be found here.

. . .

So how did the profession reach the state Volcker describes as a crisis?

  • The market pressure for corporate performance has increased dramatically over the last 10 years. That pressure has produced better results for shareholders, but also a higher fatality rate as management teams pressed too hard at the margin.
  • The standard-setters floundered in the issue de jour quagmire, writing hugely complicated standards that were unintelligible and irrelevant to the bigger problems.
  • The SEC fiddled while the dot-com bubble burst. Deriding and undermining management teams and the auditors, the past administration made a joke of financial restatements.
  • We've had no vision for the future of financial reporting. Annual reports, 10Ks and 10Qs are obsolete. Bloomberg and Yahoo! Finance have replaced the horse-and-buggy vehicles with summary financial information linked to breaking news.
  • We've had no vision for the future of accounting. Today's mixed model is criticized one day for recognizing unrealized fair value contractual gains and alternatively for not recognizing the fair value of financial instruments.
  • The auditors dropped their required skeptical attitude and embraced business partnering philosophies. Adding value and justifying the audit fees became the mandate. Management teams and audit committees promoted this, too.
  • Audit committees have not kept up with the challenges of the assignment. True financial reporting experts are needed on these committees, not the general management expertise required by the stock exchange rules.

Beta Gamma Sigma honor society --- http://cba.unomaha.edu/bg/ 

I’ve been a member of BGS for 40 years, but somehow I’ve managed to overlook B-Zine

From Beta Gamma Sigma BZine Electronic Magazine --- http://cba.unomaha.edu/bg/ 

CEOs may need to speak up
by Tim Weatherby, Beta Gamma Sigma
As more Fortune 500 companies and their executives are sucked into the current crisis, it may be time for the good guys to put their two cents in. The 2002 Beta Gamma Sigma International Honoree did just that in April.
http://www.betagammasigma.org/news/bzine/august02feature.html

How Tyco's CEO Enriched Himself
by Mark Maremont and Laurie P. Cohen, The Wall Street Journal
The latest story of corporate abuse surrounds the former Tyco CEO. This story provides a vivid example of the abuses that are leading many to question current business practices.
http://www.msnbc.com/news/790996.asp

A Lucrative Life at the Top
by MSNBC.com
Highlights pay and incentive packages of several former corporate executives currently under investigation.
http://www.msnbc.com/news/783953.asp

A To-Do List for Tyco's CEO
by William C. Symonds, BusinessWeek online
The new CEO of Tyco has a tough job ahead of him cleaning up the mess left behind.
http://www.businessweek.com/magazine/content/02_32/b3795050.htm

Implausible Deniability: The SEC Turns Up CEO Heat
by Diane Hess, TheStreet.com
The SEC's edict requires written statements, under oath, from senior officers of the 1,000 largest public companies attesting to the accuracy of their financial statements.
http://www.thestreet.com/markets/taleofthetape/10029865.html

Corporate Reform: Any Idea in a Storm?
by BusinessWeek online
Lawmakers eager to appease voters are trying all kinds of things.
http://www.businessweek.com/magazine/content/02_32/b3795045.htm

Sealing Off the Bermuda Triangle
by Howard Gleckman, BusinessWeek online
Too many corporate tax dollars are disappearing because of headquarters relocations, and Congress looks ready to act.
http://www.businessweek.com/bwdaily/dnflash/jun2002/nf20020625_2167.htm 


"Adding Insult to Injury: Firms Pay Wrongdoers' Legal Fees," by Laurie P. Cohen, The Wall Street Journal, February 17, 2004 --- http://online.wsj.com/article/0,,SB107697515164830882,00.html?mod=home%5Fwhats%5Fnews%5Fus 

You buy shares in a company. The government charges one of the company's executives with fraud. Who foots the legal bill?

All too often, it's you.

Consider the case of a former Rite Aid Corp. executive. Four days before he was set to go to trial last June, Frank Bergonzi pleaded guilty to participating in a criminal conspiracy to defraud Rite Aid while he was the company's chief financial officer. "I was aggressive and I pressured others to be aggressive," he told a federal judge in Harrisburg, Pa., at the time.

Little more than a month later, Mr. Bergonzi sued his former employer in Delaware Chancery Court, seeking to force the company to pay more than $5 million in unpaid legal and accounting fees he racked up in connection with his defense in criminal and civil proceedings. That was in addition to the $4 million that Rite Aid had already advanced for Mr. Bergonzi's defense in civil, administrative and criminal proceedings.

In October, the Delaware court sided with Mr. Bergonzi. It ruled that Rite Aid was required to advance Mr. Bergonzi's defense fees until a "final disposition" of his legal case. The court interpreted that moment as sentencing, a time that could be months -- or even years -- away. Mr. Bergonzi has agreed to testify against former colleagues at coming trials before he is sentenced for his crimes.

Rite Aid's insurance, in what is known as a directors-and-officers liability policy, already has been depleted by a host of class-action suits filed against the company in the wake of a federal investigation into possible fraud that began in late 1999. "The shareholders are footing the bill" because of the "precedent-setting" Delaware ruling, laments Alan J. Davis, a Philadelphia attorney who unsuccessfully defended Rite Aid against Mr. Bergonzi.

Rite Aid eventually settled with Mr. Bergonzi for an amount it won't disclose. While it is entitled to recover the fees it has paid from Mr. Bergonzi after he is sentenced, the 58-year-old defendant has testified he has few remaining assets. "We have no reason to believe he'll repay" Rite Aid, Mr. Davis says.

Rite Aid has lots of company. In recent government cases involving Cendant Corp.; Worldcom Inc., now known as MCI; Enron Corp.; and Qwest Communications International Inc., among others, companies are paying the legal costs of former executives defending themselves against fraud allegations. The amount of money being paid out isn't known, as companies typically don't specify defense costs. But it totals hundreds of millions, or even billions of dollars. A company's average cost of defending against shareholder suits last year was $2.2 million, according to Tillinghast-Towers Perrin. "These costs are likely to climb much higher, due to a lot of claims for more than a billion dollars each that haven't been settled," says James Swanke, an executive at the actuarial consulting firm.

Continued in the article


Corporate Accountability: A Toolkit for Social Activists
The Stakeholder Alliance (ala our friend Ralph Estes and well-meaning social accountant) --- http://www.stakeholderalliance.org/


From the Chicago Tribune, February 19, 2002  --- http://www.smartpros.com/x33006.xml 

International Standards Needed, Volcker Says

WASHINGTON, Feb. 19, 2002 (Knight-Ridder / Tribune News Service) — Enron Corp.'s collapse was a symptom of a financial recklessness that spread during the 1990s economic boom as investors and corporate executives pursued profits at all costs, former Federal Reserve Chairman Paul Volcker told a Senate committee Thursday.

Volcker -- chairman of the new oversight panel created by Enron's auditor, the Andersen accounting firm, to examine its role in the financial disaster -- told the Senate Banking Committee he hoped the debacle would accelerate current efforts to achieve international accounting standards. Such standards could reassure investors around the world that publicly traded companies met certain standards regardless of where such companies were based, he said.

"In the midst of the great prosperity and boom of the 1990s, there has been a certain erosion of professional, managerial and ethical standards and safeguards," Volcker said.

"The pressure on management to meet market expectations, to keep earnings rising quarter by quarter or year by year, to measure success by one 'bottom line' has led, consciously or not, to compromises at the expense of the public interest in full, accurate and timely financial reporting," he added.

But the 74-year-old economist also blamed the new complexity of corporate finance for contributing the problem. "The fact is," Volcker said "the accounting profession has been hard-pressed to keep up with the growing complexity of business and finance, with its mind-bending complications of abstruse derivatives, seemingly endless varieties of securitizations and multiplying, off-balance-sheet entities. (Continued in the article.)

 


May 15, 2003 message from Dave Albrecht [albrecht@PROFALBRECHT.COM

I've been teaching Intermediate Financial Accounting for several years. Recently, I've been thinking about having students read a supplemental book . Given the current upheaval, there are several possibilities for additional reading. Can anyone make a recommendation? BTW, these books would make great summer reading.

Dave Albrecht

Benston et. al. (2003). Following the Money: The Enron Failure and the State of Corporate Disclosure.

Berenson, Alex. (2003). The Number: How the Drive for Quarterly Earnings Corrupted Wall Street and Corporate America.

Brewster, Mike. (2003). Unaccountable: How the Accounting Profession Forfeited an Public Trust.

Brice & Ivins. (2002.) Pipe Dreams: Greed, Ego and the Death of Enron.

DiPiazza & Eccles. (2002). Building Public Trust: The Future of Corporate Reporting.

Fox, Loren. (2002). Enron, the Rise and Fall.

Jeter, Lynne W. (2003). Disconnected: Deceit and Betrayal at Worldcom.

Mills, D. Quinn. (2003). Wheel, Deal and Steal: Deceptive Accounting, Deceitful CEOs, and Ineffective Reforms.

Mulford & Comiskey. (2002). The Financial Numbers Game: Detecting Creative Accounting Practices.

Nofsinger & Kim. (2003). Infectious Greed: Restoring Confidence in America's Companies.

Squires, Susan. (2003). Inside Arthur Andersen: Shifting Values, Unexpected Consequences.

Swartz & Watkins. (2003). Power Failure: The Inside Story of the Collapse of Enron.

Toffler, Barbara. (2003). Final Accounting: Ambition, Greed and the Fall of Arthur Andersen

May 15, 2003 reply from Bruce Lubich [blubich@UMUC.EDU

I would add Schilit, Howard. (2002) Financial Shenanigans.

Bruce Lubich

May 15, 2003 reply from Neal Hannon [nhannon@COX.NET

Suggested Additions to Summer Book List:

Financial Shenanigans : How to Detect Accounting Gimmicks & Fraud in Financial Reports by Howard Schilit (McGraw-Hill Trade; 2nd edition (March 1, 2002))

How Companies Lie: Why Enron Is Just the Tip of the Iceberg by Richard J. Schroth, A. Larry Elliott

Quality Financial Reporting by Paul B. W. Miller, Paul R. Bahnson

Take On the Street: What Wall Street and Corporate America Don't Want You to Know by Arthur Levitt, Paula Dwyer (Contributor)

And for fun: Who Moved My Cheese? An Amazing Way to Deal with Change in Your Work and in Your Life by Spencer, M.D. Johnson, Kenneth H. Blanchard

Neal J. Hannon, CMA Chair, I.T. Committee, Institute of Management Accountants Member, XBRL_US Steering Committee University of Hartford (860) 768-5810 (401) 769-3802 (Home Office)

 


Book Recommendation from The AccountingWeb on April 25, 2003

The professional service accounting firm is being threatened by a variety of factors: new technology, intense competition, consolidation, an inability to incorporate new services into a business strategy, and the erosion of public trust, just to name a few. There is relief. And promise. And hope. In The Firm of the Future: A Guide for Accountants, Lawyers, and Other Professional Services, confronts the tired, conventional wisdom that continues to fail its adherents, and present bold, proven strategies for restoring vitality and dynamism to the professional service firm. http://www.amazon.com/exec/obidos/ASIN/0471264245/accountingweb 


Question
What is COSO?

Answer --- http://www.coso.org/ 

COSO is a voluntary private sector organization dedicated to improving the quality of financial reporting through business ethics, effective internal controls, and corporate governance. COSO was originally formed in 1985 to sponsor the National Commission on Fraudulent Financial Reporting, an independent private sector initiative which studied the causal factors that can lead to fraudulent financial reporting and developed recommendations for public companies and their independent auditors, for the SEC and other regulators, and for educational institutions.

The National Commission was jointly sponsored by the five major financial professional associations in the United States, the American Accounting Association, the American Institute of Certified Public Accountants, the Financial Executives Institute, the Institute of Internal Auditors, and the National Association of Accountants (now the Institute of Management Accountants). The Commission was wholly independent of each of the sponsoring organizations, and contained representatives from industry, public accounting, investment firms, and the New York Stock Exchange.

The Chairman of the National Commission was James C. Treadway, Jr., Executive Vice President and General Counsel, Paine Webber Incorporated and a former Commissioner of the U.S. Securities and Exchange Commission. (Hence, the popular name "Treadway Commission"). Currently, the COSO Chairman is John Flaherty, Chairman, Retired Vice President and General Auditor for PepsiCo Inc.


Title:  ENRON: A Professional's Guide to the Events, Ethical Issues, and Proposed Reforms 
Authur: L. Berkowitz, CPA
ISBN: 0-8080-0825-0
Publisher:  CCH --- http://tax.cchgroup.com/Store/Products/CCE-CCH-1959.htm?cookie%5Ftest=1 
Pub. Date:  July 2002

Title:  Take On the Street: What Wall Street and Corporate America Don't Want You to Know
Authors:  Arthur Levitt and Paula Dwyer (Arthor Levitt is the highly controversial former Chairman of the SEC)
Format: Hardcover, 288pp.  This is also available as a MS Reader eBook --- http://search.barnesandnoble.com/booksearch/ISBNinquiry.asp?userid=16UOF6F2PF&isbn=0375422358 
ISBN: 0375421785
Publisher: Pantheon Books
Pub. Date: October  2002
See http://search.barnesandnoble.com/booksearch/isbnInquiry.asp?userid=16UOF6F2PF&isbn=0375421785 

This is Levitt's no-holds-barred memoir of his turbulent tenure as chief overseer of the nation's financial markets. As working Americans poured billions into stocks and mutual funds, corporate America devised increasingly opaque strategies for hoarding most of the proceeds. Levitt reveals their tactics in plain language, then spells out how to intelligently invest in mutual funds and the stock market. With integrity and authority, Levitt gives us a bracing primer on the collapse of the system for overseeing our capital markets, and sage, essential advice on a discipline we often ignore to our peril - how not to lose money. http://www.amazon.com/exec/obidos/ASIN/0375421785/accountingweb 

Don Ramsey called my attention to the following audio interview:
For a one-hour audio archive of Diane Rehm's recent interview with Arthur Levitt, go to this URL:   http://www.wamu.org/ram/2002/r2021015.ram

A free video from Yale University and the AICPA (with an introduction by Professor Rick Antle and Senior Associate Dean from Yale).  This video can be downloaded to your computer with a single click on a button at http://www.aicpa.org/video/ 
It might be noted that Barry Melancon is in the midst of controversy with ground swell of CPAs and academics demanding his resignation vis-a-vis continued support he receives from top management of large accounting firms and business corporations.

A New Accounting Culture
Address by Barry C. Melancon
President and CEO, American Institute of CPAs
September 4, 2002
Yale Club - New York City
Taped immediately upon completion

From The Conference Board
Corporate Citizenship in the New Century: Accountability, Transparency, and Global Stakeholder Engagement
Publication Date:  July 2002
Report Number:  R-1314-02-RR --- http://www.conference-board.org/publications/describe.cfm?id=574 

My new and updated documents the recent accounting and investment scandals are at the following sites:

Bob Jensen's threads on the Enron/Andersen scandals are at  http://faculty.trinity.edu/rjensen/fraud.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 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 


Disconnected: Deceit and Betrayal at Worldcom, by Lynne W. Jeter


Inside Arthur Andersen: Shifting Values, Unexpected Consequences by Lorna McDougall, Cynthia Smith, Susan E. Squires, William R. Yeack.


Final Accounting: Ambition, Greed and the Fall of Arthur Andersen by Barbara Ley Toffler and Jennifer Reingold


Bisk CPEasy's "Accounting Profession Reform: Restoring Confidence in the System" --- http://www.cpeasy.com/ 


"The fall of Andersen," Chicago Tribune --- http://www.chicagotribune.com/business/showcase/chi-andersen.special 

Chicago's Andersen accounting firm must stop auditing publicly traded companies following the firm's conviction for obstructing justice during the federal investigation into the downfall of Enron Corp. For decades, Andersen was a fixture in Chicago's business community and, at one time, the gold standard of the accounting industry. How did this legendary firm disappear?

Civil war splits Andersen
September 2, 2002.  Second of four parts

The fall of Andersen
September 1, 2002.  This series was reported by Delroy Alexander, Greg Burns, Robert Manor, Flynn McRoberts and E.A. Torriero. It was written by McRoberts.

Greed tarnished golden reputation
September 1, 2002.  First of four parts

'Merchant or Samurai?'
September 1, 2002.  Dick Measelle, then-chief executive of Andersen's worldwide audit and tax practice, explores a corporate cultural divide in an April 1995 newsletter essay to Andersen partners.

What will the U.S. accounting business look like when the dust settles on Arthur Andersen? http://faculty.trinity.edu/rjensen/fraud041202.htm#Future 
Also see http://faculty.trinity.edu/rjensen/FraudConclusion.htm 

The Washington Post put together a terrific Corporate Scandal Primer that includes reviews and pictures of the "players," "articles,", and an "overview" of each major accounting and finance scandal of the Year 2002 --- http://www.washingtonpost.com/wp-srv/business/scandals/primer/index.html 
I added this link to my own reviews at http://faculty.trinity.edu/rjensen/fraud.htm#Governance

 

The AccountingWeb recommends a number of books on accounting fraud --- http://www.amazon.com/exec/obidos/ASIN/0471353787/accountingweb/103-6121868-8139853 

  • The Fraud Identification Handbook by George B. Allen (Preface)
  • Financial Investigation and Forensic Accounting by George A. Manning
  • Business Fraud by James A. Blanco, Dave Evans
  • Document Fraud and Other Crimes of Deception by Jesse M. Greenwald, Holly K. Tuttle (Illustrator)
  • Fraud Auditing and Forensic Accounting by Jack Bologna, et al
  • The Financial Numbers Game by Charles W. Mulford, Eugene E. Comiskey
  • How to Reduce Business Losses from Employee Theft and Customer Fraud by Alfred N. Weiner
  • Financial Statement Fraud by Zabihollah Rezaee, Joseph T. Wells
  • Transnational Criminal Organizations, Cybercrime, and Money Laundering by James R. Richards

The three books below are reviewed in the December 2002 issue of the Journal of Accountancy, pp. 88-90 --- http://www.aicpa.org/pubs/jofa/dec2002/person.htm 

Two Books on Financial Statement Fraud

Financial Statement Fraud:  Prevention and Detection
by Zabihollah Razaee (Certified Fraud Examiner and Accounting Professor at the University of Memphis)
Format: Hardcover, 336pp.
ISBN: 0471092169
Publisher: Wiley, John & Sons, Incorporated
Pub. Date: March  2002 
http://search.barnesandnoble.com/booksearch/isbnInquiry.asp?userid=16UOF6F2PF&isbn=0471092169  

The Financial Numbers Game:  Detecting Creative Accounting Practices
by Charles W. Mulford and Eugene Comiskey (good old boys from the Georgia Institute of Technology)
Format: Paperback, 408pp.
ISBN: 0471370088
Publisher: Wiley, John & Sons, Incorporated
Pub. Date: February  2002 
http://search.barnesandnoble.com/booksearch/isbnInquiry.asp?userid=16UOF6F2PF&isbn=0471370088
 

One New Book on Accounting Professionalism and Public Trust

Building Public Trust:  The Future of Corporate Reporting
by Samuel A. DiPiazza, Jr (CEO of PricewaterhouseCoopers (PwC))
and Robert G. Eccies (President of Advisory Capital Partners)
Format: Hardcover, 1st ed., 192pp.
ISBN: 0471261513
Publisher: Wiley, John & Sons, Incorporated
Pub. Date: June  2002 
http://search.barnesandnoble.com/booksearch/isbnInquiry.asp?userid=16UOF6F2PF&isbn=0471261513
 

Books on Fraud --- Enter the word "fraud" in the search box at http://www.bn.com/ 

 

Yahoo's choices for top fraud sites --- http://dir.yahoo.com/Society_and_Culture/Crime/Types_of_Crime/Fraud/Finance_and_Investment/ 

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.

My Interview With The Baltimore Sun --- http://faculty.trinity.edu/rjensen/fraudBaltimoreSun.htm 

My Philadelphia Inquirer Interview 1 --- http://faculty.trinity.edu/rjensen/philadelphia_inquirer.htm 

My Philadelphia Inquirer Interview 2 ---  http://faculty.trinity.edu/rjensen/FraudPhiladelphiaInquirere022402.htm 

My Interview With National Public Radio --- http://faculty.trinity.edu/rjensen/fraudNPRfeb7.htm 

Question
Should companies be allowed to outsource internal auditing to their external auditors?
An Enron Message

Shari Thompson in the early 1990s was an African American internal auditor in Enron trying her best to be a good auditor.

She gave me permission to forward two of her messages that I received out of the blue from her. For those of you that still hold deep abiding sympathies for Andersen's top management, I suggest that you read both of these messages, especially Message 2.

Message 1 appears below. Note that this message contains a lot more messaging than just her message to me. That messaging is very critical of some BYU professors and arguments that internal auditing might be outsourced to external auditors.

My main Enron and Worldcom fraud document (especially note Enron's Timeline) ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm
This Timeline will soon be updated for Shari's assertion that Enron outsourced internal auditing to Andersen in 1994.

My Enron Quiz will soon be updated for Shari's messages --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm  

Bob Jensen's threads on professionalism and auditor independence are at (scroll down) ---  http://faculty.trinity.edu/rjensen/Fraud001.htm

 

Message 1 from Shari Thompson to Bob Jensen

-----Original Message-----
From: Thompson, Shari [
mailto:shari.thompson@pvpl.com
Sent: Friday, February 27, 2009 2:33 PM
To:
'dboje@nmsu.edu' ; rjensen@trinity.edu
Subject: Please update your Enron blog (from former Enron Internal Auditor)

Why is it that everyone who chronologizes Enron's fall misses a hugely significant, contributing factor to Enron's demise?  That is, that Enron's entire internal audit department was systematically eliminated by Andersen, when the internal audit function was outsourced to Andersen.  This outsourcing was instrumental in allowing Lay/Skilling/Fastow to commit accounting fraud undetected for a long period of time.

 The outsourcing of Enron's internal audit function is one of the most festering flaws in the debacle, yet no one has sufficiently reported it.  As a former Enron senior internal auditor, I have brought this flaw to the attention of reporters and bloggers over the years since 2001.  To no avail, however.  Some of them respond "interesting, I never knew that."  But that's it.  No one follows up and reports on the incestuous relationship Enron had with Andersen as the "internal" audit department.

Now we have three professors concluding that companies should outsource internal audit to external auditors.  Please be cognizant enough to add the rest of the story, so that the Finance world can clearly connect the dots between outsourcing internal audit and accounting fraud.  http://www.cfo.com/article.cfm/13111528

Shari Thompson CIA
Direct 402.829.5248 Mobile 402.740.4012

 _____________________________________________

From: Thompson, Shari

Sent: Friday, February 27, 2009 1:28 PM
To: 'richard.chambers@theiia.org' ; 'edward.nusbaum@gt.com '; 'douglas_prawitt@byu.edu '; 'nsharp@mays.tamu.edu '; 'davidwood@byu.edu'
Subject: Thank you to IIA President Richard Chambers

 Good afternoon Mr. Chambers,

I just read an article about professors at Brigham Young and Texas A&M claiming that companies gain from having external auditors perform their internal audits.  I was a senior internal auditor for Enron and subsidiaries (before outsourcing to Andersen) for 24 years (1981 to 2004).  I can attest that having companies use their external auditor as internal auditor is a toxic and deceptive practice.

Thank you so much for voicing your disagreement with this conclusion.  Please keep up the fight to not have this practice become acceptable again.

____________________________________________________________

 Mr. Nusbaum:

You've changed your tune much from your 2006 letter to the SEC when you advocated " Equally without question is that these early experiences with implementation have been costly, but we cannot and should not go back."  http://www.sec.gov/news/press/4-511/enusbaum051006.pdf

____________________________________________________________

 Messieurs Prawitt, Wood, and Sharp:

I am shocked and appalled at your "findings."  Has someone at KPMG, PWC, E&Y or D&T paid you enormous sums of money in return for your publishing such a ludicrous recommendation to outsource internal audit to external auditors?  How could you even preliminarily come to such an incestuous conclusion?

I invite you to talk to me about real world consequences of the unintelligence of outsourcing internal audit to externals.  Blending the two functions is purely a management's self-serving act.  The very phrase "outsourcing internal audit" is an oxymoron, and the terms "outsource" and "internal audit" should be forever mutually exclusive.

I'm 50 years old, an expert internal auditor that worked for Enron and its subsidiaries for 24 of my 28 years in the auditing industry.  And yet I-as well as hundreds of my former Enron colleagues, and untold others around the world-have no 401k nor ESOP savings to show for all my years of hard work.  Why?  Because of the very thing you recommend-outsourcing internal audit.

 When I was a college student years ago, I enjoyed engaging in theoretical debates with my professors.  However, they were wise enough to caveat their opinions with warnings that they'd never worked-or hadn't worked for some time-in corporate America.  Unfortunately, you lack the sageness to recognize the limitations of your insulated confines of collegiate life.

 You state: "Our results indicate that, prior to SOX, outsourcing the work of the IAF to the external auditor is associated with lower accounting risk as compared to keeping the IAF in-house or outsourcing the work of the IAF to a third party other than the external auditor."

*       Must I remind you that the lack of accounting controls is precisely what tanked Enron?

*       Must I remind you of why were there were no controls?  Because Lay, Fastow and Skilling hired Andersen to perform both internal and external audits.  Lay, Fastow, and Skilling knew that Andersen's heads would willingly participate in accounting fraud cover-up as long as Enron paid them well.  And they also knew that any Andersen soul brave enough to dissent would be summarily removed from the Enron account, or from Andersen altogether.

*       Do you know that a few months before the outsourcing to Andersen, one of my former internal audit colleagues discovered irregularities in Enron's accounting transactions related to a bank in New York?  A few months later, after the internal auditors discussed the matter with Lay, Lay outsourced the entire audit function.  This outsourcing came after several yearly sales pitches by Andersen, where Andersen requested the internal auditing job.  It's clear that Lay felt the internal auditors were getting too close to uncovering fraud.  So he outsourced the function to a bunch of yes-men.

 I can only conclude that you obviously have been recently cut in on Lay's, Skilling's or Fastow's Enron bounty.

 

Shari Thompson CIA
Direct 402.829.5248
Mobile 402.740.4012

 

Message 2 from Shari Thompson to Bob Jensen

Hi Bob,

Thanks for your reply. I should mention that I really like your website, and have referred to it many times over the years. It was very helpful when studying for the CIA exam—some of the exam study guides don’t do near a good job as your site in explaining accounting theory, especially the complexities introduced changed since I was in college…

But, to your question, the internal auditors came from a number of the (back then anyway) big 8, and also many of us were from industry. Like for instance, I’ve never worked for a public accounting firm. (Could have something to do with when I graduated in 1980 many of publics wouldn’t hear of hiring a female, let alone a African American female. But that’s another story.) So anyway, the internal audit department in Enron Houston was initially formed in 1986 as a combining of all the audit departments of Enron subsidiaries around the nation. So we came from all over. I came in from Omaha, others from Enron subsidiaries on the East Coast, Texas and Oklahoma. The goal after the “merger” of HNG & InterNorth was to centralize the audit function. So, there weren’t an inordinate amount of internal auditors from Andersen as from any other public accounting firm. I’ve not read Eichenwald’s book. I’ll check it out.

Actually the department was eliminated as far as being an effective, functional department. That is, it was eliminated by Enron’s replacing us “real” internal auditors with fake Andersen “internal” auditors. So technically the department still existed in name only, but was functionally ineffective since it was outsourced to Andersen. This outsourcing happened in 1994. I had, at that time, worked for an Enron subsidiary in Omaha for about a year, so I wasn’t at risk of losing my job. Everyone else in the Houston office, however, was told by Andersen that they had 12 months to get their CPA’s or they were out. Many of them that had CPA’s quit anyway, because they didn’t like the environment of the Andersen-run department. We didn’t know what was going on, we just knew something wasn’t right, and didn’t like it. So most of the real auditors quit, or were run out by Andersen leaning on them to get their CPA. The CPA requirement was just a ploy to get the real auditors out as fast as possible.

An interesting development: While writing this email, one of the author’s (Doug Prawitt) of the article that prompted my email called. He explained to me that the CFO.com reporter omitted key pieces of his interview. Namely, that he did not recommend outsourcing to externals, and that this finding is one of thousands of points of information in their study. I apologized for the email-trigger finger, but he said he enjoyed the opportunity to meet me. And hopes to talk to me again about my experience at Enron, which I welcome. I am definitely enjoying the opportunity to communicate with you as well.

Regards,
Shari

 

Note from Bob Jensen

My main Enron and Worldcom fraud document (especially note Enron's Timeline) ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm
This Timeline will soon be updated for Shari's assertion that Enron outsourced internal auditing to Andersen in 1994.

My Enron Quiz will soon be updated for Shari's messages --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm  

Bob Jensen's threads on professionalism and auditor independence are at (scroll down) ---  http://faculty.trinity.edu/rjensen/Fraud001.htm

 

 

Articles on Internal Auditing and Fraud Investigation 
Web Site of Mark R. Simmons, CIA CFE 
http://www.dartmouth.edu/~msimmons/
 

Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations.  It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes. (Institute of Internal Auditors)

Fraud Investigation consists of the multitude of steps necessary to resolve allegations of fraud - interviewing witnesses, assembling evidence, writing reports, and dealing with prosecutors and the courts. (Association of Certified Fraud Examiners)

This site focuses on topics that deal with Internal Auditing and Fraud Investigation with certain hyper-links to other associated and relevant sources. It is dedicated to sharing information.

 

Other Shared and Unshared Course Material

You might find some useful material at http://www.indiana.edu/~aisdept/newsletter/current/forensic%20accounting.html

I have two cases and some links to John Howland's course materials at http://faculty.trinity.edu/rjensen/acct5342/262wp/262case1.htm

You might find some materials of interest at http://faculty.trinity.edu/rjensen/ecommerce/assurance.htm

Also see http://www.networkcomputing.com/1304/1304ws2.html

Micromash has a bunch of courses, but I don't think they share materials for free --- http://www.cyberu.com/classes.asp

Important Database  --- From the Scout Report on February 1, 2001

LLRX.com: Business Filings Databases http://www.llrx.com/columns/roundup19.htm 

This column from Law Library Resource Xchange (LLRX) (last mentioned in the September 7, 2001 Scout Report) by Kathy Biehl becomes more interesting with every revelation of misleading corporate accounting practices. This is a straightforward listing of state government's efforts to provide easy access to required disclosure filings of businesses within each state. Each entry is clearly annotated, describing services offered and any required fees (most services here are free). The range of information and services varies considerably from very basic (i.e. "name availability") to complete access to corporate filings. The noteworthy exception here is tax filings. Most states do not currently include access to filings with taxing authorities.

 

Threads on Accounting for Derivative Financial Instruments 
http://faculty.trinity.edu/rjensen/caseans/000index.htm 

Threads on Accounting, Business, Economic, and Related History 
http://faculty.trinity.edu/rjensen/history.htm 

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

What's Right and What's Wrong With Special Purpose Entities (SPEs) http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm

Bob Jensen's Threads on Accounting Theory
http://faculty.trinity.edu/rjensen/theory.htm

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

 

Video Summary of the Enron Mess

Hi Bernadine,
 
Do you mean that my 100+ pages are not "succinct?" --- http://faculty.trinity.edu/rjensen/fraud.htm 

Because of your message I wrote the summary of the Enron mess at Betting the Farm: Where's the Crime?

 
Actually, there was a wonderful overview on Sam Donaldson's Sunday Morning (January 13) ABC show called "This Week."   You can purchase it for $30 at http://www.abcnewsstore.com/product-details.cgi?_item_code=B020113+01 
The show and video are entitled "The Collapse of Enron."  You might watch for follow-ups on future Sunday mornings (10:00 a.m. in the Midwest Time Zone).  I captured the show on my VCR and plan to play it for students.  
 
If you have RealPlayer, you can download the first few minutes of another show (free) from http://abcnews.go.com/sections/business/DailyNews/enron_inquiry020111.html
Scroll down to the Video link for "Enron Furor Grows"  and download the video segment.
 
One of the best summary articles to date is the Time Magazine article at http://www.time.com/time/business/article/0,8599,193520,00.html
This article will probably not be free after a few days, so download it now. 
 
As Linda Kidwell noted, download the three free articles at http://www.accountingmalpractice.com/res/articles/enron-1.pdf
 
We are still awaiting good reviews of the specifics on how Enron lost money.  It appears to be a combination of debt and derivative financial speculation with much of the details hidden in Cayman Island SPEs formed by the double-dealing Enron CFO named Andy Fastow.  But I have seen specifics other than the limited amount of information that you can find in the revised financial statements.
 
At Enron's Website, the annual reports are still glowing.  For example, in the Year 2000 Enron Annual Report, you can still read the following in the Letter to Shareholders at http://www.enron.com/corp/investors/annuals/2000/shareholder.html

****************************************************************************************

Enron’s performance in 2000 was a success by any measure, as we continued to outdistance the competition and solidify our leadership in each of our major businesses. In our largest business, wholesale services, we experienced an enormous increase of 59 percent in physical energy deliveries. Our retail energy business achieved its highest level ever of total contract value. Our newest business, broadband services, significantly accelerated transaction activity, and our oldest business, the interstate pipelines, registered increased earnings. The company’s net income reached a record $1.3 billion in 2000. 
**************************************************************************************

That of course is a bunch of bull since Enron was forced to revise the past five years worth of financial statements and Enron performance was not a success by any measure.  I can't find any mention of the infamous financial statement revisions at Enron's Website.  Everything is still glowing and gilded with gold at the Enron site.
 

Bob (Robert E.) Jensen
Jesse H. Jones Distinguished Professor of Business
Trinity University, San Antonio, TX 78212
Voice: (210) 999-7347  Fax:  (210) 999-8134 
Email:  rjensen@trinity.edu
http://faculty.trinity.edu/rjensen

 

-----Original Message-----
From: Bernadine and Peter Raiskums [mailto:berna@GCI.NET]
Sent: Monday, January 14, 2002 1:10 PM
To: AECM@LISTSERV.LOYOLA.EDU
Subject: Enron

Can someone point me to a site where I can find a succint recap of the issues in the Enron case?
 
Bernadine Raiskums, Adjunct
University of Alaska Anchorage
 

 


 

Deloitte Touche Tomatsu
See http://faculty.trinity.edu/rjensen/Fraud001.htm#others


 

Bob Jensen's Enron Quiz With Answers --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

Timeline of key events in the history of the Enron scandal

The Justice Racer Cannot Beat a Snail:  Andersen's David Duncan Finally Has Closure

"Andersen Figure Settles Charges: Former Head of Enron Team Barred From Some Professional Duties," by Kristen Hays, SmartPros, January 29, 2008 --- http://accounting.smartpros.com/x60631.xml 

The former head of one-time Big Five auditing firm Arthur Andersen's Enron accounting team has settled civil charges that he recklessly failed to recognize that the risky yet lucrative client cooked its books.

David Duncan, who testified against his former employer after Andersen cast him aside as a rogue accountant, didn't admit or deny wrongdoing in a settlement with the Securities and Exchange Commission announced Monday.

The SEC said in the settlement that he violated securities laws and barred him from ever practicing as an accountant in a role that involves signing a public company's financial statements, such as a chief accounting officer. But he could be a company director or another kind of officer and was not assessed any fines or otherwise sanctioned.

Three other former partners at the firm have been temporarily prohibited from acting as accountants before the SEC in separate settlements unveiled Monday.

Andersen crumbled amid the Enron scandal after the accounting firm was indicted, tried and found guilty -- a conviction that eventually was overturned on appeal.

The settlements came six years after Andersen came under fire for approving fudged financial statements while collecting tens of millions of dollars in fees from Enron each year.

Greg Faragasso, an assistant director of enforcement for the SEC, said Monday that the agency focused on wrongdoers at Enron first and moved on to gatekeepers accused of allowing fraud to thrive at the company.

"When auditors of public companies fail to do their jobs properly, investors can get hurt, as happened quite dramatically in the Enron matter," he said.

Barry Flynn, Duncan's longtime lawyer, said his client has made "every effort" to cooperate with authorities and take responsibility for his role as Andersen's head Enron auditor.

That included pleading guilty to obstruction of justice in April 2002, testifying against his former employer and waiting for years to be sentenced until he withdrew his plea with no opposition from prosecutors.

"After six years of government investigations and assertions, surrounding his and Andersen's activities, it was decided that it was time to get these matters behind him," Flynn said.

Duncan, 48, has worked as a consultant in recent years.

He was a chief target in the early days of the government's Enron investigation as head of a team of 100 auditors who oversaw Enron's books. In the fall of 2001, he and his staff shredded and destroyed tons of Enron-related paper and electronic audit documents as the SEC began asking questions about Enron's finances.

Andersen fired Duncan in January 2002, saying he led "an expedited effort to destroy documents" after learning that the SEC had asked Enron for information about financial accounting and reporting.

The firm also disciplined several other partners, including the three at the center of the other settlements announced Monday. They are Thomas Bauer, 54, who oversaw the books of Enron's trading franchise; Michael Odom, 65, former practice director of the Gulf region for Andersen; and Michael Lowther, 51, the former partner in charge of Andersen's energy audit division.

Their settlement agreements said that they weren't skeptical enough of risky Enron transactions that skirted accounting rules. Odom and Lowther were barred from accounting before the SEC for two years, and Bauer for three years. None was fined.

Their lawyer, Jim Farrell, declined to comment Monday.

Duncan's firing and the other disciplinary moves were part of Andersen's failed effort to avoid prosecution. But the firm was indicted on charges of obstruction of justice in March 2002, and Duncan later pleaded guilty to the same charge.

In Andersen's trial, Duncan recalled how he advised his staff to follow a little-known company policy that required retention of final audit documents and destruction of drafts and other extraneous paper.

That meeting came 11 days after Nancy Temple, a former in-house lawyer for Andersen, had sent an e-mail to Odom advising that "it would be helpful" that the staff be reminded of the policy.

Duncan testified that he didn't believe their actions were illegal at the time, but after months of meetings with investigators, he decided he had committed a crime.

Bauer and Temple invoked their 5th Amendment rights not to testify in the Andersen trial. However, Bauer testified against former Enron Chairman Ken Lay and CEO Jeff Skilling in their 2006 fraud and conspiracy trial.

Andersen insisted that the document destruction took place as required by policy and wasn't criminal, but the firm was convicted in June 2002.

Three years later the U.S. Supreme Court unanimously overturned the conviction because U.S. District Judge Melinda Harmon in Houston gave jurors an instruction that allowed them to convict without having to find that the firm had criminal intent.

That ruling paved the way for Duncan -- the only individual at Andersen charged with a crime -- to withdraw his guilty plea in December 2005.

In his plea, he said he instructed his staff to comply with Andersen's document policy, knowing the destroyed documents would be unavailable to the SEC. But he didn't say he knew he was acting wrongfully.

I draw some conclusions about David Duncan (they're not pretty) at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

My Enron timeline is at http://faculty.trinity.edu/rjensen/FraudEnron.htm#EnronTimeline

 


Enron and the Social Contract
May 4, 2007 message from Ruth Bender [r.bender@CRANFIELD.AC.UK]

A friend recommended me this paper, presented at the European Accounting Association's annual congress last month.  It's about how Enron et al, have changed the perception of accountants and auditors, analysed through the various books published on the frauds.  As the topic has come up on various occasions in different forms on this list, I thought that it might be of interest - it's very readable. 

THE PORTRAYAL OF ACCOUNTING AND ACCOUNTANTS FOLLOWING THE ENRON COLLAPSE
Garry D. Carnegie and Christopher J. Napier
ABSTRACT                The dramatic collapse of Enron, among other corporations including Worldcom in the USA, HIH in Australia and Equitable Life Assurance Society in the UK, combined with the demise of Arthur Andersen in the early 2000s, brought professional accountants and the international accounting profession under intense scrutiny. This latest round of financial scandals provides the opportunity to examine how professional accountants, and accounting

under duress, are portrayed in popular culture. The paper examines the array of books written on the failures themselves and their implications for corporate governance and the survival of the financial system. Changing public stereotypes of accountants may lead to renegotiation or even termination of the “social contract” between society and key organisations (such as the large international accounting firms). The paper explores how commentators have drawn on the history of accounting to analyse the changing activities of accountants (including the rise of consulting) and to contrast the personalities of “founding fathers” of the US accountancy profession with their early 21st-century successors. The paper concludes that episodes such as Enron and the public reaction to the role of auditors in corporate collapse may be “negative signals of movement” for the accountancy profession, creating threats to the ongoing professionalisation project.

The conference home page is http://www.eaa2007lisbon.org/main.htm

The link to the full paper is http://www.licom.pt/eaa2007/papers/EAA2007_0268_final.pdf  -  I don't know how long the papers will be available on the conference website.

Dr Ruth Bender
Cranfield School of Management
UK
r.bender@cranfield.ac.uk

Also see http://faculty.trinity.edu/rjensen/FraudEnronSocialContract.pdf


Enron Scandal Updates

Long-time subscribers to the AECM may remember my quips (years ago) about Michael Kopper ---
These inspired AECMers to write their own quips about Enron and about accounting in general.
You can read some of these AECM originals at http://faculty.trinity.edu/rjensen/FraudEnron.htm#Humor

And don't forget about the Enron home video starring some of the real players (including Jeff Skilling) befpre they got caught --- http://faculty.trinity.edu/rjensen/FraudEnron.htm#HFV

Bob Jensen's Enron Quiz is at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

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

ENRON'S CAST OF CHARACTERS AND THEIR STOCK SALES ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales


Question
Can you detect when Jeff Skilling lied just by studying his face?

"Guest Post: Fraud Girl – Can We Detect Lying From Nonverbal Cues?" Simoleon Sense, June 20, 2010 ---
http://www.simoleonsense.com/guest-post-fraud-girl-can-we-detect-lying-from-nonverbal-cues/
This includes a video of Jeff Skilling's testimony

“The greatest past users of deception…are highly individualistic and competitive; they would not easily fit into a large organization…and tend to work by themselves. They are often convinced of the superiority of their own opinions. They do in some ways fit the supposed character of the lonely, eccentric bohemian artist, only the art they practice is different. This is apparently the only common denominator for great practitioners of deception such as Churchill, Hitler, Dayan, and T.E. Lawrence”

-Michael I. Handel (58)

Welcome Back.

Last week we wrapped up Part II of the Fraud by Hindsight case. We noted that hindsight bias is a major concern in securities litigation & fraud cases. We explained how fraud by hindsight leads judges to misinterpret relevant facts and such let financial criminals off the hook.

This week we will analyze the work of Paul Ekman, a professor at the University of California who has spent approximately 50 years analyzing human emotions and nonverbal communication. Ekman’s work is featured in the television show “Lie to Me”. One of his most popular books, Telling Lies: Clues to Deceit in the Marketplace, Politics, and Marriage, describes “how lies vary in form and how they can differ from other types of misinformation that can reveal untruths”. He claims that although ‘professional lie hunters’ can learn how to recognize a lie, the so-called ‘natural liars’ can still fool them.

So the question is:

Can most financial felons be classified as ‘natural liars’? If so, is it at all possible to catch them via their body language, voice, and facial expressions?

To test this, I examined (a clip from) the February 2002 testimony of former Enron CEO Jeff Skilling to see if I could spot any deception clues. In his testimony, Skilling pleads that his resignation from Enron was solely for personal reasons and that he had no knowledge that Enron was on the brink of collapse. In order to not be misled by Skilling’s words, I watched the testimony without sound and focused solely on his facial expressions and body movements. Ekman noted, “most people pay most attention to the least trustworthy sources – words and facial expressions – and so are easily misled” (81). In trying to be coherent with Ekman’s beliefs, this is what I found on Jeff Skilling:

Video of Jeff Skilling's testimony

Continued in article
http://www.simoleonsense.com/guest-post-fraud-girl-can-we-detect-lying-from-nonverbal-cues/

 


Enron's E-mail (Email) messages are now part of the public record at http://enron.trampolinesystems.com/

"Picking Over Enron's E-Mail Remains," by Frank Ahrens, The Washington Post, June 11, 2006, Page F06 --- Click Here

Thanks to the combination of the Internet, software that lets employers scan employee e-mail for objectionable material and the evil genius of public relations, you can now search a bunch of Enron e-mails. A company called InBoxer Inc. sponsors the search, as a way of touting its business ( http://www.enronemail.com  ).

One is from the office of the chairman (Lay) to Houston employees, telling them that their hard work had pushed Enron stock over $50 per share. In return, each would get 50 Enron stock options. Gee, thanks.

There is a mournful exchange between two employees in February 2002, two months after bankruptcy, bemoaning Enron whistle-blower Sherron Watkins's $500,000 book advance. "I want what I had," one writes.

Others include mawkish lines between ex-lovers and forwarded jokes, many of a sexual and otherwise offensive nature. (Remember when we forwarded jokes via e-mail? How 1998.)

We love picking over the carcasses of big, dead things. Here's one more way to do a little corporate autopsy.

Continued in article

"Science Puts Enron E-Mail to Use," by Ryan Singel, Wired News, January 30, 2006 ---

In March 2001, just a few months before Enron CEO Jeffrey Skilling resigned, an employee e-mailed him a joke about a policeman pulling over a speeding driver, whose wife subsequently rats him out to the cop for other offenses, including being drunk.

Skilling and Enron chairman Ken Lay, whose federal trial on multiple felony fraud charges starts Monday, might not see the irony that, like the driver's wife, their e-mails will soon be testifying against them, both in court and in public opinion.

Enron's inbox first hit the internet in March 2003 when the Federal Energy Regulatory Commission made public more than 1.5 million e-mails from 176 Enron employees as part of its investigation of the company's manipulation of California energy markets in 2000.

Journalists quickly scoured the e-mail for embarrassing moments and incriminating missives. Among the finds: Lay family members' thoughts about finding the perfect wedding photographer (someone who did one of the Kennedy's weddings), Enron executives angling for ambassadorships and positions in the Bush administration, instructions from Tom DeLay's staff to Lay and Skilling on how to handle $100,000 contributions and messages from Lay's secretary bemoaning the fact that she could not get tech support to fix Lay's phone, which would disconnect if answered before the third ring.

All this among countless jokes about Texas, sex, nuns, women, Latinos and priests. Other tasteful tidbits include an offensive booty-call contract and a fashion critique of government lawyers investigating Enron.

The e-mails drew the attention of more than just Californians looking for some payback for the rolling blackouts and astronomical energy bills. InBoxer, an antispam company, turned to the archive to help test its newest product, which scans company e-mails in real time for objectionable content or confidential information, according to CEO Roger Matus.

For an accurate test, Matus needed a sample of corporate e-mail in all its raw, unadulterated drama and glory. He was unsure of how useful the Enron e-mails would be, until he loaded the database and looked at the first message.

The e-mail read in whole: "So you were looking for a one-night stand, after all?"

"That was the moment I knew we had a good testing corpus," Matus said.

Of the 500,000 e-mails InBoxer included in the database, the company's algorithms identified 10,275 with offensive words and another 71,268 that included potentially inappropriate messages, such as sexual innuendos or lists of employee Social Security numbers.

"Enron had an extreme culture of people who worked hard and played hard," Matus said.

Company engineers also found some great jokes, including one about how to feed a pill to a cat, inspiring InBoxer to make the e-mails searchable inside a demo of the new product, called the Anti-Risk Appliance.

While searching through the e-mails for more on the Raptor subterfuge, visitors can also try to win Apple iPod shuffles given away to those who dig up the funniest joke, the most fireable e-mail, and the most regrettable message sent.

Commercial outfits aren't the only ones exploiting the Enron e-mail dump.


Reply from Jagdish Gangolly on February 16, 2011

Bob,

 
You may have given out the following source for Enron Email database,
but here it is anyway.

 
http://www.cs.cmu.edu/~enron/

 
A cottage industry analysing this dataset has developed over the past few
years. Here are some examples.

 
http://www.isi.edu/~adibi/Enron/Enron_Dataset_Report.pdf
http://bailando.sims.berkeley.edu/enron_email.html
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.92.2782&rep=rep1&type=pdf
http://ieeexplore.ieee.org/Xplore/login.jsp?url=http://ieeexplore.ieee.org/iel5/5624551/5639307/05639909.pdf%3Farnumber%3D5639909&authDecision=-203
http://www.mendeley.com/research/discovering-important-nodes-through-graph-entropy-the-case-of-enron-email-database/

 

 
Jagdish

 


“There are three kinds of people you don’t make look bad: your mom, the home plate umpire and your own lawyer on direct. Direct examination is supposed to be the open-book exam, the 200 points you get on your SAT for spelling your name right. By making his attorney look bad, Ken Lay blew it.” Brian Wice, defense . . .Lay has another trial following this one, concerning four counts of bank fraud, that will be tried by U.S. District Judge Sim Lake. The Houston Chronicle reports that Lake asked attorneys to complete testimony by May 11 in order for closing arguments to begin on May 15.
"Testimony Ends in Enron Trial," AccountingWeb, May 4, 2006 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=102111

Update on May 26, 2006

Top Enron Executives are now convicted felons

"Lay, Skilling Are Convicted of Fraud:  Jurors Reject Defense Claim That Enron Was Clean; Question of Credibility Two 'Very Controlling People'," by John R. Emshwiller, Gary McWilliams, and Ann Davis, The Wall Street Journal, May 26, 2006; Page A1 --- http://online.wsj.com/article/SB114789594247955693.html?mod=todays_us_page_one

The convictions of former Enron Corp. chairman Kenneth Lay and former president Jeffrey Skilling decimated their high-stakes argument that Enron was a law-abiding company done in by newspaper reports, short-sellers and market panic. The jury's decision cemented the once-highflying energy company's legacy as one of the most egregious corporate offenders of the 1990s.

The verdicts yesterday against both men on numerous federal fraud and conspiracy charges cap a string of prosecutions in which hundreds of senior corporate executives at numerous companies have been held accountable for wrongdoing on their watches.

Once viewed as one of the biggest business success stories of the 1990s, Enron collapsed in 2001, the first of a string of corporate scandals. Its fall marked a dramatic end to the stock-market boom and the beginning of a wave of corporate and regulatory reforms, including the 2002 Sarbanes-Oxley law.

Juror Kathy Harrison, an elementary-school teacher, said after the verdicts that she hoped executives at other companies would realize that "those in charge have responsibility. There's too much hurt here. If something good can come out, companies can be aware that they must be conscientious." (Read more reactions to the verdicts.)

After delivering their verdicts, the Enron jurors said they had focused partly on the credibility of the two former executives. In a risky legal strategy, both men had argued that no crimes were committed at Enron, apart from a few largely irrelevant ones involving former Chief Financial Officer Andrew Fastow. Messrs. Lay and Skilling both testified during the trial, and both faced withering cross-examinations by prosecutors.

Judge Sim Lake read the string of guilty verdicts in a packed courtroom. Both defendants stood calmly as family members gasped and some began to sob.

Mr. Skilling, 52 years old, was convicted on 19 of 28 counts of conspiracy, fraud and insider trading. He was acquitted on nine counts of insider trading. Mr. Lay, 64, was convicted on all six conspiracy and fraud counts he faced. After reading the jury verdicts, Judge Lake also found Mr. Lay guilty of all four counts in a separate banking-fraud case heard by the judge while the jury was deliberating.

After the verdicts were announced, Mr. Lay joined more than a dozen friends and family members in a circle in one corner of the courtroom to pray. One of Mr. Lay's supporters, Rev. Bill Lawson, could be heard invoking the story of Jesus, "who was convicted and even executed," he said.

"We'll all come through this stronger," said Mr. Lay, occasionally tugging at the hand of his wife, Linda, who had sat through the entire four-month trial. Later, Mr. Lawson said he advised Mr. Lay "to hang in there and trust God."

In a telephone interview last night, Mr. Skilling said that when he was pronounced guilty on the first count of conspiracy, "that floored me. God, there was no conspiracy." He said that the relatively short jury deliberations had raised his hopes. But "we were just on a tilted football field," he said, referring to going on trial in Enron's headquarters city.

The convictions came despite Messrs. Lay and Skilling putting on one of the most expensive criminal defenses ever, spending an estimated $60 million. Both men remain free pending sentencing, which is set for Sept. 11. Each faces many years in prison.

Attorneys for both men said they would appeal the verdicts, which came on the sixth day of jury deliberations that many observers had expected to stretch for weeks. The verdict "doesn't change our view of what happened at Enron, or of Jeff Skilling's innocence," said a clearly upset Daniel Petrocelli, Mr. Skilling's lead lawyer. "We told our story and the jury disagreed with it."

At a press conference after the verdicts, several jurors said that government witnesses, many of them former Enron executives testifying as part of plea bargains, had convinced them that illegal activities had occurred at Enron, and that the defendants were responsible.

Defense lawyers had decided to put both Mr. Skilling and Mr. Lay on the stand. "I wanted badly to believe what they were saying," said juror Wendy Vaughan, a small-business owner. But "there were places in their testimony where I felt their character was questioned," she said.

"Both men said they had their hands firmly on the wheel" of the company, said another juror, elementary-school principal Freddy Delgado. For the two executives to later claim they didn't know about wrongdoing, said Mr. Delgado, was "not the right thing."

Continued in article


Accounting Standard Setters Are Making Some Dangerous Mistakes in the Wake of Enron
From a short seller who made a fortune at the expense of Enron shareholders
From an investor who is not in favor of "principles-based standards" relative to "rule-based standards"

"Short-Lived Lessons From an Enron Short," by Jim Chanos, The Wall Street Journal, May 30, 2006; Page A14 --- http://online.wsj.com/article/SB114894232503965715.html?mod=todays_us_opinion

The convictions of Ken Lay and Jeff Skilling are less than a week old, and yet conclusions are already being drawn about whether "corporate wrongdoing" is a thing of the past. As someone with more than a passing interest in the Enron story -- I was, to quote Ken Lay's bizarre testimony, one of the "short-sellers that were organized and working together and conspiring together" against Enron -- I feel a need to examine what lessons those of us who slog it out daily in the corporate trenches might gain from Enron's spectacular collapse. I propose to offer the top 10 lessons from Enron that executives, investors and lawyers will soon forget:

1. The Enron scandal shows a need for a standards-based accounting system, rather than a rules-based one.

Wait a minute, you must be saying -- in the wake of Enron, don't we need more accounting rules to cover every possible situation, not some mushy "standards"-based guidelines?

No. It is precisely our "check-the-box" accounting rules that get written for every type of transaction that helped create the financial monster that was Enron. By having armies of clever bankers and lawyers pretzel-twist uneconomic deals into profit sources that conformed to GAAP ("Generally Accepted Accounting Principles," or "Good As Actual Profits" as it's sometimes known), dishonest management teams always hide behind the disclaimer that their accounting has been blessed by their auditors. The problem is, I can think of no major financial fraud in the 25 years I've been on Wall Street that did not have audited financials that conformed to GAAP! Yet reasonable independent auditors and audit committees, using the "standard" of economic common sense, would have unmasked most of the financial chicanery that became apparent at these companies only after their collapse.

2. Mark-to-Market accounting was not the problem at Enron, Mark-to-Model was.

Many casual observers of the Enron saga have pointed to the shortcomings of the Mark-to-Market (MTM) method of accounting that Enron used for its trading assets (i.e., the act of recording the price or value of a security, portfolio or account to reflect its current market value rather than its book value). But MTM is entirely appropriate -- and necessary -- for trading assets held at financial firms. How else would one handle valuation for assets that trade on verifiable exchanges and/or electronic networks?

In Enron's case, however, non-exchange traded assets and illiquid private deals were treated similarly, with today's "prices" derived by computer models that estimated future prices and volatility. The "estimates" in these models were helpfully provided by . . . Enron itself! As any capable financial economist will point out, today's market prices offer only a starting point for estimating future prices and volatility, which are, by definition, unknowable. In an MTM system with no independent source of current prices, when one feeds the "unknowables" of future prices and volatility, and the "probable" of time, into a computer, a "certain" current price is calculated! Neat, huh?

3. Off-balance-sheet deals and entities are "off" the balance sheet for a reason.

One would think that this concept would be pretty obvious, given the LJM, Jedi, Chewco, Deathstar, Jabba the Hut (OK, I made that last one up) monikers used to describe off-balance-sheet entities at Enron. One would be wrong. Yet it is my experience, pre- and post-Enron, that such accounting is used by companies to hide things they don't want investors to see. Pre-Enron saw silliness such as the Coca-Cola/Coca-Cola Enterprises "two-step," while today one can ponder the off-balance-sheet "land banking" that exists at the publicly traded U.S. homebuilders. If a company is determined to keep a significant aspect of its business off its books, investors should simply ask why.

4. Wall Street analysts don't "do" complex.

Isn't that what securities analysts are for, you might ask? Silly reader . . . analysis is for kids! Literally. At most large Wall Street firms, the tedious job of constructing financial models and answering client accounting queries is handled by the junior analyst on the team. It still shocks me today that when meeting with a team of "sell-side" Wall Street analysts from a firm to discuss a particular company, the senior analyst invariably concedes the answer to a complex financial question to a junior analyst working for him.

In a post-Eliot Spitzer world, how can this be? Simple. Senior analysts still spend most of their time on the road making client presentations. That is, of course, if they aren't playing golf with the CEO or organizing the menu at the next investor conference in Las Vegas. The recent attempts by certain companies to discourage hard-hitting independent research will only serve to maintain the chasm between those that "do the numbers" and those with, hopefully, the experience to know what the numbers mean.

5. The rating agency system breaks down when most needed. Rely on it at your own peril.

Time and again, when confronted with negative financial "surprises" by corporate issuers during the last decade, the "independent" ratings agencies fell down on the job. This kept slow-on-the-uptake investors dancing on the decks of numerous financial Titanics, while those heeding other signals (such as the burgeoning market for credit-default derivatives) prepared to man the lifeboats.

Whether it was the hubris of not wanting to precipitate a run on the bank (as if it wasn't happening already!), or the incompetence of one ratings agency analyst admitting to not having read the company's SEC filings, the shortcomings of an analyst-based ratings agency system became apparent in the Enron fiasco. Market-based price-discovery agents, such as short sellers in the equity market and purchasers of credit-default insurance in the bond/derivative markets, supplanted the Big Three ratings agencies as accurate predictors of Enron's financial distress.

6. Beware of, and question, unexpected executive resignations.

This lesson should seem obvious, but cognitive dissonance assures that it isn't. When Jeff Skilling resigned abruptly after six months as Enron's CEO, alarm bells should have been going off on Wall Street, as they were in Houston. But mindful of the still-bountiful fees Enron promised the Street, virtually every analyst covering Enron told his/her clients "all was well"! Didn't anyone find it disconcerting that despite claiming (the still undisclosed) "personal reasons" for his resignation, Mr. Skilling admitted on the front page of this newspaper the next day that if Enron's stock price had stayed up, "I don't think that I would have felt the pressure to leave"?

By asking the right questions, investors in August 2001 (with Enron's stock still at $40) might have been able to deduce that Enron's stock was not just a barometer of its financial health, but was also an actual component (through the investor-guarantee mechanism in the Fastow partnerships) of its health, as this newspaper's reporters would so convincingly point out two months later. Mr. Skilling hid the road map to Enron's future collapse on the front page of The Wall Street Journal, but few noticed.

7. Whistleblowers aren't whistleblowers if they blow their whistles inside the company walls.

Someone should inform Time magazine's Person-of-the-Year Department that writing a "cover-your-behind" memo to your boss about financial irregularities within the firm is not "whistleblowing." Having the guts to risk your job and reputation, by bringing evidence of those irregularities to the proper financial authorities, is. Enough said.

8. Special investigations by corporate boards are almost always a waste of time/money, and often prove highly misleading.

As a corollary to Lesson No. 7, when questions are raised internally about possible financial improprieties, corporate boards often hire counsel to conduct investigations on their behalf. This is done foremost for their own protection ("We investigated once we knew!"), and only incidentally to uncover unpleasant facts that such boards, charged with oversight as a duty, should've known about already. Many boards, in a wonderful example of willful blindness, simply don't want to know. In fact, one well-regarded Washington law firm forensic accounting SWAT team, headed by a former SEC enforcement director, managed to not find much wrong at either Enron or Tyco, despite abundant internal documents at their disposal. Such incompetence is highly rewarded in future corporate assignments. Rely on these reports at your own risk.

9. Character cannot be compartmentalized.

This lesson may be the most important of all. Investors and outside advisors often seem preoccupied with analyzing the formal propriety of specific corporate transactions, and the associated financial accounting. Questionable deals and disclosures are analyzed discretely, and not as part of any disturbing pattern of dubious corporate policies. Yet one had only to read the history of Ken Lay's involvement in the Valhalla energy-trading scandal at Enron in 1987 to detect a harbinger of scandals yet to come. That bad guys have a pattern of dishonest behavior should seem obvious, but it's not.

And, finally, 10: Friends do not let (possibly guilty) friends take the stand in criminal trials.

Let's face it, the Enron trials of Lay and Skilling had it all; greed, arrogance, an incompetent defense strategy (oh, how I wish short sellers had the power that Enron's defense team claimed we have!) and, of course, larger-than-life corporate villains. One would assume the high profile nature of the trial itself might underscore this observer's list of lessons learned from Enron's spectacular collapse. But thankfully, I'm pretty confident that they will be forgotten soon.

Mr. Chanos is managing partner of Kynikos Associates.

Bob Jensen's threads on lessons learned from Enron are given as answers to Question 3 at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

Bob Jensen's Enron Updates are at http://faculty.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates 


The Big Mystery in the Enron Trial of Lay and Skilling:
To my knowledge, neither the prosecution nor the defense is calling up the two key players who know where Enron’s accounting skeletons are buried. Rick Causey dug most of the holes and was helped by Dave Duncan when shoveling the dirt back over the bones.  

Most of the top executive orders to bury the bones allegedly went to Rick Causey who then carried them out. Causey also persuaded Duncan not to raise any fuss about the graveyard with Andersen’s Chicago office.

When Andersen’s true expert, Carl Bass, started sniffing around the bone yard, Duncan forced Bass off the audit.


Update on May 9, 2006

It appears that Rick Causey refused to testify unless granted immunity from other possible criminal charges for Enron accounting fraud.

Judge Lake refused to force prosecutors to grant immunity to the witnesses, all of whom face potential criminal liability for their role in Enron's demise. In the end, these central participants were not heard from in this case because of their fears that their statements could be used against them in subsequent prosecutions. While such an outcome is not unusual, it is particularly important in this case. It means that several meetings involving potential wrongdoing by Mr. Skilling and Mr. Lay boiled down to he-said, she-said statements on the stand. With no third witness to offer corroborating testimony either way, the truth is left in the eye of the beholder . . . Legal experts said the defense may well continue seizing on the theme of the missing witnesses in its closing arguments, which will begin next Monday and run through next Wednesday.
Alexei Barrionuevo and Kurt Eichenwald, "What Remains Unanswered at Enron Trial," The New York Times, May 9, 2006 --- http://www.nytimes.com/2006/05/09/business/businessspecial3/09enron.html

Bob Jensen's Enron updates are at http://faculty.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates

Also see the following links from http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#27

http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#21
At one point in 1999 Duncan privately agreed with his Andersen colleague Carl Bass that Enron should take an added $30-$50 million charge to earnings, but that these were not material. How much was this charge? Why do you really think Duncan did not want to force Enron to make this charge?

********************************

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

Bob Jensen's running updates on the Enron scandal are at http://faculty.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates

Bob Jensen's Enron Quiz is at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

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


May 4, 2006 reply from Linda Kidwell, University of Wyoming [lkidwell@UWYO.EDU]

Actually, I found it pretty interesting that his fee is being reported at all. What were O.J.'s DNA experts paid? How much were the Enron prosecutor's experts paid? How much were the doctors on both sides of the Terry Schiavo case paid? I suspect they did not receive a million dollars, but this is complicated testimony and Kenneth Lay has an awful lot at stake here (not that the others didn't, but I suspect the public had a more open mind). The whole point of disclosing the fee was an attempt to discredit Arnold. I have mixed feelings about that.

Linda K.

May 4, 2006 reply from Bob Jensen

Hi Linda,

Is Enron (or Enron's insurance) paying for the massive legal defense of Lay and Skilling?

Arnold's fee is a drop in the bucket relative to the multimillions being spent for Lay and Skilling. It adds insult to injury whenever legal defense of executives takes priority over creditor and low-level employee claims. The lawyers and CEOs of the U.S. have in general seen to it that the priority for them takes precedence. Their stashed millions are safe even if they do a bit of Club Fed time. Michael Milken kept over $1 billion even though he did a little Club Fed time. That's one of the reasons I hope there's a special place in hell for all of them.

My question is whether Arnold is really needed. The Chief Accounting Officer, Causey, has already confessed to accounting fraud, paid a $1,250,000 fine, and is in Federal prison for five years. Fastow has confessed to accounting fraud, paid a $30 million fine, and is in Club Fed for 10 years.

Do we need Jerry Arnold to now tell us there was no accounting fraud at Enron? Point one is that we will never believe Arnold no matter what good accounting practices he cherry picks. Point two is that accounting fraud has already been established by confessions of high-ranking Enron executives. If Arnold convinces this jury that Enron had no accounting fraud, should the confessions of Fastow and Causey be thrown out like their confessions were as insane as the confession of Zacarias Moussaoui?

The issue in the Skilling and Lay trials is not whether there was accounting fraud. The issue is whether Skilling and/or Lay perpetrated the frauds from up above or whether Causey (CAO) and Fastow (CFO) were as high as the frauds went. Having memorized all the FASB standards will not help Arnold or any other outside accounting witness answer those questions.

Fastow has already testified that he had orders from above for some of his accounting frauds. Causey mysteriously is not being called upon to testify. I'm told he prides himself on not being a rat.

Bob Jensen

May 4, 2006 reply from Richard Campbell [campbell@RIO.EDU]

Bob:

There is an article about your Rick Causey question in today’s Journal – below is the first couple of paragraphs:

Essentially BOTH the defense counsel AND the prosecutors think he may hurt each of their cases. Don’t you just love the way lawyers search for the truth???

FROM Wall Street Journal:

“At the criminal trial here of former Enron Corp. top executives Kenneth Lay and Jeffrey Skilling, the man known to some as the company's "Pillsbury doughboy" has come to loom large by his absence. Now, a final decision has to be made on whether to risk bringing him out of the refrigerator.

When he worked as Enron's chief accounting officer in the years before the company's December 2001 collapse into bankruptcy, Richard Causey's easygoing manner and soft features earned him his nickname. His accounting skills made him a key figure in some of the former energy giant's most complex and controversial financial transactions which are at the center of the alleged conspiracy and fraud case against Messrs. Lay and Skilling. Mr. Causey had been a co-defendant in the current criminal case until December, when he pleaded guilty to one count of securities fraud and admitted that he had "conspired with members of Enron's senior management to make false and misleading statements" about the company.

During three months of testimony here, Mr. Causey's name has been brought up repeatedly by both prosecution and defense -- with the former claiming he had been part of some of the company's most corrupt transactions and the latter contending that Messrs. Lay and Skilling had honestly relied on his assurances that all was well with Enron's accounting. Indeed, defense lawyers in the case have talked about calling Mr. Causey to help corroborate their claims that the company's activities were legal and proper.

Now, as the trial heads toward its conclusion, with jury deliberations expected to begin later this month, it looks as if neither side is likely to call Mr. Causey to the stand -- although a final list of prosecution witnesses is due to be filed today.”


"Enron Trial to Start Its Final Chapter:  Defense and Prosecution Rest Without Calling New Experts; Closing to Start Next Week," by Gary McWilliams, The Wall Street Journal, May 9, 2006; Page C5 --- http://online.wsj.com/article/SB114709862484846620.html?mod=todays_us_money_and_investing

With 52 days of sometimes teary, sometimes bitter testimonies completed, the conspiracy-and-fraud trial of two former top Enron Corp. executives is set to move into its final phase next week.

Yesterday, the defense and prosecution unexpectedly rested without calling further experts, paving the way for closing arguments to begin Monday. The eight-woman, four-man jury thereafter will consider six counts against former Enron Chairman Kenneth Lay and 28 counts against former President Jeffrey Skilling.

The prosecution has sought to paint the two men as using guile and bluff to improperly pad profits and deceive investors on the state of key Enron operations from 1999 through the company's collapse in 2001. The two men insist that they did nothing wrong, blaming a market panic for toppling the onetime energy giant.

U.S. District Judge Sim Lake again yesterday denied defense motions for acquittal and for immunity for former Enron executives who have refused to testify without it. The latter motion asked the judge to bar the prosecution from arguing that Mr. Skilling's version of events was contradicted by numerous government witnesses.

Allowing the prosecution's closing argument to cite the government witnesses, "would increase the unfair prejudice" that resulted from the government's refusal to offer immunity, according to Mr. Skilling's attorneys. The motion seemed designed to buttress any appeal.

The defense rested after hearing from two final defense witnesses, including a former Enron manager who contracted with a small Internet company that Messrs. Lay and Skilling had invested in personally. The prosecution had used the pair's investments in PhotoFete.com Inc. to attack their credibility, arguing they failed to comply with Enron's code of conduct.

Margaret Nadasky, a former Enron branding manager, testified she hired PhotoFete.com without knowledge of the investments. She testified that although Mr. Lay's office in September 2001 asked her to explain why she was then ending the PhotoFete.com contract, she never heard any further from Mr. Lay or his office.

The prosecution's last witness was an employee with former Enron-owned utility Portland General Electric Co. who testified that she was stunned when Enron in the fall of 2001 reported a $1 billion charge to earnings and a $1.2 billion reduction in stockholder equity. Patti Klein said the report seemed to contradict Mr. Lay's assurances that Enron would hit its earnings targets for the quarter. Enron bought the utility in 1997 and spun it off to creditors last month.

She said the disclosure wasn't what she expected from his public comments. "He promised us he would be forthcoming with information and very transparent," said Ms. Klein. Under questioning by the defense, she conceded she wasn't aware of what information Mr. Lay was receiving. Mr. Lay has maintained he was repeating information given to him by advisers and subordinates.

Meanwhile, Mr. Lay's lead defense attorney appeared in the courtroom for the first time since late March, when he underwent the first of two surgeries to clear arterial blockages. Attorney Michael Ramsey said he expects to share closing arguments with others on the defense team next week.

Yet another Enron chapter
Jurors on Wednesday rendered a split verdict in the retrial of two former executives from Enron Corp.'s defunct broadband unit, convicting one while acquitting the other of all charges. Former broadband unit finance chief Kevin Howard was found guilty on five counts of fraud, conspiracy and falsifying records. Former in-house accountant Michael Krautz was acquitted of the same charges, concluding a month-long retrial after their original case ended with a hung jury last year.
Kristen Hays, "Jury Splits in Enron Case Retrial:  Ex-Broadband Finance Chief Guilty; Ex-Accountant Acquitted," The Washington Post, May 31, 2006 --- Click Here

Benston & Hartgraves versus Rush & Arnold

In the testimony below, defense witnesses for Skilling and Lay (Walter Rush and Jerry Arnold) "attribute Enron's descent into bankruptcy proceedings to a combination of bad publicity and lost market confidence" rather than accounting fraud. This places the Professor Arnold's opinion in conflict with that of Professors Hartgraves and Benston earlier analyses based upon the lengthy Powers Report commissioned by the former Chairman of the Board of Enron.

The 208 Page February 2, 2002 Special Investigative Committee of the Board of Directors (Powers) Report--- http://news.findlaw.com/hdocs/docs/enron/sicreport/ 
Alternative 2:  http://nytimes.com/images/2002/02/03/business/03powers.pdf 
Alternative 3:  http://i.cnn.net/cnn/2002/LAW/02/02/enron.report/powers.report.pdf 
Alternative 4:  Part One | Part Two
| Part Three | Part Four

Hartgraves and Benston are come to much more negative conclusions than Jerry Arnold who was paid $1 million by the defense team to express an opinion below: "Accountants: Enron Financials Correct."

You can read the Hartgraves and Benston harsh criticisms of Enron's accounting and Andersen's auditing at

Here’s a summary just released by SmartPros. I hate the title "Accountants: Enron Financials Correct" and the inferences made that Enron’s accounting was above board. There was accounting fraud at Enron and auditing fraud at Andersen. Both the Chief Accounting Officer (Causey) and the Chief Financial Officer (Fastow) have confessed to accounting fraud and are now serving time in prison. To imply that Enron’s financial statements were “correct” is very deceiving.

In any event, Andersen does not appear to have applied the GAAP requirement to recognize asset impairment (FAS 121). From our reading of the Powers Report, the put-options written by the SPEs that, presumably, offset Enron's losses on its merchant investment, were not collectible, because the SPEs did not have sufficient net assets.
"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. 125-137:

3.3 Independent public accountants (CPAs)

The highly respected firm of Arthur Andersen audited and unqualifiedly signed Enron's financial statements since 1985.  According to the Powers Report, Andersen was consulted on and participated with Fastow in setting up the SPEs described above.  Together, they crafted the SPEs to conform to the letter of the GAAP requirement that the ownership of outside, presumably independent, investors must be at least 3% of the SPE assets.  At this time, it is very difficult to understand why they determined that Fastow was an independent investor.  Kopper's independence also is questionable, because he worked for Fastow.  In any event, Andersen appears, at best, to have accepted as sufficient Enron's conformance with the minimum specified requirements of codified GAAP.  They do not appear to have realized or been concerned that the substance of GAAP was violated, particularly with respect to the independence of the SPEs that permitted their activities to be excluded from Enron's financial statements and the recording of mark-to-market-based gains on assets and sales that could not be supported with trustworthy numbers (because these did not exist).  They either did not examine or were not concerned that the put obligations from the SPEs that presumably offset declines in Enron's investments (e.g., Rhythms) were of no or little economic value.  Nor did they require Enron to record as a liability or reveal as a contingent liability its guarantees made by or though SPEs. Andersen also violated the letter of GAAP and GAAS by allowing Enron to record issuance of its stock for other than cash as an increase in equity.  Andersen also did not have Enron adequately report, as required, related-party dealings with Fastow, an executive officer of Enron, and the consequences to stockholders of his conflict of interest.

4.1 GAAP

We believe that two important shortcomings have been revealed.  First, the US model of specifying rules that must be followed appears to have allowed or required Andersen to accept procedures that accord with the letter of the rules, even though they violate the basic objectives of GAAP accounting.  Whereas most of the SPEs in question appeared to have the minimum-required 3% of assets of independent ownership, the evidence outlined above indicates that Enron in fact bore most of the risk.  In several important situations, Enron very quickly transferred funds in the form of fees that permitted the 3% independent owners to retrieve their investments, and Enron guaranteed the SPEs liabilities.  Second, the fair-value requirement for financial instruments adopted by the FASB permitted Enron to increase its reported assets and net income and thereby, to hide losses.  Andersen appears to have accepted these valuations (which, rather quickly, proved to be substantially incorrect), because Enron was following the specific GAAP rules.

Andersen, though, appears to have violated some important GAAP and GAAS requirements.  There is no doubt that Andersen knew that the SPEs were managed by a senior officer of Enron, Fastow, and that he profited from his management and partial ownership of the SPEs he structured.  On that basis alone, it seems that Andersen should have required Enron to consolidate the Fastow SPEs with its financial statements and eliminate the financial transactions between those entities and Enron.  Furthermore, it seems that the SPEs established by Fastow were unlikely to be able to fulfill the role of closing put options written to offset losses in Enron's merchant investments.  If this were the purpose, the options should and would have been purchased from an existing institution that could meet its obligations.

Andersen also seems to have allowed Enron to violate the requirement specified in FASB Statement 5 that guarantees of indebtedness and other loss contingencies that in substance have the same characteristics, should be disclosed even if the possibility of loss is remote.  The disclosure shall include the nature and the amount of the guarantee.  Even if Andersen were correct in following the letter, if not the spirit of GAAP in allowing Enron to not consolidate those SPEs in which independent parties held equity equal to at least 3% of assets, Enron's contingent liabilities resulting from its loan guarantees should have been disclosed and described.

In any event, Andersen does not appear to have applied the GAAP requirement to recognize asset impairment (FAS 121).  From our reading of the Powers Report, the put-options written by the SPEs that, presumably, offset Enron's losses on its merchant investment, were not collectible, because the SPEs did not have sufficient net assets.  (Details on the SPEs' financial situations should have been available to Andersen.)  GAAP (FAS 5) also requires a liability to be recorded when it is probable that an obligation has been incurred and the amount of the related loss can reasonable be estimated.  The information presently available indicates that Enron's guarantees on the SPEs and Kopper's debt had become liabilities to Enron.  It does not appear that they were reported as such.

GAAP (FAS 57) specifies that relationships with related parties "cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions be competitive, free-market dealings may not exist".  As Executive Vice President and CFO, Fastow clearly was a "related party".  SEC Regulation S-K (Reg. §229.404. Item 404) requires disclosure of details of transactions with management, including the amount and remuneration of the managers from the transactions.  Andersen does not appear to have required Enron to meet this obligation.  Perhaps more importantly, Andersen did not reveal the extent to which Fastow profited at the expense of Enron's shareholders, who could only have obtained this information if Andersen had insisted on its inclusion in Enron's financial statements.

4.2 GAAS

SAS 85 warns auditors not to rely on management representations about onset values, liabilities, and related-party transactions, among other important items.  Appendix B to SAS 85 illustrates the information that should be obtained by the auditor to review how management determined the fair values of significant assets that do not have readily determined market values.  We do not have access to Andersen's working papers to examine whether or not they followed this GAAS requirement.  In the light of the Wall Street Journal report presented above of Enron's recording a fair value for the Braveheart project with Blockbuster Inc., though, we find it difficult to believe that Andersen followed the spirit and possibly not even the letter of this GAAS requirement.

SAS 45 and AICPA, Professional Standards, vol. 1, AU sec. 334 specify audit requirements and disclosures for transactions with related parties.  As indicated above, this requirement does not appear to have been followed.

An additional lesson that should be derived from the Enron debacle is that auditors should be aware of the ability of opportunistic managers to use financial engineering methods, to get around the requirements of GAAP.  For example, derivatives used as hedges can be structured to have gains on one side recorded at market or fair values while offsetting losses are not recorded, because they do not qualify for restatement to fair-value.  Another example is a loan disguised as a sale of a corporation's stock with guaranteed repurchase from the buyer at a higher price.  If this subterfuge were not discovered, liabilities and interest expense would be understated.  Thus, as auditors have learned to become familiar with computer systems, they must become aware of the means by which modern finance techniques can be used to subvert GAAP.


The above findings from the Powers Report appear to be inconsistent with the testimony of four years later.

"Accountants: Enron Financials Correct ," by Michael Graczyk (Associated Press Writer), SmartPros, May 4, 2006 --- http://accounting.smartpros.com/x52873.xml 

May 4, 2006 (Associated Press) — Last-minute changes to quarterly earnings reports prosecutors contend were ordered by Enron Corp. Chief Executive Jeffrey Skilling to improve the company's reputation on Wall Street were accurate, and not the result of improper tapping of company reserves, a defense expert testified Wednesday.

"The whole process of financial reporting, in a company as large as Enron, to get financial statements out ... is an enormous undertaking," said Walter Rush, an accounting expert hired by Skilling. "And people are scrambling, trying to get these estimates put together.

"There are changes going on up to the very last second. It is universal. Every company goes through this."

Rush was the second consecutive accounting expert to take the stand, following University of Southern California professor Jerry Arnold, who testified for Enron founder and former CEO Kenneth Lay.

They are among the last defense witnesses, as lawyers for the two top chiefs at Enron expect to conclude their case early next week, the 15th week of their federal fraud trial.

Mark Koenig, former head of investor relations at Enron, testified early in the trial that he believed top Enron executives were so bent on meeting or beating earnings expectations to keep analysts bullish on the company's stock that they made or knew of overnight changes to estimates. Paula Rieker, Koenig's former top lieutenant, said Koenig told her Skilling ordered abrupt last-minute changes to two quarterly earnings reports to please analysts and investors.

"They could have just had a bad number," Rush said, referring to Koenig's and Rieker's testimony about a late-night change in a fourth-quarter 1999 report that boosted earnings per share from 30 cents to 31 cents.

Arthur Andersen, Enron's outside accounting firm, already had the 31-cent number days earlier, Rush said.

"They could have been a couple steps behind the way the process was evolving," he said of Koenig and Rieker.

In addition, Rush said the intention to "beat the street," a phrase attributed to Skilling, was typical in business.

"Companies set goals and forecasts for themselves all the time," Rush said.

Prosecutors also contend Enron achieved its rosy earnings by drawing improperly from reserves. But Rush, responding specifically to second-quarter earnings in 2000, said a transfer from one reserve was not material since Enron had another, underreported reserve.

"That number had the effect of understating Enron's profits," he said.

He also disputed government contentions Enron executives improperly moved parts of the company's retail operation into its highly profitable wholesale business unit to hide financial problems under the guise of an accounting process called "resegmentation."

"I do believe it was properly disclosed and properly accounted for," Rush said, adding that he believed Enron went beyond the rules in disclosing particulars about the resegmentation.

"The rules only require we tell we have made a resegmentation. You just merely need to alert the reader there has been a change."

Earlier Wednesday, Arnold repeated his sentiment that Lay did not mislead investors about the company's financial health in the weeks before it filed for bankruptcy protection in December 2001.

Arnold said third-quarter 2001 financial statements cited by Lay in discussions with investors complied with Securities and Exchange Commission rules.

"That is my view," he said, answering repeated questions about the quarter when Enron reported $638 million in losses and a $1.2 billion reduction in shareholder equity.

The government contends Lay knew many Enron assets were overvalued and that losses were coming and misrepresented this to the public.

Several former high-ranking Enron executives have testified Lay misled investors when he said the losses were one-time events.

"I disagree with their interpretation," Arnold said, who noted his company had been paid $1 million for his work on the Enron defense.

Only 10 minutes into his testimony Wednesday, U.S. District Judge Sim Lake grew impatient when Arnold and prosecutor Andrew Stolter repeatedly went round and round on the same question.

"I'm not going to have sparring over minor, uncontroverted issues," a clearly irritated Lake barked.

Skilling, who testified earlier, and Lay, who wrapped up six days on the witness stand Tuesday, are accused of repeatedly lying to investors and employees about Enron when prosecutors say they knew the company's success stemmed from accounting tricks.

Skilling faces 28 counts of fraud, conspiracy, insider trading and lying to auditors, while Lay faces six counts of fraud and conspiracy.

The two men counter no fraud occurred at Enron other than that committed by a few executives, like Fastow, who stole money through secret side deals. They attribute Enron's descent into bankruptcy proceedings to a combination of bad publicity and lost market confidence.


"An Enron Factor at Top Business Schools," AccountingWeb, May 5, 2006 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=102122

The Enron scandal factors in a current report on America’s leading undergraduate business schools as identified in a BusinessWeek survey, and that bane of the accounting profession is also part of the thinking at some of those top schools.

In its first ever ranking of undergraduate business schools, based on criteria that include academic standards and intangible qualities like the learning atmosphere on campus, and the value that their graduates command in the job market, BusinessWeek ranks the University of Pennsylvania’s Wharton School number one, followed by the University of Virginia’s McIntire School, Notre Dame University’s Mendoza, and the Sloan School at the Massachusetts Institute of Technology. For a full list visit http://bwnt.businessweek.com/bschools/undergraduate/06rankings.

In discussing the significance of the rankings, the report notes that in the face of the job market’s strong demand for business professionals, students considering business school typically choose programs based on the academic reputation of the entire university but may overlook just how the institutes’ business schools compare. It also notes that the market for financial professionals is being fueled by factors that include: Sarbanes-Oxley law of 2002, enacted in the wake of the Enron scandal, a backlash against offshoring jobs, and companies making up for a lag in hiring after the terrorist attacks in 2001.

Daniel Short, dean of the number 33-ranked Neeley School of Business at Texas Christian University, seconded the thought about the accounting scandals’ impact. “Thanks to Enron, one of the most popular majors these days is accounting. Students have realized there are great opportunities, that they can go into an organization with an accounting degree and make a difference,” he says in an interview with the Dallas Morning News.

“Kids have made the leadership connection – that if the accounting is not done correctly, you wind up with the 'Enrons' of the world,” he adds. Indeed, the BusinessWeek report includes discussion of the top business schools' ability to cultivate leaders and to get students involved in business processes.

At the number nine ranked Marriott School of Business at Brigham Young University, Steven Albrecht, an associate dean, said that his school has been acting to make students “more pro active in the (accounting) profession” because of the increased demand for audit services created by Enron and the Sarbanes-Oxley law. He commented in a survey conducted last year by the accounting profession marketing and research firm, Bay Street Group.

The Bay Street Group survey found that a high percentage of business school leaders felt that shortcomings in how their schools teach ethics and real world business matters may have contributed to Enron and the other scandals. That study last year also found that business schools have been expanding their courses and extracurricular offerings to make students more aware of some of the issues that Enron brought to the surface.

The BusinessWeek survey concurs, noting, “Under increased pressure from students and recruiters, business schools have revamped their offerings, putting more emphasis on specialized classes, real-world experience, and soft skills such as leadership. Once a refuge for students with poor grades and modest ambitions, many undergraduate business programs now get MBA-like respect.”


CEOs Often Make Poor Witnesses

"Did Ken Lay Demonstrate Credibility?" by Alexei Barrionuevo, The New York Times, May 3, 2006 --- http://www.nytimes.com/2006/05/03/business/businessspecial3/03enron.html

Before he took the stand, legal analysts gave Mr. Lay better odds of an acquittal than his co-defendant, Jeffrey K. Skilling, the former Enron chief executive who forced Mr. Lay back into service after he resigned in August 2001. Mr. Skilling is charged with conspiracy and fraud, as well as insider trading violations.

But Mr. Lay's often-testy, sometimes hostile performance on the stand has many legal specialists questioning whether he increased his chances of being convicted of charges that he conspired to defraud Enron investors. When a defendant testifies in a fraud case, guilt or innocence often boils down to credibility.

By trying to resurrect his reputation rather than counter the charges against him, Mr. Lay, 64, put front and center the question of whether he bore responsibility for mismanaging Enron.

Yet he steadfastly refused to accept responsibility for any decision that might have contributed to the fall of Enron. Instead, he liberally sprinkled blame on a market panic caused by short-sellers, The Wall Street Journal, the bursting of the technology boom, the terrorist attacks of Sept. 11 and, most of all, the schemes hatched by the former chief financial officer, Andrew S. Fastow.

"Sir, you have a long list of people to blame for Enron's collapse, and it gets longer and longer as you testify," said the prosecutor, John Hueston, for whom Mr. Lay showed open contempt in four days of combative cross-examination. "Your list of people to blame and events to blame did not include yourself, did it, sir?"

Mr. Lay responded: "I did everything I could humanly do during this time. Did I make mistakes? I'm sure I did, Mr. Hueston. I had to make real-time decisions based on the information I had at the time."

Jamie Wareham, the global chairman of litigation for Paul, Hastings, Janofsky & Walker, said that chief executives often make difficult witnesses for lawyers defending them. The same qualities of toughness, charisma and confidence that propelled them to the top translate poorly in the courtroom.

Continued in article


"Prosecutor Zeroes In on Ex-Enron Chief's Finances," by Barrionevo, The New York Times, May 2, 2006 --- http://www.nytimes.com/2006/05/02/business/businessspecial3/02enron.html

Having $100 million in personal debt did not stop Kenneth L. Lay from spending $200,000 on a birthday cruise for his wife and holding onto some $30 million in real estate, even as banks were demanding repayment.

Instead, Mr. Lay, the founder and former chief executive of Enron, used financial deals with the company to maintain his lifestyle. As banks demanded payments, Mr. Lay sold shares back to Enron to meet margins calls, selling $77.5 million in 2001. At one stretch, from July 26 to Sept. 4, 2001, he sold $24 million in shares back to Enron.

Mr. Lay had claimed that the sales were his only recourse, but on Monday, a prosecutor challenged that contention, showing evidence in the fraud trial that Mr. Lay had tens of millions of dollars in real estate, separate credit lines and non-Enron stock available in the month's before Enron collapsed in December 2001.

Mr. Lay grudgingly conceded on his fifth day on the stand that those options were not pursued because, he insisted, the Enron credit line was the most efficient way to meet the margin calls, which were becoming increasingly urgent as Enron's shares were plummeting. But his lifestyle did not suffer despite his indebtedness.

"We had realized the American dream and were living a very expensive lifestyle," Mr. Lay said, adding it was "the type of lifestyle where it is difficult to turn off the spigot."

Mr. Lay's sale of Enron shares to meet bank calls was long thought to be his best defense against charges that he conspired to defraud the company, which collapsed in December 2001. Mr. Lay argued on Monday that he went to great lengths to hang onto his Enron shares, even as the debacle unfolded. He acknowledged that he maintained a risky trading position, pledging virtually his entire portfolio of liquid assets, nearly 90 percent of which was in Enron stock, as collateral against loans used to make other investments.

But his insistence on being portrayed as the proverbial captain willing to go down with his ship has become a vulnerability for him in the trial. A prosecutor, John Hueston, doggedly sought to show on Monday that Mr. Lay did not do everything he could to hold onto his Enron shares.

Mr. Lay's claim that he sold only when forced is crucial to buttressing his defense that he was telling the truth when he made rosy assessments of Enron's performance in the five months after he reassumed the chief executive post after the August 2001 resignation of Jeffrey K. Skilling, Mr. Lay's co-defendant. Mr. Skilling is charged with conspiracy, fraud and insider trading.

While the government has not charged Mr. Lay with insider trading, Mr. Hueston has used Mr. Lay's stock sales to raise questions about his credibility and truthfulness when he was encouraging employees to buy Enron shares in the late summer of 2001, even as he was unloading his.

Despite Mr. Lay's claims that he wanted to tell the "whole truth" in trial, Mr. Hueston suggested that Mr. Lay had told "Enron employees a half-truth."

On Monday, Mr. Hueston's second day of extensive questioning on the issue, the prosecutor showed, that Mr. Lay chose to meet a $483,426 margin call on July 26, 2001, with his Enron line of credit. That was despite having more than $11 million available in separate secured and unsecured credit lines separate from the Enron line. He also had $6.3 million in stocks in Compaq, Eli Lilly and a TCW stock fund, at least some of which, Mr. Hueston showed, was available for trading.

Continued in article
 

Lay Defends Family's Role In Selling Shares
Mr. Lay was also asked about his alleged 2001 comment to company colleagues that The Wall Street Journal had a "hate on" for Enron in connection with a series of articles looking at Mr. Fastow and his partnership operation. "I might have used that term," Mr. Lay acknowledged, adding that the Journal was "trying to paint a very negative image of Enron." (As previously reported, the Journal said it stands by the accuracy of its coverage.)

"Lay Defends Family's Role In Selling Shares:  Enron Ex-Chairman Says He Tried to Minimize Sales To Meet Margin Calls," by Gary McWilliams and John R. Emshwiller, The Wall Street Journal, May 2, 2006; Page C3 --- http://online.wsj.com/article/SB114649255583240444.html?mod=todays_us_money_and_investing
See Question 22 at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

"At the Enron Trial, Strange Stumbles Mar Lay's Defense:  Team Seems Caught Off Guard At Times and Ex-Chairman Gets Testy, Even to Counsel 'You Guys Are Pretty Thorough'," by John R. Emshwiller and Gary McWilliams, The Wall Street Journal, May 1, 2006; Page A1 --- http://online.wsj.com/article/SB114644932245140165.html?mod=todays_us_page_one

Kenneth Lay was known as one of the corporate world's smoothest executives as he presided over Enron Corp.'s growth into an energy-trading powerhouse. But on the witness stand, with his freedom on the line, he has faced manifold problems.

He's been uncharacteristically irascible at times. After health problems sidelined his lead lawyer, he's been left with an attorney with whom he has less rapport. His defense has sometimes seemed caught off guard by bombs lobbed by the prosecutors. And finally, the relative simplicity of the case against Mr. Lay has, oddly, seemed to work against him by leaving prosecutors freer to zero in on his credibility.

They've pummeled Mr. Lay on that front, alleging he tampered with witnesses and filed massively misleading reports about his stockholdings. Despite two years of trial preparation and millions spent on his defense, Mr. Lay at times last week seemed uncomfortable, ill-prepared and even suspicious of his own lawyer, George Secrest. "And where are you going with this, Mr. Secrest?" Mr. Lay said in response to one question. Mr. Secrest started to explain, then gave up.

When Mr. Lay was indicted in 2004 on federal conspiracy and fraud charges, many believed the case against him was weaker than that against his protege and co-defendant Jeffrey Skilling. The indictment identified Mr. Skilling, the 52-year-old former Enron president and chief executive, as the leader of the alleged scheme to cook Enron's books and lie to the public about its health.

Mr. Lay faced fewer counts, covering a shorter period, mostly the four months when he returned as CEO between Mr. Skilling's surprise August 2001 resignation and Enron's bankruptcy filing that December. The affable Mr. Lay was well known for his political skills and a Horatio Alger life story that many thought could stand him in good stead with a jury.

Instead, the prosecution has kept the 64-year-old Mr. Lay on the defensive by largely avoiding Enron's financial labyrinth and challenging him on easier-to-understand matters.

For example, the defense has blamed short-selling "vultures" -- seeking to profit from a decline in Enron shares -- for driving down the stock in 2001 and helping spark a market panic that killed the company. That line blew up in their face on Thursday when prosecutor John Hueston showed embarrassing evidence that Mr. Lay's own son, Mark, had sold the stock short in March 2001.

Continued in article

Jensen Comment
Ken Lay's controversial sales of Enron shares brought in $184,494.426 --- http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales
Of course Lou Pai will never serve time for his Enron stock sales of $270,276,065  http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales
 

Who are the two richest Enron executives to emerge unscathed by Enron's scandal?
See Question 2 at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm
 

"Lay on Defensive at Enron Trial: Prosecutors Argue Ex-Chairman Misled Investors on Stock Sales And Retail Energy Unit's Health," by John R. Emswiller and Gary McWilliams, The Wall Street Journal, April 28, 2006; Page C1 --- http://online.wsj.com/article/SB114614886688337636.html?mod=todays_us_money_and_investing

Federal prosecutors hammered at former Enron Corp. Chairman Kenneth Lay's credibility by showing he made a series of inaccurate stockholding reports that failed to disclose large sales of his Enron shares in the months before the company's December 2001 bankruptcy filing.

Mr. Lay, who faces federal conspiracy and fraud charges in connection with Enron's collapse, appeared taken aback by the assault during his first full day of cross-examination in court here, which followed two hours of tense exchanges with prosecutor John Hueston on Wednesday afternoon. Mr. Lay hasn't been charged with improper sales of stock.

At times yesterday, he stuttered in response to accusations. Other times, he accused Mr. Hueston of twisting his words or harping on irrelevant points.

Mr. Lay said repeatedly that he relied on advice from company attorneys who told him he wasn't required to disclose the disputed stock sales except once a year, since they involved turning the shares back to the company in return for cash rather than sales on the open market. He said that his Securities and Exchange Commission filings complied with the law even though they inflated the picture of his Enron holdings. In 2001, Mr. Lay obtained $70 million through these stock transactions with Enron. (Testimony excerpts)

Mr. Hueston even sought to use Mr. Lay's son against him.

Mr. Lay and his co-defendant, former Enron President Jeffrey Skilling, have consistently claimed that a concerted attack by short-sellers helped drive down Enron's share price, and contributed to the company's 2001 collapse. (Short-sellers are traders who, using borrowed shares, make profits when a stock goes down.) Mr. Hueston noted that Mr. Lay's lead attorney, Michael Ramsey, referred to short-sellers as "vultures."

Mr. Hueston then introduced evidence that Mr. Lay's son, Mark, had executed four short sales on Enron stock in March 2001. Was he a vulture? asked the prosecutor.

"I don't think he's a vulture," said Mr. Lay in a subdued voice, adding that he wasn't aware of his son's stock transactions.

As for Mr. Lay's SEC filings about his stockholdings, Mr. Hueston showed that the Enron chairman didn't include his company stock transactions in those filings.

In 2001, Mr. Lay's monthly SEC stock-ownership filings through October showed his Enron holdings hovering around 2.7 million shares.

Yet his actual holdings had declined to some 991,000 shares because of the sales back to the company, according to evidence presented by Mr. Hueston.

Mr. Lay was quietly selling off a large chunk of his holdings while telling employees and investors the shares were a "bargain," prosecutors contend. As late as September 2001, he was telling employees that he was buying stock without telling them of his far larger sales back to the company. Mr. Lay argued that his stock transactions with Enron were done to raise cash to pay pressing margin calls on personal loans. He said he didn't feel the need to report such "forced" stock sales to Enron employees or others. He added that he held on to as many Enron shares as he could because he felt the stock was undervalued.

By showing that Mr. Lay wasn't fully forthcoming about his stock sales, the government clearly hoped to buttress its contention that the former top executive was illegally hiding from the public a range of bad news about the company's finances and business operations.

Mr. Hueston also attacked Mr. Lay on his bullish remarks in 2001 about Enron's high-profile retail energy unit, which government witnesses have testified was struggling with problem contracts and large hidden losses. The prosecutor noted that up until September 2001 Mr. Lay and other executives had been highlighting the rapid growth of the unit's service contracts, predicting the total would hit $30 billion in 2001.

However, Mr. Hueston presented evidence from an Oct. 8, 2001, Enron board meeting showing that the company expected to fall short of that target by about $4.5 billion.

About a week later, Mr. Lay told securities analysts that Enron would no longer report total contract values because it was no longer a valid measure. He didn't mention anything about falling short of the previously announced $30 billion target, Mr. Hueston said.

Was the prospect of falling short of the contract target and then dropping it as a growth measure "pure coincidence?" the prosecutor asked.

"I don't know if it was pure coincidence," Mr. Lay said, adding that executives of the retail unit "convinced me and others" that there were better measures. Repeatedly yesterday, Mr. Lay said he relied heavily on others for the information and descriptions he provided to investors. Mr. Hueston pushed back that Mr. Lay, as chief executive, had the option to make the final decisions about what he and the company would tell the public.



From The Wall Street Journal Accounting Week in Review on April 27, 2006

TITLE: Lay Says 'Classic Run on Bank' Ruined Enron
REPORTER: John R. Emshwiller and Gary McWilliams
DATE: Apr 25, 2006
PAGE: C1
LINK: http://online.wsj.com/article/SB114588472143834040.html 
TOPICS: Accounting

SUMMARY: Ken Lay's testimony is reviewed in this article. Questions relate to defining a 'run-on-the-bank' and the factors that Lay's argues led up to it. Reference to a related article questions use of outside attorneys to assess corporate transactions.

QUESTIONS:
1.) Describe the events leading up to the demise of Enron Corp and the trials that are currently underway against its former leaders Kenneth Lay and Jeffrey Skilling.

2.) What is a "run on the bank"? Why does Former Enron chief executive Kenneth Lay argue that this phenomenon explains the demise of Enron? What factors does he cite in leading up to this phenomenon?

3.) Refer to the related article. When do corporations seek advice of outside counsel rather than in-house lawyers? For what transactions did Enron seek advice from its outside lawyers, Vinson & Elkins, and accountants, Arthur Andersen and Co?

4.) Why does the law firm of Vinson & Elkins now face significant risk from class action law suits related to its work with Enron? In your answer, define who is filing these class-action lawsuits.

5.) Refer again to the related article and the reliance Enron placed on opinions expressed by its outside auditors, Arthur Andersen. How does Andersen's demise leave the law firm of Vinson & Elkins at greater business risk from their work with Enron?

Reviewed By: Judy Beckman, University of Rhode Island

--- RELATED ARTICLES ---
TITLE: Energy Firm's Outside Counsel Sits in the Crosshairs of Lerach, Securities Class-Action Kingpin
REPORTER: Nathan Koppel
PAGE: C1
ISSUE: Apr 26, 2006
LINK: http://online.wsj.com/article/SB114592536742234763.html

"Lay Says 'Classic Run on Bank' Ruined Enron:   Ex-Chairman Uses Debut on Stand To Depict Charges as 'Ludicrous,' Blames Fastow, Media, Traders," by John R. Emswhiller and Gary McWilliams, The Wall Street Journal,  April 25, 2006; Page C1 --- http://online.wsj.com/article/SB114588472143834040.html?mod=todays_us_money_and_investing

Making the most important public appearance of a long public life, former Enron Corp. Chairman Kenneth Lay took the witness stand at his criminal trial, where he admitted to mistakes but firmly denied any wrongdoing in running the energy giant.

He blamed Enron's December 2001 collapse on deceitful underlings, hostile stock traders and damaging news coverage by The Wall Street Journal. Those forces collided to provoke what he called a "classic run on the bank" that set the stage for the company's bankruptcy filing. He also portrayed himself as a man still somewhat stunned by his fall from a pinnacle where he used to rub shoulders with world leaders and other corporate titans. Of all the things he had speculated about in his life, being a criminal defendant "was nowhere in any of them," he said.

Whether the jury accepts Mr. Lay's version of events could go a long way toward determining whether he and former Enron President Jeffrey Skilling are convicted in their federal conspiracy and fraud trial here. A string of government witnesses, including several former Enron executives, have testified that the defendants knew about manipulations of the company's finances and lied to the public about its condition.

Mr. Skilling completed eight days of testimony last week, in the first phase of what is viewed as the crucial period of the two men's joint defense strategy. If anything, Mr. Lay's performance is even more important, though it is expected to be only about half as long. He is Enron's best-known figure and is widely considered a more affable, and potentially more likable, figure to jurors than the more-intense Mr. Skilling. A major part of Mr. Lay's responsibilities in Enron's last years was to serve as the company's public face.

Shortly after court began yesterday morning, the 64-year-old Mr. Lay strode to the witness box, stopping to raise his right hand well above his head as Judge Sim Lake administered the witness oath. When asked if he promised to tell the truth, he answered with a clear, almost resounding "I do."

Continued in article

"Skilling Defends Enron, Himself: In First Testimony, Ex-President Denies Plot to Defraud Investors; 'I Will Fight' Until 'Day I Die'," by John r. Emshwiller and Gary McWilliams, The Wall Street Journal, April 11, 2006; Page C1 --- http://online.wsj.com/article/SB114467495953621753.html?mod=todays_us_money_and_investing

Mr. Skilling Monday dived straight into an aggressive defense of both himself and Enron that contrasted with its public image as a symbol of corporate scandal. Mr. Skilling talked of his pride in Enron's growth and the quality of its employees, even the excitement he felt walking each day into Enron's gleaming headquarters tower here. "We were making the world better," Mr. Skilling said.

Challenging claims made by several government witnesses, Mr. Skilling said he never told any of his subordinates at Enron to lie or in any way manipulate the company's financial statements. However, he also described several of the key witnesses as honest men. The defense argues that these witnesses succumbed to government pressure and pleaded guilty to crimes that they didn't commit.

He insisted that Enron was a successful and vibrant company that was undermined by a market panic partly sparked by several Wall Street Journal articles in October 2001. Monday, Paul E. Steiger, the Journal's managing editor, said the paper's reporters "were leaders in uncovering the accounting scandal at Enron. We are proud of our work."

Continued in article

"Enron Prosecutor Attacks Theory of 2001 Collapse," by Alexei Barrionuevo and Simon Romero, The New York Times, April 27, 2006 --- Click Here

A prosecutor sought Thursday to undercut Kenneth L. Lay's assertion that short sellers were part of a "conspiracy" that caused Enron's downfall, showing that one of Mr. Lay's own sons had bet that the company's stock would decline.

Under cross-examination by the prosecutor, John C. Hueston, Mr. Lay expressed surprise and became flustered when confronted with brokerage records showing that Mark Lay, his son, had sold Enron stock before its bankruptcy filing in December 2001. Mr. Lay said he did not know until Thursday that his son had been selling Enron stock during that time.

Mark Lay, a former Enron executive, left the company in 2001 to enter a local Baptist seminary.

In a day of testy exchanges, the prosecutor relentlessly attacked Mr. Lay's explanation for Enron's collapse. He also suggested Mr. Lay lied about Enron's plans to pursue a water business so he could avoid a potentially fatal credit downgrade.

And Mr. Hueston suggested Mr. Lay should have been more forthcoming with investors about tens of millions of dollars in Enron stock he was selling to meet bank demands to repay loans — even as he portrayed himself as bullish on the stock.

Mr. Lay, Enron's former chief executive, took the stand for a fourth day in his criminal fraud trial in federal court. He and Jeffrey K. Skilling, his co-defendant and also a former Enron chief executive, are accused of conspiring to defraud Enron's investors, in large part by not disclosing serious problems at the company. Lawyers in the case, which concluded its 13th week, said they expected Mr. Lay to be on the stand at least through Monday.

On Thursday Mr. Hueston challenged the defense's claims that short sellers, financial journalists and a small number of deceptive Enron executives were responsible for hysteria in 2001 that produced the chaotic collapse of the company.

Mr. Hueston asked Mr. Lay if he would describe his son as a "vulture," a term Michael W. Ramsey, a Lay lawyer, used in his opening statement to describe short sellers.

"I don't think he's a vulture, no," Mr. Lay said. But he clearly seemed pained when Mr. Hueston displayed an Oct. 26, 2001, e-mail message sent by Mark Lay to Mark Palmer, Enron's former head of media relations. In it, Mark Lay said that the "shorts are trumpeting all of the insider sales" and suggested that the company disclose insider selling more frequently, perhaps monthly.

While Mr. Lay offered no explanation for his son's actions, he said that in late 2001 Enron was "being attacked very viciously." He said that a group of hedge funds met in Florida in January 2001 and agreed to act together to push down Enron's stock price. In the weeks after the Sept. 11, 2001, terrorist attacks, Mr. Lay said, he felt that Enron was "under siege" by hostile investors and The Wall Street Journal.

Mr. Lay, 64, began the day appearing fatigued but calmer than on Wednesday afternoon, when he sparred with Mr. Hueston after testifying about his use of millions of dollars of Enron credit lines to shore up his personal finances. But when Mr. Hueston picked up that issue again, seeking to show Mr. Lay misled investors by not disclosing he had sold $77.5 million in Enron shares while buying $4 million worth, Mr. Lay's blood pressure seemed to rise again.

While Mr. Lay is not charged with insider trading, prosecutors are suggesting he chose not to disclose his large stock sales in 2001 because he knew of deep-seated problems at Enron. Mr. Lay let others represent him as bullish on Enron stock, and he urged Enron employees to purchase shares in 2001, promoting the declining stock as a "bargain."

Despite suggestions by Mr. Hueston that he had intentionally not disclosed his stock sales, Mr. Lay insisted that he had complied with reporting requirements, that he was forced to sell the shares to meet demands to repay loans and that he used a $10 million Enron bonus to pay down his Enron credit line rather than deposit the money in the bank.

"I separated the optional discretionary decisions I was making from those that were forced," he said. Disclosing his sales to Enron employees "was not required and I did not see that it was necessary," he added.

Mr. Hueston spent much of the afternoon attacking Mr. Lay on one of the government's strongest charges against him: that he misled investors and Enron's auditor, Arthur Andersen, into thinking Enron planned to use a British water company, Wessex, to pursue a growth strategy in the water business.

Prosecutors charge that Mr. Lay told David B. Duncan, the former lead Andersen partner on the Enron account, in an Oct. 12 meeting that there was a growth strategy, only to head off a credit downgrade that would result if Enron had to take a good-will charge of as much as $700 million on Wessex.

Mr. Hueston challenged Mr. Lay's denials that he discussed a water strategy at that meeting, showing that efforts were under way within the company to find a way to justify not taking the good-will charge.

Mr. Lay said those efforts were premature, since Arthur Andersen had yet to decide how much of a charge had to be taken. He belittled the work going on inside Enron to solve the impairment issue — saying it made "no business sense" — and denied knowing anything about it.

Tales from the Enron trial got you down? Like Andrew Fastow's testimony of how he laundered $10,000 as a tax-free gift to his own sons? So after work you stumble home, seeking refuge from the workaday sludge in the stark competitive world of Sports Illustrated, which this week is awash in the details of the doping case against Barry Bonds, an Icarus, legend has it, who flew toward baseball heaven on wax wings made from human growth hormone. For perspective on the Bonds myth, I called Gary Wadler, a physician who has seen it all as a member of the World Anti-Doping Agency. "Bonds and Fastow were both into cooking," Dr. Wadler offered. "Bonds cooked the record books and Fastow cooked the financial books."
Daniel Henninger, "Barry Bonds, Meet Andrew Fastow, The Wall Street Journal, March 17, 2006 --- http://www.opinionjournal.com/columnists/dhenninger/?id=110008100

From NPR
Profiles of the Enron Suspects and Other Key Players
"Enron: On the Prosecution's List," NPR, March 8, 2006 --- http://www.npr.org/templates/story/story.php?storyId=5249786

 

Skilling's Appearance Riles Former Enron Employees (with audio)
Former Enron CEO Jeffrey Skilling faces cross-examination by the prosecution as his trial resumes Monday. His appearance on the stand has revived bitter feelings among many of Enron's former employees.
Wade Goodwyn, "Skilling's Appearance Riles Former Enron Employees (with audio)," NPR, April 16, 2006 --- http://www.npr.org/templates/story/story.php?storyId=5344829

"Enron Prosecutor Questions Skilling's Story," by Vikas Bajaj and Alexei Barrionuevo, The New York Times, April 17, 2006 --- Click Here

A prosecutor tried to poke holes in the testimony of Jeffrey K. Skilling, the former Enron chief executive, today by boring in on stock sales he made in the months after he left the company and before the energy company declared bankruptcy.

In his first day cross-examining Mr. Skilling, Sean M. Berkowitz, the prosecutor, accused Mr. Skilling of selling shares because he knew the company was under an accounting investigation and faced grave problems.

Mr. Skilling, who is charged with conspiracy, fraud and insider trading, steadfastly denied the accusations, saying that he sold stock in September 2001 because he was worried about the economy after the terrorists attacks and meant to diversify his stock holdings, which were concentrated in Enron stock.

"Sir, Sept. 11 was not the only reason that you sold Enron shares on Sept. 17, was it?" Mr. Berkowitz asked.

"The only reason I sold the 500,000 shares on Sept. 17, the only reason, was Sept. 11," Mr. Skilling responded, his voice cracking slightly.

The cross-examination of Mr. Skilling, who is a co-defendant with Kenneth L. Lay, the former Enron chairman and chief executive, could be a critical turning point in the trial, which is now in its 12th week. Mr. Lay faces fraud and conspiracy charges and is expected to take the stand later in the trial.

In the long exchange over stock trades this morning, Mr. Berkowitz focused extensively on a call Mr. Skilling placed to his broker on Sept. 6 to sell 200,000 shares, less than a month after he left the company. The trade was never completed because Mr. Skilling needed to send a letter to the broker from Enron stating that he was no longer an executive and was not restricted from selling his shares.

Mr. Skilling has said before that he does not recall that specific trade and Mr. Berkowitz sought to highlight those past remarks to raise doubt about Mr. Skilling's motivations for selling stock.

"Its your testimony that you don't have a specific recollection of Sept. 6 trade and you have gone back and tried to piece it together with evidence?" Mr. Berkowitz asked.

"Yes," Mr. Skilling said.

Mr. Berkowitz built up to that exchange after earlier using questions to try to demonstrate that Mr. Skilling had spent the last four and a half years preparing and "tailoring" his testimony with all the available notes, documents and other evidence being used in the case.

"I have nothing to hide, Mr. Berkowitz, so I don't think it's a question of tailoring your testimony," Mr. Skilling said. "I will respond to your questions to the best of my ability."

As he spoke and flipped through large binders of evidence, Mr. Skilling would periodically put on and take off reading glasses. He responded calmly to Mr. Berkowitz's questions, usually with short answers.

Before the proceedings began this morning, Daniel Petrocelli, Mr. Skilling's lawyer, wished Mr. Berkowitz well in front of a group of reporters standing in the hallway of the courtroom.

"Hey Sean, lawyer to lawyer, have a good day," Mr. Petrocelli said.

"Thanks, Dan," Mr. Berkowitz responded.

Earlier in the trial, prosecutors built their case against Mr. Skilling and Mr. Lay with the testimony of a parade of former Enron executives who testified that the top officers knew of, authorized and encouraged the use of improper accounting and financial transactions to artificially boost the earnings the company reported to investors.

Defense lawyers for Mr. Skilling and Mr. Lay have tried to undercut the credibility of those witnesses and have argued that there were no major crimes committed at Enron. They contend that Mr. Skilling and Mr. Lay were kept in the dark on certain illicit transactions by a group of finance executives.

"Skilling's Temper Drawn Out on Stand:  Prosecutor Focuses on What Former Enron CEO Says He Doesn't Remember," by Carrie Johnson, The Washington Post, April 19, 2006 --- Click Here

Known within the company for his impatience, Skilling for the first time lost his cool Tuesday afternoon, asserting that prosecutors misunderstood a technical issue. As Berkowitz raised his voice and sought to proceed, the witness responded, "Let's not move on."

Defense lawyer Daniel M. Petrocelli took the unusual step of interjecting to defuse the situation. "Is there a pending question?" he asked.

Skilling apologized, only to lash out again at the prosecutor.

"I know it is difficult for you to sit here and answer questions, Mr. Skilling, and I know at times you overreact to people who are critical of the company," Berkowitz said as Skilling shook his head, his face reddened.

Skilling regained his composure and finished out the day.

Continued in article

April 18, 2006 message from Richard Campbell [campbell@RIO.EDU]

Could Jeff Skilling’s funding of his ex-girlfriend’s photo company with Enron’s money be a violation of Enron’s Code of Ethics?

See the description below:

http://blogs.wsj.com/law/ 

Richard J. Campbell

"Prosecutor and Skilling Spar Over Enron's Finances," by Alexei Barriouevo, The New York Times, April 18, 2006 --- http://www.nytimes.com/2006/04/18/business/18cnd-enron.html

Mr. Berkowitz pressed Mr. Skilling over whether he had participated in manipulating the company's quarterly earnings to meet or exceed analysts' expectations. Witnesses testified earlier in the trial that Enron pulled money from reserves in the fourth quarter of 1999 and then in the second quarter of 2000 to generate more earnings.

Mr. Skilling denied to Mr. Berkowitz that he knew anything about the change in 1999, testifying today that "there is a good chance it did not occur." And he said a conversation between two Enron investor relations executives, Paula Rieker and Mark Koenig, that Ms. Rieker testified about earlier, did not happen.

In the second quarter of 2000, acting on an expressed desire by Mr. Skilling to beat analysts' estimates, Enron accountants pulled $14 million from a reserve account to push the company's quarterly earnings up to 34 cents a share from 32 cents, witnesses testified in the trial.

Mr. Skilling testified last week that when he arrived back from a vacation in Africa he learned that the quarter was "coming in hot" and told Enron's chief accounting officer, Richard A. Causey, to "shoot for 34" cents. Mr. Berkowitz suggested today that Mr. Skilling had acted improperly by suggesting that. Mr. Skilling responded that the reserves from which Enron pulled the money "are not typically locked until right before the end of the quarter.'

Mr. Berkowitz today played an audiotape of Mr. Skilling's previous testimony before the Securities and Exchange Commission where Mr. Skilling said he never gave any instruction that caused quarterly earnings to change. "I would comment by saying something like, 'oh, wow, or gee, that's interesting,' " Mr. Skilling testified to the S.E.C.

"That was a lie, wasn't it, sir?" Mr. Berkowitz asked.

"No, that was absolutely correct," Mr. Skilling said. "Did I ever give anyone any instruction to change the results of the quarter? I did not."

Earlier, the prosecutor spent an extended period questioning Mr. Skilling about meetings and internal company memos from 2000 that, he argued, were meant to provide detail about the troubles that Enron was facing in a group of "merchant assets," which included power plants and other businesses.

"This is like looking at the baseball rankings and saying, 'Let's look at the bottom two teams,' " Mr. Skilling protested at one point when Mr. Berkowitz showed the courtroom an internal presentation.

"Let's not talk about baseball, Mr. Skilling," Mr. Berkowitz retorted. "Let's talk about Enron."

"This is a misrepresentation of what was going on," said Mr. Skilling, who noted that the presentation was incomplete because it did not show the assets that were performing well.

A little while later, Mr. Berkowitz tried to undercut that argument by displaying documents that showed 55 percent of the company's merchant assets were not living up to expectations. Mr. Skilling responded that a 50 percent success rate was not just acceptable but a sign that the business was doing well, asserting that venture capital investments fail 90 percent of the time.

"They were telling you in 2000 in June, in September and November that excessive earnings pressure resulted in bad deals and risky deals being done?" Mr. Berkowitz asked.

"No," Mr. Skilling said with slight chuckle.

"Well, O.K., the documents will tell us that," Mr. Berkowitz said.

"I guess so," Mr. Skilling, 52, said.

The questioning today appears to be aimed at bolstering the prosecution's case that Mr. Skilling and Mr. Lay authorized and encouraged the use of improper accounting and financial transactions to cover up troubles at Enron and artificially increase the company's reported earnings. After trying to show that Mr. Skilling was aware of the problems with its assets, Mr. Berkowitz questioned Mr. Skilling about sales of assets to off-the-books partnerships that Enron officials created with third-party investors.

Many of Enron's underperforming merchant assets and international power plants were sold to in part or in full to those partnerships, which were generically referred to as "raptors."

"It was your understanding that these assets would go down in value?" Mr. Berkowitz said referring to the assets sold to the partnerships.

"No," Mr. Skilling responded.

"You understand that the only reasons the sophisticated investors were interested in investing into the raptors was because they were guaranteed to receive their money back?" Mr. Berkowitz asked, suggesting that Enron told its partners that it would make them whole if the value of the assets went down.

"They looked at the overall transaction, the incubation phase and the hedging phase and must have decided that was something they were interested in doing," Mr. Skilling said.

Lawyers defending Mr. Skilling and Mr. Lay, who is expected to take the stand later in the trial, have argued that their clients did not commit any crimes at Enron, and that any wrongdoing was confined to certain illicit transactions involving a cadre of finance executives led by the company's onetime chief financial officer, Andrew S. Fastow.

 

Fastow Leaves Stand Insisting Lay and Skilling Knew
Andrew S. Fastow, Enron's former chief financial officer, ended his testimony on Monday, still insisting that Jeffrey K. Skilling and Kenneth L. Lay joined him in telling investors that Enron was profitable and healthy when all of them knew otherwise . . . Mr. Fastow struggled to further corroborate his testimony about the so-called Global Galactic list of illicit side deals he said he made with one of the former chiefs, Mr. Skilling, to guarantee profits. Mr. Fastow also tried to buttress his claims that he warned Mr. Lay, Enron's founder, in a private meeting that Enron was in desperate need of a "massive restructuring."

Alexei Barrionuevo, "Fastow Leaves Stand Insisting Lay and Skilling Knew," The New York Times, March 14, 2006 --- http://www.nytimes.com/2006/03/14/business/businessspecial3/14enron.html 

"Lesser Known Enron Executive Is Key Witness:  Imprisoned Ex-Treasurer Glisan Brings 'Boy Scout' Reputation To Testimony on Financial Deals," by John R. Emshwiller, The Wall Street Journal, March 20, 2006; Page C1 --- http://online.wsj.com/article/SB114281177496502519.html?mod=todays_us_money_and_investing 

Although he lacks the star power of some who have preceded him, Ben Glisan Jr. could become the most important witness in the government's effort to convict former Enron Corp. executives Jeffrey Skilling and Kenneth Lay of conspiracy and fraud.

Prosecutors hope the 40-year-old Mr. Glisan, Enron's former treasurer, will provide jurors with convincing support for allegations made by prior witnesses in the trial. Unlike some of those prior witnesses, Mr. Glisan was high enough up the corporate ladder to have regular contact with Messrs. Skilling and Lay, including

A trained accountant, Mr. Glisan helped design some of the financial transactions that are a major part of the alleged fraud at Enron -- and, thus, he should be able to discuss those transactions with an authority that some previous witnesses lacked. Unlike other witnesses who are cooperating with the government in hopes of reducing their sentences, Mr. Glisan simply pled guilty to an Enron-related crime to settle a 26-count indictment and is serving his five-year prison term -- potentially boosting his credibility to jurors.

Mr. Glisan was a protégé of one of the alleged fraud's central figures, former Enron Chief Financial Officer Andrew Fastow, who recently completed four days of often-contentious testimony. While privy to Mr. Fastow's thinking and actions at Enron, Mr. Glisan doesn't carry all the negatives of his former boss, who was feared and disliked by many at Enron and has admitted to stealing millions from the company.

By contrast, the affable Mr. Glisan was a generally popular figure. Even Mr. Skilling, interviewed by Enron investigators shortly after the company's December 2001 collapse into bankruptcy court, was quoted as describing Mr. Glisan as having the reputation of a "boy scout."

Defense attorneys won't be singing Mr. Glisan any campfire tunes when they cross-examine him. They are expected to portray the former treasurer as a liar who betrayed the trust of Messrs. Skilling and Lay by sharing in the booty that Mr. Fastow stole. Mr. Glisan has acknowledged reaping $1 million from a $5,000 investment with a Fastow partnership -- with the profit coming from money that Mr. Fastow admitted filching from Enron and some of his other partners. Defense attorneys hope to bring out contradictions between what Mr. Glisan and Mr. Fastow have told federal officials.

Continued in article

Also see http://www.nytimes.com/2006/03/20/business/businessspecial3/20enron.html?_r=1&oref=slogin

"Former Enron Treasurer Details His View of Internal Operations," by Gary McWilliams and John R. Emswiller, The Wall Street Journal, March 22, 2006; Page C3 --- Click Here 

He testified the company's senior executives were "manufacturing" earnings and misleading investors in 2001 to cover shortfalls and prop up the energy firm's falling stock price.

As of mid-August 2001, Messrs. Lay and Skilling knew that the company was struggling financially, yet falsely told investors it was in excellent shape, he alleged. Mr. Glisan said that in the succeeding months Enron's condition became "significantly worse," yet Mr. Lay continued to assure investors to the contrary.

Among the problems he said were "billions of dollars of embedded losses" in Enron's international assets. The prosecution introduced an Enron chart that indicated Mr. Skilling estimated the company's international businesses carried a value of $4.5 billion less than the value shown on Enron's books. Mr. Glisan said the company didn't write down the assets because it would have required "a larger loss than we could have stomached" and have serious repercussions for Enron in financial markets.

"Enron's Fastow Testifies Skilling Approved Fraud:  Ex-Executive Says Company Used Deals to Hide Losses, Chokes Up Over Lie to Wife," by John R. Emshwiller and Gary McWilliams, The Wall Street Journal,  March 8, 2006; Page A1 --- http://online.wsj.com/article/SB114174265177191437.html?mod=todays_us_page_one

"We misled Lea (Fastow's wife)," Mr. Fastow said. "She would not, in my opinion, have signed a fraudulent tax return. She did it because [the subordinate] Michael Kopper and I conspired. ... I led her to believe that."

But for most of the day, Mr. Fastow was cool and in control as he described the alleged wrongdoing at Enron. His principal target was Mr. Skilling, who helped bring him to Enron in 1990. In 1998, after Mr. Skilling became Enron's president, he tapped Mr. Fastow, then in his late-30s, as chief financial officer.

The prosecution's initial questioning focused on dealings between Enron and the LJM partnerships, which drew their initials from the first names of Mr. Fastow's wife and their two sons. Before its 2001 bankruptcy filing, Enron had routinely reported dealings with LJM and Mr. Fastow in filings with the Securities and Exchange Commission, and Enron contended that the LJM relationship was proper and that because of Mr. Fastow's familiarity with the company, Enron could do deals, such as selling assets, faster and at lower transaction costs.

But the government, in its indictment of Mr. Skilling and Mr. Lay on multiple counts of conspiracy and fraud, contends that LJM was a crucial part of the Enron fraud. Prosecutors allege that by taking money-losing investments off Enron's books and by doing other deals to produce bogus earnings, the LJM operation helped the company mask its deepening financial problems.

Mr. Fastow testified that he came up with the idea for the partnerships in 1999 as a way to help Enron manage its earnings and to enrich himself. As the partnerships' general partner, he said, he was guaranteed hundreds of thousands of dollars in annual fees from LJM1 and millions in fees from LJM2 -- with potentially even larger sums from partnership profits.

Mr. Fastow said Mr. Skilling and others were concerned about how the obvious conflict of interest between his roles as Enron's finance chief and the head of the partnerships would look to investors. "We all agreed it was a rather unusual arrangement," he said. But, he added, Mr. Skilling was enthusiastic about using LJM funds to help manipulate Enron's earnings.

The Enron president said "give me all the juice you can" from the LJMs, Mr. Fastow told the court. Mr. Fastow raised $15 million in investment capital for LJM1 and nearly $400 million for LJM2 from outside parties, many of them banks and investment banks that did business with Enron.

Mr. Fastow said the partnerships were willing to do deals that Enron "just couldn't do with others" because they were too risky or simply didn't make economic sense.

One deal involved an Enron power-plant project in Brazil. In 1999, Mr. Fastow said, Mr. Skilling asked him to have LJM buy an interest in the plant so that Enron could book income and hit its earnings target for the quarter. Mr. Fastow said he used an expletive to describe the power plant. "I told him it was a piece of s-. No one would buy it," he told jurors.

Continued in article

You can read more about Andy Fastow and Michael Kopper at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

Long-time subscribers to the AECM may remember my quips (years ago) about Michael Kopper ---
These inspired AECMers to write their own quips about Enron and about accounting in general.
You can read some of these AECM originals at http://faculty.trinity.edu/rjensen/FraudEnron.htm#Humor

Possible headlines on the Enron saga following the guilty plea of Michael J. Kopper:
  • Kopper Wired to the Top Brass (with reference to secret conspiracies with Andy Fastow)
  • The Coppers Got Kopper
  • Kopper Cops a Plea
  • Kopper’s Finish is Tarnished
  • Kopper Caper
  • Kopper Flopper
  • Kopper in the Kettle
  • A Kopper Whopper

These are Jensen originals, although I probably shouldn’t admit it.

 


At last we here from the master criminal himself --- Andy Fastow
"Excerpts from Testimony By Former Enron CFO Fastow," The Wall Street Journal, March 8, 2006 --- http://online.wsj.com/article/SB114174916581991546.html?mod=todays_us_money_and_investing 

Former Enron CFO Andy Fastow, the prosecution's star witness, testified at the Lay-Skilling trial that he ran financial partnerships designed to help Enron meet earnings targets and mask huge losses. Mr. Fastow, who hasn't spoken publicly since October 2001, is among the most highly anticipated witnesses in this trial. Following are excerpts from his testimony.

Wednesday, March 8 LAY KNEW: Fastow testified that former chairman Ken Lay was at a meeting in August 2001 in which he heard about a "hole in earnings" at Enron, just days before he gave a BusinessWeek interview claiming Enron was in its "best shape" ever. Fastow said of the Lay interview, "I think most of the statements in there are false."

* * * ON GREED: In a heated cross-examination by Skilling lawyer Daniel Petrocelli, Fastow admitted, "I believe I was extremely greedy, and that I lost my moral compass, and I've done terrible things that I very much regret."

INSIDE-OUT: Steady growth and bright prospects "was the outside view of Enron," Fastow testified. "The inside view of Enron was very different."

* * * RECURRING DREAM: Lay opted to characterize a loss on an investment in the third quarter of 2001 as "nonrecurring," even though a gain on the same holding was earlier characterized as "recurring," Fastow testified, adding, "I thought that was an incorrect accounting treatment."

* * * DEATH SPIRAL: By October 2001, Enron's suppliers refused to trade with the company and Fastow testified that he feared the company would collapse and that he and an aide went to Lay to warn him. "I said I thought this was a death spiral, a serious risk of bankruptcy. I said the majority of trades being done were to unwind positions."

* * * MORE HEROICS: "Within the culture of corruption Enron had, a culture that rewarded financial reporting rather than rewarding economic value, I believed I was being a hero. I was not. It was not a good thing. That's why I'm here today."

Tuesday, March 7 THE PROFIT PROBLEM: One of Enron's off-balance-sheet partnerships, LJM1, was designed to help the company "solve a problem," Fastow testified. "We were doing this to inflate our earnings, and I don't think we wanted to show people what we were doing.''

* * * MORE DEALS: Fastow quoted Skilling as saying, " 'Get me as much of that juice as you can,' '' after Fastow informed him that more money would need to be raised to continue making deals like LJM1. In such deals, these so-called outside entities would purchase underperforming assets from Enron to get debt off its balance sheet and boost earnings.

* * * RISKY BUSINESS: Fastow testified that partnerships like the LJMs were willing to do deals that Enron "just couldn't do with others" because they were too risky or didn't make economic sense.

* * * SKILLING'S WORD: Fastow testified about pressure from Skilling to have one of the LJMs buy a minority stake in a Brazilian power plant owned by Enron because Enron's South American unit was struggling to meet its earnings target. "I told him it was a piece of s--t, and no one would buy it,'' Fastow said, adding that he relented, in part, because Skilling assured him he wouldn't lose money on the deal. Fastow testified that there were many more "bear-hug" guarantees like this from Skilling in mid-2000.

* * * BREAKING THE LAW: Fastow testified that the LJMs were legal and did many legal deals, but "certain things I did as general partner of LJM were illegal."

* * * BELIEVE IT OR NOT: In his first day of testimony, Fastow repeatedly said that he thought he was "a hero for Enron," for coming up with these unique business deals to help the company meet Wall Street targets even when it was financially in trouble. "I thought the foundation was crumbling and we were doing everything we could to prop it up as long as we could … We were in pretty bad shape."

* * * WORRIES ABOUT PUBLICITY: Skilling was concerned, Fastow testified, that off-balance-sheet deals like the LJMs would "attract attention, and if dissected, people would see what the purpose of the partnership was, which was to mask potentially hundreds of millions of dollars of losses."

* * * FALSE TAX RETURN: Fastow tearfully admitted that he "misled" his wife about some of the money the couple earned from Enron-related deals. "She would not, in my opinion, have signed a fraudulent tax return," Fastow said. Lea Fastow served one year in federal prison for filing a false tax return.

* * * A FAMILY AFFAIR: Fastow also admitted that he had one of his top aides send $10,000 checks to each of his sons. The checks were portrayed as gifts to the boys, but really they were proceeds from a business deal. "I shouldn't have. It was the wrong thing to do."

Jensen Comment
It comes as some relief to accountants that Fastow has not yet mentioned collusion with the Andersen Auditors led by David Duncan. CFO Fastow worked in secrecy ripping off Enron itself. CAO Rick Causey worked more closely with Duncan to issue false financial statements. Rick Causey's fine for filing false Enron financial statements was $1,250,000.

You can read more details about Fastow, Causey, Duncan, and the others at
http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm


What is "The Wall Street Journal" Risk?
Under questioning from the prosecutor, John Hueston, Mr. Fastow said Enron's board and top two executives discussed the questionable nature of the partnerships, but ultimately approved them because they would help the company hide hundreds of millions dollars in losses. At one board meeting, a director wondered out loud about the "scrutiny and great problems" Enron could face if information about the partnerships became public, describing it as "The Wall Street Journal risk," testified Mr. Fastow, 44, who reached a plea bargain with prosecutors on charges against him.
Alexy Barrionuevo and Vikas, Bajaj, "Fastow Says Enron Executives Approved Deals to Hide Losses," The New York Times, March 7, 2006 --- Click Here 

Under questioning from the prosecutor, John Hueston, Mr. Fastow said Enron's board and top two executives discussed the questionable nature of the partnerships, but ultimately approved them because they would help the company hide hundreds of millions dollars in losses.

At one board meeting, a director wondered out loud about the "scrutiny and great problems" Enron could face if information about the partnerships became public, describing it as "The Wall Street Journal risk," testified Mr. Fastow, 44, who reached a plea bargain with prosecutors on charges against him.

At the same meeting, another director raised questions about the propriety of Mr. Fastow's personally profiting from LJM1; he was guaranteed $800,000 a year from the partnership regardless of how it performed financially. But Mr. Fastow asserted that Mr. Skilling came to his defense, saying, "Andy Fastow has put $1 million into the game. He should get profits because he has skin in the game."

Nonetheless, the board approved LJM1, which also had $15 million from outside investors, in early 1999. Later that year, Mr. Fastow testified, Mr. Skilling encouraged him in his efforts to create LJM2, for which he would eventually raise a total of $386 million. Mr. Fastow earned $8 million in fees from the second partnership and was entitled to 20 percent of the entity's profits.

"Get me as much juice as you can," Mr. Fastow recalled Mr. Skilling saying.

"We were using the equity to juice Enron's earnings," Mr. Fastow added, "to report as much earnings as we wanted."

Mr. Fastow follows a parade of former Enron executives who, under questioning from the prosecution, have presented critical and damaging testimony against the two former top executives, particularly Mr. Skilling. In its sixth week, the trial is the culmination of a four-year federal investigation into the failure of and fraud at Enron and is widely believed to be one of the most significant white-collar criminal prosecution ever undertaken.

Mr. Fastow spoke in a strong, clear voice with his trademark lisp, and he sipped coffee and water during his testimony. At one point he asked Mr. Hueston for some water.

Mr. Skilling bobbed his head from side to side as Mr. Fastow spoke; Mr. Lay seemed to be looking off to the side.

Before the testimony, Mr. Skilling appeared calm and chatted with a reporter about trips to Argentina.

Some legal experts had recently suggested that given the government's success thus far, they should have considered not calling Mr. Fastow as a witness, because he was so closely involved in the fraud at Enron and personally benefited from the off-balance-sheet partnerships.

A central tenet of Mr. Lay's and Mr. Skilling's defense is that Mr. Fastow masterminded most of the wrongdoing at Enron and misled his bosses about his activities. Defense lawyers intend to vigorously attack Mr. Fastow's credibility and the deal he reached with prosecutors, in which he has pleaded guilty and agreed to a prison sentence that could total 10 years.

Continued in article

 


Forwarded by Bob Overn

Question:
Did Enron's chairman ever meet with the president?

Answer: Yes,

A. Enron's chairman did meet with the president and the vice president in the Oval Office.

B. Enron gave $420,000 to the president's party over three years.

C. It donated $100,000 to the president's inauguration festivities.

D. The Enron chairman stayed at the White House 11 times.

E. The corporation had access to the administration at its highest level and even enlisted the Commerce and State Departments to grease deals for it.

F. The taxpayer-supported Export-Import Bank subsidized Enron for more than $600 million in just one transaction. Scandalous!!

G. BUT...the president under whom all this happened WASN'T George W. Bush.

SURPRISE ... It was Bill Clinton!


"Warning on Enron Recounted," by Alexei Barrionuevo, The New York Times, March 16, 2006 --- http://www.nytimes.com/2006/03/16/business/businessspecial3/16enron.html?_r=1&oref=slogin

Ms. Watkins, 46, attracted national attention after testifying before Congress in February 2002 about Enron's collapse two months earlier. She was named one of Time magazine's people of the year in 2002 for raising red flags about the company's accounting while still working there. She has since written a book with a Houston journalist about Enron's fall, and formed a consulting practice that advises companies on governance issues.

Defense lawyers, during combative cross-examination, tried to paint Ms. Watkins as an opinionated fame-seeker who had profited from the Enron scandal on the lecture circuit. The defense lawyers also suggested that Ms. Watkins was never charged with insider trading for selling Enron shares because she was wrong in believing that the Raptors were fraudulent.

Prosecutors contend that the partnerships and hedges Ms. Watkins testified about were part of a broad effort by Mr. Skilling and Mr. Lay to manipulate earnings and hide debt. The former chief executives are accused of overseeing a conspiracy to deceive investors about Enron's finances so they could profit by selling Enron shares at inflated prices.

Defense lawyers contend that prosecutors are seeking to criminalize normal business practices and that the Enron executives were the victims of thieving subordinates like Andrew S. Fastow, the former chief financial officer.

Ms. Watkins's appearance on the stand came as the government neared the end of its case. Judge Simeon T. Lake III said Wednesday that he estimated that the case could be wrapped up by the end of April.

Ben F. Glisan Jr., a former Enron treasurer, is scheduled to take the stand next week. Mr. Glisan pleaded guilty to conspiracy and is currently serving a five-year prison term.

In often-colorful testimony, Ms. Watkins recounted how she became concerned around June 2001 that about a dozen Enron assets were being hedged, or guaranteed against loss, by the Raptors vehicles, which she soon learned contained only Enron stock. The Raptors were intertwined with partnerships run by Mr. Fastow, who became Ms. Watkins's boss that summer. The value of the assets, she said, "had tanked," dragged down by Enron's plummeting share price.

After doing some investigation, she wrote an anonymous letter about her concerns, then on Aug. 22, 2001, she met with Mr. Lay to discuss them. The meeting came about a week after Mr. Lay had stepped back into the role of chief executive after the resignation of Mr. Skilling.

At the meeting, they discussed a letter of hers in which she had said that she was "incredibly nervous that Enron would implode in a wave of accounting scandals." She also noted to Mr. Lay that employees were talking about a "handshake deal" that Mr. Fastow had with Mr. Skilling that ensured that Mr. Fastow would not lose money on transactions done with the LJM partnership, which Mr. Fastow was running.

Mr. Lay seemed to take her seriously, Ms. Watkins testified.

Days after the meeting, she learned that Vinson & Elkins, the law firm that had originally approved the Raptors, was doing the internal investigation into the partnerships. The firm, after consulting with Arthur Andersen, Enron's auditor, issued a report saying that while the "optics" or appearances were bad, the accounting was appropriate.

Ms. Watkins said she remained adamant that Andersen, which had received several high-profile setbacks, should not be trusted.

"I thought this was bogus," she said of the investigation.

Concerned that Enron was manipulating its financial statements, Ms. Watkins stepped up efforts to leave the company, which she had begun shortly after she concluded the Raptors could be fraudulent. She did not leave until after the bankruptcy.

Ultimately, Mr. Lay decided to unwind the Raptors and take a write-off in a single quarter rather than restate the accounting of Enron's financial statements. Ms. Watkins, under questioning from Chip B. Lewis, a lawyer for Mr. Lay, conceded that while that was not her preference, "continuing the fraud would have been worse."

Defense lawyers sparred with Ms. Watkins from the outset. Mr. Lewis placed a copy of Ms. Watkins's book, "Power Failure," in front of her, calling it a "housewarming present."

Ms. Watkins acknowledged that she could not explain why prosecutors did not charge her with insider trading for selling Enron shares.

Continued in article

 


Special Report on the Fall of Enron  --- http://www.chron.com/news/specials/enron/
 


Master Chefs at Enron Cook the Books
Enron Corp. dipped into reserve accounts to illegally pad earnings in 2000 and improperly delayed reporting large losses in a retail energy operation the following year, former accountants testified yesterday. The testimony began the fifth week in the criminal conspiracy-and-fraud trial of former Enron Chairman Kenneth Lay and former President Jeffrey Skilling. The testimony provided new support for the Justice Department's accusations that the two top executives manipulated results at the company. Wesley Colwell, former accounting chief of Enron's wholesale energy unit, alleged he shifted a total of $14 million in July 2000 to create a two-cents-a-share boost to the company's second-quarter results. He testified that an Enron finance executive told him that month that Mr. Skilling was looking to "beat the Street" estimate of its second-quarter earnings. Mr. Colwell, who is testifying under a cooperation agreement with the government, paid a $500,000 fine to settle allegations by the Securities and Exchange Commission that he manipulated earnings. His agreement with the Justice Department requires that he testify to avoid criminal prosecution. Three previous government witnesses, all former Enron executives, pleaded guilty to crimes related to the energy giant. Mr. Colwell, who is testifying under a cooperation agreement with the government, paid a $500,000 fine to settle allegations by the Securities and Exchange Commission that he manipulated earnings. His agreement with the Justice Department requires that he testify to avoid criminal prosecution. Three previous government witnesses, all former Enron executives, pleaded guilty to crimes related to the energy giant.
Gary McWilliams and John R. Emshwiller, "Accountant Says Enron Dipped Into Reserves to Pad Earnings," The Wall Street Journal, February 28, 2006; Page C3 ---
http://online.wsj.com/article/SB114105814931084345.html?mod=todays_us_money_and_investing

"Testimony Links Skilling, Lay To Alleged Effort to Hide Losses," by John R. Emshwiller and Gary McWilliams, The Wall Street Journal, March 1, 2006; Page C2 ---
http://online.wsj.com/article/SB114114167255385382.html?mod=todays_us_money_and_investing

The former head of Enron Corp.'s retail-energy unit tied former President Jeffrey Skilling and former Chairman Kenneth Lay in testimony to an alleged effort to improperly hide hundreds of millions of dollars of losses in the division.

The testimony yesterday by David Delainey, who headed Enron Energy Services, or EES, was some of the most specific yet linking Messrs. Lay and Skilling to alleged wrongdoing. The former Enron president and chairman are in the fifth week of their federal fraud and conspiracy trial. Mr. Delainey has pleaded guilty to one count of insider trading and agreed to pay nearly $8 million in penalties. Like four previous witnesses, he is testifying for the government as part of a cooperation agreement.

Mr. Delainey took over the retail unit in early 2001 after having headed the company's profitable wholesale-energy trading operation. While Enron at the time was publicly portraying the retail unit as profitable and growing, Mr. Delainey contended yesterday that he found a problem-ridden unit burdened by hundreds of millions of dollars of losses. He said another senior executive had told him the unit's financial problems "could potentially bankrupt Enron."

At a March 29, 2001, meeting led by Mr. Skilling, Mr. Delainey testified, a decision was made to hide some of the big EES losses. Mr. Delainey said he argued the action, which involved moving some retail operations to the profitable wholesale unit, "lacked integrity" and shouldn't be done.

Continued in article

Bob Jensen's Enron Quiz is at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

 


Enron Update February 18, 2006
Enron Corp. dipped into reserve accounts to illegally pad earnings in 2000 and improperly delayed reporting large losses in a retail energy operation the following year, former accountants testified yesterday. The testimony began the fifth week in the criminal conspiracy-and-fraud trial of former Enron Chairman Kenneth Lay and former President Jeffrey Skilling. The testimony provided new support for the Justice Department's accusations that the two top executives manipulated results at the company. Wesley Colwell, former accounting chief of Enron's wholesale energy unit, alleged he shifted a total of $14 million in July 2000 to create a two-cents-a-share boost to the company's second-quarter results. He testified that an Enron finance executive told him that month that Mr. Skilling was looking to "beat the Street" estimate of its second-quarter earnings. Mr. Colwell, who is testifying under a cooperation agreement with the government, paid a $500,000 fine to settle allegations by the Securities and Exchange Commission that he manipulated earnings. His agreement with the Justice Department requires that he testify to avoid criminal prosecution. Three previous government witnesses, all former Enron executives, pleaded guilty to crimes related to the energy giant. Mr. Colwell, who is testifying under a cooperation agreement with the government, paid a $500,000 fine to settle allegations by the Securities and Exchange Commission that he manipulated earnings. His agreement with the Justice Department requires that he testify to avoid criminal prosecution. Three previous government witnesses, all former Enron executives, pleaded guilty to crimes related to the energy giant.
Gary McWilliams and John R. Emshwiller, "Accountant Says Enron Dipped Into Reserves to Pad Earnings," The Wall Street Journal, February 28, 2006; Page C3 ---
http://online.wsj.com/article/SB114105814931084345.html?mod=todays_us_money_and_investing
 


Will  Phil and Wendy Gramm forever go unpunished in the Enron scandal?
Enron trial unfolds, it's depressing that Phil and Wendy Gramm, the company's political enablers, are going unpunished and uncriticized.
Robert Scheer, "Enron's Enablers " The Nation, February 1, 2006 ---
http://www.thenation.com/doc/20060213/scheer0201

Back in 1993, when Enron was an upstart energy trader and Wendy Gramm occupied the position of chair of the CFTC, she granted the company, the biggest contributor to her husband's political campaigns, a very valuable ruling exempting its trading in futures contracts from federal government regulation.

She resigned her position six days later, not surprising given that she was a political appointee and Bill Clinton had just defeated her boss, the first President Bush. Five weeks after her resignation, she was appointed to Enron's board of directors, where she served on the delinquent audit committee until the collapse of the company.

There was perfect quid pro quo symmetry to Wendy Gramm's lucrative career: Bush appoints her to a government position where she secures Enron's profit margin; Lay, a close friend and political contributor to Bush, then takes care of her nicely once she leaves her government post.

Although she holds a doctorate in economics and often is cited as an expert on the deregulation policies she so ardently champions, Gramm insists that while serving on the audit committee she was ignorant of the corporation's accounting machinations. Despite her myopia, or because of it, she was rewarded with more than $1 million in compensation.

A similar claim of ignorance of Enron's shenanigans is the defense of her husband, who received $260,000 in campaign contributions from Enron before he pushed through legislation exempting companies like Enron from energy trading regulation.

"This act," Public Citizen noted, "allowed Enron to operate an unregulated power auction--EnronOnline--that quickly gained control over a significant share of California's electricity and natural gas market."

The gaming of the California market, documented in grotesque detail in the e-mails of Enron traders, led to stalled elevators, hospitals without power and an enormous debt inflicted on the state's taxpayers. It was only after the uproar over California's rolling blackouts, which Enron helped engineer, that the Federal Energy Regulatory Commission finally re-imposed regulatory control--and thereby began the ultimate unraveling of Enron's massive pyramid of fraud.

Jensen Comment
I've always been a bit harsh on Wendy Gramm because of the way she significantly helped Enron deregulate energy markets while she worked for the Government and later joined Enron's Board of Directors. In fairness, however, I must point out that while serving on the Board of Directors of Enron, Wendy Gramm's stock sales were exceedingly modest compared with the big winners --- http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales

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


Question
Would you like to sift through millions of Enron email messages?

"Science Puts Enron E-Mail to Use," by Ryan Singel, Wired News, January 30, 2006 ---

In March 2001, just a few months before Enron CEO Jeffrey Skilling resigned, an employee e-mailed him a joke about a policeman pulling over a speeding driver, whose wife subsequently rats him out to the cop for other offenses, including being drunk.

Skilling and Enron chairman Ken Lay, whose federal trial on multiple felony fraud charges starts Monday, might not see the irony that, like the driver's wife, their e-mails will soon be testifying against them, both in court and in public opinion.

Enron's inbox first hit the internet in March 2003 when the Federal Energy Regulatory Commission made public more than 1.5 million e-mails from 176 Enron employees as part of its investigation of the company's manipulation of California energy markets in 2000.

Journalists quickly scoured the e-mail for embarrassing moments and incriminating missives. Among the finds: Lay family members' thoughts about finding the perfect wedding photographer (someone who did one of the Kennedy's weddings), Enron executives angling for ambassadorships and positions in the Bush administration, instructions from Tom DeLay's staff to Lay and Skilling on how to handle $100,000 contributions and messages from Lay's secretary bemoaning the fact that she could not get tech support to fix Lay's phone, which would disconnect if answered before the third ring.

All this among countless jokes about Texas, sex, nuns, women, Latinos and priests. Other tasteful tidbits include an offensive booty-call contract and a fashion critique of government lawyers investigating Enron.

The e-mails drew the attention of more than just Californians looking for some payback for the rolling blackouts and astronomical energy bills. InBoxer, an antispam company, turned to the archive to help test its newest product, which scans company e-mails in real time for objectionable content or confidential information, according to CEO Roger Matus.

For an accurate test, Matus needed a sample of corporate e-mail in all its raw, unadulterated drama and glory. He was unsure of how useful the Enron e-mails would be, until he loaded the database and looked at the first message.

The e-mail read in whole: "So you were looking for a one-night stand, after all?"

"That was the moment I knew we had a good testing corpus," Matus said.

Of the 500,000 e-mails InBoxer included in the database, the company's algorithms identified 10,275 with offensive words and another 71,268 that included potentially inappropriate messages, such as sexual innuendos or lists of employee Social Security numbers.

"Enron had an extreme culture of people who worked hard and played hard," Matus said.

Company engineers also found some great jokes, including one about how to feed a pill to a cat, inspiring InBoxer to make the e-mails searchable inside a demo of the new product, called the Anti-Risk Appliance.

While searching through the e-mails for more on the Raptor subterfuge, visitors can also try to win Apple iPod shuffles given away to those who dig up the funniest joke, the most fireable e-mail, and the most regrettable message sent.

Commercial outfits aren't the only ones exploiting the Enron e-mail dump.

 

"10 Enron Players: Where They Landed After the Fall," The New York Times, January 29, 2006 --- http://www.nytimes.com/2006/01/29/business/businessspecial3/29profiles.html

Bob Jensen's Enron Quiz is at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm


Ex-Enron Broadband Engineer Recounts Chaos
An engineer hired to fix problems in Enron Corp.'s broadband unit testified Thursday that the division suffered from overall disarray and that his corrective efforts were met with internal resistance. John Bloomer, who had previously spent 18 years with General Electric Co., told jurors in the trial of five former executives of the broadband unit that he found some "disturbing things" when he "peeked under the covers" after arriving at Enron Broadband Services in 1999.
Associated Press, "Ex-Enron Broadband Engineer Recounts Chaos," The Washington Post, May 5, 2005 --- http://www.washingtonpost.com/wp-dyn/content/article/2005/05/05/AR2005050502014.html


J.P. Morgan Chase & Co. agreed to pay $2.2 billion to settle a lawsuit filed by investors in Enron
J.P. Morgan Chase & Co. agreed to pay $2.2 billion to settle a lawsuit filed by investors in Enron, according to the Associated Press. The decision by the third largest bank in the United States comes just four days after Citigroup said it would pay $2 billion to settle the claims against it in the shareholder lawsuit, which is led by the University of California’s Board of Regents.
"Another Enron Settlement," Inside Higher Ed, June 15, 2005 --- http://www.insidehighered.com/news/2005/06/15/qt


That's Enron-tainment:  Positive review on the new Enron movie
Alex Gibney's freewheeling -- and terrifically entertaining -- documentary, newly entered into national release, puts faces and voices to the men and women who've become household names since the scandal broke four years ago. Some of these former executives have already enjoyed (or endured) extensive face time on TV. But now they're characters in the context of a film that's been adapted from the book of the same name by Bethany McLean and Peter Elkind, and the big screen lends new immediacy to their appearance. That's not to say Mr. Gibney's documentary turns its characters into real people. Given the scale of the human and economic damage, of the deception and very possibly the pathological self-deception, there may not be any real people behind those scrupulously straight faces. Still, "The Smartest Guys in the Room" gives us the same sort of perverse pleasure that's been a staple of "60 Minutes" over the years -- watching world-class crooks tell world-class lies.
"That's Enron-tainment: Company's Chief Cheats Give 'Smartest Guys' Energy:  Documentary Tracing Firm's Fall Is Provocative, Proudly Partisan; 'Machuca': Classy Class Drama," The Wall Street Journal, April 29, 2005; Page W1 ---
http://online.wsj.com/article/0,,SB111473473039520299,00.html?mod=todays_us_weekend_journal

You can download Enron's Infamous Home Video
Although it has nothing to do with the above professional movie, Jim Borden sent me a copy of the amateur video recording of Rich Kinder's departure from Enron (Kinder preceded Skilling as President of Enron).  This 1996 video features nearly half an hour of absurd skits, songs and testimonials by company executives.  It features CEO Jeff Skilling proposing Hypothetical Future Value (HPV) accounting with in retrospect is too true to be funny during the subsequent melt down of Enron.  George W. Bush (then Texas Governor Bush and his father) appear in the video.  You can download parts of it at  http://www.cs.trinity.edu/~rjensen/video/windowsmedia/enron3.wmv
Warning:  The above video is in avi format and takes a very long time to download.  It probably dovetails nicely into Alex Gibney's new Hollywood movie.

As far as partying accountants go, let's never forget Rich Kinder's Enron Departure Party before the meltdown of Enron (it features Jeff Skilling in the flesh speaking about Hypothetical Future Value Accounting) --- http://www.cs.trinity.edu/~rjensen/video/windowsmedia/enron3.wmv

Footnote:  Rich Kinder left Enron, formed his own energy company, and became a billionaire --- http://www.mcdep.com/MR11231.PDF
See Question 2 at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm


Tattle Tale Games Lawyers Play:  Skilling Seeks to Name Names
Former Enron Corp. President and CEO Jeffrey Skilling is trying to pull dozens of ex-colleagues and business associates into the public glare of his criminal conspiracy case. The move sheds light on both the breadth of alleged fraud at the fallen energy giant and the legal strategy of Mr. Skilling.

"Lawyers for Enron Ex-President Ask Judge in Case to Make Public List of 114 Alleged Co-Conspirators," by John R. Emshailler, The Wall Street Journal, December 10, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110264771262096639,00.html?mod=home_whats_news_us

Former Enron Corp. President and CEO Jeffrey Skilling is trying to pull dozens of ex-colleagues and business associates into the public glare of his criminal conspiracy case. The move sheds light on both the breadth of alleged fraud at the fallen energy giant and the legal strategy of Mr. Skilling.

Attorneys for Mr. Skilling have asked Houston federal judge Sim Lake to make public the names of 114 people who the government alleges in a sealed document were co-conspirators.

Mr. Skilling and his co-defendants, former Enron Chairman Kenneth Lay and former Chief Accounting Officer Richard Causey, are charged in a wide-ranging federal conspiracy indictment stemming from Enron's collapse into bankruptcy proceedings in December 2001. Prosecutors allege that Mr. Skilling, indicted earlier this year, "spearheaded" the conspiracy. All three have pleaded not guilty; a trial date hasn't been set.

Mr. Skilling's attorneys, who like the other defense attorneys have a copy of the list, say it includes former Enron officials -- likely including former Chief Financial Officer Andrew Fastow and others who already have pleaded guilty to some Enron-related crimes -- and individuals from some of the big financial institutions, law firms and other businesses with which Enron fostered close ties. The majority haven't been charged with any Enron-related crimes.

Prosecutors have cited federal confidentiality rules in keeping the 114 names under seal, in a typical move in such cases. The rationale for the rules is that even individuals accused of participating in a criminal conspiracy have a right to privacy if they haven't been formally charged.

But Mr. Skilling's legal strategy rests partly on broadly defending Enron's business practices while portraying federal prosecutors as overzealously criminalizing commonplace and legitimate business practices.

In a recent court filing, Mr. Skilling's attorneys argued that by keeping sealed 114 names the government hopes to avoid scrutiny of how "inherently implausible" it is to assert that such a large number of successful, law-abiding individuals could "participate in a vast criminal conspiracy."

Continued in the article


Laying it on the Line at Enron (or getting Layed at Enron, Lay It on the Line, Lay's Chip Getting Bagged)

"Enron Inquiry Turns to Sales by Lay's Wife," by Kurt Eichenwald, The New York Times, November 17, 2004

Federal prosecutors are investigating whether the wife of Enron's former chairman, Kenneth L. Lay, engaged in insider trading in a sale of company stock shortly before it collapsed into bankruptcy, people involved in the case said yesterday.

The sale by Mr. Lay's wife, Linda, involved 500,000 shares of Enron stock and was done through a family foundation, according to records and people involved in the case. The proceeds, totaling $1.2 million, did not go to the Lays, but were distributed to charitable organizations, which had already received pledges of contributions from the foundation.

Already, several Enron officers, including Mr. Lay; Jeffrey K. Skilling, a former chief executive; and Richard L. Causey, the former chief accounting officer, have been indicted on fraud charges. Other executives including Andrew S. Fastow, the former chief financial officer, have pleaded guilty to crimes and are serving as government witnesses.

By focusing on the transaction involving Mrs. Lay, the government could be trying to turn up the pressure on her husband in hopes of securing a guilty plea. Prosecutors used such tactics against Mr. Fastow, by starting an investigation into a comparatively minor tax violation committed by his wife, Lea.

People involved in the case said that Mr. Fastow was offered the opportunity to prevent his wife from being charged by pleading guilty; at the time he refused. Mr. Fastow did not reverse himself until his wife was indicted; she also pleaded guilty and is serving a prison term.

Andrew Weissmann, head of the Justice Department's Enron Task Force, declined to comment yesterday. A lawyer for the Lays, Michael Ramsey, confirmed the investigation, and criticized it as trying to criminalize innocent behavior to bring pressure against Mr. Lay.

"This is the last gasp of a dying prosecution,'' Mr. Ramsey said. "This is an attempt at extortion. If I tried something like this, I would be indicted.''

He said that the sale was based on information in the market and that the proceeds went to charity. Neither Ken nor Linda Lay sold any personal shares that morning, he said.

The investigation of Mrs. Lay is focusing on Nov. 28, 2001, the day investors realized that Enron was probably heading for bankruptcy.

That morning, Mrs. Lay placed an order for the foundation to sell its Enron shares sometime between 10 and 10:20, people involved in the case said. For days up until that morning, Enron had been negotiating a possible merger with a rival, Dynegy, and details of the talks had been leaking out in media reports.

The evening before, people involved said, Chuck Watson, then chairman and chief executive of Dynegy, told Mr. Lay and others at Enron that he had doubts about the merger. While Mr. Watson agreed to consult with his board and his merger team before reaching a decision, the prospects for a deal were dim.

Records show that Mr. Lay returned home that night and was in the office early the next morning. The government is investigating whether he told his wife about the falling prospects for the merger before she placed the sell order.

Before the market opened that morning, there were already rumors of problems with the deal. The news emerged at about 10:30 a.m., when Standards & Poor's announced that it was cutting its credit rating for Enron. That put Enron on the hook for making good on some $3.9 billion in debt in a matter of months.

The market reacted swiftly, knocking Enron shares down by more than $1.50 a share. Shortly after the market became aware of the downgrade, Enron shares were selling at $2.60 to $2.70, according to a transcript of a CNNfn market news broadcast that morning. Brokerage records from First Union Securities, where the foundation maintained its account, show that the shares were sold at $2.38, for proceeds of about $1.2 million. Enron shares closed at about 60 cents that day.

While the timeline of events is difficult for Mrs. Lay, the case presents numerous hurdles for the government. The largest of those is that the Lays did not profit from the sale; while their charitable group, the Linda and Ken Lay Family Foundation, did not have the assets to meet its pledges, the obligation for those commitments would remain with the foundation, not the family. Records show that, in the months after the sale, the proceeds were given away.

The second difficulty is evidentiary. If Mr. Lay did inform his wife of the imploding merger, such communication is protected as a marital confidence and its disclosure cannot be compelled. That means that the government must find a third-party witness who heard from Mr. or Mrs. Lay about any discussion to prove that she had insider knowledge at the time of the trade.

Continued in article

 

Timeline of Key Enron Events

Key Events in the Enron Saga Up to July 8, 2004
The Wall Street Journal, July 8, 2004, July 8, 2004 --- http://online.wsj.com/article/0,,SB108928566380358408,00.html?mod=home_whats_news_us 

Enron History --- http://en.wikipedia.org/wiki/Enron_scandal

1985: Houston Natural Gas merges with InterNorth to form Enron.

1985-2002 Chronology --- http://fpc.state.gov/documents/organization/9659.pdf

A chronology of New York Times articles is available at http://topics.nytimes.com/top/news/business/companies/enron/index.html?offset=0&s=newest

1994:  Enron Outsources Internal Auditing to External Auditor (Andersen) --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm#32

1996: Rich Kinder loses his CEO position to Jeff Skilling
         Enron's accounting books got cooked early on under his watch while Andersen's auditors turned a blind eye. 

You can download Enron's Infamous Home Video
Although it has nothing to do with the above professional movie, Jim Borden sent me a copy of the amateur video recording of Rich Kinder's departure from Enron (Kinder preceded Skilling as President of Enron).  This 1996 video features nearly half an hour of absurd skits, songs and testimonials by company executives.  It features CEO Jeff Skilling proposing Hypothetical Future Value (HPV) accounting with in retrospect is too true to be funny during the subsequent melt down of Enron.  George W. Bush (then Texas Governor Bush and his father) appear in the video.  You can download parts of it at  http://www.cs.trinity.edu/~rjensen/video/windowsmedia/enron3.wmv

Footnote:  Rich Kinder left Enron, formed his own energy company, and became a billionaire --- http://www.mcdep.com/MR11231.PDF
See Question 2 at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

 

January 24, 2000

Professor Lanbein’s testimony at http://www.senate.gov/~gov_affairs/012402langbein.htm 

2001

Oct. 16, 2001: Enron reports $638 million third-quarter loss and discloses $1.2 billion reduction in the value of shareholders' stake in the company, partly related to a web of partnerships run by Chief Financial Officer Andrew Fastow that had helped the company inflate profits and hide debt.

 

Oct. 24: Enron ousts CFO Fastow.

 

Oct. 31: Enron announces SEC inquiry has been upgraded to a formal investigation.

 

Dec. 2: Enron files for Chapter 11 bankruptcy, the largest in U.S. history at the time.

December 18, 2001
Robert Vigil’s testimony --- http://www.happinessonline.org/InfectiousGreed/p20.htm

2002

Jan. 23, 2002: Kenneth Lay resigns as Chairman and CEO.

 

June 15: Andersen convicted of obstruction.

 

Oct. 16: Andersen sentenced to probation and fined $500,000; firm was already banned from auditing public companies.

 

2003

March 23, 2003 --- Emails of 150 Enron executives are made public and archived

"The Immortal Life of the Enron E-mails: A decade after the Enron scandal, the company’s internal messages are still helping to advance data science and many other fields," by Jessica Leber, MIT's Technology Review, July 2, 2013 ---
http://www.technologyreview.com/news/515801/the-immortal-life-of-the-enron-e-mails/?utm_campaign=newsletters&utm_source=newsletter-daily-all&utm_medium=email&utm_content=20130702

Sept. 10, 2003: Former Enron Treasurer Ben Glisan Jr. pleads guilty to conspiracy, becomes first former Enron executive put behind bars. Glisan is sentenced to five years.

2004

Jan. 14, 2004: Andrew Fastow pleads guilty to conspiracy in a deal that calls for a 10-year sentence and his help in the continuing investigation. Lea Fastow pleads guilty to filing false tax forms in a deal that calls for a five-month sentence.

 

Jan. 22, 2004: Former chief accountant Richard Causey pleads innocent to a six-count indictment including conspiracy and fraud charges.

 

Feb. 19, 2004: Skilling indicted, pleads innocent to 35 counts accusing him of widespread schemes to mislead government regulators and investors about company's earnings.

 

May 6, 2004: Lea Fastow pleads guilty to a reduced charge of filing a false tax form, a misdemeanor, and is sentenced to one year in a federal prison, the maximum sentence.

 

July 8, 2004: Federal prosecutors unseal formal indictment of former Enron CEO Kenneth Lay; SEC to file civil charges.

 

November 18, 2004:  Ken Lay's wife comes under investigation for insider trading on Enron shares as the meltdown commenced.

December 10, 2004:  Former Enron Corp. President and CEO Jeffrey Skilling is trying to pull dozens of ex-colleagues and business associates into the public glare of his criminal conspiracy case. The move sheds light on both the breadth of alleged fraud at the fallen energy giant and the legal strategy of Mr. Skilling.

September 16, 2004:  Bye Bye Birdie
As part of an agreement with the federal government's Pension Benefit Guaranty Corporation (PBGC), beleaguered energy giant Enron Corp. has agreed to place $321 million in an escrow account in order to fully fund four defined-benefit pension plans. The money will come from proceeds of the $2.45 billion sale of the company's U.S. pipeline business. The pipeline business is considered to be Enron's most prized remaining asset.
AccounitngWeb, September 16, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99765 

 

2005

June 1, 2005:  The U.S. Supreme Court overturned the conviction of the Arthur Andersen accounting firm for destroying documents related to its Enron account before the energy giant's collapse. The ruling is not based upon guilt or innocence. It is based only on a technicality in the judge's instructions to the jury. The ruling will not lead to a revival of this once great firm that in the years preceding its collapse became known for some terrible audits of firms like Waste Management, Enron, Worldcom and other clients.  For details see http://news.bbc.co.uk/2/hi/business/4596949.stm
Also see http://accounting.smartpros.com/x48441.xml

June 15, 2005:  Following the Citigroup settlement, J.P. Morgan Chase & Co. agreed to pay $2.2 billion to settle a lawsuit filed by investors in Enron J.P. Morgan Chase & Co. agreed to pay $2.2 billion to settle a lawsuit filed by investors in Enron, according to the Associated Press. The decision by the third largest bank in the United States comes just four days after Citigroup said it would pay $2 billion to settle the claims against it in the shareholder lawsuit, which is led by the University of California’s Board of Regents. "Another Enron Settlement," Inside Higher Ed, June 15, 2005 --- http://www.insidehighered.com/news/2005/06/15/qt 

July 15, 2005: 
Enron Former Executive Pleads Guilty to Conspiracy
The guilty plea in Houston federal court yesterday by Christopher Calger, a 39-year-old former vice president in Enron's North American unit, involved a 2000 transaction known as Coyote Springs II in which the company sold some energy assets, including a turbine, to another company. In his guilty plea, Mr. Calger said that he and "others engaged in a scheme to recognize earnings prematurely and improperly" with the help of a private partnership, known as LJM2 that was run and partly owned by Enron's then-chief financial officer, Andrew Fastow. To avoid problems with Enron's outside auditors, company officials were "improperly hiding LJM2's participation in this transaction," according to Mr. Calger's plea.
John Emshjwiller, "Enron Former Executive Pleads Guilty to Conspiracy," The Wall Street Journal, July 15, 2005; Page B2 --- http://online.wsj.com/article/0,,SB112139210586786521,00.html?mod=todays_us_marketplace

August 15, 2005
"J.P. Morgan to Settle Enron 'Megaclaims' Suit," The New York Times, August 16, 2005 --- http://www.nytimes.com/aponline/business/AP-Enron-Megaclaims.html 

Two More Banks Settle Enron Claims J.P. Morgan Chase & Co. and Toronto-Dominion Bank will pay Enron a total of $480 million to settle allegations that they helped the once-mighty energy giant hide debt and inflate earnings. The settlement stems from a lawsuit filed by Enron against 10 banks. The suit contends the banks could have prevented the company's 2001 collapse if they hadn't “aided and abetted fraud,” the Houston Chronicle reported. "Two More Banks Settle Enron Claims," AccountingWeb, August 18, 2005 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=101212  

2006

May 25, 2006
Top Enron Executives are now convicted felons
"Lay, Skilling Are Convicted of Fraud:  Jurors Reject Defense Claim That Enron Was Clean; Question of Credibility Two 'Very Controlling People'," by John R. Emshwiller, Gary McWilliams, and Ann Davis, The Wall Street Journal, May 26, 2006; Page A1 ---  http://faculty.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates

May 31, 2006
Yet another Enron chapter
Jurors on Wednesday rendered a split verdict in the retrial of two former executives from Enron Corp.'s defunct broadband unit, convicting one while acquitting the other of all charges. Former broadband unit finance chief Kevin Howard was found guilty on five counts of fraud, conspiracy and falsifying records. Former in-house accountant Michael Krautz was acquitted of the same charges, concluding a month-long retrial after their original case ended with a hung jury last year.
Kristen Hays, "Jury Splits in Enron Case Retrial:  Ex-Broadband Finance Chief Guilty; Ex-Accountant Acquitted," The Washington Post, May 31, 2006 --- Click Here

July 5, 2006
Ken Lay found guilty in May 2006 on ten counts of fraud and conspiracy Prior to sentencing, Ken Lay died of a heart attack on July 5.

August 14, 2006
Federal prosecutors want former Enron Corp. CEO Jeffrey Skilling to turn over nearly $183 million for helping perpetuate one of the biggest business frauds in U.S. history - his alleged share and that of his late co-defendant, company founder Kenneth Lay. Federal prosecutors say Jeffrey K. Skilling, the former Enron chief executive, is liable not only for his own ill-gotten gains but also for those of the late Kenneth L. Lay --- Click Here

October 27, 2006
Skilling Sentenced to 24 Years plus Four Months: Club Fed is Easier Than State Prison, But Very Early Paroles Are Less Likely
Oct-27-2006 - Former Enron Chief Executive Officer (CEO) Jeffrey Skilling was sentenced last Monday to 24 years and four months in prison for his role in the corporate accounting scandal that gave its name to an era. The Securities and Exchange Commission (SEC) announced that it would begin distributions to Worldcom investors from the Fair Fund. And while the Enron and Worldcom corporate accounting scandals set the stage for congressional action and passage of the Sarbanes-Oxley Act (SOX) in 2004, criminal prosecutions in these cases have not lessened the SEC’s work load. The current stock options backdating scandal threatens to keep the SEC occupied for years. U.S. District Court Judge Sim Lake denied bond while Skilling appeals his sentence and ordered him to home confinement with an ankle monitor, the Associated Press reports. Judge Lake has recommended that Skilling be sent to a federal facility in Butner, North Carolina. There is no parole in federal sentencing, but like Bernie Ebbers, former Chief Executive Officer of Worldcom who is serving a 25-year sentence, Skilling could get two months a year taken off for good behavior.
AcountingWeb, October 27, 2006 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=102732

November 9, 2006
Enron Investors and Their Lawyers Aiming at Deep Investment Banking Pockets
Andersen Coughs Up $72.5 More Millions for Enron's Investors
Lawyers representing Enron investors have already won settlements for $7.3 billion of the $40 billion shareholders claim they lost in Enron’s 2001 collapse. On Nov. 1, the latest settlement — an agreement by Arthur Andersen, Enron’s former accounting firm, to pay $72.5 million — was disclosed. But it is far from clear whether the testimony of Mr. Fastow, a convicted felon who masterminded some of the fraudulent transactions that hid the company’s poor financial health, will be enough to push the seven banks that have not settled to the negotiating table.
Lexei Barrionuevo, "Fastow Gets His Moment in the Sun," The New York Times, November 10, 2006 --- Click Here 

November 16, 2006
Of all the Enron accounting executives (Fastow was the CFO who knew epsilon about accounting) I wanted Rick Causey sent up river. Causey was the Chief Accounting Officer who worked out most of the accounting fraud and was the closest conspirator with David Duncan, Andersen's manager of the less-than-independent audit. Causey mysteriously was not called on to testify in the trials of Lay and Skilling, purportedly because he was "not a rat." It appears that he was a bit more of a rat than previously reported.
"Ex-Enron Officer Given 5˝ Years in Prison," The New York Times, November 16, 2006 --- http://www.nytimes.com/2006/11/16/business/16enron.html

2007

****************************************

March 13, 2007 --- Arthur Andersen to Pay $73M In Enron Deal
A federal judge gave final approval to a $72.5 million settlement between Arthur Andersen and investors who sued the accounting firm over its role in the 2001 collapse of Enron.
"Arthur Andersen to Pay $73M In Enron Deal," SmartPros, March 13, 2007 --- http://accounting.smartpros.com/x56911.xml

The lead plaintiff, University of California Board of Regents, has recovered more than $7.3 billion, including $2 billion or more each from Canadian Imperial Bank of Commerce, J.P. Morgan Chase (NYSE: JPM) and Citigroup (NYSE: C), but Merrill Lynch (NYSE: MER) and Credit Suisse Group (NYSE: CS), who are also named in the lawsuit, have asked a U.S. appeals court in New Orleans to rule that the complaint should not have been certified as a class action.

U.S. District Judge Melinda Harmon signed the final order, effectively ending the now defunct accounting firm's involvement in the $40 billion class-action lawsuit.

Arthur Andersen was convicted in June 2002 of obstruction of justice for its role in the Enron saga. The U.S. Supreme Court later overturned the conviction, but the accounting firm is now virtually out of business.

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April 2, 2007 --- "Enron Pays Out $1.47B to Creditors," SmartPros, April 3, 2007 ---
http://accounting.smartpros.com/x57146.xml

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June 18, 2007
Remember the Enron Executive whose desk was a motorcycle in his tower office?
Kenneth Rice, who turned government witness and testified in the trial of former Enron CEO Jeffrey Skilling and company founder Kenneth Lay, was sentenced Monday to 27 months in prison.
"Ex-Enron Broadband Head Sentenced," The New York Times, June 18, 2007 ---
http://www.nytimes.com/aponline/business/AP-Enron-Broadband.html?ref=business

"Last of 15 Enron Defendants Sentenced:  Former Broadband Chief Gets Lesser Prison Term After Aiding Prosecutors," by Carrie Johnson, The Washington Post, June 19, 2007 --- Click Here

The former chief of Enron's Internet business unit was sentenced to 27 months in prison yesterday, closing what could be the final chapter in the Houston energy trader's downfall.

Kenneth D. Rice, 48, is the 15th and final Enron official to face punishment for his role in the company's bankruptcy more than five years ago. Under federal guidelines, he must serve nearly two years, or 85 percent, of the sentence handed down by U.S. District Judge Vanessa D. Gilmore yesterday in a Houston courtroom.

Kenneth D. Rice, shown with daughter Kirsten Rice, got a 27-month sentence. His testimony helped win the conviction of Enron's top two executives. (By F. Carter Smith -- Bloomberg News)

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"What got me here is, I lied over about a two-year period, on a number of occasions, to the investing community," Rice said yesterday, according to Bloomberg News. "I wasn't raised that way, and I'm ashamed of that."

Rice told the jury in last year's criminal trial of Enron's two top executives that he and others misrepresented the financial health of Enron Broadband Services, a highly touted division that posted billions of dollars in losses. His testimony helped prosecutors win the conviction of former chief executive Jeffrey K. Skilling, who is serving a prison term of 24 1/3 years. Company founder Kenneth L. Lay died in July 2006 before he could be sentenced.

Rice faced as much as a decade in prison and agreed to forfeit cash, sports cars and jewelry worth $14.7 million under the terms of his 2004 plea agreement. Between February 2000 and June 2001, Rice sold $53 million worth of Enron stock, some at a time when he later said he had access to secret information about its high debt burdens.

Once among Skilling's closest confidants and companions on off-road adventure tours, Rice ultimately turned against him. Rice was known within Enron's gleaming office towers as a risk taker who collected motorcycles and fast cars, including a Ferrari and a Shelby he turned over to the government as part of his plea deal.

Federal prosecutors Ben Campbell and Jonathan E. Lopez argued that Rice should receive a reduced prison term in exchange for his testimony against his former colleagues.

"Mr. Skilling would simply say . . . 'this is the number, this is what the number is going to be,' " Rice told jurors in February 2006 about the process of generating financial projections.

October 2007

Then how come Merrill Lynch is on the verge of escaping the wrath of investors because of its involvement in some of Enron's corporate and accounting frauds? The Securities and Exchange Commission lays out the facts in various documents such as Litigation Release No. 20159 and Accounting and Auditing Enforcement Release No. 2619, and in the related Complaint in the U.S. District Court.
"The Accounting Cycle:  The Merrill Lynch-Enron-Government Conspiracy," by: J. Edward Ketz, SmartPros, October 2007 --- http://accounting.smartpros.com/x59129.xml 

2008

January 20, 2008

Employees and creditors lost hope of more settlements when the U.S. Supreme Court let investment banks off the hook on January 20, 2008 --- http://www.nytimes.com/2008/01/23/business/23enron.html 

January 29, 2008

The Justice Racer Cannot Beat a Snail:  Andersen's David Duncan Finally Has Closure

"Andersen Figure Settles Charges: Former Head of Enron Team Barred From Some Professional Duties," by Kristen Hays, SmartPros, January 29, 2008 --- http://accounting.smartpros.com/x60631.xml 

The former head of one-time Big Five auditing firm Arthur Andersen's Enron accounting team has settled civil charges that he recklessly failed to recognize that the risky yet lucrative client cooked its books.

David Duncan, who testified against his former employer after Andersen cast him aside as a rogue accountant, didn't admit or deny wrongdoing in a settlement with the Securities and Exchange Commission announced Monday.

The SEC said in the settlement that he violated securities laws and barred him from ever practicing as an accountant in a role that involves signing a public company's financial statements, such as a chief accounting officer. But he could be a company director or another kind of officer and was not assessed any fines or otherwise sanctioned.

Three other former partners at the firm have been temporarily prohibited from acting as accountants before the SEC in separate settlements unveiled Monday.

Andersen crumbled amid the Enron scandal after the accounting firm was indicted, tried and found guilty -- a conviction that eventually was overturned on appeal.

The settlements came six years after Andersen came under fire for approving fudged financial statements while collecting tens of millions of dollars in fees from Enron each year.

Greg Faragasso, an assistant director of enforcement for the SEC, said Monday that the agency focused on wrongdoers at Enron first and moved on to gatekeepers accused of allowing fraud to thrive at the company.

"When auditors of public companies fail to do their jobs properly, investors can get hurt, as happened quite dramatically in the Enron matter," he said.

Barry Flynn, Duncan's longtime lawyer, said his client has made "every effort" to cooperate with authorities and take responsibility for his role as Andersen's head Enron auditor.

That included pleading guilty to obstruction of justice in April 2002, testifying against his former employer and waiting for years to be sentenced until he withdrew his plea with no opposition from prosecutors.

"After six years of government investigations and assertions, surrounding his and Andersen's activities, it was decided that it was time to get these matters behind him," Flynn said.

Duncan, 48, has worked as a consultant in recent years.

He was a chief target in the early days of the government's Enron investigation as head of a team of 100 auditors who oversaw Enron's books. In the fall of 2001, he and his staff shredded and destroyed tons of Enron-related paper and electronic audit documents as the SEC began asking questions about Enron's finances.

Andersen fired Duncan in January 2002, saying he led "an expedited effort to destroy documents" after learning that the SEC had asked Enron for information about financial accounting and reporting.

The firm also disciplined several other partners, including the three at the center of the other settlements announced Monday. They are Thomas Bauer, 54, who oversaw the books of Enron's trading franchise; Michael Odom, 65, former practice director of the Gulf region for Andersen; and Michael Lowther, 51, the former partner in charge of Andersen's energy audit division.

Their settlement agreements said that they weren't skeptical enough of risky Enron transactions that skirted accounting rules. Odom and Lowther were barred from accounting before the SEC for two years, and Bauer for three years. None was fined.

Their lawyer, Jim Farrell, declined to comment Monday.

Duncan's firing and the other disciplinary moves were part of Andersen's failed effort to avoid prosecution. But the firm was indicted on charges of obstruction of justice in March 2002, and Duncan later pleaded guilty to the same charge.

In Andersen's trial, Duncan recalled how he advised his staff to follow a little-known company policy that required retention of final audit documents and destruction of drafts and other extraneous paper.

That meeting came 11 days after Nancy Temple, a former in-house lawyer for Andersen, had sent an e-mail to Odom advising that "it would be helpful" that the staff be reminded of the policy.

Duncan testified that he didn't believe their actions were illegal at the time, but after months of meetings with investigators, he decided he had committed a crime.

Bauer and Temple invoked their 5th Amendment rights not to testify in the Andersen trial. However, Bauer testified against former Enron Chairman Ken Lay and CEO Jeff Skilling in their 2006 fraud and conspiracy trial.

Andersen insisted that the document destruction took place as required by policy and wasn't criminal, but the firm was convicted in June 2002.

Three years later the U.S. Supreme Court unanimously overturned the conviction because U.S. District Judge Melinda Harmon in Houston gave jurors an instruction that allowed them to convict without having to find that the firm had criminal intent.

That ruling paved the way for Duncan -- the only individual at Andersen charged with a crime -- to withdraw his guilty plea in December 2005.

In his plea, he said he instructed his staff to comply with Andersen's document policy, knowing the destroyed documents would be unavailable to the SEC. But he didn't say he knew he was acting wrongfully.

I draw some conclusions about David Duncan (they're not pretty) at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

February 2008

British Ex-Bankers Sentenced For Their Roles in Enron Fraud
Three former U.K. bank executives who pleaded guilty for their roles in a fraudulent scheme with former Enron Corp. Chief Financial Officer Andrew Fastow have been sentenced to a little over three years in prison. A federal judge Friday sentenced David Bermingham, Giles Darby and Gary Mulgrew to 37 months each. In November, the three men, who had worked at Greenwich NatWest, a unit of Royal Bank of Scotland Group PLC, each pleaded guilty to one count of wire fraud as part of a plea agreement. They had initially said they were not guilty of colluding with Mr. Fastow in a secret financial scam in 2000 to enrich themselves at their employer's expense. Their sentences matched the recommendation of federal prosecutors. All three also have agreed to pay their former employer more than $13 million. The trio became a cause célčbre in the U.K. throughout extradition proceedings that lasted two years. They were dubbed the "NatWest Three." Their attorneys have said they would work with prosecutors to see if the bankers can serve part of their sentences in the U.K.
The Wall Street Journal, February 25, 2008; Page B6 --- http://online.wsj.com/article/SB120389540579389219.html?mod=todays_us_marketplace 

June 3, 2008

Enron Recovery Rate Hits 50 Percent
Enron Creditors Recovery Corp. said Monday that with the latest distributions, creditors of the former Enron Corp. had received 50.3 cents on the dollar and creditors of Enron North America Corp. had gotten back 50 cents on the dollar. Both figures excluded gains, interest and dividends. John J. Ray III, president and chairman of the recovery corporation, said creditors had received "significantly more than originally was anticipated under the plan." The recovery corporation said it made a distribution Monday totaling about $4.17 billion to holders of unsecured and guaranty claims and distributed $1.87 billion on May 13 to newly allowed unsecured and guaranty claims that resulted from a settlement with Citigroup.
SmartPros, June 3, 2008 --- http://accounting.smartpros.com/x62107.xml

September 10, 2008

"Billions to Be Shared By Enron Shareholders," SmartPros, September 10, 2008 --- http://accounting.smartpros.com/x63157.xml

A federal judge has approved a plan to distribute more than $7.2 billion recovered as part of a lawsuit by Enron Corp. shareholders and investors in connection with the company's collapse.

U.S. District Judge Melinda Harmon also approved $688 million in attorneys fees, the largest ever in a securities fraud case.

About 1.5 million individuals and entities will be eligible to share in the distribution under the settlement plan. The plan was part of a $40 billion lawsuit claiming financial institutions participated in the accounting fraud that led to Enron's downfall.

The $7.2 billion comes mostly from settlements made with such financial institutions as Bank of America Corp., JPMorgan Chase & Co. and Citigroup Inc.

No mention is made of a penny to the 10,000 employees who lost their jobs and pensions.

October 15, 2008

"Former Enron Exec Pleads Guilty," USA Today, October 15, 2008 ---
http://blogs.usatoday.com/ondeadline/2008/10/ex-enron-execut.html?loc=interstitialskip

The former chief executive of Enron Broadband Services pleaded guilty today to one felony count of wire fraud rather than risk a second jury trial.

Joseph Hirko, 52, of Portland, Ore., will serve no more than 16 months in prison and must pay $8.7 million in restitution for Enron victims. He also agreed to cooperate in other broadband prosecutions. Sentencing is set for March 3.

Hirko admitted to allowing press releases to be distributed in 2000 that said a groundbreaking operating system had been embedded in Enron's broadband network that would allow users to pay only for bandwidth they used instead of a flat monthly fee. The operating system was still being developed, however, and never materialized.

In accepting the plea deal, U.S. District Judge Vanessa Gilmore issued a stern, civics reminder to Hirko, the Houston Chronicle said.

''Mr. Hirko, let me remind you that as a convicted felon, you may not vote in the upcoming election,'' Gilmore said. ''Don't make that mistake.''


March 2009
All outstanding lawsuits against Enron are dismissed ---
http://faculty.trinity.edu/rjensen/FraudEnron2009Notice.pdf


June 2009 Former Head of Auditing at Andersen, C.E. Andrews,  is appointed CEO of McGladrey

Question
How many of you recall the infamous Footnote 16 testimony of C.E. Andrews in the Senate hearings when Andersen was near but not quite over the cliff?

"McGladrey Reorganizes, Celebrates New Logo With Monster Cake," by Susan Black, Big Four Blog, June 24, 2010 ---
http://bigfouralumni.blogspot.com/2010/06/mcgladrey-reorganizes-celebrates-new.html

RSM McGladrey (tax and consulting) and partner firm McGladrey & Pullen (assurance) recently decided to go to market under the "McGladrey" brand. Combined, the firms are fifth-largest U.S. firm with revenues of $1.5 billion, 7,000 professionals in nearly 90 offices. Also, the firms recently realigned to focus on national lines of business and industry. Both firms are members of RSM International, the sixth largest global network in the world, and operate as separate legal entities in an alternative practice structure

We wonder if this is the influence of C.E. Andrews, who took over last year 2009 as president and chief operating officer of RSM McGladrey. C.E. Andrews was almost 30 years at Andersen; most recently as head of Audit. And Andersen did shorten its prior name of Arthur Andersen and changed its logo from the double doors to the orange sun.

Continued in article

 

When C.E. Andrews Fumbled a Footnote
Flashback to Year 2002 --- http://faculty.trinity.edu/rjensen/FraudEnron.htm#Senator

 


February 25, 2010

"“Honest services” fraud: Round 3:  Skilling v. U.S., 08-1394, Argument preview," by Lyle Denniston, Scotus Blog, February 26th, 2010 ---
http://www.scotusblog.com/2010/02/%e2%80%9chonest-services%e2%80%9d-fraud-round-3/

For the third time this Term, the Supreme Court will examine the scope of the controversial 1988 law that makes it a crime to commit fraud that deprives someone, such as one’s company, of “the intangible right of honest services.” It does so in the leading criminal case growing out of the Enron business scandal. This time, however, the Court may confront the constitutionality of that law, since the new case involves a claim that the law is so broadly worded that no one can know what it outlaws, thus making it unconstitutionally vague. The case has an added dimension: the Court is asked to spell out how trial judges should deal with massive negative publicity that surrounds a criminal case.

Background

In October 2001, the giant energy company, Enron Corp. — the nation’s seventh largest business firm — suddenly collapsed and soon was in bankruptcy, wiping out workers’ jobs and retirees’ savings, and devastating the entire local economy in Houston. After the company’s fall, the economic and personal disaster was often compared locally to the devastation of the Sept. 11, 2001, terrorist attacks on the U.S. The scandal mushroomed, and President George W. Bush named a special task force to track down any criminality. Three years after the fall, a major show trial started, after a wave of fevered calls for revenge for what had been done to Houston, and after other prosecutions for Enron-related crimes had raised expectations over what was called the “main event.” The flow of negative news stories dogged that trial. Now, nearly six years later, in the quiet, decorous chamber of the Supreme Court, the Justices take their first full-scale look at that trial, its outcome, and the publicity.

The appeal the Justices will hear focuses on Jeffrey K. Skilling, a longtime executive of Enron who resigned as CEO shortly before the scandal broke into public view. Skilling is now in prison, initially sentenced to 24 years and four months and ordered to pay $45 million in restitution. Although his sentence is scheduled to be reviewed anew in lower courts, that review would not directly affect his conviction. His appeal, though, seeks an entirely new trial, to be held somewhere other than Houston.

On May 25, 2006, after the four-month trial, Skilling was convicted of one count of conspiracy to commit securities fraud and wire fraud (the “honest services” charge is keyed to that count), 12 counts of securities fraud, five counts of making false statements to accountants, and one count of insider trading. The jury found him not guilty of nine counts of insider trading in Enron stock. His conviction was upheld by the Fifth Circuit Court, but that Court ordered a new sentencing because of a flaw in calculating the sentence due under federal Sentencing Guidelines.

Prosecutors charged that Skilling was at the center of an elaborate plot to deceive investors about the state of Enron’s fiscal health. The plot allegedly included over-statement of the company’s financial condition for more than two years in an attempt to keep the company’s stock price high and rising. (Convicted along with Skilling was his predecessor as CEO, Kenneth Lay, who died before he could be sentenced. Others in the case have pleaded guilty.)

Skilling’s challenge to his trial in Houston and to his conviction and sentence wound through lower courts for more than two years, then reached the Supreme Court in May of last year. It arrived on the Court’s docket just shortly before the Court on May 18 agreed to hear two other cases testing the federal “honest services” fraud law. Those cases are Black v. U.S. (08-876) and Weyhrauch v. U.S. (08-1196), both heard by the Justices on Dec. 8 and now awaiting decisions. Neither involves a direct constitutional challenge to that law. The Black case tests whether that law applies to a private individual whose alleged fraud did not result in any economic harm to his company. The Weyhrauch case tests whether the law applies to a state official if that official did not violate any state law.

Petition for Certiorari

Much of Skilling’s challenge deals with his claim that he could not possibly have gotten a fair trial in Houston amid what his lawyers call the “devastating impact” of the scandal on the entire city and region, and the resulting “vitriolic” and “blistering” publicity about the accused executives. His attorneys claimed in the petition that “the community passion” stirred up by the case “was as dramatic as any in U.S. criminal trial history.”

But, among those who specialize in criminal law, the case has a higher profile because of its broad challenge to the constitutionality of the federal law that criminalizes any form of fraud, if the misconduct deprived another of “the intangible right of honest services.” That law, enacted by Congress 22 years ago to overturn a Supreme Court decision (McNally v. U.S., 1987), is a favorite tool of federal prosecutors, especially in public and private corruption cases. Its undefined language has led to countless efforts by federal judges to give it some particular meaning in order to save its constitutionality. Skilling’s appeal assailed that effort, arguing that the resulting array of lower-court rulings “is a hodgepodge of oft-conflicting holdings, statements, and dicta” that “only the most discriminating lawyer or judge” could understand.

In Skilling’s case, the “honest services” fraud law was invoked by prosecutors to bolster their overall charge of a conspiracy to commit securities and wire fraud. One aim of his wire fraud, prosecutors said, was to deprive Enron of his “honest services.” They had other theories for the conspiracy count; those are at most implicitly at issue. The focus of Skilling’s petition, on this point, was that the “honest services” theory cannot be applied to an individual who did not make any private gain; his lawyers contended that his only purpose was to benefit Enron, by boosting the value of its stock. If the law does not exclude those who had not pursued personal gain, then it should be struck down as too vague, the petition argued. The Court should clear up lower-court confusion on the gain issue, the petition asserted, since three appeals courts allow the law to be applied even when there was no such gain, while two others do not.

The petition raised the constitutional argument in a somewhat subtle way. While implying that excluding from the law cases that do not involve private gain might save the law from being struck down, it suggested that “even that limitation may not suffice to save the statute from unconstitutional vagueness.” The implication, of course, was that the Court would have to strain to uphold the statute whether or not it narrowed it as Skilling had suggested.

The “honest services” issue was the petition’s first question. In its second, Skilling asked the Court to rule that, if negative publicity about a criminal case is so widespread and inflammatory that it creates “a presumption” that no jury could be fair, then the conviction must be overturned and a new trial automatically ordered. The problem cannot be cured, it argued, by questioning potential jurors to see if they can show that they would be fair and impartial. If juror questioning might be a remedy for such an indication of prejudice, the petition argued, the Court should rule that it actually is a remedy only if prosecutors prove “beyond a reasonable doubt” that no juror was actually prejudiced.

The Justice Department, in response, urged the Justices to bypass Skilling’s case or, at most, to hold it for action until after it decided the Black case on the scope of the “honest services” law. The government’s first argument against review was that, since the Fifth Circuit had ordered a new sentencing, the case was not really final at this stage and thus the Court should not get involved. Moreover, it noted that Skilling’s lawyers were intending to file a new motion for a new trial.

In seeking to counter his challenge regarding the absence of any proof of “private gain,” the Department said that the prosecutor’s claim of denying “honest services” to Enron was only one of three theories used to support the fraud conspiracy count against Skilling. Thus, it contended, the jury verdict on that count would have been the same even without that theory. On Skilling’s prejudical publicity claim, the government said that his would not be a good case to use to review what must be done if publicity has created “a presumption of jury prejudice” since that presumption was unwarranted in this case. Such a presumption exists, it argued, only in an extreme situation, and this case does not meet that standard. Although the Fifth Circuit had found such a presumption to exist (but allowed it to be overcome during juror question), the government contended that any such presumption was overcome in this case by questioning jurors to check for prejudice. A finding of a presumption of juror bias can be cured without resorting to automatic reversal and a new trial, it concluded.

Merits Briefs

Skilling’s brief on the merits represented some new strategic calculations by his attorneys. They put their initial emphasis on the prejudicial publicity issue, thus giving it more prominence — perhaps reflecting the fact that, if this succeeded, it could overturn all of the conviction, not just the conspiracy count keyed to “honest services” (although the brief does contend that the problem with the “honest services” charge infected the entire verdict.) Just as significantly, the brief makes an unmistakable constitutional attack on the “honest services” law, contending that it simply cannot be saved no matter how it might be narrowed, because that would not be a legitimate judicial effort.

The challenge to the publicity surrounding the case begins at the top of the brief: “Skilling’s trial never should have proceeded in Houston.” Once it was allowed to go forward there, his lawyers argued, a conviction was assured. Houston, they contended, was “rife with the anger and pain engendered by Enron’s collapse,” and “there was no legitimate justification” for not transferring the case to a place “where jurors could be presumed impartial, instead of the opposite.”

Once defense lawyers had demonstrated the effect of the Enron collapse and the ensuing publicity on the trial, the brief asserted, there was no way to cure it by asking jurors to confess to their bias — something they could not be expected to do. In fact, the juror questioning that did occur came during a “truncated” five-hour session, “with no individual questioning” of jurors, according to the brief; that process, it added, “did almost nothing to weed out prejudices exposed” on the questionnaires the jurors had filled out before being questioned.

Moving on to the “honest services” issue, the Skilling brief said that, if the negative publicity was not enough to assure a conviction, then the prosecutors’ use of a vague statute cemented their prospect of guilty verdicts for the top Enron brass. That led into the frontal challenge to the law’s constitutionality, citing again the “morass of conflict and confusion” about the law’s meaning. It noted that, while the McNally case had sought to force Congress to clarify the “honest services” concept, Congress did not do so. The brief then made a sharp new thrust: “It is beyond the judicial function to identify…the crime that Congress failed to define.”

As a fallback, the brief suggested that, if the Justices “were inclined to complete Congress’s work,” they should limit the “honest services” law to bribes and kickbacks. Going further, the brief said that the Court, if inclined to read the statute as encompassing anything beyond bribes and kickbacks, should not include the kind of conduct in which Skilling was accused of engaging: “pursuing his normal compensation scheme” without harm to Enron. Only in the brief’s concluding point did it suggest that the Court should put outside the law’s scope any conduct that did not involve direct personal gain at the company’s expense.

The Justice Department’s brief on the merits accepted the Skilling challenge of putting the prejudicial publicity issue first, and sought to refute it by contending that it is the defense counsel’s task to show juror bias, not the prosecutors’ to refute it. An accused individual, it argued, “is not deprived of a constitutional right unless he can show that a selected juror was biased” In the Skilling case, it insisted, the questioning of jurors about the effect of the publicity was not inadequate; rather, it argued, the trial judge did a “meticulous and careful” job that, in fact, “produced an unbiased jury.” The government relied upon the Court’s 1991 decision in Mu’min v. Virginia for the proposition that “a trial judge’s vigilance in voir dire is fully capable of ferreting out bias and that the judge’s decisions to seat a juror are entitled to deference on appeal.”

Moreover, the Department’s brief argued that the Court has repeatedly shown that it regards the remedy of automatic reversal of a conviction because of trial error as being available “only in a very limited class of cases.”

On Skilling’s description of the impact of Enron’s collapse on the Houston area, the government brief contended that the Constitution does not guarantee “a trial in a venue whose populace has no exposure to the effects of the defendant’s crime or adverse pretrial publicity about it.”

Turning to the constitutionality of the “honest services” law, the government repeated arguments that it has made in the other cases this Term involving that law — that is, that the body of lower court rulings that has built up over the years points in a clear direction. What those precedents mean, it asserted, is that the statute is violated if there is “a breach of the duty of loyalty, intent to deceive, and materiality.” The prosecution of Skilling, it said, satisfied all three. On the “personal gain” question, the government brief said that Skilliing, even though pursuing his own compensation interests, actually was seeking personal gain. By seeking to inflate the price of Enron stock, it contended, Skilling actually was seeking “additional personal benefits at the expense of stockholders.”

Among amici briefs, Skilling’s constitutional assault on the “honest services” law drew strenuous support from the U.S. Chamber of Commerce, the National Association of Criminal Defense Lawyers, and Texas defense counsel, and by two right-of-center legal advocacy groups — the Pacific Legal Foundation and the Cato Institute. Those two groups made a special effort to try to persuade the Court to treat the accused in complex business cases to the same protection from vague criminal laws that ordinary criminals get. The NACDL brief also sought to reinforce the Skilling challenge on the prejudicial publicity point, arguing both that jury questioning cannot cure a demonstration of likely community bias, and that the attempt to do so in this case was seriously inadequate. The government’s challenge to the Skilling demand for automatic reversal due to a “presumption” of prejudice from publicity gained the support of a host of media organizations, arguing that putting such a presumption beyond possible rebuttal would “create a significant new incentive to restrict press coverage of the most intensely followed prosecutions and thwart the value of openness.”

Analysis

It is already clear that there is, among some members of the Court (most notably, Justice Antonin Scalia), a deep skepticism about the constitutionality of the “honest services” law. The decision by Skilling’s lawyers to harden their challenge to it in their merits brief, and the support that challenge gets from amici, very likely increase the chances that the Court will be prepared to rule directly on the law’s validity. The fact that Congress has made no effort to clarify the law’s scope, in the face of a widely varying array of interpretations by lower courts, may make the Court reluctant to re-craft the law itself. The Court has seen, in the three cases this Term testing the law’s reach, how difficult it seems to be to know what it actually covers.

There was another small hint to suggest that the Court, in fact, is quite interested in the constitutional question. Three days after the Skilling merits brief was filed, with its direct complaint about the law’s validity, the Court moved the Skilling case ahead on its docket, to give the Court an earlier chance to hear lawyers’ argument on it. No one outside the Court knows why it advanced the case, but the Justices clearly were keen on getting to it.

One potential point of hesitancy, however, would be the Court’s sometime devotion to the notion that constitutional judgments should be avoided unless clearly necessary. Skilling’s lawyers have given the Court a series of alternative approaches that could save the law by narrowing it. Those are ready at hand, if the Court should find it difficult to reach five votes to nullify the law outright.

The dispute in Skilling about how to deal with pervasive negative publicity before and during a criminal trial is more difficult to analyze. His lawyers have painted a vivid portrait of the virulence of the publicity surrounding the Enron trial and just as vivid a picture of the personal and economic wreckage that the scandal-driven Enron collapse did to the Houston area. Those are portrayals that the media organizations, as amici, have not been fully successful in neutralizing. But, even if the Court were moved by the recollection of the wreckage, it is by no means clear that it would be prepared to opt for automatic reversal of convictions and a new trial as the sole available remedy. Perhaps the Court might mandate a more thorough juror questioning process than was done in the Enron case, however.

The media organizations, in the most significant point in their brief, noted that the Supreme Court has not found a case of presumed prejudice by publicity about a criminal trial since the “watershed case of Sheppard v. Maxwell,” and that was 44 years ago. (Actually, according to the Justice Department merits brief, the last instance was somewhat further in the past than that: the case of Rideau v. Louisiana in 1963, 47 years ago.)

June 24, 2010 Skilling wins his Supreme Court case that will now be sent back to the lower courts. Winning this appeal does not necessarily mean that he will receive an early release for prison. The Supreme Court denied his request for a new trial in Houston due to adverse publicity about Enron ---
http://www.nytimes.com/2010/06/25/us/25scotus.html?hp

2011

Belatedly after more than a decade (the name of the whistleblower is not disclosed and he was not an Enron employee)
"IRS pays Enron whistleblower $1.1 million," by David S. Hilzenrath, Washington Post, March 15, 2011 ---
http://www.washingtonpost.com/business/economy/irs-pays-enron-whistleblower-11-million/2011/03/15/ABFLAEb_story.html

May 18, 2011
Andy Fastow is out of prison

November 8, 2011
"ENRON’S TENTH ANNIVERSARY: THE CRIMES," by Anthony H. Catanach and J. Edward Ketz, Grumpy Old Accountants, November 7, 2011
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/357#more-357

May 2013
"DEAL REACHED: Former Enron CEO Jeff Skilling Could Get Out Of Prison 10 Years Early," by Erin Fuchs, Business Insider,  May 8, 2013 ---
http://www.businessinsider.com/jeffrey-skilling-plea-deal-2013-5

Former Enron CEO Jeff Skilling has reached a deal with federal prosecutors to get out of prison a decade before his 24-year prison sentence is up.

Under the deal Skilling — who was convicted of fraud for his role in the collapse of Enron — would get out of prison in 2017, the Justice Department announced. Skilling has agreed to forfeit more than $40 million and give up the right to appeal his conviction.

A Justice Department spokesman said the deal ensures Skilling is "appropriately punished" and that Enron victims get restitution. A judge will have to sign off on the deal.

Skilling has served six years of his sentence so far. In October 2006, Skilling got the 24-year sentence for his role in the massive accounting fraud that caused Enron's downfall.

Continued in article


Read more: http://www.businessinsider.com/jeffrey-skilling-plea-deal-2013-5#ixzz2SjY5iMMb
 

November 2013

"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 whistle-blowing ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

Bob Jensen's threads on Enron, including a timeline ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

 

 

February 2019

Former Enron CEO Jeffrey Skilling released from federal custody ---
https://www.businessinsider.com/r-former-enron-ceo-jeffrey-skilling-released-from-federal-custody-2019-2

 


More Absurd Dictatorial and Counterproductive Behavior of Big Brother (read that the  Texas State Board of Public Accountancy)
Courtesy of his former doctoral student Bill Kinney, Bob Jensen was contacted by Danny and was then briefly quoted in this one ---
"Accountants, Texas board still at odds over Enron," by Danny Robbins, Bloomberg, December 24, 2010 ---
http://www.bloomberg.com/news/2010-12-24/accountants-texas-board-still-at-odds-over-enron.html 

To many in the accounting world, Carl Bass is a hero. Long before Enron became a worldwide symbol of scandal, Bass told his supervisors at Arthur Andersen LLP that something was amiss with the Houston energy giant.

But the Texas state board that licenses accountants sees Bass differently — as unfit to continue in his profession.

Nearly a decade after Enron collapsed and took Arthur Andersen with it, the work of Bass and another former Andersen partner, Thomas Bauer, as Enron auditors is still being debated in a highly contentious and costly proceeding.

The Texas State Board of Public Accountancy has stripped Bass and Bauer of their CPA licenses after determining they violated professional standards in their audits. But the pair has pushed back with a legal challenge that led a judge to rule that the license revocations should be voided because the board violated the Texas Open Meetings Act.

The revocations remain in effect while the matter is under appeal, which could take at least a year.

The upshot is a standoff playing out after most of the figures in the Enron scandal have had their days in court and raising questions about a little-known state agency that doesn't rely on the Legislature for funding.

William Treacy, the board's executive director, said it's in the public interest for Bass and Bauer to be barred from working as CPAs. He cited the depth of the Enron scandal, which led to more than $60 million in lost company stock value and more than $2 billion in losses from employee pension plans.

"There's a lot more than two licenses at stake," Treacy said. "Let's not forget the thousands of people who lost their life savings, their jobs and their pensions."

The board argues that Bass and Bauer should have their licenses revoked because they failed to follow accepted accounting practices in conducting Enron audits in 1997 and 1998.

But some observers believe the case is more one of overzealousness by the agency than insufficient audits.

Wayne Shaw, a professor of corporate governance at SMU's Cox School of Business in Dallas, said it's unusual to see licenses revoked over flawed audits unless the accountants were complicit or showed total disregard for accepted procedures. That's particularly true for audits like those involved with Enron, he said.

"I don't think people comprehend how complex Enron was, the mathematics behind some of these transactions," Shaw said.

Some experts contacted by The Associated Press were stunned to learn that the state was taking such drastic action against Bass. Documents released by a U.S. House committee in 2002 showed that he challenged Enron's accounting practices as early as 1999 and was later removed from Andersen's Professional Standards Group because of complaints from Enron over his criticism.

"Instead of punishing Carl Bass, he should be given a medal," said Bob Jensen, a former accounting professor at Trinity University in San Antonio.

Jensen said the Texas accounting board has gained a reputation as "Big Brother."

"What's happening (with Bass and Bauer) strikes me as absolutely absurd, but it doesn't surprise me," he said.

The two former accountants, both of whom still live in the Houston area, declined interview requests through their attorneys.

The state board voted to revoke the licenses in June 2008 even after a panel of administrative law judges recommended that the accountants merely be fined and admonished. But State District Judge Rhonda Hurley kept the issue alive in April when she agreed with Bass, Bauer and another plaintiff that the board engaged in a "charade of deliberation" when it went into executive session four times while considering the panel's recommendations.

The board contends that it went into executive session only to discuss potential litigation with its attorney, a scenario that would make the meetings legal.

Arthur Andersen, once one of the so-called "Big Five" accounting firms, was found guilty of obstructing justice in 2002 for the shredding of Enron-related documents. Although the conviction was reversed by the U.S. Supreme Court, the damage to the Chicago-based firm's reputation was enough to put it out of business.

The document destruction occurred in the Houston office, where both Bass and Bauer worked, but neither one was involved.

Records obtained by the AP show that the Texas board has spent $3.1 million over the last eight years to investigate and prosecute Bass, Bauer and five other former Andersen employees for their work on Enron audits related to the company's now-famous spinoffs with Star Wars-inspired names, Chewco and Jedi.

Documents that came to light when Enron filed for bankruptcy showed Andersen auditors failed to uncover that the company was using the entities to hide its debt illegally.

Bauer was barred from practicing before the Securities and Exchange Commission for three years because he didn't exercise due professional care despite "numerous red flags" associated with the transactions. Bass wasn't disciplined by the SEC.

Treacy said the expenditures aren't out of line because the board is one of Texas' seven self-directed, semi-independent regulatory agencies. That means its funding comes strictly from fees, fines and other revenue it generates.

"We're not subsidized by the state of Texas, and the (accounting) profession wants it that way," he said. "If we need to raise our license fees to prosecute cases, the profession supports us."

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

 

 


 


A long listing of Enron Updates is available at http://faculty.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates

Bob Jensen's Enron Quiz is at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm


Andersen Partners in the Aftermath of Enron:  Protiviti and Huron in Particular

Some Andersen partners stayed on at the Andersen firm (that is no longer an auditing firm) and some continued to make their living at Andersen's training facility in St. Charles, Illinois. In 2005, the U.S. Supreme Court overturned Andersen's conviction for obstruction of justice ---
http://en.wikipedia.org/wiki/Arthur_Andersen_LLP_v._United_States

The U.S. Supreme Court overturned the conviction of the Arthur Andersen accounting firm for destroying documents related to its Enron account before the energy giant's collapse. The ruling is not based upon guilt or innocence. It is based only on a technicality in the judge's instructions to the jury. The ruling will not lead to a revival of this once great firm that in the years preceding its collapse became known for some terrible audits of firms like Waste Management, Enron, Worldcom and other clients.  For details see http://news.bbc.co.uk/2/hi/business/4596949.stm
Also see http://accounting.smartpros.com/x48441.xml

Former Andersen partners who formed two consulting firms are not fairing so well at the moment. But the things at Protivii are a bit more rosy than things at Huron.

First there's the huge book cooking (creative accounting) scandal at Huron Consulting that has now sucked in PwC as well ---
 Huron Consulting Group was formed in May of 2003 in Chicago with a core set of 213 following the implosion of huge Arthur Andersen headquartered in Chicago. The timing is much more than mere coincidence since a lot of Andersen professionals were floating about looking for a new home in Chicago. In the past I've used the Huron Consulting Group published studies and statistics about financial statement revisions of other companies. I never anticipated that Huron Consulting itself would become one of those statistics. I guess Huron will now have more war stories to tell clients ---
http://faculty.trinity.edu/rjensen/fraud001.htm#Cooking

Protiviti was formed largely of Andersen's former internal auditing consultants and has a history outlined below.

"Protiviti Responds to Tough Financial Crisis, Now More Bullish," The Big Four Blog, February 8, 2010 ---
http://www.bigfouralumni.blogspot.com/

Protiviti, as many will recall, was principally Andersen’s internal audit service line, and these professionals joined the multi-billion dollar organization Robert Half International ($RHI) in 2002 to form their own division, separate from the staffing units for which RHI is better known for – Accountemps, Office Team and Management Resources. Starting with just over 700 employees in 25 locations, Protiviti has certainly grown in size and scope, and now is a global business consulting and internal audit firm providing risk, advisory, and transaction services; with 2,500 professionals in 62 locations in 17 countries worldwide. The Protiviti division accounts for 13% of total parent company RHI revenues; and within Protiviti itself, international operations were 30% of total Protiviti revenues.

All the senior management at Protiviti continue to be Andersen alumni:

Joseph A. Tarantino, President and Chief Executive Officer, ex-head of Arthur Andersen’s Financial Services Assurance practice for metropolitan New York
Carol M. Beaumier, Executive Vice President, Global Industry Programs, ex-partner in Arthur Andersen’s Regulatory Risk Services practice
Robert B. Hirth Jr., Executive Vice President, Global Internal Audit, ex-partner with Arthur Andersen
James Pajakowski, Executive Vice President, Global Risk Solutions, ex-partner with Arthur Andersen
Gary Peterson, Executive Vice President, International Operations, ex-partner at Arthur Andersen

We haven’t focused on Protiviti for the longest time, but our attention was brought back after seeing RHI’s full year 2009 results. We were quite surprised to see that despite its size, Protiviti had a full year 2009 loss. Yes, a loss of $30 million for the entire year on revenues of $384 million.

To dig deeper into this situation, we had to go back all the way to 2007, analyze a whole series of quarterly earnings and read through multiple earnings transcripts (courtesy: SeekingAlpha.com).

An interesting picture emerges from our analysis, vividly demonstrating the intensity and rapidity of the global slowdown, and consequent management efforts to cope with business shrinkage.

In 2007, Protiviti had revenues of $552 million, gross margin of $175 million (32% of revenues), and operating income of $21 million (4% of revenues). In 2008, revenues held reasonably flat at $547 million, but gross margin had decreased by $20 million to $155 million (28% of revenues), and operating income fell by $14 million, a full 66% to $7 million (1% of revenues). In 2009, the situation had rapidly deteriorated, with revenues falling 30% to $384 million, gross margin plunging by $75 million to $80 million (21% of revenues), and operating income declining precipitously by $38 million to a net loss figure of $(31) million (negative 8% of revenues). In a matter of just 24 months, Protiviti’s top line had eroded by 30% and its operations had gone from a healthy profit to a huge loss.

A deeper look at the quarterly earnings for two full years, 2008 and 2009, reveals the full extent of the situation.

In 2007, Protiviti had good operating results, with 3,300 employees, up a whopping 16% from 2006, as management hired talent in sync with increased demand for its services.

From Q1-2008 to Q3-2008, in the first three quarters of 2008, revenues continued at the 2007 quarterly run-rate of about $140 million, but total costs, principally direct compensation costs from all the increased staff levels were up 4%, increasing from 68% of revenues in 2007 to 72% of revenues in the first three quarters of 2008. Things were still on a decent footing at that time, operating income was a few million dollars profit on the average each quarter, not at 2007 levels, but certainly not at losses either. The expected increase in 2008 revenues had not been seen, and the increased cost line continued to pressure Protiviti’s profits. A review of the Q3-2008 quarterly earnings call shows that management was cautiously optimistic about Protiviti’s performance and prospects, and there were initial efforts to bring costs in line with flat revenues. Given that RHI had not ever managed Protiviti through a downturn, senior management could not provide decent guidance on revenues for the upcoming fourth quarter.

Then, with the collapse of Lehman Brothers in September 2008, the financial crisis became really severe in Q4-2008.

In Q4-2008, Protiviti’s revenues fell to $125 million, $15 million below the run rate seen in the last three quarters, but Protiviti had already started moving to reducing its cost base. Both direct costs and SG&A costs were quickly reined in, and the cost base in Q4-2008 was reduced by $12 million in comparison to Q3-2008, to almost offset the $15 million loss in revenue. Overall, operating income for Q4-2008 decreased to $1 million from $4 million in Q3-2009.

At the end of 2008, Protiviti had seen flat revenues to 2007, but a sharp drop in profits. The firm had 3,200 employees, 100 lower than the 3,300 at the end of 2007, through some initial layoffs. Its likely no-one imagined how 2009 would turn out.

In Q1-2009, Protiviti’s revenue fell to $100 million, $25 million below Q4-2008 (some of this was attributed to seasonally slow first quarters), but this is when Protiviti really started to manage its employee base. It took an $8 million extraordinary charge in the quarter for severance costs, with an intent to manage its employee compensation costs in line with falling revenues. There was also a contemporaneous reduction in SG&A, but the quarter still ended with a $11 million operating loss, as total costs in the quarter could not come down far enough with the rapid decline in revenue.

In Q2-2009, quarterly revenues had fallen another $10 million to $90 million, however, the cost base also fell by $10 million from the previous quarter and the operating loss position of $11 million held steady from the prior quarter. Protiviti took an additional $2 million employee severance restructuring charge in the quarter. By this time, management had recognized the severity of the issue and were taking active steps to manage costs in line with declining revenues. Management said that US operations had better profitability than international operations, which were being scrutinized in detail. Also, the division was taking steps to diversify away purely from Internal Audit and Sarbox type work into IT audit and co-sourcing to create a larger set of non-correlated service lines.

By Q3-2009, the positive cost impact of the reductions in staff were showing on the bottom line. Q3-2009 revenues were $96 million, a good $6 million better than the $90 million in Q2-2009 in terms of revenue, with the third quarter being sequentially generally better than the second quarter. Costs in Q3-2009 were also $7 million better than Q2-2009, with the net result that operating profit increased by $12 million from Q2-2009 to Q3-2009. Q3-2009 turned in a small operating income of $1 million. Q3-2009 gross margin% matched what were historical levels in the first half of 2008.

In Q4-2009, the operating situation was quite similar to Q3-2009, as revenues and costs generally held steady and flat. Revenue was $96 million, staff utilization improved and operating income was essentially zero.

Protiviti ended 2009 with $384 million in revenue, 30% lower than 2008, and with an operating loss of $21 million (net of restructuring charges) compared with $7 million of operating profit in 2008. The big change in 2009 was the employee base, the year ended with 2,500 employees, 700 employees lower than the end of the previous year. This was a gut-wrenching 22% reduction in staff, in that 1 out of every 5 professionals with Protiviti who was working at the end of 2008 was no longer at the firm in 2009.

As we turn into 2010, management appears much more bullish about Protiviti’s 2010 prospects and indicated generally that the division will aim to generate positive operating profit for this year. The problem seems to lie in Protiviti’s operations outside the US, which are offsetting a higher level of US profitability, and there seems to be serious effort to turn that around. It indicates that operating costs levels have now been sized to a $400 million revenue business; and anecdotal evidence at Protiviti consultants indicates there is growing confidence that there will higher levels of business in this year.

Anyone who has passed through this crisis will recall with clarity how difficult the last quarter of 2008 and the first half of 2009 really was. This is a case study on Protiviti, but likely representative of all consulting and accounting firms, who faced and continue to face a crisis unprecedented in modern times. The decline in Protiviti (a Big 4 firm spin off) is in line with the decreases in Advisory service lines at the Big Four firms, however the magnitude of the fall is much higher at Protiviti, much to its smaller size and smaller footprint in higher-growth emerging countries of the world.

While we have been able only to tell the story from the public financials, we do recognize there is a deep human cost, in terms of lost jobs, continued unemployment, potentially poor morale, and tough disengagement and working conditions. We invite Protiviti alumni to join the Big4 LinkedIn group, which has a robust discussion and job board to extend their network and keep abreast of developments. And if any of our readers have first-hand or deeper knowledge of this situation, we welcome your comments.


First, kudos to the Audit Committee (John McCartney, Dubose Ausley and James Edwards) for unearthing this issue and pursuing it fearlessly to its terrible end at Huron Consulting.

From The Wall Street Journal Weekly Accounting Review on August 6, 2009

Huron Takes Big Hit as Accounting Falls Short
by Gregory Zuckerman
Aug 05, 2009
Click here to view the full article on WSJ.com

TOPICS: Accounting Changes and Error Corrections, Advanced Financial Accounting, Mergers and Acquisitions

SUMMARY: Huron Consulting Group, Inc., was formed in May 2002 by partners from the now-defunct Arthur Andersen LLP. "Today, fewer than 10% of the company's employees came directly from Arthur Andersen." The firm provides "...financial and legal consulting services, including forensic-style investigative work...." The firm announced restatement of earnings for fiscal years 2006, 2007, and 2008 and the first quarter of 2009 due to inappropriate accounting for payments made to acquire four businesses between 2005 and 2007. The payments were made after the acquisitions for earn-outs: additional amounts of cash payments or stock issuances based on earning specific financial performance targets over a number of years following the business combinations. However, portions of these earn-out payments were redistributed to employees remaining with Huron after the acquisitions based on specific performance measures by these employees rather than being based on their relative ownership interests in the firms prior to acquisition by Huron. Consequently, those payments are deemed to be compensation expense. The amounts restated thus reduce net income for the periods of restatement and reduce future income amounts, but do not affect cash flows of the firm. Negative shareholder reaction to this announcement by a firm which provides consulting services in this area certainly is not surprising.

CLASSROOM APPLICATION: Accounting for allocation of a purchase price in a business combination is covered in this article.

QUESTIONS: 
1. (Introductory) In general, how do we account for assets acquired in business combinations? How are cash payments and stock issued to selling shareholders accounted for?

2. (Introductory) What are contingent payments in a business combination? What are the two main types of contingent payments and what are their accounting implications?

3. (Introductory) Which of the above 2 types of contingent payments were employed in the Huron acquisition agreements for businesses it acquired over the years 2005 to 2008?

4. (Advanced) Obtain the SEC 8_k filing by Huron for the restatement announcement, dated July 31, 2009, and the filing answering subsequent questions and answers as posted on its web site, dated August 3, 2009 available at http://www.sec.gov/Archives/edgar/data/1289848/000119312509160844/d8k.htm and http://www.sec.gov/Archives/edgar/data/1289848/000128984809000017/exh99-1.htm respectively. What was the problem which made the original acquisition accounting improper? What accounting standard establishes requirements for handling corrections of errors such as this? In your answer, explain why the company discloses that investors must not rely on the previously released financial statements.

5. (Advanced) Refer specifically to the August 3, 2009, filing obtained above. What were the ultimate journal entries made to correct these errors? Explain the components of these entries.

6. (Advanced) The author of this article writes that this error in reporting and subsequently required restatement "...suggests [that] a closer alliance between consulting and accounting isn't such a bad idea." What is the SEC requirement that divides consulting and accounting? Do you think this problem with reporting would have arisen had the firm been allowed to perform both auditing, accounting, and consulting services to its clients? Support your answer.

Reviewed By: Judy Beckman, University of Rhode Island

 

"Huron Takes Big Hit as Accounting Falls Short," by Gregory Zuckerman, The Wall Street Journal, August 5, 2009 ---
http://online.wsj.com/article/SB124943146672806361.html?mod=djem_jiewr_AC

Financial downturns often expose accounting problems at companies, but scandals have been noticeably absent in the recent turmoil. Not so anymore.

Late Friday, Huron Consulting Group Inc. said it would restate the last three years of financial results, withdraw its 2009 earnings guidance and lower its outlook for 2009 revenue. The accounting snafu, which has decimated the company's shares, was all the more surprising because Huron traces its roots to Arthur Andersen LLP, the accounting firm at the heart of the last wave of scandals.

A dose of added irony is that Huron makes its money providing financial and legal consulting services, including forensic-style investigative work, and tries to help clients avoid these types of mistakes.

"One of their businesses is forensic accounting -- they're experts in this," says Sean Jackson, an analyst at Avondale Partners in Nashville, Tenn., who dropped his rating to the equivalent of "hold" from "buy." "Investors are saying, 'These guys had to know what happened with the accounting, or they should have known.'"

Investors fear the accounting issues, which will reduce net income by $57 million for the periods in question, might damage the firm's credibility. Huron's shares fell 70% on Monday, well below the price of its initial public offering in 2004. On Tuesday, Huron shares rose four cents to $13.73.

Huron, based in Chicago, was started in May 2002 by refugees from Arthur Andersen who fled the firm after it was indicted for its role in the collapse of Enron Corp. At the time, the group said that it would specialize in bankruptcy and litigation work, as well as education and health-care consulting, and that it would work with more than 70 former clients of Arthur Andersen. Arthur Andersen's guilty verdict was later overturned, but it was too late to save the firm, which was dismantled. Today, fewer than 10% of the company's employees came directly from Andersen, according to a Huron spokeswoman.

Huron on Friday also announced preliminary second-quarter revenue that was shy of analyst expectations, along with the resignation of Gary Holdren, its board chairman and chief executive, along with the resignations of finance chief Gary Burge and chief accounting officer Wayne Lipski. "No severance expenses are expected to be incurred by the company as a result of these management changes," Huron's regulatory filing said.

After its founding by 25 Andersen partners and more than 200 employees, Huron grew rapidly. It soon had 600 employees and counted firms like Pfizer, International Business Machines and General Motors as clients. Growing scrutiny of accounting firms that also did consulting made Huron's consulting-only business look promising, and shares soared from below $20 five years ago to nearly $44 before the news on Friday.

That is when Huron dropped its bombshell -- one that suggests a closer alliance between consulting and accounting isn't always such a bad idea. Huron is restating financial statements to correct how it accounted for certain acquisition-related payments to employees of four businesses that Huron purchased since 2005.

Huron said the employees shared "earn-outs," or financial rewards based on the performance of acquired units after the transaction was completed, with junior employees at the units who weren't involved in the original sale. They also distributed some of the proceeds based on performance of employees who remained at Huron, not based on the ownership interests of those employees in the businesses that were sold.

The payments were legal. The problem was how Huron accounted for these payouts. The compensation should have been booked as a noncash operating expense of the company. Huron said the payments "were not kickbacks" to Huron management, but rather went to employees of the acquired businesses.

The method the company used to book the payments served to increase its profit. The adjustments reduced the company's net income, earnings per share and other measures, though it didn't affect its cash flow, assets or liabilities.

Part of investors' concern is that they aren't entirely sure what happened at Huron. The company's executives aren't speaking with analysts, some said on Tuesday.

Employees and big producers now might bolt from Huron, Avondale Partners' Mr. Jackson says.

"It's still unclear what happened, but it's almost irrelevant at this point," says Tim McHugh, an analyst at William Blair & Co., who has the equivalent of a "hold" on the stock, down from a "buy" last week. "The company's brand has been impaired and turnover of key employees is a significant risk."

December 3, 2009 reply from Francine McKenna [retheauditors@GMAIL.COM]

I, of course, blame Huron mostly on PwC.  That's my schtick.

http://retheauditors.com/2009/08/10/pwc-and-huron-consulting-goodwill-too-good-to-be-true/

But a little bit on the AA legacy.

http://retheauditors.com/2009/08/04/huron-consulting-go-on-take-the-money-and-run/

Francine

Bob Jensen's threads on the Huron scandal are at
http://faculty.trinity.edu/rjensen/fraud001.htm#Cooking

Bob Jensen's threads on PwC are at
http://faculty.trinity.edu/rjensen/fraud001.htm

 


The Famous Enron Video on Hypothetical Future Value (HFV) Accounting 

The video shot at Rich Kinder's retirement party at Enron features CEO Jeff Skilling proposing Hypothetical Future Value (HPV) accounting with in retrospect is too true to be funny during the subsequent melt down of Enron.

The people in this video are playing themselves and you can actually see CEO Jeff Skilling, Chief Accounting Officer Richard Causey, and others proposing cooking the books.  You can download my rendering of a Windows Media Player version of the video from http://www.cs.trinity.edu/~rjensen/video/windowsmedia/enron3.wmv 
You may have to turn the audio up full blast in Windows Media Player to hear the music and dialog.

"Feds Want To See Enron Videotape President Bush Also Takes Part In Skit," Click2Houston.com, December 16, 2002 --- http://www.click2houston.com/money/1840050/detail.html 

Skits and jokes by a few former Enron Corp. executives at a party six years ago were funny then, but now border on bad taste in light of the events of the past year.

VIDEO Feds Want To See Controversial Enron Videotape Watch Clips From Enron Retirement Tape INTERACTIVES The End Of Enron What's The Future Of Enron? 

A videotape of a January 1997 going-away party for former Enron President Rich Kinder features nearly half an hour of absurd skits, songs and testimonials by company executives and prominent Houstonians, the Houston Chronicle reported in its Monday editions.

The collection is all meant in good fun, but some of the comments are ironic in the current climate of corporate scandal.

In one skit, former Administrative Executive Peggy Menchaca played the part of Kinder as he received a budget report from then-President Jeff Skilling, who played himself, and Financial Planning Executive Tod Lindholm.

When the pretend Kinder expressed doubt that Skilling could pull off 600 percent revenue growth for the coming year, Skilling revealed how it could be done.

"We're going to move from mark-to-market accounting to something I call HFV, or hypothetical future value accounting," Skilling joked as he read from a script. "If we do that, we can add a kazillion dollars to the bottom line."

Richard Causey, the former chief accounting officer who was embroiled in many of the business deals named in the indictments of other Enron executives, made an unfortunate joke later on the tape.

"I've been on the job for a week managing earnings, and it's easier than I thought it would be," Causey said, referring to a practice that is frowned upon by securities regulators. "I can't even count fast enough with the earnings rolling in."

Joe Sutton and Rebecca Mark, the two executives credited with leading Enron on an international buying spree, did a painfully awkward rap for Kinder, while former Enron Broadband Services President Ken Rice recounted a basketball game where employees from Enron Capital & Trade beat Kinder's Enron Corp. team, 98-50.

"I know you never forget a number, Rich," Rice said.

President George W. Bush, who then was governor of Texas, also took part in the skit, as did his father.

At the party, the younger Bush pleaded with Kinder: "Don't leave Texas. You're too good a man."

The governor's father also offered a send-off to Kinder, thanking him for helping his son reach the governor's mansion.

"You have been fantastic to the Bush family," the elder Bush said. "I don't think anybody did more than you did to support George."

Federal investigators told News2Houston Tuesday that they want to take a closer look at the tape.

Investigators with the House committee on government reform are in the process of obtaining a copy of the tape, according to News2Houston.

Former federal prosecutor Phil Hilder said that what was a joke could become evidence for federal investigators.

"There's matters on there that a prosecutor may want to introduce as evidence should it become relevant," Hilder said.

Former employees were shocked to see the tape.

"It's too close to the truth, very close to the truth," said Debra Johnson, a former Enron employee. "I think there's some inside truth to the jokes that they portrayed."


 

Early 1995 Warning Signs That Bad Guys Were Running Enron and That Political Whores Were Helping

There were some warning signs, but nobody seemed care much as long as Enron was releasing audited accounting reports showing solid increases in net earnings.  Roger Collins sent me a 1995 link that lists Enron among the world's "10 Most Shameless Corporations."  I guess they are reaping what was sown.  

SHAMELESS:
1995'S 10 WORST
CORPORATIONS


Shell
BHP
ADM
CHIQUITA
ENRON <--------------
DOW CHEMICAL
JOHNSON & JOHNSON
3M
DUPONT
WARNER-LAMBERT

by Russell Mokhiber and Andrew Wheat
http://www.essential.org/monitor/hyper/mm1295.04.html 

The module about Enron in 1995 reads as follows:

Enron's Political Profit Pipeline

In early 1995, the world's biggest natural gas company began clearing ground 100 miles south of Bombay, India for a $2.8 billion, gas-fired power plant -- the largest single foreign investment in India.

Villagers claimed that the power plant was overpriced and that its effluent would destroy their fisheries and coconut and mango trees. One villager opposing Enron put it succinctly, "Why not remove them before they remove us?"

As Pratap Chatterjee reported ["Enron Deal Blows a Fuse," Multinational Monitor, July/August 1995], hundreds of villagers stormed the site that was being prepared for Enron's 2,015-megawatt plant in May 1995, injuring numerous construction workers and three foreign advisers.

After winning Maharashtra state elections, the conservative nationalistic Bharatiya Janata Party canceled the deal, sending shock waves through Western businesses with investments in India.

Maharashtra officials said they acted to prevent the Houston, Texas-based company from making huge profits off "the backs of India's poor." New Delhi's Hindustan Times editorialized in June 1995, "It is time the West realized that India is not a banana republic which has to dance to the tune of multinationals."

Enron officials are not so sure. Hoping to convert the cancellation into a temporary setback, the company launched an all-out campaign to get the deal back on track. In late November 1995, the campaign was showing signs of success, although progress was taking a toll on the handsome rate of return that Enron landed in the first deal. In India, Enron is now being scrutinized by the public, which is demanding contracts reflecting market rates. But it's a big world.

In November 1995, the company announced that it has signed a $700 million deal to build a gas pipeline from Mozambique to South Africa. The pipeline will service Mozambique's Pande gas field, which will produce an estimated two trillion cubic feet of gas.

The deal, in which Enron beat out South Africa's state petroleum company Sasol, sparked controversy in Africa following reports that the Clinton administration, including the U.S. Agency for International Development, the U.S. Embassy and even National Security adviser Anthony Lake, lobbied Mozambique on behalf of Enron.

"There were outright threats to withhold development funds if we didn't sign, and sign soon," John Kachamila, Mozambique's natural resources minister, told the Houston Chronicle. Enron spokesperson Diane Bazelides declined to comment on the these allegations, but said that the U.S. government had been "helpful as it always is with American companies." Spokesperson Carol Hensley declined to respond to a hypothetical question about whether or not Enron would approve of U.S. government threats to cut off aid to a developing nation if the country did not sign an Enron deal.

Enron has been repeatedly criticized for relying on political clout rather than low bids to win contracts. Political heavyweights that Enron has engaged on its behalf include former U.S. Secretary of State James Baker, former U.S. Commerce Secretary Robert Mosbacher and retired General Thomas Kelly, U.S. chief of operations in the 1990 Gulf War. Enron's Board includes former Commodities Futures Trading Commission Chair Wendy Gramm (wife of presidential hopeful Senator Phil Gramm, R-Texas), former U.S. Deputy Treasury Secretary Charles Walker and John Wakeham, leader of the House of Lords and former U.K. Energy Secretary.


To this I have added the following :  

From the Free Wall Street Journal Educators' Reviews for November 1, 2001 

TITLE: Enron Did Business With a Second Entity Operated by Another Company Official; No Public Disclosure Was Made of Deals
REPORTER: John R. Emshwiller and Rebecca Smith
DATE: Oct 26, 2001
PAGE: C1
LINK: Print Only in the WSJ on October 26, 2001

TOPICS: Disclosure Requirements, Financial Accounting, Financial Statement Analysis

SUMMARY: Enron's financial statement disclosures have been less than transparent. Information is arising as the SEC makes an inquiry into the Company's accounting and reporting practices with respect to its transactions with entities managed by high-level Enron managers. Yet, as discussed in a related article, analysts remain confident in the stock.

QUESTIONS:

1.) Why must companies disclose related party transactions? What is the significance of the difference between the wording of SEC rule S-K and FASB Statement of Financial Accounting Standards No. 57, Related Party Transactions that is cited at the end of the article?

2.) Explain the logic of why a drop in investor confidence in Enron's business transactions and reporting practices could affect the company's credit rating.

3.) Explain how an analyst could argue, as did one analyst cited in the related article, that he or she is confident in Enron's ability to "deliver" earnings even if he or she cannot estimate "where revenues are going to come from" nor where the company will make profits.

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: Heard on the Street: Most Analysts Remain Plugged In to Enron
REPORTER: Susanne Craig and Jonathan Weil
PAGE: C1
ISSUE: Oct 26, 2001
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004043182760447600.djm 

TITLE: Enron Officials Sell Shares Amid Stock-Price Slump
REPORTER: Theo Francis and Cassell Bryan-Low
PAGE: C14
ISSUE: Oct 26, 2001
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004043341423453040.djm


From The Wall Street Journal Accounting Educators' Review on November 8, 2001
Subscribers to the Electronic Edition of the WSJ can obtain reviews in various disciplines by contacting wsjeducatorsreviews@dowjones.com 
See http://info.wsj.com/professor/ 

TITLE: Arthur Andersen Could Face Scrutiny On Clarity of Enron Financial Reports 
REPORTER: Jonathan Weil 
DATE: Nov 05, 2001 
PAGE: C1 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004919947649536880.djm  
TOPICS: Accounting, Auditing, Creative Accounting, Disclosure Requirements

SUMMARY: Critics argue that Arthur Andersen LLP has failed to ensure that Enron Corp.'s financial disclosures are understandable. Enron is currently undergoing SEC investigation and is being sued by shareholders. Questions relate to disclosure quality and auditor responsibility.

QUESTIONS: 

1.) The article suggests that the auditor has the job of making sure that financial statements are understandable and accurate and complete in all material respects. Does the auditor bear this responsibility? Discuss the role of the auditor in financial reporting.

2.) One allegation is that Enron's financial statements are not understandable. Should users be required to have specialized training to be able to understand financial statements? Should the financial statements be prepared so that only a minimal level of business knowledge is required? What are the implications of the target audience on financial statement preparation?

3.) Enron is facing several shareholder lawsuits ; however, Arthur Anderson LLP is not a defendant. What liability does the auditor have to shareholders of client firms? What are possible reasons that Arthur Anderson is not a defendant in the Enron cases?

4.) What is the role of the SEC in the investigation? What power does the SEC have to penalize Enron Corp. and Arthur Anderson LLP?

SMALL GROUP ASSIGNMENT: Should financial statements be understandable to users with only general business knowledge? Prepare an argument to support your position.

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


From The Wall Street Journal Accounting Educators' Review on November 6, 2001
Subscribers to the Electronic Edition of the WSJ can obtain reviews in various disciplines by contacting wsjeducatorsreviews@dowjones.com 
See http://info.wsj.com/professor/ 

TITLE: Behind Shrinking Deficits: Derivatives? 
REPORTER: Silvia Ascarelli and Deborah Ball 
DATE: Nov 06, 2001 PAGE: A22 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004996045480162960.djm  
TOPICS: Derivatives 

SUMMARY: An Italian university professor and public-debt management expert issued a report this week explaining how a European country used a swap contract to effectively receive more cash in 1997. That country is believed to be Italy although top officials deny such "window dressing" practices. 1997 was a critical year for Italy if it was to be included in the EMU (European Monetary Union) and become a part of the euro-zone. To qualify for entry, a country's deficit could not exceed 3% of gross domestic product. In 1996 Italy's deficit was 6.7% of GDP, however, the country succeeded in "slashing its budget deficit to 2.7%" in 1997. The question now is whether Italy accomplished this reduction by clamping down on waste and raising revenues or engaging in deceptive swaps usage.

QUESTIONS: 

1.) Why was the level of Italy's budget deficit so critical in 1997? How did Italy's 1997 budget deficit compare with its 1996 level?

2.) What is an interest rate swap? How can the use of swap markets decrease borrowing costs? What is a currency swap? When would firms tend to use these derivative instruments?

3.) Does the European Union condone the use of interest rate swaps by its euro-zone members as a way to manage their public debt? According to the related article, who are the biggest users of swaps in Europe? Do the U.S. and Japan use them to manage their public debt?

4.) According to the related article, interest-rate swaps now account for what proportion of the over-the-counter derivatives market? Go to the web page for the Bank of International Settlement at www.bis.org . Select Publications & Statistics then go to International Financial Statistics. Go to the Central Bank Survey for Foreign Exchange and Derivatives Market Activity. Look at the pdf version of the report, specifically Table 6. What was average daily turnover, in billions of dollars, of interest-rate swaps in April 1995? 1998? and 2001? By what percentage did interest-rate swap usage increase from 1995-1998? 1998-2001?

5.) According to the related article, how did the swaps contract allegedly used by Italy differ from a standard swaps contract? What was the "bottom line" result of this arrangement?

6.) Assume Italy did indeed use such measures to "window dress" their financial situation and gain entry into the euro-zone. What actions should be taken to prevent such loopholes in the future?

Reviewed By: 
Jacqueline Garner, Georgia State University and Univ. of Rhode Island 
Beverly Marshall, Auburn University
Peter Dadalt, Georgia State University

--- RELATED ARTICLE in the WSJ --- 

TITLE: Italy Used Complicated Swaps Contract To Deflate Budget in Bid for Euro Zone 
REPORTER: Silvia Ascarelli and Deborah Ball
ISSUE: Nov 05, 2001 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004908712922656320.djm 


From The Wall Street Journal Accounting Educators' Review on November 8, 2001
Subscribers to the Electronic Edition of the WSJ can obtain reviews in various disciplines by contacting wsjeducatorsreviews@dowjones.com 
See http://info.wsj.com/professor/ 

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

SUMMARY: 
Enron's financial statements have long been charged with being undecipherable; however, they are now considered to contain violations of GAAP. Enron filed documents with the SEC indicating that financial statements going back to 1997 "should not be relied upon." Questions deal with materiality and auditor independence.

QUESTIONS: 
1.) What accounting errors are reported to have been included in Enron's financial statements? Why didn't Enron's auditors require correction of these errors before the financial statements were issued?

2.) What is materiality? In hindsight, were the errors in Enron's financial statements material? Why or why not? Should the auditors have known that the errors in Enron's financial statements were material prior to their release? What defense can the auditors offer?

3.) Does Arthur Andersen provide any services to Enron in addition to the audit services? How might providing additional services to Enron affect Andersen's decision to release financial statements containing GAAP violations?

4.) The article states that Enron is one of Arthur Andersen's biggest clients. How might Enron's size have contributed to Arthur Andersen's decision to release financial statements containing GAAP violations? Discuss differences in audit risk between small and large clients. Discuss the potential affect of client firm size on auditor independence.

5.) How long has Arthur Andersen been Enron's auditor? How could their tenure as auditor contributed to Andersen's decision to release financial statements containing GAAP violations?

6.) The related article discusses how Enron's consolidation policy with respect to the JEDI and Chewco entities impacted the company's financial statements. What is meant by the phrase consolidation policy? How could a policy not to consolidate these entities help to make Enron's financial statements look better? Why would consolidating an entity result in a $396 million reduction in net income over a 4 year period? How must Enron have been accounting for investments in these entities? How could Enron support its accounting policies for these investments?

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

RELATED WSJ ARTICLES
TITLE: Enron Cuts Profit Data of 4 Years by 20% 
REPORTER: John R. Emshwiller, Rebecca Smith, Robin Sidel, and Jonathan Weil 
PAGE: A1,A3 
ISSUE: Nov 09, 2001 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1005235413422093560.djm 

TITLE: Arthur Andersen Could Face Scrutiny On Clarity of Enron Financial Reports 
REPORTER: Jonathan Weil 
DATE: Nov 05, 2001 
PAGE: C1 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004919947649536880.djm  
TOPICS: Accounting, Auditing, Creative Accounting, Disclosure Requirements


Hi John,

There are some activists with a much longer and stronger record of lamenting the decline in professionalism in auditing and accounting. For some reason, they are not being quoted in the media at the moment, and that is a darn shame!

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 to save the profession from what it is now going through in the wake of the Enron scandal.

I suspect that the fear of activists (other than Briloff) is that complaining too loudly will lead to a government takeover of auditing. This in, my viewpoint, would be a disaster, because it does not take industry long to buy the regulators and turn the regulating agency into an industry cheerleader. The best way to keep the accounting firms honest is to forget the SEC and the AICPA and the rest of the establishment and directly make their mistakes, deceptions, frauds, breakdowns in quality controls expensive to the entire firms, and that is easier to do if the firms are in the private sector! We are seeing that now in the case of Andersen --- in the end its the tort lawyers who clean up the town.

The problem with most activists against the private sector is that they've not got much to rely upon except appeals for government intervention. That's like asking pimps, whores, and Wendy Gramm to clean up town.  You can read more about how Wendy Gramm sold her soul to Enron at http://faculty.trinity.edu/rjensen/fraud.htm#Farm 

Bob Jensen




Modernization of the (CPA) Profession's Independence Rules
http://www.aicpa.org/stream/indrulewebcast/index.html# 

Click on the above link to view a thirty-minute archived webcast on the AICPA's newly adopted rules.

After you view this webcast, we invite you to participate on December 4 at 1 p.m. (Eastern Standard Time) in a live, interactive web conference. During that web conference, a panel consisting of representatives from the AICPA Professional Ethics Executive Committee, the AICPA Ethics and State Societies and Regulatory Affairs divisions and NASBA will address your questions about the rules.

Please provide us your questions via e-mail after viewing the archived webcast. We will respond to those questions during the live webcast on December 4.

To view/register for the live webcast on December 4, click the "live webcast" button located on the AICPA Video Player.

The FASB also has a video that focuses on the supreme importance of independence in the CPA profession.  

FASB 40-Minute Video, Financially Correct (Quality of Earnings)

The price is $15.

 

Updates on Enron's Creative Accounting Scandal ---  http://faculty.trinity.edu/rjensen/fraud.htm 

Big Five firm Andersen is in the thick of a controversy involving a 20% overstatement in Enron's net earnings and financial statements dating back to 1997 that will have to be restated. http://www.accountingweb.com/item/63352 

One of the main causes for the restatements of financial reports that will be required of Enron relates to transactions in which Enron issued shares of its own stock in exchange for notes receivable. The notes were recorded as assets on the company books, and the stock was recorded as equity. However, Lynn Turner, former SEC chief accountant, points out, "It is basic accounting that you don't record equity until you get cash, and a note doesn't count as cash. The question that raises is: How did both partners and the manager on this audit miss this simple Accounting 101 rule?"

In addition, Enron has acknowledged overstating its income in the past four years of financial statements to the tune of $586 million, or 20%. The misstatements reportedly result from "audit adjustments and reclassifications" that were proposed by auditors but were determined to be "immaterial."

There is a chance that such immaterialities will be determined to be unlawful. An SEC accounting bulletin states that certain adjustments that might fall beneath a materiality threshold aren't necessarily material if such misstatements, when combined with other misstatements, render "the financial statements taken as a whole to be materially misleading."


The recent news of Enron Corp.'s need to restate financial statements dating back to 1997 as a result of accounting issues missed in Big Five firm Andersen's audits, has caused the Public Oversight Board to decide to take a closer look at the peer review process employed by public accounting firms. http://www.accountingweb.com/item/64184 


"Andersen Passes Peer Review Accounting Firm Cleared Despite Finding of Deficiencies," by David S. Hilzenrath,  The Washington Post, January 3, 2002 --- http://www.washingtonpost.com/wp-dyn/articles/A54551-2002Jan2.html 

But the review of Andersen reflected the limitations of the peer-review process, in which each of the so-called Big Five accounting firms is periodically reviewed by one of the others. Deloitte's review did not include Andersen's audits of bankrupt energy trader Enron Corp. -- or any other case in which an audit failure was alleged, Deloitte partners said yesterday in a conference call with reporters. 

. . 

Concluding Remarks
In its latest review, Deloitte said Andersen auditors did not always comply with requirements for communicating with their overseers on corporate boards. According to Deloitte's report, in a few instances, Andersen failed to issue a required letter in which auditors attest that they are independent from the audit client and disclose factors that might affect their independence.

In a recent letter to the American Institute of Certified Public Accountants, Andersen said it has addressed the concerns that Deloitte cited.

Deloitte & Touche in the Hot Seat

"Fugitive Billions," Washington Post Editorial, June 3, 2002, Page A14 --- http://www.washingtonpost.com/wp-dyn/articles/A49512-2002Jun2.html 

IN THE AFTERMATH of Enron, the tarnished auditing profession has mounted what might be called the "complexity defense." This involves frowning seriously, intoning a few befuddling sentences, then sighing that audits involve close-call judgments that reasonable experts could debate. According to this defense, it isn't fair to beat up on auditors as they wrestle with the finer points of derivatives or lease receivables -- if they make calls that are questionable, that's because the material is so difficult. Heck, it's not as though auditors stand by dumbly while something obviously bad happens, such as money being siphoned off for the boss's condo or golf course.

Really? Let's look at Adelphia Communications Corp., the nation's sixth-largest cable firm, which is due to be suspended from the Nasdaq stock exchange today. On May 24, three days after the audit lobby derailed a Senate attempt to reform the profession, Adelphia filed documents with the Securities and Exchange Commission that reveal some of the most outrageous chicanery in corporate history. The Rigas family, which controlled the company while owning just a fifth of it, treated Adelphia like a piggy bank: It used it, among other things, to pay for a private jet, personal share purchases, a movie produced by a Rigas daughter, and (yes!) a golf course and a Manhattan apartment. In all, the family helped itself to secret loans from Adelphia amounting to $3.1 billion. Even Andrew Fastow, the lead siphon man at Enron, made off with a relatively modest $45 million.

Where was Deloitte & Touche, Adelphia's auditor, whose role was to look out for the interests of the nonfamily shareholders who own four-fifths of the firm? Deloitte was apparently inert when Adelphia paid $26.5 million for timber rights on land that the family then bought for about $500,000 -- a nifty way of transferring other shareholders' money into the Rigas's coffers. Deloitte was no livelier when Adelphia made secret loans of about $130 million to support the Rigas-owned Buffalo Sabres hockey team. Deloitte didn't seem bothered when Adelphia used smoke and mirrors to hide debt off its balance sheet. In sum, the auditor stood by while shareholders' cash left through the front door and most of the side doors. There is nothing complex about this malfeasance.

When Adelphia's board belatedly demanded an explanation from its auditor, it got a revealing answer. Deloitte said, yes, it would explain -- but only on condition that its statements not be used against it. How could Deloitte have forgotten that reporting to the board (and therefore to the shareholders) is not some special favor for which reciprocal concessions may be demanded, but rather the sole reason that auditors exist? The answer is familiar. Deloitte forgot because of conflicts of interest: While auditing Adelphia, Deloitte simultaneously served as the firm's internal accountant and as auditor to other companies controlled by the Rigas family. Its real allegiance was not to the shareholders but to the family that robbed them.

It's too early to judge the repercussions of Adelphia, but the omens are not good. When audit failure helped to bring down Enron, similar failures soon emerged at other energy companies -- two of which fired their CEOs last week. Equally, when audit failure helped to bring down Global Crossing, similar failure emerged at other telecom players. Now the worry is that Adelphia may signal wider trouble in the cable industry. The fear of undiscovered booby traps is spooking the stock market: Since the start of December, when Enron filed for bankruptcy, almost all macro-economic news has been better than expected, but the S&P 500 index is down 2 percent.

Without Enron-Global Crossing-Adelphia, the stock market almost certainly would be higher. If the shares in the New York Stock Exchange were a tenth higher, for example, investors would be wealthier by about $1.5 trillion. Does anyone in government care about this? We may find out when Congress reconvenes this week. Sen. Paul Sarbanes, who sponsored the reform effort that got derailed last month, will be trying to rally his supporters. Perhaps the thought of that $1.5 trillion -- or even Adelphia's fugitive $3 billion -- will get their attention.


The above article must be juxtaposed against this earlier Washington Post article:

"Andersen Passes Peer Review Accounting Firm Cleared Despite Finding of Deficiencies," by David S. Hilzenrath,  The Washington Post, January 3, 2002 --- http://www.washingtonpost.com/wp-dyn/articles/A54551-2002Jan2.html 

But the review of Andersen reflected the limitations of the peer-review process, in which each of the so-called Big Five accounting firms is periodically reviewed by one of the others. Deloitte's review did not include Andersen's audits of bankrupt energy trader Enron Corp. -- or any other case in which an audit failure was alleged, Deloitte partners said yesterday in a conference call with reporters. 

. . 

Concluding Remarks
In its latest review, Deloitte said Andersen auditors did not always comply with requirements for communicating with their overseers on corporate boards. According to Deloitte's report, in a few instances, Andersen failed to issue a required letter in which auditors attest that they are independent from the audit client and disclose factors that might affect their independence.

In a recent letter to the American Institute of Certified Public Accountants, Andersen said it has addressed the concerns that Deloitte cited.


 



"How to Spot the Next Enron," by George Anders, Fast Company, December 19, 2007 ---
http://www.fastcompany.com/magazine/58/ganders.html
As cited by Smoleon Sense, on September 23, 2009 ---
http://www.simoleonsense.com/investors-beware-how-to-spot-the-next-enron/

Want to know how to avoid being fooled by the next too-good-to-be-true stock-market darling? Just remember these six tips from the cynics of Wall Street, the short sellers.

If only we could have spotted the rascals ahead of time. That's the lament of anyone who bought Enron stock a year ago, or who worked at a now-collapsed company like Global Crossing or who trusted any corporate forecast that proved way too upbeat. How could we have let ourselves be fooled? And how do we make sure that we don't get fooled again?

It's time to visit with some serious cynics. Some of the shrewdest advice comes from Wall Street's short sellers, who make money by betting that certain stocks will fall in price. They had a tough time in the 1990s, when it paid to be optimistic. But it has been their kind of year. Almost every day, new accounting jitters rock the stock market. And if you aren't asking about hidden partnerships and earnings manipulation -- the sort of outrages that short sellers love to expose -- you risk being blindsided by yet another business wipeout.

Think of short sellers as being akin to veteran cops who walk the streets year after year. They pick up subtle warning signs that most of us miss. They see through alibis. And they know how to quiz accomplices and witnesses to put together the whole story, detail by detail. It's nice to live in a world where we can trust everything we're told because everyone behaves perfectly. But if the glitzy addresses of Wall Street have given way to the tough sidewalks of Mean Street these days, we might as well get smart about the neighborhood.

The first rule of these streets, says David Rocker, a top New York money manager who has been an active short seller for more than two decades, is not to get mesmerized by a charismatic chief executive. "Most CEOs are ultimately salesmen," Rocker says. "If they showed up on your doorstep and said, 'I've got a great vacuum cleaner,' you wouldn't buy it right away. You'd want to see if it works. It's the same thing with a company."

A legendary case in point involves John Sculley, former CEO of Apple Computer. In 1993, he briefly became chief executive of a little wireless data company called Spectrum Information Technologies and spoke glowingly of its prospects. Spectrum's stock promptly tripled. But those who had looked closely at Spectrum's technology weren't nearly as impressed.

Just four months later, Sculley quit, saying that Spectrum's founders had misled him. The company restated its earnings, backing away from some aggressive treatment of licensing revenue that had inflated profits. The stock crashed. The only ones who came out looking smart were the short sellers who disregarded the momentary excitement of having a big-name CEO join the company. Instead, those short sellers focused on the one question that mattered: Are Spectrum's products any good?

So in the wake of Enron, you want to know what to look for in other companies. Or, more to the point, you need to know what to look for in your own company, so you're not stuck explaining what happened to your missing 401(k) fund. Here are six basic pointers from the short-selling community.

1. Watch cash flow, not reported net income. During Enron's heyday from 1999 to 2000, the company reported very strong net income -- aided, we now know, by dubious accounting exercises. But the actual amount of cash that Enron's businesses generated wasn't nearly as impressive. That's no coincidence.

Companies can create all sorts of adjustments to make net income look artificially strong -- witness what we've seen so far with Enron and Global Crossing. But there's only one way to show strong cash flow from operations: Run the business well.

2. Take a wary look at acquisition binges. Some of the most spectacular financial meltdowns of recent years have involved companies that bought too much, too fast. Cendant, for example, grew fast in the mid-1990s by snapping up the likes of Days Inn, Century 21, and Avis but overreached when it bought CUC International Inc., a direct-marketing firm. Accounting irregularities at CUC led to massive write-downs in 1997, which sent the combined company's stock plummeting.

3. Be mindful of income-accelerating tricks. Conservative accounting says that long-term contracts should not be treated as immediate windfalls that shower all of their benefits on today's financial statements. Sell a three-year magazine subscription, and you've got predictable obligations until 2005. Those expenses will slowly flow onto your financial statements -- and it's prudent to book the income gradually as well.

But in some industries, aggressive practitioners like to put jumbo profits on the books all at once. Left for later are worries about how to deal with the eventual costs of those long-term deals. In a recent Barron's interview, longtime short seller Jim Chanos identified such "gain on sale" accounting tricks as a sure sign that the management is being too aggressive for its own good.

Jensen Comment
Cash flow statements are useful, but they are no panacea replacement of accrual accounting and earnings analysis. One huge problem is that unscrupulous executives can more easily manipulate/manage cash flows --- http://faculty.trinity.edu/rjensen/theory01.htm#CashVsAccrualAcctg

Question
What do the department store chains WT Grant and Target possibly have in common?

Answer
WT Grant had a huge chain of departments stores across the United States. It declared bankruptcy in the sharp 1973 recession largely because of a build up of accounts receivable losses. Now in 2008 Target Corporation is in a somewhat similar bind.

In 1980 Largay and Stickney (Financial Analysts Journal) published a great comparison of WT Grant's cash flow statements versus income statements. I used this study for years in some of my accounting courses. It's a classic for giving students an appreciation of cash flow statements! The study is discussed and cited (with exhibits) at http://www.sap-hefte.de/download/dateien/1239/070_leseprobe.pdf
It also shows the limitations of the current ratio in financial analysis and the problem of inventory buildup when analyzing the reported bottom line net income.

From The Wall Street Journal Accounting Weekly Review on March 14, 2008

 

IIs Target Corp.'s Credit Too Generous?
by Peter Eavis
The Wall Street Journal

Mar 11, 2008
Page: C1
Click here to view the full article on WSJ.com
http://online.wsj.com/article/SB120519491886425757.html?mod=djem_jiewr_AC
 

TOPICS: Allowance For Doubtful Accounts, Financial Accounting, Financial Statement Analysis, Loan Loss Allowance

SUMMARY: "'Target appears to have pursued very aggressive credit growth at the wrong time," says William Ryan, consumer-credit analyst at Portales Partners, a New York-based research firm. "Not so." says Target's chief financial officer, Douglas Scovanner, "The growth in the credit-card portfolio is absolutely not a function of a loosening of credit standards or a lowering of credit quality in our portfolio."

CLASSROOM APPLICATION: This article covers details of financial statement ratios used to analyze Target Corp.'s credit card business. It can be used in a financial statement analysis course or while covering accounting for receivables in a financial accounting course

QUESTIONS: 
1. (
Introductory) What types of credit cards has Target Corp. issued? Why do companies such as Target issue these cards?

2. (
Introductory) In general, what concerns analysts about Target Corp.'s portfolio of receivables on credit cards?

3. (
Introductory) How can a sufficient allowance for uncollectible accounts alleviate concerns about potential problems in a portfolio of loans or receivables? What evidence is given in the article about the status of Target's allowance for uncollectible accounts?

4. (
Advanced) "...High growth may make it [hard] to see credit deterioration that already is happening..." What calculation by analyst William Ryan is described in the article to better "see" this issue? From where does he obtain the data used in the calculation? Be specific in your answer.

5. (
Advanced) Refer again to the calculation done by the analyst Mr. Ryan. How does that calculation resemble the analysis done for an aging of accounts receivable?

6. (
Advanced) What other financial analysis ratio is used to assess the status of a credit-card loan portfolio such as Target Corp.'s?

7. (
Advanced) If analysts prove correct in their concern about Target Corp.'s credit-card receivable balance, what does that say about the profitability reported in this year? How will it impact next year's results?
 

Reviewed By: Judy Beckman, University of Rhode Island
 

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

 


From The Washington Post, December 2, 2001 --- 
http://www.washingtonpost.com/wp-dyn/articles/A44063-2001Dec1.html
 

"At Enron, the Fall Came Quickly: Complexity, Partnerships Kept Problems From Public View"

By Steven Pearlstein and Peter Behr
Washington Post Staff Writers
Sunday, December 2, 2001; Page A01

Only a year ago, Ken Lay might have been excused for feeling on top of the world.

The company he founded 15 years before on the foundation of a sleepy Houston gas pipeline company had grown into a $100 billion-a-year behemoth, No. 7 on Fortune's list of the 500 largest corporations, passing the likes of International Business Machines Corp. and AT&T Corp. The stock market valued Enron Corp.'s shares at nearly $48 billion, and it would add another $15 billion before year-end.

Enron owned power companies in India, China and the Philippines, a water company in Britain, pulp mills in Canada and gas pipelines across North America and South America. But those things were ancillary to the high-powered trading rooms in a gleaming seven-story building in Houston that made it the leading middleman in nationwide sales of electricity and natural gas. It was primed to do the same for fiber-optic cable, TV advertising time, wood pulp and steel. Enron's rise coincided with a stock market boom that made everyone less likely to question a company if it had "Internet" and "new" in its business plan.

And, to top it off, Lay's good friend, Texas Gov. George W. Bush, on whom he and his family had lavished $2 million in political contributions, had just been elected president of the United States.

Enron intended to become "the World's Greatest Company," announced a sign in the lobby of its Houston headquarters. Lay was widely hailed as a visionary.

A year later, Lay's empire, and his reputation, are a shambles. Enron's stock is now virtually worthless. Many of its most prized assets have been pledged to banks and other creditors to pay some of its estimated $40 billion debt. Company lawyers are preparing a bankruptcy court filing that is expected to come as soon as this week and may be the biggest and most complex ever. Most of Enron's trading customers have gone elsewhere.

Retirement Losses

The company's 21,000 employees have lost much of their retirement savings because their pension accounts were stuffed with now-worthless Enron stock, and many expect to lose their jobs as well this coming week. Some of the nation's biggest mutual-fund companies, including Alliance Capital, Janus, Putnam and Fidelity, have lost billions of dollars in value.

Meanwhile, the Securities and Exchange Commission, headed by a Bush appointee, is investigating the company and its outside auditors at Arthur Andersen, while the House and Senate energy committees plan hearings.

It will take months or years to definitively answer the myriad questions raised by Enron's implosion. Why did it happen, and why so quickly? What did Enron's blue-chip board of directors and auditors know of the financial shenanigans that triggered the company's fall when hints of them became public six weeks ago? Should government regulators have been more vigilant?

Even now, however, it is clear that Enron was ruined by bad luck, poor investment decisions, negligible government oversight and an arrogance that led many in the company to believe that they were unstoppable.

By this fall, a recession, the dot-com crash and depressed energy prices had taken a heavy toll on the company's financial strength. The decline finally forced the company to reveal that it had simply made too many bad investments, taken on too much debt, assumed too much risk from its trading partners and hidden much of it from the public.

Such sudden falls from great heights recur in financial markets. In the late 1980s, its was junk-bond king Drexel Burnham Lambert. In the 1990s, it was Long Term Capital Management, the giant hedge fund. Like Enron, Drexel and Long Term Capital helped create and dominate new markets designed to help businesses and investors better manage their financial risks. And, like Enron, both were done in by failing to see the risks that they themselves had taken on.

It was in the trading rooms where Enron's big profits were made and the full extent of its ambitions were revealed.

Early on, the contracts were relatively simple and related to its original pipeline business: a promise to deliver so many cubic feet of gas to a fertilizer factory on a particular day at a particular price. But it saw the possibilities for far more in the deregulation of electric power markets, which would allow new generating plants running on cheap natural gas to compete with utilities. Lay and Enron lobbied aggressively to make it happen. After deregulation, independent power plants and utilities and industries turned to Enron for contracts to deliver the new electricity.

The essential idea was hardly new. But unlike traditional commodity exchanges, such as the Chicago Board of Trade and the New York Mercantile Exchange, Enron was not merely a broker for the deals, putting together buyers and sellers and taking transaction fees. In many cases, Enron entered the contract with the seller and signed a contract with the buyer. Enron made its money on the difference in the two prices, which were never posted in any newspaper or on any Web site, or even made available to the buyers and sellers. Enron alone set them.

By keeping its trading book secret, Enron was able to develop a feel for the market. And virtually none of its activity came under federal regulation because Enron and other power marketers were exempted from oversight in 1992 by the Commodity Futures Trading Commission -- then headed by Wendy Gramm, who is now an Enron board member.

Because it was first in the marketplace and had more products than anyone else, "Enron was the seller to every buyer and the buyer to every seller," said Philip K. Verleger Jr., a California energy economist.

The contracts became increasingly varied and complex. Enron allowed customers to insure themselves against all sorts of eventualities -- a rise and fall in prices or interest rates, a change in the weather, the inability of a customer to pay. By the end, the volume in the financial contracts reached 15 to 20 times the volume of the contracts to actually deliver gas or electricity. And Enron was employing a small army of PhDs in mathematics, physics and economics -- even a former astronaut -- to help manage its risk, backed by computer systems that executives once claimed would take $100 million to replicate.

Dominant Energy Supplier

Enron was so dominant -- it was responsible for one-quarter of the gas and electricity traded in the United States -- that it became a prime target for California officials seeking culprits for the energy price shocks last year and this. It was an image Enron didn't improve by publicly rebuffing a state legislative subpoena for its trading records.

How much risk Enron was taking on itself, and how much it was laying off on other parties, was never revealed. Verleger said last week that Enron once had one of the best risk-disclosure statements in the energy industry. But once the financial contracts began to outpace the basic energy contracts, the statements, he said, suddenly became more opaque. "It was, 'Trust us. We know what we're doing,' " he said.

None of that, however, was of much concern to investors and lenders, who saw Enron as the vanguard of a new industry. New sales and earnings justified an even higher stock price, still more borrowing and more investment.

By 1997, however, after lenders began to express concern about the extent of Enron's indebtedness, chief financial officer Andrew Fastow developed a strategy to move some of the company's assets and debts to separate private partnerships, which would engage in trades with Enron. Fastow became the manager of some of the largest partnerships, with approval of the audit committee of Enron's board.

Enron's description of the partnerships were, at best, baffling: "share settled costless collar arrangements," and "derivative instruments which eliminate the contingent nature of existing restricted forward contracts." More significantly, Enron's financial obligations to the partnerships if things turned sour were not explained.

When Enron released its year-end financial statements for 2000, questions about the partnerships were raised by James Chanos, an investor who had placed a large bet that Enron stock would decline in the ensuing months. Such investors, known as short sellers, often try to "talk down" a stock, and Enron executives dismissed Chanos's questions as nothing more than that.

On Oct. 16, however, it became clear that Chanos was onto something. On that day, Enron reported a $638 million loss for the third quarter and reduced the value of the company's equity by $1.2 billion. Some of that was related to losses suffered by the partnerships, in which Enron had hidden investment losses in a troubled water-management division, a fiber-optic network and a bankrupt telecommunications firm. The statement also revealed that the promises made to the partnerships to guarantee the value of their assets could wind up costing $3 billion.

Within a week, as Enron stock plummeted, Fastow was ousted and the Securities and Exchange Commission began an inquiry. Then, on Nov. 8, bad turned to worse when Enron announced it was revising financial statements to reduce earnings by $586 million over the past four years, in large part to reflect losses at the partnerships. It was also disclosed that Fastow made $30 million in fees and profits from his involvement with the outside partnerships.

The last straw was Enron's admission that it faced an immediate payment of $690 million in debt -- catching credit analysts by surprise -- with $6 billion more due within a year. Fearful that they wouldn't get paid for electricity and gas they sold to Enron, energy companies began scaling back their trading.

Desperate to salvage some future for the company, Lay agreed to sell Enron to crosstown rival Dynegy Inc. for $10 billion in stock. Perhaps more important, Dynegy agreed to assume $13 billion of Enron's debts and to inject $1.5 billion in cash to reassure customers and lenders and to keep its operations going. But when Dynegy officials got a closer look at Enron's books during Thanksgiving week, it found that the problems were far worse than they had imagined. They decided the best deal was no deal.

"The story of Enron is the story of unmitigated pride and arrogance," said Jeffrey Pfeffer, a professor of organized behavior at Stanford Business School who has followed the company in recent months. "My impression is that they thought they knew everything, which [is] always the fatal flaw. No one knows everything."

As harsh as it is, that view is shared by many in the energy industry: customers and competitors, stock analysts who cover the company and politicians and regulators in Washington and state capitals. In their telling, Enron officials were bombastic, secretive, boastful, inflexible, lacking in candor and contemptuous of anyone who didn't agree with their philosophy and acknowledge their preeminence.

Last month, sitting in the lobby of New York's Waldorf-Astoria hotel, Lay seemed to acknowledge that pride may have been a factor in the company's fall. "I just want to say it was only a few people at Enron that were cocky," he said.

Lay declined to name them, but most would put Jeffrey Skilling at the top of the list. Lay tapped Skilling, a whiz kid with the blue-chip consulting firm of McKinsey & Co. and the architect of Enron's trading business, to succeed him as chief executive in February.

Shortly after taking over the top spot, Skilling appeared at a conference of analysts and investors in San Francisco and lectured the assembled on how Enron's stock, then at record levels, was undervalued nonetheless because it did not recognize the company's broadband network, worth $29 billion, or an extra $37 a share.

Skilling loved nothing more than to mock executives from old-line gas and electric utilities or companies that still bought paper from golf-playing salesmen rather than on EnronOnline.

Skilling once called a stock analyst an expletive for questioning Enron's policy of refusing to release an update of its balance sheet with its quarterly earnings announcement, as nearly every other public corporation does.

Skilling Resigns

In August, after Enron's stock had fallen by half, Skilling resigned as chief executive after six months on the job, citing personal reasons.

As for Lay, some question how much he really understood about the accounting ins and out. When asked about the partnerships by a reporter in August, he begged off, saying, "You're getting way over my head."

Lynn Turner, who recently resigned as chief accountant at the Securities and Exchange Commission, said Enron's original financial statements for the past three years involve clear-cut errors under SEC rules that had to have been known to Enron's auditors at Arthur Andersen.

Turner, now director of the Center for Quality Financial Reporting at Colorado State University, said that based on information now reported by the company, he believes the auditors knew the real story about the partnerships but declined to force the company to account for them correctly.

Why? "One has to wonder if a million bucks a week didn't play a role," Turner said. He was referring to the $52 million a year in fees Andersen received last year from Enron, its second-largest account, divided almost equally between auditing work and consulting services.

Anderson spokesman David Talbot recently described the problems with Enron's books as "an unfortunate situation."

If Enron's auditors failed investors, the same might be said for its board of directors -- and, in particular, the members of the audit committee that is charged with reviewing the company's financial statements. The committee is headed by Robert Jaedicke, a former dean of the Stanford University business school and the author of several accounting textbooks. Members include Paulo Ferrz Pereira, former president of the State Bank of Rio de Janeiro; John Wakeham, former head of the British House of Lords who headed a British accounting firm; and Gramm, the former Commodity Futures Trading Commission chairman.

Wakeham received $72,000 last year from Enron, in addition to his director's fee, for consulting advice to the company's European trading office, according to Enron's annual proxy statement. And Enron has contributed to the center at George Mason University, where Gramm heads the regulatory studies program.

Charles O'Reilly, a Stanford University business school professor, said that while such donations rarely "buy" the cooperation of directors, they do indicate the problem when chief executives and directors develop a "pattern of reciprocity" in which they do favors for each other and gradually become reluctant to rock the boat, particularly on complex accounting matters.

"Boards of directors want to give favorable interpretation to events, so even when they are nervous about something, they are reluctant to make a stink," O'Reilly said.

Stock analysts were equally easy on Enron, despite the company's insistence on putting out financial statements that, even in Lay's words, were "opaque and difficult to understand."

Many analysts admit now that they really didn't know what was going on at the company even as they continued to recommend the stock to investors. They were rewarded for it by an ever-rising stock price that seemed to confirm their good judgment.

"It's so complicated everybody is afraid to raise their hands and say, 'I don't understand it,' " said Louis B. Gagliardi, an analyst with John S. Herold Inc. in Norwalk, Conn.

"It wasn't well understood. At the same time, it should have been. There's a burden on the analysts. . . . There's guilt to be borne all around here."


"Enron Readies For Layoffs, Legal Battle:  Rival Dynegy Sues For Pipeline Network," The Washington Post, December 3, 2001 --- http://www.washingtonpost.com/wp-dyn/articles/A52318-2001Dec3.html
By Peter Behr Washington Post Staff Writer Tuesday, December 4, 2001; Page E01

Enron Corp.'s record bankruptcy action rattled its Houston home base yesterday, as the energy trader prepared to lay off 4,000 headquarters employees and began a bitter legal struggle with Dynegy Inc., its neighbor and would-be rescuer, over the causes of its monumental collapse.

Enron told most of its Houston workers to go home and await word on whether their jobs were gone. Meanwhile, Dynegy filed a countersuit against Enron demanding ownership of one of its major pipeline networks -- an asset Dynegy was promised when it advanced $1.5 billion to Enron as part of its aborted Nov. 9 takeover agreement.

The legal battle began Sunday, when Enron filed a $10 billion damage suit against Dynegy, claiming it was forced into a Chapter 11 bankruptcy proceeding when Dynegy pulled back its purchase offer following intense negotiations the weekend after Thanksgiving.

Dynegy's chairman and chief executive, Chuck Watson, said yesterday in a conference call that Enron's lawsuit "is one more example of Enron's failure to take responsibility for its own demise."

"Enron's rapid disintegration," he added, follows "a general loss of public confidence in its leadership and credibility."

Dynegy's shares fell $3.18, or 10 percent, to $27.17 yesterday because of investors' fears that the bankruptcy process will tie up Dynegy's claim to the Omaha-based Northern Natural Gas Co. pipeline, forcing it to write down the $1.5 billion payment to Enron.

"Dynegy is now entangled in this Enron mess," said Commerzbank Securities analyst Andre Meade.

"Investors fear the $1.5 billion investment might not be easily converted into ownership of the pipeline," said Tom Burnett, president of Merger Insight, an affiliate of Wall Street Access, a New York-based brokerage and financial adviser.

On the broader impact of Enron's bankruptcy, Donald E. Powell, chairman of the Federal Deposit Insurance Corp., said in an interview that regulators believe so far that losses on loans to the ailing energy company will be painful but not large enough to cause any bank to fail. However, he said that the ripple effect on other Enron creditors, who in turn may find it harder to repay bank loans, is more difficult to gauge.

"Enron is a complex company," said Powell. "It will take some time to digest the consequences to the banking industry." The FDIC insures deposits at the nation's 9,747 banks and thrifts.

Shares of Enron's major European bank lenders also fell yesterday on overseas markets.

The stock price of J.P. Morgan Chase, one of Enron's lead bankers, fell 3 percent, or $1.17, to $36.55. Enron told a bankruptcy court judge in Manhattan that it has arranged up to $1.5 billion in financing from J.P. Morgan Chase and Citigroup to keep operating as it reorganizes under Chapter 11 bankruptcy protection, according to the Associated Press.

The charges and countercharges between Enron and Dynegy are the opening rounds in a what legal experts predict will be a relentless battle between the two Houston companies.

Hundreds of lawyers representing investors and employees are lining up to question Enron executives and the former Enron officials who quit or were fired in the past four months as the fortunes of the powerful energy trading company disintegrated.

Ahead of them are Securities and Exchange Commission investigators probing whether Enron concealed critical information about its problems from shareholders. Investigators from the House Energy and Commerce Committee are headed for Houston this week to pursue a congressional inquiry into the largest bankruptcy action in U.S. history.

And in the lead position is U.S. Bankruptcy Judge Arthur J. Gonzalez in New York, who has sweeping powers under federal law to oversee claims against Enron, as the company tries to restore its trading business and settle creditors' claims.

Dynegy's immediate goal is to have the ownership of the Northern gas pipeline decided in state court in Texas, where the companies are located, said Dynegy attorney B. Daryl Bristow of Baker Botts.

"Could the bankruptcy court try to put the brakes on this? They could. We'll be in court trying to stop it from happening," Bristow said.


A Message from Duncan Williamson [duncan.williamson@TESCO.NET]

I'm sticking my neck out a bit and offering you all a PDF file I put together on the Enron Affair. I've taken a wide variety of sources in an attempt to explain where I think we are with this case. What Enron does (or did), what has happened and so on. It's a sort of position paper that attempts to explain the facts to non accountants and novice accountants. It's 24 pages long but doesn't take that much time to download. I have used materials from messages on this list and hope the authors don't mind and I have credited them by name. I have used Bob Jensen's bookmarks, too; as well as a whole host of other things.

I'd be grateful for any comments on this paper, or even offers of help to improve what I've done. I have to say I did it in a bit of a hurry and won't be offended by any criticism, providing it's constructive.

I have tested my links and they work for me: let me know of any problems, though. It's at http://www.duncanwil.co.uk/pdfs.html  link number 1

Incidentally, if you haven't been to my site recently (or at all), you can see my latest news at http://www.duncanwil.co.uk/news0212.html . I have a very nice looking Newsletter waiting for you: complete with Xmas theme. Please check my home page every week for the latest newsletter as it is linked from there (take a look now, you'll see what I mean). At the moment I am managing to add content at a significant rate; and will point out that I have developed several new features over the last three months or so, as well as the materials and pages themselves.

My home page (sorry, my Ho! Ho! Home Page) is at http://www.duncanwil.co.uk/index.htm  and is equally festive (well, with a name like Ho! Ho! Home Page it would have to be, wouldn't it?)

Looking forward to seeing you on line!

Best wishes

Duncan Williamson


"The Internet Didn't Kill Enron," By Robert Preston, Internet Week, November 30, 2001 ---  http://www.internetweek.com/enron113001.htm 

"We have a fundamentally better business model."

That's how Jeffrey Skilling, then president of Enron Corp., summarized his company's startling ascendancy a year ago, as Enron's revenues were soaring on the wings of its Internet-based trading model.

It was hard to find fault with Enron's strategy of brokering energy and other commodities over the Internet rather than commanding the means of production and distribution. EnronOnline, its year-old commodity-trading site, already was handling more than $1 billion a day in transactions and yielding the bulk of the company's profits. At its peak, Enron sported a market cap of $80 billion, bigger than all its competitors combined.

See Also Forum: Enron E-Biz Meltdown: What Went Wrong? More Enron Stories

Today, Enron is near bankruptcy, the status of EnronOnline is touch and go, ENE is a penny stock and Skilling is out of a job. Last year's Fortune 7 wunderkind, hailed by InternetWeek and others as one of the most innovative companies in America, overextended itself to the point of insolvency.

So was Enron's "better business model" fundamentally flawed? With the benefit of 20/20 hindsight, what can Internet-inspired companies in every industry learn from Enron's demise?

For one thing, complex Internet marketplaces of the kind Enron assembled are fragile. Enron prospered on the Net not so much because it had good technology -- though the proprietary EnronOnline platform is considered leading-edge -- but because online customers trusted the company to meet its price and delivery promises.

As Skilling told InternetWeek a year ago, "certainty of execution and certainty of fulfillment are the two things people worry about with commodity products." Enron, by virtue of its expertise, networked relationships and reputation, could guarantee those things.

Once it came to light, however, that Enron was playing fast with its financials -- doing off-balance sheet deals and engaging in other tactics to inflate earnings -- customers (as well as investors and partners) lost confidence in the company. And Enron came tumbling down.

Furthermore, advantages conferred by superior technology and information-gathering are fleeting. Competitors learn and mimic and catch up. Barriers to market entry evaporate. Profit margins narrow.

Enron, short of incessant innovation, could never hope to corner Internet market-making, especially in industries, like telecommunications and paper, that it didn't really understand. In its core energy market, perhaps Enron was too quick to eschew refineries and pipelines for the volatile, information-based business of trading.

But it wasn't Internet that killed the beast; it was management's insatiable appetite for expansion and, by all accounts, personal enrichment.

It's too easy to kick Enron now that it's down. It did a lot right. The competition and deregulation and vertical "de-integration" Enron drove are the future of all industries, even energy. Enron was making markets on the Internet well before its competitors knew what hit them.

Was Enron on to a better business model? You bet it was. But like any business model, it wasn't impervious to rules of conduct and principles of economics.


Enron's Former CEO Walks Away With $150 Million

One of the really sad part of the Enron scandal is that the thousands of Enron employees were not allowed to sell Enron shares in their pension funds and were left hold empty pension funds.  One elderly Enron employee on television last evening lamented that his pension of over $2 million was reduced to less than $10,000.  

But such is not the case for top executives.  According to Newsweek Magazine, December 10, 2001 on Page 6, "Enron chief and Bush buddy grabs $150 million while employees lose their shirts.  Probe him."


A Message from the Managing partner and CEO of Andersen
"Enron: A Wake-Up Call,"  by Joe Berardino
The Wall Street Journal, December 4, 2001, Page A18 http://interactive.wsj.com/archive/retrieve.cgi?id=SB1007430606576970600.djm&template=pasted-2001-12-04.tmpl 

A year ago, Enron was one of the world's most admired companies, with a market capitalization of $80 billion. Today, it's in bankruptcy.

Sophisticated institutions were the primary buyers of Enron stock. But the collapse of Enron is not simply a financial story of interest to major institutions and the news media. Behind every mutual or pension fund are retirees living on nest eggs, parents putting kids through college, and others depending on our capital markets and the system of checks and balances that makes them work.

Our Responsibilities

My firm is Enron's auditor. We take seriously our responsibilities as participants in this capital-markets system; in particular, our role as auditors of year-end financial statements presented by management. We invest hundreds of millions of dollars each year to improve our audit capabilities, train our people and enhance quality.

When a client fails, we study what happened, from top to bottom, to learn important lessons and do better. We are doing that with Enron. We are cooperating fully with investigations into Enron. If we have made mistakes, we will acknowledge them. If we need to make changes, we will. We are very clear about our responsibilities. What we do is important. So is getting it right.

Enron has admitted that it made some bad investments, was over-leveraged, and authorized dealings that undermined the confidence of investors, credit-rating agencies, and trading counter-parties. Enron's trading business and its revenue streams collapsed, leading to bankruptcy.

If lessons are to be learned from Enron, a range of broader issues need to be addressed. Among them:

Rethinking some of our accounting standards. Like the tax code, our accounting rules and literature have grown in volume and complexity as we have attempted to turn an art into a science. In the process, we have fostered a technical, legalistic mindset that is sometimes more concerned with the form rather than the substance of what is reported.

Enron provides a good example of how such orthodoxy can make it harder for investors to appreciate what's going on in a business. Like many companies today, Enron used sophisticated financing vehicles known as Special Purpose Entities (SPEs) and other off-balance-sheet structures. Such vehicles permit companies, like Enron, to increase leverage without having to report debt on their balance sheet. Wall Street has helped companies raise billions with these structured financings, which are well known to analysts and investors.

As the rules stand today, sponsoring companies can keep the assets and liabilities of SPEs off their consolidated financial statements, even though they retain a majority of the related risks and rewards. Basing the accounting rules on a risk/reward concept would give investors more information about the consolidated entity's financial position by having more of the assets and liabilities that are at risk on the balance sheet; certainly more information than disclosure alone could ever provide. The profession has been debating how to account for SPEs for many years. It's time to rethink the rules.

Modernizing our broken financial-reporting model. Enron's collapse, like the dot-com meltdown, is a reminder that our financial-reporting model -- with its emphasis on historical information and a single earnings-per-share number -- is out of date and unresponsive to today's new business models, complex financial structures, and associated business risks. Enron disclosed reams of information, including an eight-page Management's Discussion & Analysis and 16 pages of footnotes in its 2000 annual report. Some analysts studied these, sold short and made profits. But other sophisticated analysts and fund managers have said that, although they were confused, they bought and lost money.

We need to fix this problem. We can't long maintain trust in our capital markets with a financial-reporting system that delivers volumes of complex information about what happened in the past, but leaves some investors with limited understanding of what's happening at the present and what is likely to occur in the future.

The current financial-reporting system was created in the 1930s for the industrial age. That was a time when assets were tangible and investors were sophisticated and few. There were no derivatives. No structured off-balance-sheet financings. No instant stock quotes or mutual funds. No First Call estimates. And no Lou Dobbs or CNBC.

We need to move quickly but carefully to a more dynamic and richer reporting model. Disclosure needs to be continuous, not periodic, to reflect today's 24/7 capital markets. We need to provide several streams of relevant information. We need to expand the number of key performance indicators, beyond earnings per share, to present the information investors really need to understand a company's business model and its business risks, financial structure and operating performance.

Reforming our patchwork regulatory environment. An alphabet soup of institutions -- from the AICPA (American Institute of Certified Public Accountants) to the SEC and the ASB (Auditing Standards Board), EITF (Emerging Issues Task Force) and FASB (Financial Accounting Standards Board) to the POB (Public Oversight Board) -- all have important roles in our profession's regulatory framework. They are all made up of smart, diligent, well-intentioned people. But the system is not keeping up with the issues raised by today's complex financial issues. Standard-setting is too slow. Responsibility for administering discipline is too diffuse and punishment is not sufficiently certain to promote confidence in the profession. All of us must focus on ways to improve the system. Agencies need more resources and experts. Processes need to be redesigned. The accounting profession needs to acknowledge concerns about our system of discipline and peer review, and address them. Some criticisms are off the mark, but some are well deserved. For our part, we intend to work constructively with the SEC, Congress, the accounting profession and others to make the changes needed to put these concerns to rest.

Improving accountability across our capital system. Unfortunately, we have witnessed much of this before. Two years ago, scores of New Economy companies soared to irrational values then collapsed in dust as investors came to question their business models and prospects. The dot-com bubble cost investors trillions. It's time to get serious about the lessons it taught us. Market Integrity

In particular, we need to consider the responsibilities and accountability of all players in the system as we review what happened at Enron and the broader issues it raises. Millions of individuals now depend in large measure on the integrity and stability of our capital markets for personal wealth and security.

Of course, investors look to management, directors and accountants. But they also count on investment bankers to structure financial deals in the best interest of the company and its shareholders. They trust analysts who recommend stocks and fund managers who buy on their behalf to do their homework -- and walk away from companies they don't understand. They count on bankers and credit agencies to dig deep. For our system to work in today's complex economy, these checks and balances must function properly.

Enron reminds us that the system can and must be improved. We are prepared to do our part.


February 2002 Updates
Energy and Commerce and Financial Services Committees continue their investigation into Enron's finances with testimony from William Powers, Jr., Chair of the Special Investigation Committee of the Board of Directors of Enron, SEC Chairman Harvey Pitt and Joe Berardino, Andersen CEO. You can access transcripts from the Financial Services Committee at http://www.house.gov/financialservices/testoc2.htm  , and the Energy and Commerce Committee at http://energycommerce.house.gov/ 


Denny Beresford called my attention to the following interview. I found it interesting how Joe Berardino got vague when asked for specifics on "specific changes" that Andersen will call for in the future. My reactions are still the same in my commentary below.

"Andersen's CEO: Auditing Needs "Some Changes" Joseph Berardino harbors no doubts that Enron's fall means his firm's 'reputation is on the line'," Business Week, December 14, 2001 --- http://www.businessweek.com/bwdaily/dnflash/dec2001/nf20011214_7752.htm 

The following is only a short excerpt from the entire interview with Questions being asked by Business Week and Answers being provided by Joe Berardino, CEO of Andersen (the firm that audits Enron).

Q: If we can go beyond the immediate issues: What changes should this lead to in the practice of accounting?
A:
That's hell of a good question. And we're giving that a lot of thought. As I look at this, there needs to be some changes, no question. The marketplace has taken a severe psychological blow, not to mention the financial blow. I think as a profession, we have taken a hit.

And so I think we're prepared to think very boldly about change. I'd suggest to you that I've got two factors that I will consider in suggesting or accepting change. No. 1: Will this change -- whatever it might be -- significantly help us in improving the public's perception and trust in our profession? Secondly, will it really make a difference in terms of helping us improve our practice? And I'd also suggest that the capital market needs to look at itself and say whether or not everything performed as well as it could have.

Q: I don't quite understand what specific change you'd like to see. Some people have said the auditing ought to be much more tightly regulated, somehow divorced from the firms...that the government ought to handle or oversee it. And consulting and auditing certainly ought to be separated. Do you think such dramatic changes are necessary?
A:
I hear the same things, too.... As each day goes on, we all are learning something new. And people are having a broader perspective on what happened. And I'm not saying this should take forever, but let's give us a little more time to stand back...before we rush to solve the problems of the world.

Q: May I ask one quick question specific to Enron? Where does the fault here lie -- with you, with them, with the press, the marketplace?
A:
I think we're all in the fact-gathering stage, and the thing that I've been encouraged by, walking around Capitol Hill today, is our lawmakers are in a fact-gathering stage. Let's just let this play out a little bit.


Arthur Andersen LLP had one organizational policy that, more than any other single factor, probably led to the implosion of the firm?  What was that policy and how did it differ from the other major international accounting firms? 

April 3, 2002 message from Dennis Beresford [dberesfo@TERRY.UGA.EDU

One of the things that I find most fascinating about the Enron/Andersen saga is how much inside information is being made public (thanks to our electronic age). Yesterday the House Energy and Commerce Committee released a series of internal Andersen memos showing the dialogue between the executive office accounting experts and the Houston office client service people. While I haven't had a chance to read all 94 pages yet, the memos are reported to show that the executive office experts raised significant questions about Enron's accounting. But the Houston people were able to ignore that advice because Andersen's internal policies required the engagement people to consult but not necessarily to follow the advice they received. As far as I know, all other major accounting firms would require that consultation advice be followed.

You can view and download the 94 pages at: http://energycommerce.house.gov/107/news/04022002_527.htm#docs 

Denny Beresford

Concerning the Self-Regulation Record of State Boards of Accountancy:  Don't Kick Them Really Hard Until They Are Already Dying
Andersen's failure to comply with professional standards was not the result of the actions on one 'rogue' partner or 'out-of-control' office, but resulted from Andersen's organizational structure and corporate climate that created a lack of independence, integrity and objectivity.
Texas State Board of Public Accountancy, May 24, 2002
"Texas Acts to Punish Arthur Andersen," San Antonio Express News, May 24, 2002, Page 1.
At the time of this news article, the Texas State Board announced that it was recommending revoking Arthur Andersen LLP's accounitn license in Texas and seeking $1,000,000 in fines and penalties.
Bob Jensen's threads on the Enron/Andersen scandals are at http://faculty.trinity.edu/rjensen/fraud.htm 

 

 


Pricewaterhouse Coopers Is Also Being Investigated for Enron Dealings

One of my students forwarded this link.

"PwC: Sharing the Hot Seat with Andersen? PricewaterhouseCoopers' dual role at Enron and its controversial debt-shielding partnerships has congressional probers asking questions," Business Week Online , February 15, 2002 --- http://businessweek.com/bwdaily/dnflash/feb2002/nf20020215_2956.htm 

So far in the Enron scandal, Arthur Andersen has borne all the weight of the accounting profession's failures. But that's about to change. BusinessWeek has learned that congressional investigators are taking a keen interest in PricewaterhouseCoopers' role -- or roles -- in deals between Enron and its captive partnerships. A congressional source says the House Energy & Commerce Committee is collecting documents and interviewing officials at PwC.

At issue is the firm's work for both Enron and those controversial debt-shielding partnerships, set up and controlled by then-Chief Financial Officer Andrew Fastow. On two occasions -- in August, 1999, and May, 2000 -- the world's biggest accounting firm certified that Enron was getting a fair deal when it exchanged its own stock for options and notes issued by the Fastow-controlled partnerships.

Investigators plan to question the complex valuation calculations that underlie the opinions. Enron ultimately lost hundreds of millions of dollars on the deals. A PwC spokesman says the firm stands by its assessment of the deals' value at the time.

OVERLAP. Perhaps more significantly, Pricewaterhouse was working for one of the Fastow partnerships -- LJM2 Co-Investment -- at the same time it assured Enron that the Houston-based energy company was getting a fair deal in its transactions with LJM2. In effect, PwC was providing tax advice to help LJM2 structure its deal -- the first of the so-called Raptor transactions -- while the accounting firm was also advising Enron on the value of that deal.

Pricewaterhouse acknowledges the overlapping engagements but says its dual role did not violate accounting's ethics standards, which require firms to maintain a degree of objectivity in dealing with clients. The firm says the work was done by two separate teams, which did not share data. PwC's spokesman says LJM2's tax structure wasn't a factor in its opinion on the deal's valuation. And, the spokesman says, each client was informed about the other engagement. That disclosure may mean that the firm's actions were in the clear, says Stephen A. Zeff, professor of accounting at Rice University in Houston.

Lynn Turner, former chief accountant at the Securities & Exchange Commission, still has questions. "The standard [for accountants] is, you've got to be objective," says Turner, who now heads the Center for Quality Financial Reporting at Colorado State University. "The question is whether [Pricewaterhouse] met its obligation to Enron's board and shareholders to be objective when it was helping LJM2 structure the transaction it was reviewing. From a common-sense perspective, does this make sense?"

"NO RECOLLECTION." PwC's contacts on both sides of the LJM2 deal were Fastow and his subordinates. BusinessWeek could not determine whether Enron's board, the ultimate client for the fairness opinion, knew of Pricewaterhouse's dual engagements. But W. Neil Eggleston, the attorney representing Enron's outside directors, says Robert K. Jaedicke, chairman of the board's audit committee, has "no recollection of this conflict being brought to the audit committee or the board."

In any case, Capitol Hill's interest in these questions could prove embarrassing to Pricewaterhouse. The firm is charged with overseeing $130 million in assets as bankruptcy administrator of Enron's British retail arm. On Feb. 12, SunTrust Banks said it had dumped Arthur Andersen, its auditor for 60 years, in favor of PwC. And given the huge losses Enron eventually suffered on the LJM and LJM2 deals, the energy trader's shareholders may target PwC's deep pockets as a source of restitution in the biggest bankruptcy in American history.

The fairness opinions were necessary because Enron's top financial officers -- most notably Fastow, the managing partner of LJM and LJM2 -- were in charge on both sides of these transactions. Indeed, both of PwC's fairness opinions were addressed to Ben F. Glisan Jr., a Fastow subordinate who became Enron's treasurer in May, 2000. Glisan left Enron in November, 2001, after the company discovered he had invested in the first LJM partnership.

SELLING POINT. Since the deals were not arms-length negotiations between independent parties, Pricewaterhouse was called in to assure Enron's board that the company was getting fair value. Indeed, minutes from a special board meeting on June 28, 1999, show that Fastow used PwC's fairness review as a selling point for the first deal.

That complex transaction was designed to let Enron hedge against a drop in value of its investment in 5.4 million shares of Rhythms NetConnections, an Internet service provider. PwC did not work for LJM at the time it ruled on that deal's fairness for Enron. The firm valued LJM's compensation to Enron at between $164 million and $204 million.

The second deal, involving LJM2, was designed to indirectly hedge the value of other Enron investments. That deal was even more complex, and PwC's May 5, 2000, opinion does not put a dollar value on it. Instead, it says, "it is our opinion that, as of the date hereof, the financial consideration associated with the transaction is fair to the Company [Enron] from a financial point of view."

"CRISIS OF CONFIDENCE." Some documents associated with LJM2 identified Pricewaterhouse as the partnership's auditor. A December, 1999, memo prepared by Merrill Lynch to help sell a $200 million private placement of LJM2 partnership interests listed the firm as LJM2's auditor. In fact, KPMG was the auditor. The PwC spokesman says his firm didn't even bid for the LJM2 audit contract. Merrill Lynch declined to comment on the erroneous document.

The PwC spokesman acknowledges that congressional investigators have been in touch with the firm. "We are cooperating with the [Energy & Commerce] Committee," he says. On Jan. 31, the New York-based auditor said it would spin off its consulting arm, in part because of concerns that Enron has raised about the accounting profession. "We recognize that there is a crisis of confidence," spokesman David Nestor told reporters. As probers give Pricewaterhouse a closer look, that crisis could become far more real for the Big Five's No. 1.


Enron Former Executive Pleads Guilty to Conspiracy
The guilty plea in Houston federal court yesterday by Christopher Calger, a 39-year-old former vice president in Enron's North American unit, involved a 2000 transaction known as Coyote Springs II in which the company sold some energy assets, including a turbine, to another company. In his guilty plea, Mr. Calger said that he and "others engaged in a scheme to recognize earnings prematurely and improperly" with the help of a private partnership, known as LJM2 that was run and partly owned by Enron's then-chief financial officer, Andrew Fastow. To avoid problems with Enron's outside auditors, company officials were "improperly hiding LJM2's participation in this transaction," according to Mr. Calger's plea.
John Emshjwiller, "Enron Former Executive Pleads Guilty to Conspiracy," The Wall Street Journal, July 15, 2005; Page B2 --- http://online.wsj.com/article/0,,SB112139210586786521,00.html?mod=todays_us_marketplace


Where is the blame for failing to protect the public by improving GAAP?


On January 10, 2002, Big Five firm Andersen notified government agencies investigating the Enron situation that in recent months members of the firm destroyed documents relating to the Enron audit. The Justice Department announced it has begun a criminal investigation of Enron Corp., and members of the Bush administration acknowledged they received early warning of the trouble facing the world's top buyer and seller of natural gas. http://www.accountingweb.com/item/68468 

An Allan Sloan quotation from Newsweek Magazine, December 10, 2001, Page 51 --- http://www.msnbc.com/news/666184.asp?0dm=-11EK 

As Enron tottered, it lost trading business. Its remaining customers began to gouge it—that’s how trading works in the real world. Don’t blame the usual suspects: stock analysts. Rather, blame Arthur Andersen, Enron’s outside auditors, who didn’t blow the whistle until too late. (Andersen says it’s far too early for me to be drawing conclusions.)
Allan Sloan, Newsweek Magazine

The Gottesdiener Law Firm, the Washington, D.C. 401(k) and pension class action law firm prosecuting the most comprehensive of the 401(k) cases pending against Enron Corporation and related defendants, added new allegations to its case today, charging Arthur Andersen of Chicago with knowingly participating in Enron's fraud on employees.
Lawsuit Seeks to Hold Andersen Accountable for Defrauding Enron Investors, Employees --- http://www.smartpros.com/x31970.xml 

Andersen was also recently in the middle of two other scandals involving Sunbeam and Waste Management, Inc. In May 2001, Andersen agreed to pay Sunbeam shareholders $110 to settle a securities fraud lawsuit. In July 2001, Andersen paid the SEC a record $7 million to settle a civil fraud complaint, which alleged that senior partners had failed to act on knowledge of improper bookkeeping at Waste Management, Inc. These "accounting irregularities" led to a $1.4 billion restatement of profits, the largest in U.S. corporate history. Andersen also agreed to pay Waste Management shareholders $20 million to settle its securities fraud claims against the firm.

A Joe Berardino quotation from The Wall Street Journal, December 4, 2001, Page A18 --- 
Mr. Berardino places most of the blame on weaknesses and failings of U.S. Generally Accepted Accounting Standards (GAAP).

Enron reminds us that the system can and must be improved.  We are prepared to do our part.
Joe Berardino,  Managing Partner and CEO of Andersen

Bob Jensen's threads on SPEs are at 
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
 


Pitt: Elevating the Accounting Profession
By: SmartPros Editorial Staff http://www.smartpros.com/x33087.xml 

Feb. 25, 2002 — Securities and Exchange Commission (former) chairman Harvey L. Pitt said in a speech Friday that the SEC needs to "ensure that auditors and accounting firms do their jobs as they were intended to be done."

Addressing securities lawyers in Washington D.C., Pitt outlined the steps the SEC intends to take to accomplish this goal.

Pitt said while "some would try to make accountants guarantors of the accuracy of corporate reports," it "is difficult and often impossible to discover frauds perpetrated with management collusion."

"The fact that no one can guarantee that fraud has not been perpetrated does not mean, however, that we cannot, or should not, improve the level and quality of audits," he added.

The SEC chief also mentioned present day accounting standards, calling them "cumbersome."

Pitt gave a brief overview of the solutions proposed by the SEC since the Enron crisis began for the accounting profession. He said the SEC is advocating changes in the Financial Accounting Standards Board, seeking greater influence over the standard-setting board and to move toward a principles-based set of accounting standards. In addition, the SEC is proposing a private-sector regulatory body, predominantly comprised of persons unaffiliated with the accounting profession, for oversight of the profession.

Pitt also said he is concerned about the current structure where managers and directors are rewarded for short-term performance. The SEC will work with Congress and other groups to improve and modernize the current disclosure and regulatory system.

"Compensation, especially in the form of stock options, can align management's interests with those of the shareholders but not if management can profit from illusory short-term gains and not suffer the consequences of subsequent restatements, the way the public does," he said.

Pitt said the agency will try to recoup money for investors in cases where executives reap the benefits from such practices.

As for dishonest managers, Pitt said the SEC is looking into making corporate officers and directors more responsive to the public's expectations and interests through clear standards of professionalism and responsibilities, and severe consequences for anyone that does not live up to his or her ficuciary obligations.

"We are proposing to Congress that we be given the power to bar egregious officers and directors from serving in similar capacities for any public company," said Pitt.

As a side note, the accounting profession's "brain drain" did not go unmentioned by Pitt. He said "the current environment -- with its scrutiny and criticism of accountants -- is unlikely to create a groundswell of interest on the part of top graduates to become auditors."

The SEC intends to help transform and elevate the performance of the profession to deal with this issue, he added.


In its first Webcast meeting, the Securities & Exchange Commission approved the issuance for comment of rule proposals on disclosures about "critical" accounting estimates. The Commission's rule proposals introduce possible requirements for qualitative disclosures about both the "critical" accounting estimates made by a company in applying its accounting policies and disclosures about the initial adoption of an accounting policy by a company
http://www.accountingweb.com/item/79709
 


THE RELUCTANT REFORMER 

SEC Chairman Harvey Pitt now has the Herculean task of cleaning up a financial mess that has been getting worse for years. Will Pitt, a savvy conservative who's wary of regulation, crack down on corporate abuses?

Available to all readers: http://www.businessweek.com/premium/content/02_12/b3775001.htm?c=bwinsidermar15&n=link60&t=email 

Few SEC chiefs have come into office with the qualifications Pitt brings. He knows both the agency and the industries it regulates intimately. In a quarter-century of representing financial-fraud defendants he has been exposed to nearly every known form of chicanery. The Reluctant Reformer has enormous potential to end the epidemic of financial abuse plaguing Corporate America. And when it comes to getting things done, there's a chance that Pitt's conciliatory style could achieve much more than Levitt's saber-rattling.

Will this historic moment in American business produce a historic reformer? Or will Pitt succumb to the pressures--from his party, from Wall Street, and from his own ideology--and devote himself to little more than calming the troubled political waters around his President? Super-lawyer Pitt likes to say that since he took the helm at the SEC, he now works for "the most wonderful client of all--the American investor." It's time for him to deliver for that client as he has for so many others before.

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.  


News Release from Andersen --- http://andersen.com/website.nsf/content/MediaCenterNewsReleaseArchiveAndersenStatement011402!OpenDocument 

Statement of Andersen — January 14, 2002

As the firm has repeatedly stated, Andersen is committed to getting the facts, and taking appropriate actions in the Enron matter. We are moving as quickly as possible to determine all the facts.

The author of the October 12 e-mail which has been widely reported on is Ms. Nancy Temple, an in-house Andersen lawyer. Her Oct. 12 email, which was sent to Andersen partner Michael Odom, the risk management partner responsible for the Houston office, reads "Mike - It might be useful to consider reminding the engagement team of our documentation and retention policy. It will be helpful to make sure that we have complied with the policy. Let me know if you have any questions" and includes a link to the firm's policy on the Andersen internal website. The firm policy linked to her email prohibits document destruction under some circumstances and authorizes it under other circumstances.

At the time Ms. Temple sent her e-mail, work on accounting issues for Enron's third quarter was in progress. Ms. Temple has told the firm that it was this current uncompleted work that she was referring to in her email and that she never told the audit team that they should destroy documents for past audit work that was already completed. Mr. Odom has told Andersen that when he received Ms. Temple's email, he forwarded it to David Duncan, the Enron engagement partner, with the comment "More help" meaning that Ms. Temple's email was reminding them of the existing policy. It is important to recognize that the release of these communications are not a representation that there were no inappropriate actions. There were other communications. We are continuing our review and we hope to be able to announce progress in that regard shortly.

Attached are copies of the two emails and a copy of the Andersen records retention policy.

The following files are available for download in PDF format:

Copy of two e-mails (15k, 1 page)

Policy statement: Client Engagement Information - Organization, Retention and Destruction, Statement No. 760 (140k, 26 pages)

Policy statement - Practice Administration: Notification of Threatened or Actual Litigation, Governmental or Professional Investigations, Receipt of a Subpoena, or Other Requests for Documents or Testimony (Formal or Informal), Statement No. 780 (106k, 8 pages)


Bob Jensen's Commentary on the Above Message From the CEO of Andersen
     (The Most Difficult Message That I Have Perhaps Ever Written!)
     This is followed by replies from other accounting educators.

The Two Faces of Large Public Accounting Firms

I did not sleep a wink on the night of December 4, 2001.  The cowardly side of me kept saying "Don't do it Bob."  And the academic side of me said "Somebody has to do it Bob."  Before my courage won out at 4:00 a.m., I started to write this module.

Let me begin by stating that my loyalty to virtually all public accounting firms, especially large accounting firms, has been steadfast and true for over 30 years of my life as an accounting professor.  I am amazed at the wonderful things these firms have done in hiring our graduates and in providing many other kinds of support for our education programs.  In practice, these firms have generally performed their auditing and consulting services with high competence and high integrity.

I view a large public accounting firm like I view a large hospital.  Two major tasks of a hospital are to help physicians do their jobs better and to protect the public against incompetent and maverick physicians.  Two major tasks of the public accounting firms on audits is to help corporate executives account better and to protect the public from incompetent and maverick corporate executives.  Day in and day out, hospitals and public accounting firms do their jobs wonderfully even though it never gets reported in the media.  But the occasional failings of the systems make headlines and, in the U.S., the trial lawyers commence to circle over some poor dead or dying carcass. 

When the plaintiff's vultures are hovering, the defendant's attorneys generally advise clients to never say a word.  I fully expected Enron's auditors to remain silent.  The auditing firm that certified Enron's financial statement was the AA firm that is now called Andersen and for most of its life was previously called Arthur Andersen or just AA.  Aside from an occasional failing, the AA firm over the years has been one of the most respected among all the auditing firms.  

It therefore shocked me when the Managing Partner and CEO of Andersen, Joe Beradino, wrote a piece called "Enron:  A Wake-Up Call" in the December 4 edition of The Wall Street Journal (Page A18).  That article opened up my long-standing criticism of integrity in large public accounting firms.  I will focus upon the main defense raised by Mr. Beradono.  His main defense is that when failing to serve the best public interests, the failings are more in GAAP than in the auditors who certify that financial statements are/were fairly prepared under GAAP.  Mr. Beradino's places most of the blame on the failure of GAAP to allow Off-Balance Sheet Financing (OBSF).  In the cited article, Mr Beradono states:

Like many companies today, Enron used sophisticated financing vehicles known as Special Purpose Entities (SPEs) and other off-balance-sheet structures.  Such vehicles permit companies, like Enron, to increase leverage without having to report debt on their balance sheet.  Wall Street has helped companies raise billions with these structured financings, which are well known to analysts and investors.

As the rules stand today, sponsoring companies can keep the assets and liabilities of SPEs off their consolidated financial statements, even though they retain a majority of the related risks and rewards.  Basing the accounting rules on a risk/reward concept would give investors more information about the consolidated entity's financial position by having more of the assets and liabilities that are at risk on the balance sheet ...

There is one failing among virtually all large firms that I've found particularly disturbing over the years, but I've not stuck my neck out until now.  In a nutshell, the problem is that large firms often come down squarely on both sides of a controversial issue, sometimes preaching virtue but not always practicing what is preached.  The firm of Andersen is a good case in point.

  1. On the good news side, Andersen has generally had an executive near the top writing papers and making speeches on how to really improve GAAP.  For example, I have the utmost respect for Art Wyatt.   Dr. Wyatt (better known as Art) is a former accounting professor who, for nearly 20 years, served as the Arthur Andersen's leading executive on GAAP and efforts to improve GAAP.  Dr. Wyatt's Accounting Hall of Fame tribute is at http://www.uif.uillinois.edu/public/InvestingIL/issue27/art10.htm 

    Nobody has probably written better articles lamenting off-balance sheet financing than Art Wyatt while he was at Andersen.  I always make my accounting theory students read  "Getting It Off the Balance Sheet," by Richard Dieter and Arthur R. Wyatt, Financial Executive, January 1980, pp. 44-48.  In that article, Dieter and Wyatt provide a long listing of OBSF ploys and criticize GAAP for allowing too much in the way of OBSF.  I like to assign this article to students, because I can then point to the great progress the Financial Accounting Standards Board (FASB) made in ending many of the OBSF ploys since 1980.  The problem is that the finance industry keeps inventing ever new and ever more complex ploys such as derivative instruments and structured financings that I am certain Art Wyatt wishes that GAAP would correct in terms of not keeping debt of the balance sheet.  It is analogous to plugging bursting dike.  You get one whole plugged and ten more open up!

  2. On the bad news side, Andersen and other big accounting firms, under intense pressure from large clients, have sometimes taken the side of the clients at the expense of the public's best interest.  They sometimes dropped laser-guided bombs on efforts of the leaders like Dr. Wyatt, the FASB, the IASB, and the SEC to end OBSF ploys.  On occasion, the firm's leaders initially came out in in theoretical favor of ending an OBSF ploy and later reversed position after listening to the displeasures of their clients.  My best example here is the initial position take by Andersen's leaders to support the very laudable FASB effort to book vested employee stock compensation as income statement expenses and balance sheet liabilities.  Apparently, however, clients bent the ear of Andersen and led the firm to change its position.  Andersen dropped a bomb on the beleaguered FASB by widely circulating a pamphlet entitled "Accounting for Stock-Based Compensation" in August of 1993.  In that pamphlet under the category "Arthur Andersen Views," the official position turned against booking of employee stock compensation:


Quote From "Accounting for Stock-Based Compensation" in August of 1993.
Arthur Andersen Views

In December 1992, in a letter to the FASB, we expressed the view that the FASB should not be addressing the stock compensation issue and that continuation of today's accounting is acceptable.  We believe it is in the best interests of the public, the financial community, and the FASB itself for the Board to address those issues that would have a significant impact on improving the relevance and usefulness of financial reporting.  In our view, employers' accounting for stock options and other stock compensation plans does not meet that test. 

Despite our opposition, and the opposition of hundreds of others, the FASB decided to complete their deliberations and issue an ED.  We believe the FASB's time and efforts could have been better spent on more important projects.

I can't decide whether it is better to describe the above reply haughty or snotty --- I think I will call it both.

The ill-fated ED that would have forced booking of employee stock options never became a standard because of the tough fight put up against it my large accounting firms, their clients, and the U.S. Congress and Senate.

Returning to Joe Beradino's most current lament of how Special Purpose Entities (SPEs) are not accounted for properly under GAAP, we must beg the question regarding what efforts Andersen has made over the years to get the FASB, the IASB, and the SEC end off-balance-sheet financing with SPEs.  Andersen has made a lot of revenue consulting with clients on how to enter into SPEs and, thereby, take tax and reporting advantages.  Andersen in fact formed a New York Structured Finance Group to assist clients in this regard.  See http://www.securitization.net/knowledgebank/accounting/index.asp 

Joe Beradino wrote the following:   "Like many companies today, Enron used sophisticated financing vehicles known as Special Purpose Entities (SPEs) and other off-balance-sheet structures."  The auditing firm, Andersen, that he heads even publishes a journal called Structured Thoughts advising clients on how to enter into and manage structured financings such as SPEs.  For example, the January 5, 2001 issue is at http://www.securitization.net/pdf/aa_asset.pdf 

I will close this with a quotation from a former Chief Accountant of the Securities and Exchange Commission.

Quote From a Chief Accountant of the SEC
(Well Over a Year Before the Extensive Use of SPEs by Enron Became Headline News.)
So what does this information tell us? It tells us that average Americans today, more than ever before, are willing to place their hard earned savings and their trust in the U.S. capital markets. They are willing to do so because those markets provide them with greater returns and liquidity than any other markets in the world and because they have confidence in the integrity of those markets. That confidence is derived from a financial reporting and disclosure system that has no peer. A system built by those who have served the public proudly at organizations such as the Financial Accounting Standards Board ("FASB") and its predecessors, the stock exchanges, the auditing firms and the Securities and Exchange Commission ("SEC" or "Commission"). People with names like J.P. Morgan, William O. Douglas, Joseph Kennedy, and in our profession, names like Spacek, Haskins, Touche, Andersen, and Montgomery.

 

But again, improvements can and should be made. First, it has taken too long for some projects to yield results necessary for high quality transparency for investors. For example, in the mid 1970's the Commission asked the FASB to address the issue of whether certain equity instruments like mandatorily redeemable preferred stock, are a liability or equity? Investors are still waiting today for an answer. In 1982, the FASB undertook a project on consolidation. One of my sons who was born that year has since graduated from high school. In the meantime, investors are still waiting for an answer, especially for structures, such as special purpose entities (SPEs) that have been specifically designed with the aid of the accounting profession to reduce transparency to investors. If we in the public sector and investors are to look first to the private sector we should have the right to expect timely resolution of important issues.

"The State of Financial Reporting Today: An Unfinished Chapter"

Remarks by Lynn E. Turner,  
Chief Accountant U.S. Securities & Exchange Commission, 
May 31, 2001 --- http://www.sec.gov/news/speech/spch496.htm 

 

 

The research question of interest to me is whether the large accounting firms, including Andersen, have been following the same course of coming down on both sides of a controversial issue.  Lynn Turner's excellent quote above stresses that SPEs have been a known and controversial accounting issue for 20 years.  The head of the firm that audited Enron asserts that the public was mislead by Enron's certified financial statements largely because of bad accounting for SPEs.

Thus I would like discover evidence that Andersen and the other large accounting firms have actively assisted the FASB, the IASB, and the SEC in trying to bring SPE debt onto consolidated balance sheets or whether they have actively resisted such attempts because of pressure from large clients like Enron who actively resisted booking of enormous SPE debt in consolidated financial statements.

One thing is certain.  The time was never better to end bad SPE accounting and bad accounting for structured financing in general before Lynn Turner's son becomes a grandfather.

However, SPEs are not bad per se.  You can read more about SPE uses and abuses at 
    http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
 


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 


 

Ernst & Young changes its mind
Firm reported to reverse its stance on how companies account for stock options. 
CNN Money, February 14, 2003 --- http://money.cnn.com/2003/02/14/news/companies/ernstandyoung.reut/index.htm 
Also see Bob Jensen's threads on this topic at http://faculty.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

 

 

Ernst & Young changes its mind

Firm reported to reverse its stance on how companies account for stock options.
February 14, 2003 : 6:26 AM EST


NEW YORK (Reuters) - Accounting firm Ernst & Young has reversed its opinion on how companies should account for stock options, saying financial statements should reflect their bottom-line cost, the New York Times reported Friday.

The firm, which is under fire for advising executives at Sprint (FON: Research, Estimates) to set up tax shelters related to their stock option transactions, made its change of heart public in a letter to the Financial Accounting Standards Board (FASB), the article said.

Ernst & Young, along with other major accounting groups, maintained for years that options should not be deducted as a cost to the companies that grant them, but the Times reported that now the firm says options should be reflected as an expense in financial statements.

The FASB, which makes the rules for the accounting profession, and the International Accounting Standards Board, its international counterpart, are trying to develop standards that are compatible for domestic and international companies.

In its letter, Ernst & Young said it strongly supported efforts by both groups to develop a method to ensure that "stock-based compensation is reflected in the financial statements of issuing enterprises," the report said. The firm expressed reservations about methods that might be used to value options, but it noted that the current environment requires that the accounting for options provide relevant information to investors.

The letter had been in the works for some time and was unrelated to the recent events surrounding its advice to the Sprint executives, Beth Brooke, global vice chairwoman at Ernst & Young, told the Times.

 


 

"Tax-Shelter Sellers Lie Low For Now, Wait Out a Storm," by Cassel Bryan-Low and John D. McKinnon, The Wall Street Journal, February 14, 2003, Page C1 --- http://online.wsj.com/article/0,,SB1045188334874902183,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs 

With the Internal Revenue Service, Congress and even their own clients on their case, tax-shelter promoters are changing their act to survive.

Using names that evoke an aggressive Arnold Schwarzenegger movie is undesirable right now. Which may be why accounting firm Deloitte & Touche LLP's corporate tax-shelter group has ditched its informal name, Predator, and morphed into a new group with a safer, if duller, name: "Comprehensive Tax Solutions."

KPMG LLP has taken a similar tack. Last year, it disbanded some teams that pitched aggressive strategies -- including some named after the Shakespearean plays "The Tempest" and "Othello" -- to large corporate clients and their top executives. The firm also created a separate chain of command for partners dealing with technical tax issues; those partners handling ethical and regulatory issues report to different bosses.

Shelter promoters also have largely abandoned their strategy of selling one-size-fits-all tax-avoidance plans to hundreds or even thousands of corporate and individual clients. IRS investigators targeted these plans, especially in the past two years, as the government began requiring firms to disclose lists of their clients for abusive tax shelters. Other shelter firms are going down-market, pitching tax-avoidance plans to real-estate agents and car dealers, rather than the super-rich. Demand for tax-avoidance schemes of all kinds is bound to rebound sharply, promoters figure, especially when the stock market rebounds.

For now, though, some traditional corporate clients and wealthy individuals are getting nervous about using aggressive tax-avoidance plans. The IRS cracked down last year to try to force several big accounting firms -- KPMG, BDO Seidman LLP and Arthur Andersen LLP, among others -- to hand over documents about the tax shelters their corporate clients were using. The travails of Sprint Corp.'s two top executives, who are being forced out for using a complicated tax-avoidance scheme, is the latest big blow to tax shelters.

This week, about 100 financial executives gathered for cocktails at a hotel in Sprint's hometown of Kansas City, Kan. Milling outside the dining room, the discussion quickly turned to tax shelters. The debate: Should executives turn to their company's outside auditors for personal tax strategies, given that executives are pitted against the auditor if the tax strategies turn out to be faulty? The risk for executives lies not only in getting stuck with back taxes and penalties, but, as the Sprint case demonstrates, a severely damaged personal reputation.

Some large accounting firms once earned as much as $100 million or more in revenue annually from their shelter-consulting business at the market's peak around 2000. Now, the revenues are in sharp decline, partners at Big Four firms say. In some cases, business from wealthy individuals has dropped about 75% from a few years ago. Business from corporate clients has suffered less, because accounting firms have been able to persuade customers to buy customized, more costly, advice.

Ernst & Young LLP says a group there that had sold tax strategies for wealthy individuals has been shut. E&Y does continue to sell tax strategies to corporate clients, but, a spokesman says: "We don't offer off-the-shelf strategies that don't have a business purpose."

Among the downsides of tax-shelter work: litigation risk. Law firm Brown & Wood LLP, which is now a part of Sidley Austin Brown & Wood LLP, is a defendant in two lawsuits filed in December by disgruntled clients, who allege the law firm helped accountants sell bogus tax strategies by providing legal opinions that the transactions were proper. The suits, one filed in federal court in Manhattan and one in state court in North Carolina, contend that the law firm knew or should have known the tax strategies weren't legitimate.

Continued at http://online.wsj.com/article/0,,SB1045188334874902183,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs 

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

Jensen Note:  Accounting educators might ask their students why performance looked better.  
Hint:  See the article and see one of Bob Jensen's former examinations at 
http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/Exam02VersionA.htm
 


The following is an important article in accounting. It shows how something students may think is a minor deal can have an enormous impact on reported performances of corporations.

It also illustrates the enormous ramifications of controversial and complex tax shelters invented by tax advisors from the same firm (in this case E&Y) that also audits the financial statements. It appears that one of the legacies of the not-so-lame-duck Harvey Pitt who's still at the SEC is to continue to allow accounting firms to both conduct audits and do consulting on complex tax shelters for the client. Is this an example of consulting that should continue to be allowed?

SPRINT RECEIVED big tax benefits in 1999 and 2000 from the exercise of stock options by its executives. The exercises also made the telecom concern's performance look better. Sprint President Ronald LeMay is negotiating for a larger severance package.
Ken Brown and Rebecca Blumenstein, The Wall Street Journal, February 13, 2002 --- http://online.wsj.com/article/0,,SB104510738662209143,00.html?mod=technology_main_whats_news 

NEW YORK -- While Sprint Corp.'s two top executives have lost their jobs and face financial ruin over the use of tax shelters on their stock-option gains, the company itself received big tax benefits from the options these and other Sprint executives exercised.

Regulatory filings show that Sprint had a tax benefit of $424 million in 2000 and $254 million in 1999 stemming from its employees' taxable gains of about $1.9 billion from the exercise of options in those two years. Sprint, which was burning through cash at the time as the telecommunications market bubble burst, had virtually no tax bill in 1999 and 2000, because of sizable business losses. But the Overland Park, Kan., company was able to carry the tax savings forward to offset taxes in future years.

Under the complicated accounting and tax rules that govern stock options, the exercises also made Sprint's performance look better by boosting the company's net asset value, an important measure of a company's financial health.

The dilemma facing Sprint and its two top executives over whether to reverse the options shows how the executives' personal financial situation had become inextricably intertwined with the company's interests. In Sprint's case, the financial interests of the company and its top two executives had diverged. Both were using the same tax adviser, Ernst & Young LLP. The matter has renewed debate about whether such dual use of an auditing firm creates auditor-independence issues that can hurt shareholders.

Stock-option exercises brought windfalls to Sprint employees as the company's shares rose in anticipation of a 1999 planned merger with Worldcom Inc., which later was blocked by regulators.

Sprint Chairman and Chief Executive William T. Esrey and President Ronald LeMay sought to shield their gains from taxes using a sophisticated tax strategy offered by Ernst & Young. That tax shelter now is under scrutiny by the Internal Revenue Service. If it's disallowed, the executives would owe tens of millions of dollars in back taxes and interest.

Sprint recently dismissed the two men and intends to name Gary Forsee, vice chairman of BellSouth Corp., to succeed Mr. Esrey. Messrs. Esrey and LeMay are now trying to negotiate larger severance packages with the company because of their unexpected dismissals. (See related article.)

Sprint, like other companies, was allowed to take as a federal income-tax deduction the value of gains reaped from all those stock options that employees exercised during the year. Between 1999 and 2000, Mr. LeMay exercised options with a taxable gain of $149 million, while Mr. Esrey exercised options with a taxable gain of $138 million. Assuming the standard 35% corporate tax rate on the $287 million in options gains, the executives would have helped the company realize $100 million of tax savings in those two years.

If the company had agreed to unwind the transactions -- by buying back the shares and issuing new options -- the $100 million in savings would have been wiped out and the company would have had to record a $100 million compensation expense, which would have cut earnings.

"They would have had a large compensation expense immediately at the moment of recision equal to the tax benefit they would have foregone," says Robert Willens, Lehman Brothers tax-and-accounting analyst. "So there was no way they were going to do that."

The tax savings to Sprint revealed in the filings shed light on why the company opted not to unwind the now-controversial options exercises of Messrs. Esrey and LeMay. The executives wanted to unwind the options at the end of 2000 after learning that the IRS was frowning on the tax shelters they had used and the value of Sprint's stock had fallen markedly. However, the conditions the SEC put on such a move would have been expensive for the company. The subject wasn't discussed by the board of directors, according to people familiar with the situation. It isn't clear what role Messrs. Esrey and LeMay played in making the decision not to unwind the options.

Many tax-law specialists believe the IRS will rule against the complicated shelters, which the two executives have said could spell their financial ruin. Because Sprint's stock price collapsed after Sprint's planned merger with Worldcom was rejected by regulators in June 2000, the executives were left holding shares worth far less than the tax bill they could potentially face if their shelters are disallowed by the IRS.

If the telecommunications company had unwound the transactions, Sprint would have had to restate and lower its 1999 profits. The company could have seen its earnings pushed lower for years to come and might have been forced to refile its back taxes at a time when Sprint's cash was limited, according to tax experts.

The large companywide burst of options activity demonstrates just what a frenzy was taking place within Sprint in the wake of its proposed $129 billion merger with Worldcom. In 1998, Sprint deducted only $49 million on its federal taxes from employees exercising their stock options. That swelled to $424 million in 2000.

The push to exercise options in 2000 was intensified by Sprint's controversial decision to accelerate the timing of when millions of options vested to the date of shareholder approval of the Worldcom deal -- not when the deal was approved by regulators. The deal ultimately was approved by shareholders and rejected by regulators. In the meanwhile, many executives took advantage of their options windfalls, while common shareholders got saddled with the falling stock price.

Continued in the article.

 

Jensen Note:  Accounting educators might ask their students why performance looked better.  
Hint:  See the article and see one of Bob Jensen's former examinations at 
http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/Exam02VersionA.htm
 

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

Februrary 13, 2003 reply from Ed Scribner

Paragraph on p. A17 of Wall Street Journal, Tuesday, February 11, 2003, about E&Y's advice to Sprint executives William Esrey and Ronald LeMay:

Along with selling the executives on the tax shelters, Ernst & Young advised them against putting Sprint shares aside to pay for potential taxes and to claim thousands of exemptions so they would owe virtually no taxes. The accountant advised Mr. LeMay to claim more than 578,000 [sic] exemptions on his 2000 federal tax W4 form, for example. 

Can this be for real? 

Ed Scribner 
Department of Accounting & Business Computer Systems 
Box 30001/MSC 3DH New Mexico State University 
Las Cruces, NM, USA 88003-8001

February 13, 2003 reply from Todd Boyle [tboyle@ROSEHILL.NET

Of course, they aren't binding and don't persuade the IRS or anybody else, very much. The main effect of "Comfort Letters" has been that they reduce the likelihood of penalties on the taxpayer. As such, the accounting profession has a printing press, for printing money. The "audit lottery" already exhibits much lower taxes, statistically. Together with "Comfort Letters" the whole arrangement makes the CPA a key enabler of financial crime, an unacceptable moral hazard.

Legislation is needed (A) Whenever a "Comfort Letter exists, if penalties otherwise applicable on the taxpayer are abated, those penalties shall be born by the author of the "Comfort Letter"

and (B) Whenever such determination is made that a "Comfort Letter" defense was successfully raised by a taxpayer, the author of the "Comfort Letter" shall be required to provide IRS with a list of all clients and TINs, to whom that position in the "Comfort Letter" was explained or communicated."

Todd Boyle CPA - Kirkland WA

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

 


My second Philadelphia Inquirer Interview
February 24, 2002 Message from James Borden [james.borden@VILLANOVA.EDU

Here is a brief excerpt from an article entitled "Accounting Firms demand change, then they resist it".

...Accountants should have been championing change, not fighting it, several accounting professors said. "They say they're for motherhood, but they're selling prostitution," said Bob Jensen, an accounting professor at Trinity University in San Antonio, Texas.

You can read the full article at http://www.philly.com/mld/philly/business/2736217.htm 

Be aware that articles only stay freely available for about a week at the Philadelphia Inquirer.

Jim Borden Villanova University

Also see http://faculty.trinity.edu/rjensen/FraudPhiladelphiaInquirere022402.htm 


My first Philadelphia Inquirer Interview --- http://faculty.trinity.edu/rjensen/philadelphia_inquirer.htm 
"As Enron scandal continues to unfold, more intriguing elements come to light," by Miriam Hill, Philadelphia Inquirer, January 23, 2002


A February 24, 2002 message from Elliot Kamlet [ekamlet@BINGHAMTON.EDU

When the FASB tried to force FAS 133 (fair value), at least one, maybe two bills were introduced in congress to bar the FASB from doing so. Financial executives, fearful of the impact of stock options on the bottom line and fearful of what action the IRS might take if the options were to be valued at fair value, used an incredible amount of pressure to make sure this method was not adopted. As a result, it is only recommended. If you read Coca Cola footnote 12, it does give the fair value measured by Black Scholes.

APB 25 and FAS 133 are applicable. So Coca Cola using APB 25 values options at the difference between the exercise price and the market price (generally -0-). But Boeing uses FAS 133, the recommended method of using an option pricing model, such as Black-Scholes, to value options issued at fair value. FAS 133 is not required, only recommended.

Auditors would need to be competent to evaluate the fair value valuation if the total is material. However, they could just hire their own expert to meet the requirement.

Elliot Kamlet


On January 11, 2002 Ruth Bender, Cranfield School of Management wrote the following:

On a related subject, the front page of the UK journal Accountancy Age yesterday was full of outraged comments from partners of the other Big 5 firms. However, what worried me was what it was that was outraging  them. 

 It wasn't that Andersen made the 'errors of judgement' - but that Bernadino > had admitted them in public.


From Time Magazine on January 14, 2002.

Just four days before Enron disclosed a stunning $618 million loss for the third quarter—its first public disclosure of its financial woes—workers who audited the company's books for Arthur Andersen, the big accounting firm, received an extraordinary instruction from one of the company's lawyers. Congressional investigators tell Time that the Oct. 12 memo directed workers to destroy all audit material, except for the most basic "work papers." And that's what they did, over a period of several weeks. As a result, FBI investigators, congressional probers and workers suing the company for lost retirement savings will be denied thousands of e-mails and other electronic and paper files that could have helped illuminate the actions and motivations of Enron executives involved in what now is the biggest bankruptcy in U.S. history.

Supervisors at Arthur Andersen repeatedly reminded their employees of the document-destruction memo in the weeks leading up to the first Security and Exchange Commission subpoenas that were issued on Nov. 8. And the firm declines to rule out the possibility that some destruction continued even after that date. Its workers had destroyed "a significant but undetermined number" of documents related to Enron, the accounting firm acknowledged in a terse public statement last Thursday. But it did not reveal that the destruction orders came in the Oct. 12 memo. Sources close to Arthur Andersen confirm the basic contents of the memo, but spokesman David Tabolt said it would be "inappropriate" to discuss it until the company completes its own review of the explosive issue.

Though there are no firm rules on how long accounting firms must retain documents, most hold on to a wide range of them for several years. Any deliberate destruction of documents subject to subpoena is illegal. In Arthur Andersen's dealings with the documents related to Enron, "the mind-set seemed to be, If not required to keep it, then get rid of it," says Ken Johnson, spokesman for the House Energy and Commerce Committee, whose investigators first got wind of the Oct. 12 memo and which is pursuing one of half a dozen investigations of Enron. "Anyone who destroyed records out of stupidity should be fired," said committee chairman Billy Tauzin, a Louisiana Republican. "Anyone who destroyed records to try to circumvent our investigation should be prosecuted."

The accounting for a global trading company like Enron is mind-numbingly complex. But it's crucial to learning how the company fell so far so fast, taking with it the jobs and pension savings of thousands of workers and inflicting losses on millions of individual investors. At the heart of Enron's demise was the creation of partnerships with shell companies, many with names like Chewco and JEDI, inspired by Star Wars characters. These shell companies, run by Enron executives who profited richly from them, allowed Enron to keep hundreds of millions of dollars in debt off its books. But once stock analysts and financial journalists heard about these arrangements, investors began to lose confidence in the company's finances. The results: a run on the stock, lowered credit ratings and insolvency.

Shredded evidence is only one of the issues that will get close scrutiny in the Enron case. The U.S. Justice Department announced last week that it was creating a task force, staffed with experts on complex financial crimes, to pursue a full criminal investigation. But the country was quickly reminded of the pervasive reach of Enron and its executives—the biggest contributors to the Presidential campaign of George W. Bush—when U.S. Attorney General John Ashcroft had to recuse himself from the probe because he had received $57,499 in campaign cash from Enron for his failed 2000 Senate re-election bid in Missouri. Then the entire office of the U.S. Attorney in Houston recused itself because too many of its prosecutors had personal ties to Enron executives—or to angry workers who have been fired or have seen their life savings disappear.

Texas attorney general John Cornyn, who launched an investigation in December into 401(k) losses at Enron and possible tax liabilities owed to Texas, recused himself because since 1997 he has accepted $158,000 in campaign contributions from the company. "I know some of the Enron execs, and there has been contact, but there was no warning," he says of the collapse.

Bush told reporters that he had not talked with Enron CEO Kenneth L. Lay about the company's woes. But the White House later acknowledged that Lay, a longtime friend of Bush's, had lobbied Commerce Secretary Don Evans and Treasury Secretary Paul O'Neill. Lay called O'Neill to inform him of Enron's shaky finances and to warn that because of the company's key role in energy markets, its collapse could send tremors through the whole economy. Lay compared Enron to Long-Term Capital Management, a big hedge fund whose near collapse in 1998 required a bailout organized by the Federal Reserve Board. He asked Evans whether the Administration might do something to help Enron maintain its credit rating. Both men declined to help.

An O'Neill deputy, Peter Fisher, got similar calls from Enron's president and from Robert Rubin, the former Treasury Secretary who now serves as a top executive at Citigroup, which had at least $800 million in exposure to Enron through loans and insurance policies. Fisher—who had helped organize the LTCM bailout—judged that Enron's slide didn't pose the same dangers to the financial system and advised O'Neill against any bailout or intervention with lenders or credit-rating agencies.

On the evidence to date, the Bush Administration would seem to have admirably rebuffed pleas for favors from its most generous business supporter. But it didn't tell that story very effectively—encouraging speculation that it has something to hide. Democrats in Congress, frustrated by Bush's soaring popularity and their own inability to move pet legislation through Congress, smelled a chance to link Bush and his party to the richest tale of greed, self-dealing and political access since junk-bond king Michael Milken was jailed in 1991. That's just what the President, hoping to convert momentum from his war on terrorism to the war on recession, desperately wants to avoid. The fallout will swing on the following key questions:

Was a crime committed?

The justice investigation will be overseen in Washington by a seasoned hand, Josh Hochberg, head of the fraud section and the first to listen to the FBI tape of Linda Tripp and Monica Lewinsky in the days leading to the case against President Clinton. The probe will address a wide range of questions: Were Enron's partnerships with shell corporations designed to hide its liabilities and mislead investors? Was evidence intentionally or negligently destroyed? Did Enron executives' political contributions and the access that the contributions won them result in any special favors? Did Enron executives know the company was sinking as they sold $1.1 billion in stock while encouraging employees and other investors to keep buying?

"It's not hard to come up with a scenario for indictment here," says John Coffee, professor of corporate law at Columbia University. "Enough of the facts are already known to know that there is a high prospect of securities-fraud charges against both Enron and some of its officers." He adds that "once you've set up a task force this large, involving attorneys from Washington, New York and probably California, history shows the likelihood is they will find something indictable."

Enron has already acknowledged that it overstated its income for more than four years. The question is whether this was the result of negligence or an intent to defraud. Securities fraud requires a willful intent to deceive. It doesn't look good, Coffee says, that key Enron executives were selling stock shortly before the company announced a restatement of earnings.

As for Arthur Andersen, criminal charges could result if it can be shown that its executives ordered the destruction of documents while being aware of the existence of a subpoena for them. A likely ploy will be for prosecutors to target the auditors, hoping to turn them into witnesses against Enron. Says Coffee: "If the auditors can offer testimony, that would be the most damaging testimony imaginable."

http://www.time.com/time/business/article/0,8599,193520,00.html 


The Time Magazine link above is at http://www.time.com/time/business/article/0,8599,193520,00.html 

That article provides links to  learning about "Lessons From the Enron Collapse" and why the Andersen liability is so unlike virtually all previous malpractice suits.

Lessons from the Enron Collapse Part I - Old line partners wanted ... http://www.accountingmalpractice.com/res/articles/enron-1.pdf 

Part II - Why Andersen is so exposed ... http://www.accountingmalpractice.com/res/articles/enron-2.pdf 

Part III - An independence dilemma http://www.accountingmalpractice.com/res/articles/enron-3.pdf 

Main link --- http://www.accountingmalpractice.com


Dingell Takes Pitt to Task in Wake Of Enron Debacle; Full Investigation Sought --- http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm 

Bob Jensen's threads on SPEs are at 
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
 


"The Big Five Need to Factor in Investors," Business Week, December 24, 2001, Page 32 --- http://www.businessweek.com/ (not free to download for non-subscribers)

At issue are so-called special-purpose entities (SPEs), such as Chewco and JEDI partnerships Enron used to get assets like power plants off its books.  Under standard accounting, a company can spin off assets --- an the related debts --- to an SPE if an outside investor puts up capital worth at least 3% of the SPEs total value.  

Three of Enron's partnerships didn't meet the test --- a fact auditors Arthur Andersen LLP missed.  On Dec. 12, Andersen CEO Joseph F. Berardino told the House Financial Services Committee his accountants erred in calculating one partnership's value.  On others, he says, Enron withheld information from its auditors:  The outside investor put up 3%, but Enron cut a side deal to cover half of that with its own cash.  Enron denies it withheld any information.

Does that absolve Andersen?  Hardly.  Auditors are supposed to uncover secret deals, not let them slide.  Critics fear the New Economy emphasis means auditors will do even less probing.

The 3% rule for SPEs is also too lax.

To Andersen's credit, it has long advocated a tighter rule.  But that would crimp the Big Five's clients --- companies and Wall Street.  Accountants have helped stall changes.  

Enron's collapse may finally breat that logjam.  Like it or not, the Big Five must accept new rules that give investors a clearer picture of what risks companies run with SPEs.

The rest of the article is on Page 38 of the Business Week Article.


"Arthur Andersen:  How Bad Will It Get?" Business Week, December 24, 2001, pp. 30-32 --- http://www.businessweek.com/ (not free to download for non-subscribers)

QUOTE 1
Berardino, a 51-year-old Andersen lifer, may find the firm's competence in auditing complex financial companies questioned.  While Andersen was its auditory, Enron's managers shoveled debt into partnerships with Enron's own ececs to get it off the balance sheet --- a dubious though legal ploy.  In one case, says Berardino, hoarse from defending the firm on Capitol Hill, Andersen's auditors made an "error in judgment" and should have consolidated the partnership in Enron's overall results.  Regarding another, he says Enron officials did not tell their auditor about a "separate agreement" they had with an outside investor, so the auditor mistakenly let Enron keep the partnership's results separate.  (Enron denies that the auditors were not so informed.)

QUOTE 2
Enron says a special board committee is investgating why management and the board did not learn about this arrangement until October.  Now that Enron has consolidated such set-ups into its financial statements, it had to restate its financial reports from 1997 onward, cutting earnings by nearly $500 million.  Damningly, the company says more than four years' worth of audits and statements approved by Andersen "should not be relied upon."


"Let Auditors Be Auditors," Editorial Page, Business Week, December 24, 2001, Page 96 --- http://www.businessweek.com/ (not free to download for non-subscribers)

But neither proposal (plans proposed by SEC Commission Chairman Harvey L. Pitt) goes far enough.  GAAP, the generally accepted accounting principles, desperately need to be revamped to deal with cash flow and other issues relevant in a fast-moving, high-tech economy.  The whole move to off-balance sheet accounting should be reassessed.  Opaque partnerships that hide assets and debt do not serve the interests of investors.  Under heavy shareholder pressure from the Enron fallout, El Paso Corp. just moved $2 billion in partnership debt onto the balance sheet. Finally, Pitt should consider requiring companies to change their auditors who go easy on them, as we have seen time and time again.


The Big Five Firms 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 


The SEC Responds
Remarks by Robert K. Herdman Chief Accountant U.S. Securities and Exchange Commission American Institute of Certified Public Accountants' Twenty-Ninth Annual National Conference on Current SEC Developments Washington, D.C., December 6, 2001 --- http://www.sec.gov/news/speech/spch526.htm 
Also see http://www.smartpros.com/x32080.xml 


Although the Securities and Exchange Commission has never in the past brought an enforcement action against an audit committee or a member of an audit committee, recent remarks by SEC commissioners and staff indicate this may change in the future. SEC Director of Enforcement Stephen Cutler said, "An audit committee or audit committee member can not insulate herself or himself from liability by burying his or her head in the sand. In every financial reporting matter we investigate, we will look at the audit committee." http://www.accountingweb.com/item/73263 


Message 1 (January 5, 2002) from a former Chairman of the Financial Accounting Standards Board (Denny Beresford)

Bob,

You might be interested in the following link to an article in the Atlanta newspaper that mentions my own economic setback re: Enron.

http://www.accessatlanta.com/ajc/epaper/editions/saturday/business_c3d246cc7171f08b0067.html 

Denny

In case it goes away on the Web, I will provide one quote from "INVESTMENT OUTLOOK: ENRON'S COLLAPSE: INVESTORS' COSTLY LESSON Situation shows danger of listening to analysts, failing to understand complex financial reports," Atlanta Journal-Constitution, December 29, 2001 --- http://www.accessatlanta.com/ajc/epaper/editions/saturday/business_c3d246cc7171f08b0067.html 

"When Warren Buffett spoke on campus a few months ago, he said you ought not to invest in something you don't understand," said Dennis Beresford, Ernst & Young executive professor of accounting at the University of Georgia.

That's one of the lessons for investors from the Enron case, according to Beresford and others. Another is that "some analysts are better touts than helpers these days,'' Beresford said.

"Enron was a very complicated company,'' he said. "Beyond that, its financial statements were extremely complicated. If you read the footnotes of the reports very carefully, you might have had some questions."

But a lot of individuals and institutional investors did not have questions, even months into the decline in Enron stock.

At least one brokerage house was recommending Enron as a "strong buy" in mid-October, after the stock had fallen 62 percent from its 52-week high last December. The National Association of Investors Corp., a nonprofit organization that advises investment clubs, featured Enron as an undervalued stock in the November issue of Better Investing magazine.

Beresford, a former chairman of the standards-setting Financial Accounting Standards Board, even bought "a few shares'' of Enron in October when the price dropped below book value. But he didn't hold them for long.

"It became clear to me that the numbers were going to be deteriorating very quickly and that the marketplace had lost confidence in the management,'' he said.

On Oct. 16, Enron announced a $1 billion after-tax charge, a third-quarter loss and a reduction in shareholder equity of $1.2 billion. A little more than a week later, Enron replaced its chief financial officer.

On Nov. 8, the company said it would restate its financial statements for the prior four years. On Dec. 2, Enron filed for Chapter 11 bankruptcy protection.

One of the issues in Enron's case is its accounting for hedging transactions involving limited partnerships set up by its then-chief financial officer. Enron's filings with the Securities and Exchange Commission reported the existence of the limited partnerships and the fact that a senior member of Enron's management was involved. But, as the SEC noted later, "very little information regarding the participants and terms of these limited partnerships were disclosed by the company."

"The SEC requires a certain amount of disclosure, but if you can't understand accounting, you're hobbled,'' said Scott Satterwhite, an Atlanta-based money manager for Artisan Partners. "If you can't understand what the accounting statements are telling you, you probably should look elsewhere. If you read something that would seem to be important and you can't understand it, it's a red flag.''


Message 2 (January 8, 2002) from Dennis Beresford, former Chairman of the Financial Accounting Standards Board

Bob,

In response to Enron, the major accounting firms have developed some new audit "tools" that can be accessed at: http://www.aicpa.org/news/relpty1.htm

Also, the firms have petitioned the SEC to require some new disclosures relating to special purpose entities and similar matters. The firms' petition is at: http://www.sec.gov/rules/petitions.shtml

I understand the SEC will probably also tell companies that they need to enhance their MD&A disclosures about special purpose entities.

Denny


From The Wall Street Journal's Accounting Educators' Reviews on January 10, 2002

TITLE: Accounting Firms Ask SEC for Post-Enron Guide 
REPORTER: Judith Burns and Michael Schroeder 
DATE: Jan 07, 2002 PAGE: A16 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1010358829367934440.djm  
TOPICS: Auditing, Accounting, Auditing Services, Auditor Independence, Disclosure, Disclosure Requirements, Regulation, Securities and Exchange Commission

SUMMARY: As a part of a greater effort to restore public confidence in accounting work, the Big Five accounting firms have asked the SEC to provide immediate guidance to public companies concerning some disclosures. In addition, the Big Five accounting firms have promised to abide by higher standards in the future.

QUESTIONS: 
1.) Why do the Big Five accounting firms need the SEC to issue guidance to public companies on disclosure issues? What is the role of the SEC in financial reporting? Why are the Big Five accounting firms looking to the SEC rather than the FASB?

2.) Why are the Big Five accounting firms concerned about public confidence in the accounting profession? Absent public confidence in accounting, what is the role, if any, of the independent financial statement audit?

3.) What role does consulting by auditing firms play in the public's loss of confidence in the accounting profession? Should an independent audit firm be permitted to perform consulting services for it's audit clients?

4.) What is the purpose of the management discussion and analysis section of corporate reporting? Is the independent auditor responsible for the information contained in management's discussion and analysis?

5.) Comment on the statement by Michael Young that, "Corporate executives are being dragged kicking and screaming into a world of improved disclosure." Why would executives oppose improved disclosure?

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

 


International Reactions and An Editorial from Double Entries on December 13, 2001

The big issue this week and one that is likely to dominate the accounting headlines for sometime is the Enron controversy. We have three items on Enron this week in the United States section including a brief summary from Frank D'Andrea and verbatim statements from the Big Five firms and the AICPA. We will continue to post the latest news to the website at http://accountingeducation.com  and as per normal a summary of those items in future issues of Double Entries.

While the Enron story is big, we also have extensive news from around the world including Australia, Canada, Ireland and the United Kingdom. It seems that the accrual accounting in government tidal wave that first started in New Zealand back in the early 1990s has now swept through Australia, the United States and now into Canada where the Canadian Federal government is to adopt accrual accounting. Who is to be next? Is this the solution to better financial accounting/accountability in the pubic sector? We welcome your views on this issue.

Till next week ...

Andrew Priest and Andy Lymer, Editors, 
AccountingEducation.com's Double Entries
Double_Entries@accountingeducation.com 

[27] AICPA STATEMENT ON ENRON & AUDIT QUALITY The following is a statement from James G. Castellano, AICPA Chair and Barry Melancon, AICPA President and CEO on Enron and audit quality released on December 4, 2001. The statement has been reported verbatim for your information. Click through to http://accountingeducation.com/news/news2363.html  for the statement [AP].

[28] STATEMENT FROM BIG FIVE CEOS ON ENRON The following is being issued jointly by Andersen, KPMG, Deloitte & Touche, PricewaterhouseCoopers and Ernst & Young. We have reported the statement verbatim: As with other business failures, the collapse of Enron has drawn attention to the accounting profession, our role in America's financial markets and our public responsibilities. We recognize that a strong, diligent, and effective profession is a critically important component of the financial reporting system and fundamental to maintaining investor confidence in our capital markets. We take our responsibility seriously. [Click through to http://accountingeducation.com/news/news2362.html  for the balance of the statement] [AP].

[29] ENRON AND ARTHUR ANDERSON UNDER THE LOOKING GLASS All eyes are on Enron these days, as the Company has filed for bankruptcy protection, the largest such case in the U.S. The Enron collapse has the whole accounting and auditing industry astir. The lack of confidence in Enron by investors was the result of several factors, including inadequate disclosure for related-party transactions, financial misstatements and massive off-balance-sheet liabilities. Whilst this issue has been extensively covered in the Press, we provide a brief summary of the story in our full item at http://accountingeducation.com/news/news2355.html . More details will follow on this important issue as it continues to unfold [FD].


Betting the Farm:  Where's the Crime?

The story is as old as history of mankind.  A farmer has two choices.  The first is to squeeze out a living by tilling the soil, praying for rain, and harvesting enough to raise a family at a modest rate of return on capital and labor.  The second is to go to the saloon and bet the farm on what seems to be a high odds poker hand such as a full house or four deuces.  

When CEO Ken Lay says that the imploding of Enron was due to an economic downturn and collapse of energy prices, he is telling it like it is.  He and his fellow executives Jeff Skilling and Andy Fastow did indeed begin to bet the farm six years ago on a relatively sure thing that energy prices would rise.  They weren't betting the farm (Enron) on a literal poker hand, but their speculations in derivative financial instruments were tantamount to betting on a full house or four deuces.  And as their annual bets went sour, they borrowed to cover their losses and bet the borrowed money in increasingly large-stake hands in derivative financial instruments.

Derivative financial instruments are two-edged swords.  When used conservatively,  they can be used to eliminate certain types of risk such as when a forward contract, futures contract, or swap is used to lock in a future price or interest rate such that there is no risk from future market volatility.  Derivatives can also be used to change risk such as when a bond having no cash flow risk and value risk is hedged so that it has no value risk at the expense of creating cash flow risk.  But if there is no hedged item when a derivative is entered into, it becomes a speculation tantamount to betting the farm on a poker hand.  The only derivative that does not have virtually unlimited risk is a purchased option.  Contracts in forwards, futures, swaps (which are really portfolio of forwards), and written options have unlimited risks unless they are hedges.

Probably the most enormous example of betting on derivatives is the imploding of a company called Long-Term Capital (LTC).  LTC was formed by two Nobel Prize winning economists (Merton and Scholes) and their exceptionally bright former doctoral students.  The ingenious arbitrage scheme of LTC was almost a sure thing, like betting on four deuces in a poker game having no wild cards.  But when holding four deuces, there is a miniscule probability that the hand will be a loser.  The one thing that could bring LTC's bet down was the collapse of Asian markets, that horrid outcome that eventually did transpire.  LTC was such a huge farm that its gambling losses would have imploded the entire world's securities marketing system, Wall Street included.  The world's leading securities firms put up billions to bail out LTC, not because they wanted to save LTC but because they wanted to save themselves.  You can read about LTC and the other famous derivative financial instruments scandals at http://faculty.trinity.edu/rjensen/fraud.htm#DerivativesFraud 

There is a tremendous (one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova video explaining why LTC collapsed.  Go to http://www.pbs.org/wgbh/nova/stockmarket/ 

Given Enron's belated restatement of reported high earnings since 1995 into huge reported losses, it appears that Enron was covering its losses with borrowed money that its executives  threw back into increasingly larger gambles that eventually put the entire farm (all of Enron) at risk.  As one reporter stated in a baseball metaphor, "Enron was swinging for the fences."

Whether or not top executives of a firm should be allowed to bet the farm is open to question.  Since Orange County declared bankruptcy after losing over $1 billion in derivatives speculations, most corporations have written policies that forbid executives from speculating in derivatives.  Enron's Board of Directors purportedly (according to Enron news releases) knew the farm was on the line in derivatives speculations and did not prevent Skilling, Fastow, and Lay from putting the entire firm in the pot.  

So where's the crime?  

The crime lies in deceiving employees, shareholders, and investors and hiding the relatively small probability of losing the farm by betting on what appeared to be a great hand.  The crime lies in Enron executives' siphoning millions from the bets into their pockets along the way while playing a high stakes game with money put up by creditors, investors, and employees.

The crime lies is accounting rules that allow deception and hiding of risk through such things as special purpose entities (SPEs) that allow management to keep debt off balance sheets, thereby concealing risk.  The crime lies at the foot of an auditing firm, Andersen, that most certainly knew that the farm was in the high-stakes pot but did little if anything to inform the public about the high stakes game that was being played with the Enron farm in the pot.  Andersen contends that it played by each letter of the law, but it failed to let on that the letters spelled THE FARM IS IN THE POT AT ENRON!  The crime lies in having an audit committee that either did not ask the right questions or went along with the overall deception of the public.

So who should pay?

I hesitate to answer that, but I really like the analysis in three articles by Mark Cheffers that Linda Kidwell pointed out to me.  These are outstanding assessments of the legal situation at this point in time.

I have greatly updated my threads on this, including an entire section on the history of derivatives fraud in the world. Go to http://faculty.trinity.edu/rjensen/fraud.htm 

Note especially the following link to Mark Cheffers' articles at  --- http://www.accountingmalpractice.com.

Lessons from the Enron Collapse Part I - Old line partners wanted ... http://www.accountingmalpractice.com/res/articles/enron-1.pdf

Part II - Why Andersen is so exposed ... http://www.accountingmalpractice.com/res/articles/enron-2.pdf

Part III - An independence dilemma http://www.accountingmalpractice.com/res/articles/enron-3.pdf

Bob Jensen's threads on derivative financial instruments are at http://faculty.trinity.edu/rjensen/caseans/000index.htm 

 




NASA

[The General Accounting Office] said the Arthur Andersen audits were audit failures," says Gregory Kutz.  "They had given NASA clean audit opinions for five years."

PricewaterhouseCoopers, the agency's auditor, issued a disclaimed opinion on NASA's 2003 financial statements. PwC complained that NASA couldn't adequately document more than $565 billion — billion — in year-end adjustments to the financial-statement accounts, which NASA delivered to the auditors two months late. Because of "the lack of a sufficient audit trail to support that its financial statements are presented fairly," concluded the auditors, "it was not possible to complete further audit procedures on NASA's September 30, 2003, financial statements within the reporting deadline established by [the Office of Management and Budget]."

"NASA, We Have a Problem," by Kris Frieswick, CFO Magazine, May 2004, pp.54-64 --- http://www.cfo.com/article/1,5309,13502,00.html?f=home_magazine 

Can Gwendolyn Brown fix the space agency's chronic financial woes?

The National Aeronautics and Space Administration has long been criticized for its inability to manage costs. During the 1990s, faced with flat budgets and ambitious program goals, NASA adopted a management approach of "faster, better, cheaper." But by the decade's end, the approach was blamed for a number of mission failures. Meanwhile, the cost of the International Space Station (ISS) spiraled billions of dollars over budget. Embattled administrator Daniel Goldin resigned in 2001 after nearly 10 years on the job, and NASA named Sean O'Keefe, a self-described "bean counter," as Goldin's replacement. Fourteen months later, the loss of the Columbia space shuttle and its seven astronauts shook the agency to its core.

Then, last January, President George W. Bush unveiled a grand "vision" of landing astronauts on the moon by 2020, and on Mars sometime thereafter. The vision gave NASA a new sense of mission, lifted its morale, and raised expectations of steadily increasing budgets. But the vision also came under fire from critics who wondered fire from critics who wondered why the country needed to go to Mars, and how it could afford it.

Two weeks later, troubling new doubts were raised about NASA's financial management. PricewaterhouseCoopers, the agency's auditor, issued a disclaimed opinion on NASA's 2003 financial statements. PwC complained that NASA couldn't adequately document more than $565 billion — billion — in year-end adjustments to the financial-statement accounts, which NASA delivered to the auditors two months late. Because of "the lack of a sufficient audit trail to support that its financial statements are presented fairly," concluded the auditors, "it was not possible to complete further audit procedures on NASA's September 30, 2003, financial statements within the reporting deadline established by [the Office of Management and Budget]."

Ironically, the PwC audit report was posted on the NASA inspector general's Website on March 11 — the same day that O'Keefe testified before a Senate appropriations subcommittee regarding the agency's FY 2005 budget request. But no one seemed to notice, or care.

NASA says blame for the financial mayhem falls squarely on the so-called Integrated Financial Management Program (IFMP), an ambitious enterprise-software implementation. In June 2003, the agency finished rolling out the core financial module of the program's SAP R/3 system. NASA's CFO, Gwendolyn Brown, says the conversion to the new system caused the problems with the audit. In particular, she blames the difficulty the agency had converting the historical financial data from 10 legacy systems — some written in COBOL — into the new system, and reconciling the two versions for its year-end reports. Brown says that despite the difficulties with both the June 30 quarterly financial-statement preparation and the year-end close, the system is up and running, and she has confidence in the accuracy of the agency's financial reporting going forward.

Continued in the article (this is a very long article)

 




Worldcom Fraud

The Worldcom/Andersen Scandal 

KPMG’s “Unusual Twist”
While KPMG's strategy isn't uncommon among corporations with lots of units in different states, the accounting firm offered an unusual twist: Under KPMG's direction, Worldcom treated "foresight of top management" as an intangible asset akin to patents or trademarks.
 

This "foresight of top management" led to a 25-year prison sentence for Worldcom's CEO, five years for the CFO (which in his case was much to lenient) and one year plus a day for the controller (who ended up having to be in prison for only ten months.) Yes all that reported goodwill in the balance sheet of Worldcom was an unusual twist.

The Worldcom fraud accompanied by one of the largest bankruptcies is characterized by what, in my viewpoint, was the worst audit in the history of the world that contributed, along with Enron, to the implosion of the historic Arthur Andersen accounting firm.

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 was wrong. Interestingly, Andersen actually lost the audit midstream to KPMG, but KPMG hired the 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 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


2008 Update on Worldcom Fraud (and a bit of history)

"SEC Settlement with Auditors of Worldcom: Too Little, Too Late?" by Tom Selling, The Accounting Onion, April  21, 2008 --- http://accountingonion.typepad.com/theaccountingonion/2008/04/sec-settles-wit.html

Coming on the heels of accusations that the SEC is trending toward less vigorous enforcement against financial reporting violations, the SEC published here and here its settlements with the two Arthur Andersen partners that planned and supervised the 2001 audit of Worldcom. Six years later, the settlements amount to little more than slaps on the wrist: both auditors were suspended from practicing before the SEC for at least three years, no monetary penalties were assessed, and no admissions of guilt were obtained. (By the way, one of the auditors has let his CPA license lapse, and the other is still licensed as a CPA in Mississippi.)

I have three questions for the SEC. First, why were these individuals allowed to settle without admitting or denying guilt in what appears to have been an open-and-shut case? Second, why were no monetary penalties assessed? Third, why did it take six years, with only this so-called "settlement" to show for all this time and, presumably, effort?

I'll leave any kind of thorough treatment of the last two questions for future ruminations (feel free to do it without me!), and will focus henceforth on my dissatisfaction with a settlement that does not require auditors to admit to the public that they made inexcusable mistakes -- in what was apparently a slam-dunk case.

Background

Most readers will recall that the Worldcom accounting fraud was astonishing for both the magnitude of the errors in the financial statements, and the simplicity of the accounting. We're not talkin' 'bout complex financial arrangements, arcane consolidation, pension, stock option or revenue recognition rules; we're talkin' the third week of Accounting 101. We're talkin' about capitalizing telephone line access fees ("line costs") that should have been expensed. Over a number of quarters, $3 billion in payments that should have been reported as expenses on the income statement were parked in property and equipment (P&E) accounts on the balance sheet. The "top-side" accounting entries to effectuate the fraudulent misstatements circumvented internal controls and were made by accountants with the highest authority in the company.

The $3 billion capitalization of line costs was the first of the Worldcom accounting frauds to come to light, but it paled in comparison to the additional $8 billion of accounting misstatements that were subsequently discovered. As Cynthia Cooper, the whistle blower on the first $3 billion wrote in her recent book (I reviewed it here):

"...[top management at Worldcom] had a process called 'close the gap,' whereby they would compare quarterly revenue to Wall Street expectations, analyze potential items they could record to make up the difference, and book revenue items that had not been booked in the past."

Given the magnitude of the misstatements, it doesn't seem possible that they could have occurred in the absence of a broken audit. The two Andersen partners on the Worldcom account were charged with violating the SEC's own rules of professional conduct as they apply to accountants* who practice before the Commission: Rule 102(e). That also should have kept things relatively simple, as the case would be made before an administrative law judge; no interaction with the courts or other government agencies would have been required. I'm not a lawyer, but I think that the threshold standard of proof in such a case would have been the same as civil litigation, "preponderance of evidence."

Also, the SEC reached only for the low-hanging fruit when bringing their charges against the two audit partners, both of whom had been involved with Worldcom for a number of years. Basically, in addition to intentional, knowing or reckless conduct, the most difficult to prove, there are two other ways that an accountant can violate Rule 102(e):

A single instance of highly unreasonable conduct that results in a violation of professional standards in circumstances in which the accountant should know that heightened scrutiny is warranted, or; Repeated instances of (merely) unreasonable conduct, each resulting in a violation of professional standards, that indicate a lack of competence. The SEC wisely chose the second of these two. All they wanted, and needed, to address was conduct in violation of the equivalent of the third week of Accounting 101 plus the third or fourth week of Auditing 101. At the risk of being tedious, but to educate my readers who are taking Auditing 101 and to make the point that the SEC must have had a slam-dunk case, here is but a sample of the SEC's allegations:

Andersen discovered fraud of a similar nature a year earlier, and affecting the same PP&E accounts. There were other strong indicators that fraud might occur, like the financial straits of the CEO, a history of aggressive accounting, and industry factors. Consequently, the engagement team classified overall audit risk as "maximum." However, substantive tests of PP&E , one of the most significant balance sheet categories, were not expanded. The auditor's did not design or implement procedures to review top-side entries, evidently relying on management's representation that there were no significant top-side entries--even though fraud via top-side entries took place just one year earlier. Additions to the PP&E accounts were only examined through the third quarter of 2001, and not as of the end of the fiscal year. $841 million of the fraudulent charges to PP&E occurred in the fourth quarter. A reconciliation of beginning and ending PP&E balances was not done. If the auditors had done so, they would have discovered that the $3 billion in fraudulent charges to PP&E were made in circumvention of normal approval processes. The expense accounts that were reduced by the top side entries were not reconciled to the financial statements and general ledger. "Had they done so, the auditors would have discovered that the line cost expenses they were testing were significantly larger than the line cost expenses reflected in Worldcom's financial statements and general ledger." Back to the Question

Let's be generous, and presume that those who pull the levers at the SEC subjugate their personal interests for the public interest. Indeed, one could argue that there have been many cases where the SEC obtained the same monetary fines and sanctions -- or maybe even more -- in a settled action than it could have gotten in court. One of the reasons this may be the case is that many defendants have an economic disincentive to admit guilt in an SEC action. That's because (once again, I'm not a lawyer) one who admits guilt to the government may not deny it in a private action -- where the money penalties could be much bigger.

So, in many instances, it may actually serve the public interest to give defendants the option of settlement with the SEC without an admission of guilt; but, my point is that it is certainly not always the case. Now, ceasing to presume motives as pure as the driven snow, the SEC counts scalps, and a settlement containing an agreement to be sanctioned, however meaningless, counts as a scalp to be hung up in their reports to Congress. Fewer settlements means more trials, and more trials means fewer scalps. Even considering the predispositon for scalps of any color, this case took six years just to get settled! And, how many defendants are coerced into settling without admitting or denying guilt just so the SEC can have their scalp, even though they truly feel they did nothing wrong, but need to get the matter put behind them?

Focusing specifically on the case of the Worldcom auditors, I can't possibly see how the public interest was served by settling without a fine, and without an admission of guilt. If there was ever a case where the SEC could have sent an unequivocal message by making its case in court, this one was it. Can anyone say that more was gained by settling? Given the magnitude of the numbers, timing and other circumstances, can anyone say that the the public does not rightfully want to know whether and how Worldcom's auditors violated the basic standards of their profession?

And, not only is there a message opportunity, the public deserves more justice and closure. Will private litigation against these auditors take place? I doubt it, because their pockets probably aren't deep enough to fund the private attorneys. Therefore, the argument of a defendant loathe to settle because of exposure to private litigation goes poof. Will the AICPA or state accountancy boards discipline these auditors? It's been six years, and so far not a peep from them either -- just one more reason we need the PCAOB.

For the SEC, it shouldn't be about the money they collect in fines, or the number of years of sanctions they obtain from settlement, or even (and this is, I admit, controversial) about the sheer number of cases they bring. It should be about deterrence: the message sent by a case that will contribute to greater trust in the capital markets by reducing the risk of fraud. The reality, though, is that it is very convenient and self-serving to measure monetary fines,** volume of cases and years barred from practicing before the Commission. The flip side of this reality is that one cannot possibly measure how many frauds did not occur because of the threat of vigorous and consequential law enforcement. Ergo, the focus of bureaucrats on the the scalps; in the case of the 2001 Worldcom audit in results in giving unduly short shrift to deterrence.

-----------
*Note to students: the SEC rules of professional conduct apply to all accountants at public companies -- not just their auditors.

**Well, maybe you can't always measure the effectiveness of the SEC by the fines they mete out. See Jonathan Weil's commentary in bloomberg.com on how he believes SEC Chair Cox inflated the numbers he reported in recent congressional testimony.


2006 Update on Worldcom Fraud
U.S. Judge Denise Cote of the U.S. Court for the Southern District of New York said the distribution should be made "as soon as practicable." More than one dozen investment banks, including Citigroup Inc. and JPMorgan Chase & Co., agreed to pay about $6.15 billion to resolve allegations that they helped Worldcom sell bonds when they should have known the phone company was concealing its true financial condition. The remaining balance from available settlement funds will continue to accrue interest until other claims are processed and disputed claims are resolved, Cote said in her four-page order.

"Judge OKs $4.52 bln payout to Worldcom investors," Reuters, November 29, 2006 --- Click Here


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/

 


2005 Update on Worldcom Fraud
Former Worldcom Investors can now claim back some of the billions of dollars they lost in a massive accounting fraud, after a federal judge approved legal settlements of "historic proportions." The deal approved Wednesday by U.S. District Judge Denise Cote, will divide payments of $6.1 billion among approximately 830,000 people and institutions that held stocks or bonds in the telecommunications company around the time of its collapse in 2002.
Larry Neumeister, "Judge OKs $6.1B in Worldcom Settlements," The Washington Post, September 22, 2005 --- http://snipurl.com/WorldcomSettlement   


University of California gets a settlement from Citigroup as part of its losses in the Worldcom accounting scandal
Citigroup has agreed to pay the University of California more than $13 million to settle a lawsuit over liability for the university’s investments in Worldcom, a company that collapsed in 2002. The university sued over inaccurate analyses of Worldcom, which led UC to pay more than it would have otherwise to buy stock in the company.
Inside Higher Ed, April 7, 2006 --- http://www.insidehighered.com/news/2006/04/07/qt


Worldcom defendants in $651 million deal
A group of investment banks and other defendants agreed on Thursday to pay a combined $651 million to a coalition of institutional investors that lost money in Worldcom Inc.'s collapse. . . . More than 65 institutional investors are part of the pact, including the largest U.S. pension fund, the California Public Employees' Retirement System. Others set to get payments include the California State Teachers' Retirement System and pension funds in Illinois, Washington state and Tennessee. The bulk of the settlement will be paid by Worldcom's former investment banks -- primarily Citigroup and JP Morgan Chase & Co -- that underwrote Worldcom Inc. securities, according to plaintiffs' law firm Lerach Coughlin Stoia Geller Rudman & Robbins of San Diego.
Martha Graybow, "Worldcom defendants in $651 mln deal," The Washington Post, October 27, 2005 --- http://snipurl.com/wpOct27


Class action suits are troublesome, but often these are the only resort for bilked investors
You claim the lawyers are the only ones who make out. That's wrong. So far, despite the fact that that the issuer, Worldcom, is bankrupt, we have obtained settlements totaling $4.8 billion for bondholders and $1.2 billion for stockholders. That's the biggest settlement in history by far for bondholders and the second biggest for stockholders. These suits are about money and losses, but they are more about rebuilding confidence in the underlying values of our economic and political institutions.
Alan G. Hevesi, New York State Comptroller, "Worldcom's World Record Fraud," The Wall Street Journal, April 8, 2005 --- http://online.wsj.com/article/0,,SB111292210015601586,00.html?mod=todays_us_opinion

Ebbers Found Guilty
Former Worldcom Chief Executive Bernard J. Ebbers was convicted of participating in the largest accounting fraud in U.S. history, handing the government a landmark victory in its prosecution of an unprecedented spate of corporate scandals.  After eight days of deliberation, the jury found Mr. Ebbers guilty of all nine counts against him, including conspiracy and securities fraud, related to an $11 billion accounting fraud at the onetime highflying telecommunications giant.  Mr. Ebbers, 63 years old, now faces the prospect of spending many years in jail. He is expected to appeal.
"Ebbers Is Convicted In Massive Fraud:  Worldcom Jurors Say CEO Had to Have Known; Unconvinced by Sullivan," The Wall Street Journal, March 16, 2005; Page A1 --- http://online.wsj.com/article/0,,SB111090709921580016,00.html?mod=home_whats_news_us

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

Heavy price for poor research
J. P. Morgan Chase, which sold billions of dollars in Worldcom bonds to the public about a year before the company filed for bankruptcy, agreed yesterday to pay $2 billion to settle investors' claims that it did not conduct adequate investigation into the financial condition of Worldcom before the securities were sold.  The bank reached its settlement with Alan G. Hevesi, comptroller of New York and trustee of the New York State Common Retirement Fund, the lead plaintiff representing investors who lost money when Worldcom collapsed in 2002.
Gretchen Morgenson, "Bank to Pay $2 Billion to Settle Worldcom Claims," The New York Times, March 17, 2005 --- http://www.nytimes.com/2005/03/17/business/17worldcom.html 

Two More Banks Settle Enron Claims
J.P. Morgan Chase & Co. and Toronto-Dominion Bank will pay Enron a total of $480 million to settle allegations that they helped the once-mighty energy giant hide debt and inflate earnings. The settlement stems from a lawsuit filed by Enron against 10 banks. The suit contends the banks could have prevented the company's 2001 collapse if they hadn't “aided and abetted fraud,” the Houston Chronicle reported.
"Two More Banks Settle Enron Claims," AccountingWeb, August 18, 2005 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=101212

Pays to go bankrupt!
MCI predicted a net loss for this year and reported a massive $22.2 billion profit for 2003 as a result of accounting adjustments related to the bankruptcy.
Shawn Young, The Wall Street Journal, April 30, 2004, Page B3 --- http://online.wsj.com/article/0,,SB108327600038897861,00.html?mod=technology_main_whats_news 


From The Wall Street Journal Accounting Weekly Review on July 22, 2005

TITLE: Ebbers Is Sentenced to 25 Years for $11 Billion Worldcom Fraud
REPORTERS: Dionne Searcey, Shawn Young, and Kara Scannell
DATE: Jul 14, 2005
PAGE: A1
LINK:
http://online.wsj.com/article/0,,SB112126001526184427,00.html 
TOPICS: Accounting Fraud, Capital Spending, Accounting, Financial Accounting

SUMMARY: "Bernard J. Ebbers...was sentenced to 25 years in prison for orchestrating the biggest corporate accounting fraud in U.S. history."

QUESTIONS: 1.) What is the one accounting practice cited in the article as the basis for committing fraud at Worldcom? In your answer, differentiate between accounting for capital investments and operating expenditures.

2.) The article describes defense attorneys' and other lawyers' surprise at the severity of Ebbers's sentence, comparing it to the length of sentence for criminals who have taken another's life. Who was harmed by this fraud and how devastating could the harm have been to those victims?

3.) Why is a chief executive officer held responsible for financial reporting of the entity under his or her command? Why did jurors believe that Ebbers could not have unaware of the fraud at Worldcom?

Reviewed By: Judy Beckman, University of Rhode Island

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


Ten former directors of Worldcom have agreed to pay $18 million of their own money to settle a lawsuit by investors.
Grechen Morgensen, The New York Times, January 6, 2004 ---
http://www.nytimes.com/2005/01/06/business/06tele.html?hp&ex=1105074000&en=b956e943855a1d2b&ei=5094&partner=homepage

"It's just extraordinarily rare for a director to pay money out of his own pocket," said Michael Klausner, a law professor at Stanford University who is studying the personal liability of directors. Mr. Klaus-ner and his fellow researchers have so far found only four cases from 1968 to 2003 in which directors contributed their own money to settle a shareholder lawsuit. "It is extremely unusual," he said. If the settlement deters people from serving on corporate boards, that will run counter to the interests of institutional investors, who have called for a greater role for independent directors in corporate governance, Mr. Klausner said. Newer laws, like the Sarbanes-Oxley Act of 2002, adopted in the wake of the Enron and Worldcom bankruptcies, are also requiring a greater role for outside directors.
Jonathan D. Glater, "A Big New Worry for Corporate Directors," The New York Times, January 6, 2005 --- http://www.nytimes.com/2005/01/06/business/06board.html
Jensen Comment:  Why should anybody be shielded by insurance if they are co-conspirators in fraud?

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


"A Worldcom Settlement Falls Apart," by Gretchen Morgenson, The New York Times, February 3, 2005 --- http://www.nytimes.com/2005/02/03/business/03tele.html 

A landmark settlement last month that had 10 former Worldcom directors agreeing to pay $18 million from their own pockets to investors who lost money in the company's failure was scuttled yesterday.

The settlement fell apart after the judge overseeing the case ruled that one aspect of the deal was illegal because it would have limited the directors' potential liability and exposed the investment banks that are also defendants in the case to greater damages. The lead plaintiff in the case said it could not proceed with the settlement with that provision removed.

When the settlement was announced, it was hailed as a rare case where an investor held directors responsible for problems occurring on their watch. Because yesterday's ruling turned on one technical aspect of the settlement with the former Worldcom directors, it is not expected to deter restive shareholders from trying to make corporate board members accountable.

The ruling by Judge Denise Cote of Federal District Court in Manhattan - who is presiding over the shareholder suit against directors and executives from Worldcom, its investment banks and Arthur Andersen, its auditor - sided with lawyers for the banks, who objected to the deal almost immediately after it was announced.

The judge's ruling means that the 10 directors will remain as defendants in the case. As such, they face the possibility of paying significantly more than they had agreed to in the settlement if they are found liable by a jury for investor losses.

Federal law states that in cases involving the sale of securities, as this one does, defendants found liable for losses by a jury are responsible for the entire amount of the damages. But in 1995, the Private Securities Litigation Reform Act provided that directors involved in such a case are responsible only for their part of the fault, as determined by the jury. This law was intended to protect directors from staggering damages in such cases.

The settlement with the former Worldcom directors was unfair to the investment bank defendants, their lawyers argued, because with the board members no longer named as defendants in the case, the banks could not reduce their own liability in a verdict by the amount of the investors' losses that the jury concluded was the responsibility of the company's former directors.

For example, under the terms of the settlement, the banks would have been limited to a reduction in damages of $90 million, the estimated net worth of the directors. A jury might find the directors responsible for far less.

The settlement, had it gone through, would also have prevented the banks from being able to sue the directors and possibly recover money from them. Sixteen banks are named as defendants, including J. P. Morgan Chase, Deutsche Bank and Bank of America.

Continued in the article


From The Wall Street Journal Weekly Accounting Review on April 1, 2005

TITLE: MCI Warns About Internal Controls
REPORTER: David Enrich
DATE: Mar 17, 2005
PAGE: B5
LINK: http://online.wsj.com/article/0,,SB111101999280681798,00.html 
TOPICS: Auditing, Financial Accounting, Income Taxes, Accounting Information Systems, Internal Controls, Sarbanes-Oxley Act

SUMMARY: MCI has disclosed material weaknesses in its internal control over accounting for income taxes and other areas.

QUESTIONS:
1.) Why has MCI uncovered weaknesses in its internal controls? Over what areas of accounting are its controls in question?

2.) How do the circumstances faced by MCI demonstrate the need to assess internal controls every year?

3.) Why do you think that the steps undertaken by MCI to resolve its deficiencies in income tax accounting for the current year are not sufficient to allow auditors to conclude that the company's income tax controls are, in general, effective?

4.) The company lists several factors that are particularly difficult areas in which to consider income tax implications, including fresh-start accounting, asset impairments, and cancellation of debt. Define each of these terms. From what transactions do you think each issue arises? For each term, why do you think that it is particularly difficult to assess income tax implications?

Reviewed By: Judy Beckman, University of Rhode Island


"Worldcom Case Against Banks To Go to Trial," by Diya Gullapalli, The Wall Street Journal, December 16, 2004; Page C4 --- http://online.wsj.com/article/0,,SB110315786738701568,00.html?mod=technology%5Fmain%5Fwhats%5Fnews 

In a decision that threatens to keep the underwriters of two bond offerings from Worldcom Inc. embroiled in litigation, a federal judge yesterday rejected a motion to dismiss a class-action case by the remaining defendants.

While the firms said they had relied upon auditor Arthur Andersen LLP's clean bill of health on Worldcom when selling the bonds, the judge said the underwriters should have done their own legwork to size up the telecommunications company, which filed for bankruptcy after a massive accounting fraud.

Continued in the article


Two of the most stunning business collapses of the last few years produced hefty settlements for some of the victims this week. Current and former Enron employees received the news on Wednesday of the $85 million partial settlement in the would-be class action lawsuit.

"Worldcom Investors, Enron Employees Win Settlements," AccountingWEB, May 13, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99161 

Two of the most stunning business collapses of the last few years produced hefty settlements for some of the victims this week.

Citigroup, Inc. on Monday agreed to pay $2.65 billion to investors who claim the firm’s brokerage unit pumped up Worldcom despite their knowledge of massive losses at the company. The suit, which sought $54 billion, also alleged that Citigroup's brokerage arm, Salomon Smith Barney, offered big loans to Worldcom’s then-chief executive Bernard Ebbers in a swap for investment banking business.

Citigroup, the world's largest bank, denies wrongdoing. The payout will go to investors who bought Worldcom stock or bonds and lawyers in the class action, the Washington Post reported. According to some expert estimates, shareholders lost $2.6 billion in the Worldcom collapse. Bondholders got about 36 cents on the $1.

Worldcom's $104 billion bankruptcy in 2002 was the biggest in corporate history, and the $2.65 billion settlement is among the largest to result from the accounting scandals of the past five years. MCI, the second-largest U.S. long distance telephone company, emerged from bankruptcy last month.

In a separate settlement, current and former Enron employees got news of an $85 million partial settlement Wednesday in the would-be class action lawsuit. The settlement would benefit 12,000 to 20,000 current and former Enron employees.

If U.S. District Court Judge Melinda Harmon OKs the deal, it will be late summer or fall before any money is added to the retirement plans, the Houston Chronicle reported.

The Enron employees who lost millions of dollars in retirement money say the energy company’s officers failed to execute their duties in administering the pension plan, which had almost two-thirds of the employees’ assets in company stock. The stock plummeted from a high of almost $85 to less than $1 as the company spiraled toward bankruptcy.

The $85 million insurance policy that was handed over settles claims against human resource employees and company directors, but not those against former Enron chairman Kenneth Lay and former chief executive Jeffrey Skilling.

In a related matter, former company directors agreed to pay a total of $1.5 million to resolve a suit by the U.S. Department of Labor, which also sought to recover lost retirement money. The settlement also needs court approval.

Labor Secretary Elaine Chao has said that Lay "went so far as to tout the (Enron) stock as a good investment for his own employees — even after he had been warned that a wave of accounting scandals was about to engulf the corporation," the Associated Press reported.

Lynn Sarko, a Seattle-based lawyer for the employees, said much of the lawsuit will still proceed against Lay and Skilling. "This will be a small piece of the ultimate recovery," she said.


March 26, 2004 message from AccountingWEB.com [AccountingWEB-wire@accountingweb.com

U.S. Bankruptcy Judge Arthur Gonzalez has ordered Worldcom to stop paying its external auditor KMPG after 14 states announced last week that the Big Four firm gave the company advice designed to avoid some state taxes --- http://www.accountingweb.com/item/98927

AccountingWEB.com - Mar-24-2004 - U.S. Bankruptcy Judge Arthur Gonzalez has ordered Worldcom to stop paying its external auditor KMPG after 14 states announced last week that the Big Four firm gave the company advice designed to avoid some state taxes.

Worldcom called the judge’s move a "standard procedural step," which occurs anytime a party in a bankruptcy proceeding has objections to fees paid to advisors. A hearing is set for April 13 to discuss the matter, the Wall Street Journal reported.

Both KPMG and MCI, which is the name Worldcom is now using, say the states claims are without merit and expect the telecommunications giant to emerge from bankruptcy on schedule next month.

"We're very confident that we'll win on the merits of the motion," MCI said.

Last week, the Commonwealth of Massachusetts claimed it was denied $89.9 million in tax revenue because of an aggressive KPMG-promoted tax strategy that helped Worldcom cut its state tax obligations by hundreds of millions of dollars in the years before its 2002 bankruptcy filing, the Wall Street Journal reported.

Thirteen other states joined the action led by Massachusetts Commissioner of Revenue Alan LeBovidge, who filed documents last week with the U.S. Bankruptcy Court for the Southern District of New York. The states call KPMG’s tax shelter a "sham" and question the accounting firm’s independence in acting as Worldcom’s external auditor or tax advisor, the Journal reported.

KPMG disputes the states’ claims. George Ledwith, KPMG spokesman, told the Journal, "Our corporate-tax work for Worldcom was performed appropriately, in accordance with professional standards and all rules and regulations, and we firmly stand behind it. We are confident that KPMG remains disinterested as required for all of the company's professional advisers in its role as Worldcom's external auditor. Any allegation to the contrary is groundless."


A FeloniousParent Takes on the Name of Its Juvenile Delinquent Child

"Worldcom Changes Its Name and Emerges From Bankruptcy," by Kenneth N. Gilpin, The New York Times, April 20, 2004 ---  http://www.nytimes.com/2004/04/20/business/20CND-MCI.html 

Worldcom Inc. emerged from federal bankruptcy protection this morning with the new name of MCI, about 21 months after the scandal-tainted company sought protection from creditors in the wake of an $11 billion accounting fraud.

"It really is a great day for the company," Michael D. Capellas, MCI's president and chief executive, said in a conference call with reporters. "We come out of bankruptcy with virtually all of our core assets intact. But it's been a marathon with hurdles."

The bankruptcy process has allowed MCI to dramatically pare its debt from $41 billion to about $6 billion. And although that cutback will reduce debt service payments by a little more than $2 billion a year, the company still faces some hurdles in its comeback effort.

In addition to changing its new name, the company added five people to its board.

Richard Breeden, the former chairman of the Securities and Exchange Commission who serves as MCI's court-appointed monitor, has imposed some restrictions on board members to make their actions more transparent. Those include a requirement that directors give two weeks' notice before selling MCI stock.

Even though MCI has emerged from bankruptcy, Judge Jed S. Rakoff, the federal district judge who oversaw the S.E.C.'s civil lawsuit against the company, has asked Mr. Breeden to stay on for at least two years.

For the time being, MCI shares will trade under the symbol MCIAV, which has been the symbol since the company went into bankruptcy.

Peter Lucht, an MCI spokesman, said it will be "several weeks, not months" before MCI lists its shares on the Nasdaq market.

In early morning trading, MCIAV was quoted at $18, down $1.75 a share.

It was just about a year ago that Worldcom unveiled its reorganization plan, which included moving its headquarters from Clinton, Miss., to Ashburn, Va., and renaming the company after its long-distance unit, MCI.

Worldcom had merged with MCI in a transaction that was announced in 1997.

Although its outstanding debt has been dramatically reduced, MCI faces daunting challenges, not the least of which are pricing pressures in what remains a brutally competitive telecommunications industry.

MCI has already warned it expects revenues to drop 10 percent to 12 percent this year.

To offset the revenue decline, the company has taken steps to cut costs.

Last month, MCI announced plans to lay off 4,000 employees, reducing its work force to about 50,000.

"It's going to be a tough year," Mr. Capellas said. "But the good news about our industry is that people do communicate, and they communicate in more ways."

Mr. Capellas cited four areas where he saw growth potential for MCI: increased business from the company's current customers; global expansion; additions to MCI's array of products; and expansion of the company's security business.

"Even though there are certain areas in the industry that are compressing, we think there is some space to grow," he said.

In the course of the bankruptcy, MCI said it lost none of its top 100 customers. And in January the federal government, which collectively is MCI's biggest customer, lifted a six-month ban that had prohibited the company from bidding for new government contracts.

To a certain extent, MCI's growth prospects will be hampered by its bondholders, whose primary interest is to ensure they are repaid for their investment as soon as possible.

Even though many who contributed to the Worldcom scandal are gone, it will probably be some time before memories of what happened fade.

All of the senior executives and board members from the time when Bernard Ebbers was chief executive are no longer with the company.

Five executives, including Scott Sullivan, Worldcom's former chief financial officer, have pleaded guilty to federal charges for their roles in the scandal and are cooperating with the government in its investigation.

Mr. Ebbers has pleaded innocent to charges including conspiracy and securities fraud.

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.”

 Verizon, one of MCI's most outspoken opponents, never filed a lawsuit against MCI. But last spring, the company's general counsel, William Barr, said MCI had operated as "a criminal enterprise," referring to the company's accounting fraud. Mr. Barr also argued that the company should be liquidated rather than allowed out of bankruptcy. Mr. Barr couldn't be reached for comment Monday. Commenting on the settlement, Verizon spokesman Peter Thonis said, "we understand that this is still under criminal investigation and nothing has changed in that regard."
Shawn Young, and Almar Latour, The Wall Street Journal, February 24, 2004 --- http://online.wsj.com/article/0,,SB107755372450136627,00.html?mod=technology_main_whats_news


"U.S. Indicts Worldcom Chief Ebbers," by Susan Pullam, almar Latour, and ken Brown, The Wall Street Journal, March 3, 2004 --- http://online.wsj.com/article/0,,SB107823730799144066,00.html?mod=home_whats_news_us 

In Switch, CFO Sullivan Pleads Guilty,
Agrees to Testify Against Former Boss

After trying for two years to build a case against Bernard J. Ebbers, the federal government finally charged the man at the top of Worldcom Inc., amid growing momentum in the prosecution of the big 1990s corporate scandals.

Mr. Ebbers was indicted Tuesday for allegedly helping to orchestrate the largest accounting fraud in U.S. history. The former chairman and chief executive, who had made Worldcom into one of the biggest stock-market stars of the past decade, was charged with securities fraud, conspiracy to commit securities fraud and making false filings to regulators.

After a grueling investigation, prosecutors finally got their break from an unlikely source: Scott Sullivan, Worldcom's former chief financial officer. He had vowed to fight charges against him and was set to go to trial in late March. But instead, after a recent change of heart, he pleaded guilty Tuesday to three charges just before Mr. Ebbers's indictment was made public. Mr. Sullivan also signed an agreement to cooperate in the case against his former boss.

The indictment, which centers around the two executives' private discussions as they allegedly conspired to mislead investors, shows that Mr. Sullivan's cooperation already has yielded big results for prosecutors. "Ebbers and Sullivan agreed to take steps to conceal Worldcom's true financial condition and operating performance from the investing public," the indictment stated.

Worldcom, now known as MCI, is one of the world's largest telecommunications companies, with 20 million consumer and corporate customers and 54,000 employees. The company's investors lost more than $180 billion as the accounting fraud reached $11 billion and drove the company into bankruptcy. Ultimately almost 20,000 employees lost their jobs.

Attorney General John Ashcroft traveled to New York Tuesday to announce the indictment, as years of prosecutors' efforts in Worldcom and other big corporate fraud cases finally start to bear fruit. Little progress had been made in the Worldcom case since five employees pleaded guilty to fraud charges in the summer of 2002. As outrage over the wave of corporate scandals built, prosecutors struggled with several key puzzle pieces as they sought to assign blame for the corporate wrongdoing.

They were initially unable to make cases against Mr. Ebbers and Enron Corp. Chief Executive Jeffrey Skilling. And Mr. Sullivan and former Enron Chief Financial Officer Andrew Fastow gave every indication that they were going to vigorously fight the charges against them. Enron, the Houston-based energy company, filed for bankruptcy-court protection in 2001.

But in recent weeks a lot has changed. In January Mr. Fastow pleaded guilty and agreed to cooperate with prosecutors. Soon afterward the government indicted his former boss, Mr. Skilling. Meanwhile, highly publicized fraud trials of the top executives of Tyco International Ltd. and Adelphia Communications Corp. are under way in New York and prosecutors have continued to make plea agreements in the cases stemming from the fraud at HealthSouth Corp. Two former HealthSouth executives agreed to plead guilty Tuesday (see article). Former HealthSouth Chairman Richard Scrushy was indicted last year.

Mr. Ashcroft in his announcement Tuesday said that two years of work had paid off with more than 600 indictments and more than 200 convictions of executives. "America's economic strength depends on ... the accountability of corporate officials," he said.

Mr. Sullivan, a close confidant of Mr. Ebbers, pleaded guilty to three counts of securities fraud. He secretly began cooperating with prosecutors in recent weeks, according to people close to the situation.

Continued in the article


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 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.

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.

Bob Jensen's threads on the state of accountancy can be found at http://faculty.trinity.edu/rjensen/FraudConclusion.htm


Citigroup agreed to pay $2.65 billion to settle a suit brought by investors of the former Worldcom, who lost billions when the telecom firm filed for Chapter 11. Citigroup said it would take a $4.95 billion charge in the second quarter.

"Citigroup Will Pay $2.65 Billion To Settle Worldcom Investor Suit," by Mitchell Pacelle, The Wall Street Journal, May 11, 2004, Page A1 --- http://online.wsj.com/article/0,,SB108419118926806649,00.html?mod=home_whats_news_us

In one of the largest class-action settlements ever, Citigroup Inc. agreed to pay $2.65 billion to settle a suit brought by investors of the former Worldcom Inc., who lost billions when the telecommunications giant filed for bankruptcy in 2002 after a massive accounting scandal.

The world's largest financial-services firm, facing many other lawsuits tied to its role in other corporate scandals, also announced it was substantially beefing up its reserves earmarked for pending litigation. Following the bank's addition of $5.25 billion pretax to reserves, and the payment of the Worldcom settlement, Citigroup will have $6.7 billion in litigation reserves remaining.

The actions open an expensive new chapter in the bank's continuing clean-up efforts. Coming nearly a year after its last major settlement with regulators, settlement of the Worldcom lawsuit, which stemmed from Citigroup's underwriting of Worldcom securities, suggests that resolving complaints from private investors could be far more costly for the bank than making amends with the government.

The round of corporate and investment-banking scandals that shook the markets in 2001 and 2002 led to a spate of regulatory actions against New York-based Citigroup and other Wall Street titans. In an unprecedented series of pacts last year, Citigroup and other investment banks settled with regulators at a collective cost of more than $1 billion. But lawsuits brought by investors claiming billions of dollars of damages continue to hang over the banking industry.

Citigroup said it would take a second-quarter after-tax charge of $4.95 billion, or 95 cents a share, to cover the settlement and increase in litigation reserves. Other cases facing the company involve financing that it arranged for energy giant Enron Corp. before its collapse and alleged abuses in the way it allocated shares in hot initial public offerings during the stock-market boom.

The Worldcom settlement itself, with certain buyers of Worldcom shares and bonds, will cost Citigroup $1.64 billion after tax, because the $2.65 billion payout is tax deductible, the company said.

The Worldcom lawsuit, certified as a class action on behalf of hundreds of thousands of bond and stock purchasers, alleges that Citigroup and other investment banks that underwrote about $17 billion of Worldcom bonds in May 2000 and May 2001 didn't conduct adequate due diligence before bringing the securities to market. Besides Citigroup, the defendants include 17 other underwriters that handled about two-thirds of the bonds, including J.P. Morgan Chase & Co., Deutsche Bank AG and Bank of America Corp.

The suit also focused in part on Citigroup's Salomon Smith Barney unit and its former star telecommunications analyst Jack Grubman, who was accused of touting Worldcom stock until two months before the telecommunications company collapsed. The lawsuit alleged that Mr. Grubman knew that his public statements about Worldcom, which the suit claims helped drive up the value of the stock, weren't accurate. Mr. Grubman, one of the most influential Wall Street analysts during the tech boom, left Citigroup in August 2002 amid allegations of conflict of interest.

Worldcom filed for bankruptcy protection in July 2002, and recently emerged from court protection under the name of MCI Corp. Its former bondholders received new stock and bonds, but its former shareholders received nothing.

Citigroup and Mr. Grubman, as well as other defendants in the suit, have previously denied the accusations. Citigroup didn't admit to any wrongdoing under the settlement Monday.

"I personally believe we did not participate in any way in fraudulent activities," Citigroup's chief executive, Charles Prince, said Monday. But in light of "the current litigation environment," he said, "I was not willing to roll the dice for the stockholders to try to score a big win."

The plaintiffs, led by the New York State Common Retirement Fund, described the settlement with Citigroup as the second-largest securities class action settlement ever, after a $3.2 billion settlement against Cendant Corp. in 2000, but the largest against a third party in connection with work conducted for a corporate wrongdoer. MCI wasn't a party to the settlement.

Continued in article


Worldcom Inc.'s restated financial reports aren't even at the printer yet, and already new questions are surfacing about whether investors can trust the independence of the company's latest auditor, KPMG LLP -- and, thus, the numbers themselves.

I suspect by now, most of you are aware that after the world's largest accounting scandal ever, our Denny Beresford accepted an invitation to join the Board of Directors at Worldcom.  This has been an intense addition to his day job of being on the accounting faculty at the University of Georgia.  Denny has one of the best, if not the best, reputations for technical skills and integrity in the profession of accountancy.  In the article below, he is quoted extensively while coming to the defense of the KPMG audit of the restated financial statements at Worldcom.  I might add that Worldcom's accounting records were a complete mess following Worldcom's deliberate efforts to deceive the world and Andersen's suspected complicity in the crime.  If Andersen was not in on the conspiracy, then Andersen's Worldcom audit goes on record as the worst audit in the history of the world.  For more on the Worldcom scandal, go to http://faculty.trinity.edu/rjensen/fraud.htm#WorldcomFraud 

"New Issues Are Raised Over Independence of Auditor for MCI," by Jonathan Weil, The Wall Street Journal, January 28, 2004 --- http://online.wsj.com/article/0,,SB107524105381313221,00.html?mod=home_whats_news_us 

Worldcom Inc.'s restated financial reports aren't even at the printer yet, and already new questions are surfacing about whether investors can trust the independence of the company's latest auditor, KPMG LLP -- and, thus, the numbers themselves.

The doubts stem from a brewing series of disputes between state taxing authorities and Worldcom, now doing business under the name MCI, over an aggressive KPMG tax-avoidance strategy that the long-distance company used to reduce its state-tax bills by hundreds of millions of dollars from 1998 until 2001. MCI, which hopes to exit bankruptcy-court protection in late February, says it continues to use the strategy. Under it, MCI treated the "foresight of top management" as an asset valued at billions of dollars. It licensed this foresight to its subsidiaries in exchange for royalties that the units deducted as business expenses on state tax forms.

It turns out, of course, that Worldcom management's foresight wasn't all that good. Bernie Ebbers, the telecommunications company's former chief executive, didn't foresee Worldcom morphing into the largest bankruptcy filing in U.S. history or getting caught overstating profits by $11 billion. At least 14 states have made known their intention to sue the company if they can't reach tax settlements, on the grounds that the asset was bogus and the royalty payments lacked economic substance. Unlike with federal income taxes, state taxes won't necessarily get wiped out along with MCI's restatement of companywide profits.

MCI says its board has decided not to sue KPMG -- and that the decision eliminates any concerns about independence, even if the company winds up paying back taxes, penalties and interest to the states. MCI officials say a settlement with state authorities is likely, but that they don't expect the amount involved to be material. KPMG, which succeeded the now-defunct Arthur Andersen LLP as MCI's auditor in 2002, says it stands by its tax advice and remains independent. "We're fully familiar with the facts and circumstances here, and we believe no question can be raised about our independence," the firm said in a one-sentence statement.

Auditing standards and federal securities rules long have held that an auditor "should not only be independent in fact; they should also avoid situations that may lead outsiders to doubt their independence." Far from resolving the matter, MCI's decision not to sue has made the controversy messier.

In a report released Monday, MCI's Chapter 11 bankruptcy-court examiner, former U.S. Attorney General Richard Thornburgh, concluded that KPMG likely rendered negligent and incorrect tax advice to MCI and that MCI likely would prevail were it to sue to recover past fees and damages for negligence. KPMG's fees for the tax strategy in question totaled at least $9.2 million for 1998 and 1999, the examiner's report said. The report didn't attempt to estimate potential damages.

Actual or threatened litigation against KPMG would disqualify the accounting firm from acting as MCI's independent auditor under the federal rules. Deciding not to sue could be equally troubling, some auditing specialists say, because it creates the appearance that the board may be placing MCI stakeholders' financial interests below KPMG's. It also could lead outsiders to wonder whether MCI is cutting KPMG a break to avoid delaying its emergence from bankruptcy court, and whether that might subtly encourage KPMG to go easy on the company's books in future years.

"If in fact there were problems with prior-year tax returns, you have a responsibility to creditors and shareholders to go after that money," says Charles Mulford, an accounting professor at Georgia Institute of Technology in Atlanta. "You don't decide not to sue just to be nice, if you have a legitimate claim, or just to maintain the independence of your auditors."

In conducting its audits of MCI, KPMG also would be required to review a variety of tax-related accounts, including any contingent state-tax liabilities. "How is an auditor, who has told you how to avoid state taxes and get to a tax number, still independent when it comes to saying whether the number is right or not?" says Lynn Turner, former chief accountant at the Securities and Exchange Commission. "I see little leeway for a conclusion other than the auditors are not independent."

Dennis Beresford, the chairman of MCI's audit committee and a former chairman of the Financial Accounting Standards Board, says MCI's board concluded, based on advice from outside attorneys, that the company doesn't have any claims against KPMG. Therefore, he says, KPMG shouldn't be disqualified as MCI's auditor. He calls the tax-avoidance strategy "aggressive." But "like a lot of other tax-planning type issues, it's not an absolutely black-and-white matter," he says, explaining that "it was considered to be reasonable and similar to what a lot of other people were doing to reduce their taxes in legal ways."

Mr. Beresford says he had anticipated that the decision to keep KPMG as the company's auditor would be controversial. "We recognized that we're going to be in the spotlight on issues like this," he says. Ultimately, he says, MCI takes responsibility for whatever tax filings it made with state authorities over the years and doesn't hold KPMG responsible.

He also rejected concerns over whether KPMG would wind up auditing its own work. "Our financial statements will include appropriate accounting," he says. He adds that MCI officials have been in discussions with SEC staff members about KPMG's independence status, but declines to characterize the SEC's views. According to people familiar with the talks, SEC staff members have raised concerns about KPMG's independence but haven't taken a position on the matter.

Mr. Thornburgh's report didn't express a position on whether KPMG should remain MCI's auditor. Michael Missal, an attorney who worked on the report at Mr. Thornburgh's law firm, Kirkpatrick & Lockhart LLP, says: "While we certainly considered the auditor-independence issue, we did not believe it was part of our mandate to draw any conclusions on it. That is an issue left for others."

Among the people who could have a say in the matter is Richard Breeden, the former SEC chairman who is overseeing MCI's affairs. Mr. Breeden, who was appointed by a federal district judge in 2002 to serve as MCI's corporate monitor, couldn't be reached for comment Tuesday.

KPMG’s “Unusual Twist”
While KPMG's strategy isn't uncommon among corporations with lots of units in different states, the accounting firm offered an unusual twist: Under KPMG's direction, Worldcom treated "foresight of top management" as an intangible asset akin to patents or trademarks.
 

Worldcom Inc.'s restated financial reports aren't even at the printer yet, and already new questions are surfacing about whether investors can trust the independence of the company's latest auditor, KPMG LLP -- and, thus, the numbers themselves.

I suspect by now, most of you are aware that after the world's largest accounting scandal ever, our Denny Beresford accepted an invitation to join the Board of Directors at Worldcom.  This has been an intense addition to his day job of being on the accounting faculty at the University of Georgia.  Denny has one of the best, if not the best, reputations for technical skills and integrity in the profession of accountancy.  In the article below, he is quoted extensively while coming to the defense of the KPMG audit of the restated financial statements at Worldcom.  I might add that Worldcom's accounting records were a complete mess following Worldcom's deliberate efforts to deceive the world and Andersen's suspected complicity in the crime.  If Andersen was not in on the conspiracy, then Andersen's Worldcom audit goes on record as the worst audit in the history of the world.  For more on the Worldcom scandal, go to http://faculty.trinity.edu/rjensen/fraud.htm#WorldcomFraud 

"New Issues Are Raised Over Independence of Auditor for MCI," by Jonathan Weil, The Wall Street Journal, January 28, 2004 --- http://online.wsj.com/article/0,,SB107524105381313221,00.html?mod=home_whats_news_us 

Worldcom Inc.'s restated financial reports aren't even at the printer yet, and already new questions are surfacing about whether investors can trust the independence of the company's latest auditor, KPMG LLP -- and, thus, the numbers themselves.

The doubts stem from a brewing series of disputes between state taxing authorities and Worldcom, now doing business under the name MCI, over an aggressive KPMG tax-avoidance strategy that the long-distance company used to reduce its state-tax bills by hundreds of millions of dollars from 1998 until 2001. MCI, which hopes to exit bankruptcy-court protection in late February, says it continues to use the strategy. Under it, MCI treated the "foresight of top management" as an asset valued at billions of dollars. It licensed this foresight to its subsidiaries in exchange for royalties that the units deducted as business expenses on state tax forms.

It turns out, of course, that Worldcom management's foresight wasn't all that good. Bernie Ebbers, the telecommunications company's former chief executive, didn't foresee Worldcom morphing into the largest bankruptcy filing in U.S. history or getting caught overstating profits by $11 billion. At least 14 states have made known their intention to sue the company if they can't reach tax settlements, on the grounds that the asset was bogus and the royalty payments lacked economic substance. Unlike with federal income taxes, state taxes won't necessarily get wiped out along with MCI's restatement of companywide profits.

MCI says its board has decided not to sue KPMG -- and that the decision eliminates any concerns about independence, even if the company winds up paying back taxes, penalties and interest to the states. MCI officials say a settlement with state authorities is likely, but that they don't expect the amount involved to be material. KPMG, which succeeded the now-defunct Arthur Andersen LLP as MCI's auditor in 2002, says it stands by its tax advice and remains independent. "We're fully familiar with the facts and circumstances here, and we believe no question can be raised about our independence," the firm said in a one-sentence statement.

Auditing standards and federal securities rules long have held that an auditor "should not only be independent in fact; they should also avoid situations that may lead outsiders to doubt their independence." Far from resolving the matter, MCI's decision not to sue has made the controversy messier.

In a report released Monday, MCI's Chapter 11 bankruptcy-court examiner, former U.S. Attorney General Richard Thornburgh, concluded that KPMG likely rendered negligent and incorrect tax advice to MCI and that MCI likely would prevail were it to sue to recover past fees and damages for negligence. KPMG's fees for the tax strategy in question totaled at least $9.2 million for 1998 and 1999, the examiner's report said. The report didn't attempt to estimate potential damages.

Actual or threatened litigation against KPMG would disqualify the accounting firm from acting as MCI's independent auditor under the federal rules. Deciding not to sue could be equally troubling, some auditing specialists say, because it creates the appearance that the board may be placing MCI stakeholders' financial interests below KPMG's. It also could lead outsiders to wonder whether MCI is cutting KPMG a break to avoid delaying its emergence from bankruptcy court, and whether that might subtly encourage KPMG to go easy on the company's books in future years.

"If in fact there were problems with prior-year tax returns, you have a responsibility to creditors and shareholders to go after that money," says Charles Mulford, an accounting professor at Georgia Institute of Technology in Atlanta. "You don't decide not to sue just to be nice, if you have a legitimate claim, or just to maintain the independence of your auditors."

In conducting its audits of MCI, KPMG also would be required to review a variety of tax-related accounts, including any contingent state-tax liabilities. "How is an auditor, who has told you how to avoid state taxes and get to a tax number, still independent when it comes to saying whether the number is right or not?" says Lynn Turner, former chief accountant at the Securities and Exchange Commission. "I see little leeway for a conclusion other than the auditors are not independent."

Dennis Beresford, the chairman of MCI's audit committee and a former chairman of the Financial Accounting Standards Board, says MCI's board concluded, based on advice from outside attorneys, that the company doesn't have any claims against KPMG. Therefore, he says, KPMG shouldn't be disqualified as MCI's auditor. He calls the tax-avoidance strategy "aggressive." But "like a lot of other tax-planning type issues, it's not an absolutely black-and-white matter," he says, explaining that "it was considered to be reasonable and similar to what a lot of other people were doing to reduce their taxes in legal ways."

Mr. Beresford says he had anticipated that the decision to keep KPMG as the company's auditor would be controversial. "We recognized that we're going to be in the spotlight on issues like this," he says. Ultimately, he says, MCI takes responsibility for whatever tax filings it made with state authorities over the years and doesn't hold KPMG responsible.

He also rejected concerns over whether KPMG would wind up auditing its own work. "Our financial statements will include appropriate accounting," he says. He adds that MCI officials have been in discussions with SEC staff members about KPMG's independence status, but declines to characterize the SEC's views. According to people familiar with the talks, SEC staff members have raised concerns about KPMG's independence but haven't taken a position on the matter.

Mr. Thornburgh's report didn't express a position on whether KPMG should remain MCI's auditor. Michael Missal, an attorney who worked on the report at Mr. Thornburgh's law firm, Kirkpatrick & Lockhart LLP, says: "While we certainly considered the auditor-independence issue, we did not believe it was part of our mandate to draw any conclusions on it. That is an issue left for others."

Among the people who could have a say in the matter is Richard Breeden, the former SEC chairman who is overseeing MCI's affairs. Mr. Breeden, who was appointed by a federal district judge in 2002 to serve as MCI's corporate monitor, couldn't be reached for comment Tuesday.

KPMG’s “Unusual Twist”
While KPMG's strategy isn't uncommon among corporations with lots of units in different states, the accounting firm offered an unusual twist: Under KPMG's direction, Worldcom treated "foresight of top management" as an intangible asset akin to patents or trademarks.
 

Bob Jensen's threads on the Worldcom/MCI scandal are at http://faculty.trinity.edu/rjensen/fraud.htm#WorldcomFraud 

Bob Jensen's threads on KPMG's recent scandals are at http://faculty.trinity.edu/rjensen/fraud.htm#KPMG 


The potential claims against KPMG represent the most pressing issue for MCI. The report didn't have an exact tally of state taxes that may have been avoided, but some estimates range from $100 million to $350 million. Fourteen states likely will file a claim against the company if they don't reach settlement, said a person familiar with the matter.

"MCI Examiner Criticizes KPMG On Tax Strategy," by Dennis K. Berman, Jonathan Weil, and Shawn Young, The Wall Street Journal, January 27, 2004 --- http://online.wsj.com/article/0,,SB107513063813611621,00.html?mod=technology%5Fmain%5Fwhats%5Fnews 

The examiner in MCI's Chapter 11 bankruptcy case issued a report critical of a "highly aggressive" tax strategy KPMG LLP recommended to MCI to avoid paying hundreds of millions of dollars in state income taxes, concluding that MCI has grounds to sue KPMG -- its current auditor.

MCI quickly said the company would not sue KPMG. But officials from the 14 states already exploring how to collect back taxes from MCI could use the report to fuel their claims against the telecom company or the accounting firm. KPMG already is under fire by the U.S. Internal Revenue Service for pushing questionable tax shelters to wealthy individuals.

In a statement, KPMG said the tax strategy used by MCI is commonly used by other companies and called the examiner's conclusions "simply wrong." MCI, the former Worldcom, still uses the strategy.

The 542-page document is the final report by Richard Thornburgh, who was appointed by the U.S. Bankruptcy Court to investigate legal claims against former employees and advisers involved in the largest accounting fraud in U.S. history. It reserves special ire for securities firm Salomon Smith Barney, which the report says doled out more than 950,000 shares from 22 initial and secondary public offerings to ex-Chief Executive Bernard Ebbers for a profit of $12.8 million. The shares, the report said, "were intended to and did influence Mr. Ebbers to award" more than $100 million in investment-banking fees to Salomon, a unit of Citigroup Inc. that is now known as Citigroup Global Markets Inc.

In the 1996 initial public offering of McLeodUSA Inc., Mr. Ebbers received 200,000 shares, the third-largest allocation of any investor and behind only two large mutual-fund companies. Despite claims by Citigroup in congressional hearings that Mr. Ebbers was one of its "best customers," the report said he had scant personal dealings with the firm before the IPO shares were awarded.

Mr. Thornburgh said MCI has grounds to sue both Citigroup and Mr. Ebbers for damages for breach of fiduciary duty and good faith. The company's former directors bear some responsibility for granting Mr. Ebbers more than $400 million in personal loans, the report said, singling out the former two-person compensation committee. Mr. Thornburgh added that claims are possible against MCI's former auditor, Arthur Andersen LLP, and Scott Sullivan, MCI's former chief financial officer and the alleged mastermind of the accounting fraud. His criminal trial was postponed Monday to April 7 from Feb. 4.

Reid Weingarten, an attorney for Mr. Ebbers, said, "There is nothing new to these allegations. And it's a lot easier to make allegations in a report than it is to prove them in court." Patrick Dorton, a spokesman for Andersen, said, "The focus should be on MCI management, who defrauded investors and the auditors at every turn." Citigroup spokeswoman Leah Johnson said, "The services that Citigroup provided to Worldcom and its executives were executed in good faith." She added that Citigroup now separates research from investment banking and doesn't allocate IPO shares to executives of public companies, saying Citigroup continues to believe its congressional testimony describing Mr. Ebbers as a "best customer." An attorney for Mr. Sullivan couldn't be reached for comment.

The potential claims against KPMG represent the most pressing issue for MCI. The report didn't have an exact tally of state taxes that may have been avoided, but some estimates range from $100 million to $350 million. Fourteen states likely will file a claim against the company if they don't reach settlement, said a person familiar with the matter.

While KPMG's strategy isn't uncommon among corporations with lots of units in different states, the accounting firm offered an unusual twist: Under KPMG's direction, Worldcom treated "foresight of top management" as an intangible asset akin to patents or trademarks. Just as patents might be licensed, Worldcom licensed its management's insights to its units, which then paid royalties to the parent, deducting such payments as normal business expenses on state income-tax returns. This lowered state taxes substantially, as the royalties totaled more than $20 billion between 1998 to 2001. The report says that neither KPMG nor Worldcom could adequately explain to the bankruptcy examiner why "management foresight" should be treated as an intangible asset.

Continued in the article

Continued in the article

Bob Jensen's threads on KPMG's recent scandals are at http://faculty.trinity.edu/rjensen/fraud.htm#KPMG 


 

January 28, 2004 reply from Amy Dunbar [Amy.Dunbar@BUSINESS.UCONN.EDU

 

Jonathan Weil stated:

Dennis Beresford, the chairman of MCI's audit committee and a former chairman of the Financial Accounting Standards Board, says MCI's board concluded, based on advice from outside attorneys, that the company doesn't have any claims against KPMG. Therefore, he says, KPMG shouldn't be disqualified as MCI's auditor. He calls the tax-avoidance strategy "aggressive." But "like a lot of other tax-planning type issues, it's not an absolutely black-and-white matter," he says, explaining that "it was considered to be reasonable and similar to what a lot of other people were doing to reduce their taxes in legal ways."

Dunbar's comments: 
After reading the report filed by the bankruptcy examiner, I question the label "aggressive." The tax savings resulted from the "transfer" of intangibles to Mississippi and DC subsidiaries; the subs charged royalties to the other members of the Worldcom group; the other members deducted the royalties, minimizing state tax, BUT Mississippi and DC do not tax royalty income. Thus, a state tax deduction was generated, but no state taxable income. The primary asset transferred was "management foresight." KPMG did not mention this intangible in its tax ruling requests to either Mississippi or DC, burying it in "certain intangible assets, such as trade names, trade marks and service marks."

The examiner argues that "management foresight" is not a Sec. 482 intangible asset because it could not be licensed. His conclusion is supported by Merck & Co, Inc. v. U.S., 24 Cl. Ct. 73 (1991).

Even if it was an intangible asset, there is an economic substance argument: "the magnitude of the royalties charged was breathtaking (p. 33)." The total of $20 billion in royalties paid in 1998-2001 exceeded consolidated net income during that period. The royalties were payments for the other group members' ability to generate "excess profits" because of "management foresight."

Beresford's argument that this tax-planning strategy was similar to what other people were doing simply points out that market for tax shelters was active in the state area, as well as the federal area. The examiner in a footnote 27 states that the examiner "does not view these Royalty Programs to be tax shelters in the sense of being mass marketed to an array of KPMG customers. Rather, the Examiner's investigation suggest that the Royalty Programs were part of the overall restructuring services provided by KPMG to Worldcom and prepresented tailored tax advice provided to Worldcom only in the context of those restructurings." I find this conclusion to be at odds with the examiner's discussion of KPMG's reluctance to cooperate and "a lack of full cooperation by the Company and KPMG. Requests for interviews were processed slowly and documents were produced in piecemeal fashion." Although the examiner concluded that he ultimately interviewed the key persons and that he received sufficient information to support his conclusions, I question whether he had sufficient information to determine that KPMG wasn't marketing this strategy to other clients. Indeed, KPMG apparently called this strategy a "plain vanilla" strategy to Worldcom, which implies to me that KPMG considered this off-the-shelf tax advice.

I worry that if we don't call a spade a spade, the "aggressive" tax sheltering activity will continue at the state level. Despite record state deficits, the states appear to be unwilling to enact any laws that could cause a corporation to avoid doing business in that state. In the "race to the bottom" for corporate revenues, the states are trying to outdo each other in offering enticements to corporations. The fact that additional sheltering is going on at the state level, over and above the federal level, is evident from the fact that state tax bases are relatively lower than the federal base (Fox and Luna, NTJ 2002). Fox and Luna ascribe the deterioration to a combination of explicit state actions and tax avoidance/evasion by buinesses. They discuss Geoffrey, Inc v. South Carolina Tax Commission (1993), which involves the same strategy of placing intangibles in a state that doesn't tax royalty income. Thus, the strategy advised by KPMG may well have been plain vanilla, but the fact remains that management foresight is not an intangible that can generate royalties. That is where I think KPMG overstepped the bounds of "aggressive." What arms-length company would have paid royalties to Worldcom for its management foresight?

Amy Dunbar
University of Connecticut

 

January 28, 2004 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU

Amy, 

Without getting into private matters I would just observe that one shouldn't accept at face value everything that is in the newspaper - or everything that is in an Examiner's report.

Denny
University of Georgia

 


From The Wall Street Journal Accounting Educators' Review on January 30, 2004

TITLE: New Issues Are Raised Over Independence of Auditor for MCI
REPORTER: Jonathan Weil
DATE: Jan 28, 2004
PAGE: C1
LINK: http://online.wsj.com/article/0,,SB107524105381313221,00.html 
TOPICS: Audit Quality, Auditing, Auditing Services, Auditor Independence, Tax Evasion, Tax Laws, Taxation

SUMMARY: The financial reporting difficulties at Worldcom Inc. continue as the independence of KPMG LLP is questioned. Questions focus on auditor independence.

QUESTIONS:
1.) What is auditor independence? Be sure to include a discussion of independence-in-fact and independence-in-appearance in your discussion.

2.) Why is auditor independence important? Should all professionals (e.g. doctors and lawyers) be independent? Support your answer.

3.) Can accounting firms provide tax services to audit clients without compromising independence? Support your answer.

4.) Does the relationship between KPMG and MCI constitute a violation of independence-in-fact? Does the relationship between KPMG and MCI constitute a violation of independence-in-appearance? Support your answers with authoritative guidance.

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

Bob Jensen's threads on KPMG's recent scandals are at http://faculty.trinity.edu/rjensen/fraud.htm#KPMG 


Note from Bob Jensen
Especially note Amy Dunbar’s excellent analysis (above) followed by a troubling reply by Chair of MCI’s Audit Committee, Denny Beresford.  I say “troubling,” because all analysts and academics have to work with are the media reports, interviews with people closest to the situation, and reports released by MCI and/or government files made public.  Sometimes we have to wait for the full story to unfold in court transcripts. 

I have always been troubled by quick judgments that auditors cannot be independent when auditing financial reports when other professionals in the firm have provided consulting and tax services.  I don’t think this is the real problem of independence in most instances.  The real problem lies in the dependence of the audit firm (especially a local office) on the enormous audit fees from a giant corporation like Worldcom/MCI.  The risk of losing those fees overshadows virtually every other threat to auditor independence.  

Although I think Amy’s analysis is brilliant in analyzing the corporate race to the bottom in tax reporting and the assistance large accounting firms provided in winning the race to the bottom, I don’t think the threat that KPMG’s controversial tax consulting jeopardized auditor independence nearly as much as the huge fixed cost KPMG invested in taking over a complete mess that Andersen left at the giant Worldcom/MCI.  It will take KPMG years to recoup that fixed cost, and I’m certain KPMG will do everything in its power to not lose the client.  On the other hand, the Worldcom/MCI audit is now the focal point of world attention, and I’m virtually certain that KPMG is not about to put its worldwide reputation for integrity in auditing in harms way by performing a controversial audit of Worldcom/MCI at this juncture.   KPMG has enough problems resulting from prior legal and SEC pending actions to add this one to the firm’s enormous legal woes at this point in time.

Hi Mac,

I agree with the 15% rule Mac, but much depends upon whether you are talking about the local office of a large accounting firm versus the global firm itself. My best example is the local office of Andersen in Houston. Enron's auditing revenue in that Andersen office was about $25 million. Although $25 million was a very small proportion of Andersen's global auditing revenue, it was so much in the local office at Houston that the Houston professionals doing the audit under David Duncan were transformed into a much older "profession of the world" in fear of losing that $25 million.

Also there is something different about consulting revenue vis-ŕ-vis auditing revenue. The local office in charge of an audit may not even know many of the consultants on the job since many of an accounting firm's consultants, especially in information systems, come from offices other than the office in charge of the audit.

Years ago (I refuse to say how many) I was a lowly staff auditor for E&Y on an audit of Gates Rubber Company in Denver. We stumbled upon a team of E&Y data processing consultants from E&Y in the Gates' plant. Our partner in charge of the Gates audit did not even know there were E&Y consultants from Cleveland who were hired (I think subcontracted by IBM) to solve an data processing problem that arose.

Bob Jensen

-----Original Message-----
From: MacEwan Wright, Victoria University Sent: Friday, January 30, 2004 5:21 PM
Subject: Re: Case Questions on Independence of Auditor for MCI

Dear Bob,

Given that, on average, consulting fees used to represent around 50% of fees from a client, the consulting aspect tended to reinforce the fee dependency. The old ethical rule in Australia that 15% of all fees could come from one client was probably too large. A 15% drop in revenue would severely cramp the style of a big practice. Regards,
Mac Wright


"Worldcom to Write Down $79.8 Billion of Good Will," by Simon Romero, The New York Times, March 14, 2003 

Worldcom, the long-distance carrier that is mired in the nation's largest bankruptcy filing, said yesterday that it was writing down $79.8 billion of its good will and other assets. The move is an acknowledgment that many areas of the company's vast telecommunications network are essentially worthless. The company said in a statement that all existing good will, valued at $45 billion, would be written down. Worldcom also said it would reduce the value of $44.8 billion of equipment and other intangible assets to about $10 billion. Worldcom had previously signaled that it was considering the write-downs, but the immensity of the values involved surprised some analysts. Worldcom's write-downs are second only to those of AOL Time Warner, which recently wrote down nearly $100 billion of assets.

Continued in the article.

March 12, 2003 message from David Albrecht [albrecht@PROFALBRECHT.COM]

I finished reading Disconnected: Deceit and Betrayal at Worldcom, by Lynne W. Jeter

Here is my review of the book submitted to Amazon.

Why to buy this book: This book will bring you up to speed on Worldcom.

What this book does: (1) gives a fact-based history of Worldcom from start (1984) to just past the end (December, 2002), (2) identifies and discusses key figures in the rise and fall, (3) introduces the foibles of Ebbers, (3) describes the clash of corporate culture following of MCI acquisition (4) describes accounting coverup in broad terms (5) suggests five reasons for the fall: denial of Sprint takeover, inability to integrate and manage MCI, costly excess capacity entering the business slowdown of 2000-2003, revenue loss as a result of long-distance competition, Ebbers inadequacies.

What this book does not: (1) provide acceptable levels of detail in the acquisitions, (2) give enough detail for the strengths and weaknesses of key figures, (3) provide sufficient detail about the accounting cover up, (4) thoroughly analyze each of the reasons the reasons for the fall.

The author is somewhat confused by accounting terms, and perhaps about what the accounting issues were.

After reading this book, you will be ready for (and need to read) the next books that come out on Worldcomm. At least, I want to know more about it.

Having panned the book, I still would recommend it to my students.

David Albrecht
Bowling Green State University


Hi Janko,

Worldcom will go down in history as one of the worst audits in the history of the world.  It was a far worse audit by Andersen than the Andersen audit of Enron.

Worldcom is not the most exciting research study, because the fraud was so simple.  It is, however, an interesting study of how bad audits were becoming as audit firms commenced to succumb to client pressures, especially very large clients like Worldcom.

The main GAAP violations at Worldcom concerned booking of expenses as assets --- over $3 billion overstated. The company also violated revenue recognition rules in GAAP. Many of the GAAP violations are summarized in the recent class action lawsuit against Worldcom --- http://www.whafh.com/cases/complaint/worldcomcmplt.htm 

*****************************************

NATURE OF THE ACTION

This is a class action on behalf of a class (the "Class") of all persons who purchased or otherwise acquired the securities of Worldcom Corporation between February 10, 2000 and November 1, 2000 (the "Class Period), seeking to pursue remedies under the Securities Exchange Act of 1934 ("1934 Act").

During the Class Period, defendants, including Worldcom, its Chief Executive Officer, Bernard Ebbers and its Chief Financial Officer, Scott Sullivan, issued a series of false statements to the investing public. During the Class Period, Worldcom reported seemingly unstoppable growth in revenue and profitability despite unprecedented competition in the telecommunications industry, transforming Worldcom into the second largest long-distance carrier in the United States, second only to industry giant AT&T. Indeed, Worldcom, headed by Ebbers and Sullivan, acquired billions of dollars worth of companies in the span of a few years - - including the then largest merger ever, the 1998 MCI merger. Throughout the Class Period, defendants represented that the massive MCI merger was an enormous success - contributing heavily to synergies, revenues and growth.

As defendants knew, due to industry-wide pressure, there was simply no way to continue the significant revenue and earnings growth the market had come to demand from Worldcom absent further consolidation. To that end, Ebbers in October, 1999 announced Worldcom’s largest merger ever, a deal to merge with number three in the industry, Sprint Telecommunications. The Sprint Merger was crucial to Worldcom for several reasons: (1) due to increased competition, Worldcom’s revenue growth was slowing dramatically due to regular forced contract renegotiations as a result of lower prices for long-distance and telecommunications services; (2) Worldcom’s account receivable situation was out of control, with hundreds of millions of receivables going uncollected but remaining on its books for long periods of time; and (3) Worldcom did not have a significant presence in the wireless business, and needed Sprint’s wireless division to allow the Company to compete with major telecommunications providers such as AT&T who did have wireless operations. The Sprint Merger would not only provide a conduit of increased revenue by which defendants could mask Worldcom’s deteriorating financial condition, but also provided a means to hide the enormous amount of uncollectible accounts receivables through integration-related charges.

Throughout 1999 and the first two quarters of 2000, the Company reported strong sales and growth, and became an investor favorite, reaching $62 per share in late 1999. Worldcom was followed by numerous analysts who favorably commented on the Company and its potential, especially in light of the highly anticipated Sprint Merger. Behind the positive numbers, however, there were significant problems growing at Worldcom which threatened the Company’s ability to compete.

According to numerous former employees, the Company resorted to a myriad of improper revenue recognition and sales practices in order to report favorable financial results in line with analysts’ estimates despite the significant, and worsening financial decline Worldcom was then experiencing. Defendants’ fraud involved : (a) failing to take necessary write-offs in order to avoid a charge to earnings (¶¶58-72); (b) intentionally misrepresenting rates to customers (¶¶74-81); (c) switching customers' long distance service to Worldcom without customer approval (¶¶82-83); (d) recognizing revenue from accounts which had been canceled by customers (¶¶84-87); (e) "double-billing" (¶¶91-92); (f) back-dating contracts to recognize additional revenue at the end of a fiscal quarter (¶97); (g) failing to properly account for contracts which had been renegotiated or discounted (¶¶93-96, 98-99); and (h) deliberately understating expenses. (¶¶88-90). Further, despite defendants' frequent statements regarding Worldcom's increased network expansion3 capabilities, the Company was experiencing substantial difficulties performing "build-outs", or network expansions, a failure which limited the Company's growth.

In addition, the number of uncollectible receivables skyrocketed during the Class Period, in part because those receivables represented phony sales that never should have been booked, and in part because defendants allowed over half a billion of worthless accounts receivable to remain on Worldcom's books in order to delay a charge against earnings required by Generally Accepted Accounting Principles ("GAAP"). Defendants knew about the increasing amount of uncollectible accounts by virtue of a monthly written report which detailed all accounts deemed uncollectible by virtue of prolonged litigation, bankruptcy or other circumstances. Indeed, defendants received detailed monthly packages regarding accounts receivables and their status, which included lengthy case histories, litigation summaries, a description of the most recent action taken by the Legal Department, and updates. Ebbers himself received these reports because he was the individual at Worldcom responsible for authorizing writeoffs in excess of $25 million - - accounts for which his express approval was required.

Defendants implicitly encouraged the widespread improper revenue recognition tactics employed by Worldcom employees, as well as the failures to properly reserve for and account for uncollectible accounts, for several reasons. First, defendants were desperate to complete the Sprint Merger. As defendants knew, Sprint shareholders were scheduled to vote on the pending merger on April 28, 2000, and it was essential that Worldcom appear to be a financially strong company in order for the vote to pass. Therefore, defendants reported phenomenal financial results for the first quarter on April 27, 2000 - one day before the Sprint shareholder vote on the merger.

Once Sprint and Worldcom shareholders approved the Merger, defendants kept up their barrage of false statements to avoid attracting negative attention while federal regulators considered the deal, and to ensure the deal was completed on the most favorable terms possible. Defendants intended to use Worldcom stock as currency to merge with Sprint, and the higher the price of Worldcom stock, the cheaper the purchase. It was also crucial to inflate the price of Worldcom stock in order to complete public offerings of debt in May and June, 2000 - for nearly $6 billion - to be used as to pay existing debt and free up additional borrowing capacity in order to pay for the costs of integrating Sprint.

Defendant also had personal reasons to misrepresent Worldcom’s financial results. If the Sprint Merger was completed, Ebbers felt the stock would "go through the roof"and he stood to gain hundreds of millions of dollars in profits as a result of his considerable Worldcom holdings, including soon-to-vest stock options. Ebbers was also strongly motivated to inflate Worldcom’s stock price to avoid a forced sale of his stock which he bought through a loan years before. In fact, in order to meet margin calls when the price of Worldcom stock declined, Ebbers regularly received multi-million dollar personal loans from the Company at the expense of Worldcom shareholders. Similarly, Sullivan, keenly aware of the Company’s accounting fraud because of his position as the Company’s top financial officer, divested himself of nearly $10 million worth of Worldcom stock on August 1, 2000. John Sidgemore, the Company’s Chief Technology Officer and a Worldcom Director, aware of the lack of new products being produced by the Company, sold over $12 million worth of Worldcom stock in May, 2000.

On July 13, 2000, defendants were forced to reveal that the Sprint Merger had been rejected by federal regulators. As a result, defendants scrambled to put together another deal which could conceal the problems at Worldcom. On September 5, 2000, defendants announced an intent to merge with Intermedia Communications, Inc. ("Intermedia") an Internet-services company which included its subsidiary, Digex, a company that manages web sites for business. This acquisition too would be completed using Worldcom stock as currency, so it was essential for the stock price to remain artificially inflated to complete the deal on favorable terms. The Intermedia deal, however, ran into unexpected hurdles and delays, and was the subject of lawsuits filed in Delaware Chancery Court by Digex shareholders, seeking to block the deal, and alleging the deal was financially unfair to Digex shareholders given Worldcom's worsening financial condition. As a result of the focusing of a spotlight on Worldcom's true financial status, defendants could no longer hide Worldcom's problems. On October 26, 2000, defendants revealed that the Company was forced to write down $405 million of uncollectible receivables due to bankruptcies of certain wholesale customers. The $405 million was stated in after-tax terms to deflect attention from the even higher whopping pre-tax write off of $685 million. The stock dropped from over $25 to slightly over $21 on October 26, 2000, on trading volumes of nearly 70 million shares.

On November 1, 2000, defendants dropped the other shoe, announcing a massive restructuring which would create a separate tracking stock for MCI - - a concession that the integration of MCI and Worldcom had not worked and was not profitable for investors. Defendants also revealed that the Company had been experiencing dramatic declines in growth and profitability. Fourth quarter 2000 earnings would be between $0.34 and $0.37 share - a far cry from the $0.49 analysts and investors expected, and which defendants said was an estimate they were comfortable with "from top to bottom." In addition, rather than earning $2.13 per share in 2001, defendants expected only between $1.55 and $1.65. The stock dropped over 20% in one day in response, sinking to a new 52 week low of $18.63 on November 1, 2000.

During a November 1, 2000 conference call, Defendant Ebbers revealed that he had "let investors down." He also admitted that, contrary to his repeated Class Period statements detailing the Company’s successful acquisition strategy which included purchasing billions of dollars worth of assets from telecommunications and Internet companies, some of the acquired assets "should have been disposed of sooner."

Worldcom stock has never recovered, and traded at slightly over $18 per share in May, 2001. As a result, Worldcom investors who purchased securities during the Class Period, have lost billions. The following chart indicates the impact of defendants' false statements on the market for Worldcom securities:

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One thing you might look into is the extortion that various CEOs, including Ebbers at Worldcom, forced upon large investment banks. These CEOs threatened to withdraw the business of their large companies if the investment banks did not give them new shares in various IPOs of other companies. In other words, this extortion did not directly involve a company like Worldcom, but Bernie Ebbers extorted $11 million from Salamon, Smith, Barney by threatening to withdraw Worldcom's business with the investment bank. See http://news.com.com/2100-1033-956167.html?tag=cd_mh 

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Top current and former Worldcom executives scored millions of dollars from hot initial public offerings made available to them by Salomon Smith Barney and its predecessor companies, records released on Friday by the U.S. House Financial Services Committee showed. Bernie Ebbers, the former chief executive of Worldcom, made some $11.1 million from 21 IPOs, including $4.56 million off the sale of Metromedia Fiber Network shares and almost $2 million from rival Qwest Communications International shares, according to the documents.

"This is an example of how insiders were able to game the system at the expense of the average investor," Rep. Michael Oxley, R-Ohio, chairman of the committee, said in a statement. "It raises policy questions about the fairness of the process that brings new listings to the markets."

The committee released the documents within moments of receiving the information it had subpoenaed from Salomon Smith Barney, a unit of Citigroup, as it investigates whether the company offered IPO shares to win investment banking business.

In the late 1990s through early 2000, technology IPOs were almost guaranteed to soar in the open market, meaning those investors who were able to buy shares at the offering prices would likely haul in large, risk-free gains.

Salomon got hundreds of millions in fees from telecommunications deals over the years. A memo turned over to the committee by Salomon showed that star telecommunications analyst Jack Grubman, who recently left the firm, was sent a memo about which executives got shares in two IPOs.

A lawyer for the firm was said to have not found any evidence of a "quid pro quo," in which it received investment banking business in exchange for the IPO allocations.

"We believe the allocations at issue fit well within the range of discretion that regulators have traditionally accorded securities firms in deciding how to allocate IPO shares," Jane Sherburne, the Salomon lawyer, said in a letter to the committee.

The committee's investigation comes after Worldcom admitted in June and July to a whopping $7.68 billion in accounting errors dating back to 1999, and the No. 2 U.S. long-distance telephone and Internet data mover was forced to file for bankruptcy protection in July.

James Crowe, Worldcom's former chairman, made $3.5 million by selling 170,000 shares of Qwest on Aug. 27, 1997, two months after he acquired the shares in the company's IPO, according to the documents. Former Worldcom Director Walter Scott made $2.4 million in his sale of 250,000 shares less than a month after Qwest went public.

Ironically, the man at the center of the Worldcom controversy, Scott Sullivan, who was fired for his role in the accounting debacle, lost $13,059 in the nine IPOs he received allocations.

His biggest losses came from the sale of Rhythms NetConnections, losing $144,450 when he sold his 7,000 shares in May 2001, two years after the company went public but less than three months before Rhythms filed for bankruptcy.

Representatives for Ebbers, Sullivan and Worldcom were not immediately available for comment.

The National Association of Securities Dealers last month proposed new rules to stop investment banks from allocating IPO shares to favored clients, but the rules would require approval from the Securities and Exchange Commission.

*****************************************

 

Bob Jensen

-----Original Message----- 
From: Janko Hahn [mailto:janko.hahn@web.de]  
Sent: Friday, October 18, 2002 4:04 AM 
To: Jensen, Robert Subject: Questions about Worldcom

Dear Professor Jensen,

I´m writing a thesis paper round about 15 pages about the manipulation at Enron and Worldcom here at the office of Professor Coenenberg. Last semester, you have been here in Augsburg, so I had a look at your homepage and it was a great help for me about Enron (I think, the main points to mention are SPE´s and derivatives).

But I´m still not shure what to write about worldcom: in different articles I can read about failures in the books, but nothing specific I can present.

So I have three questions, perhaps you can help me:

1. what have been the main points of manipulations at Worldcom? Where in the Gaap standards can I refer to?

2. why are the credits to the CEO Ebbers so important? Of course, they are really big and Ebbers won´t be able to pay them back, but this is no manipulation? So why do all the newspapers focus on this point?

3. Are these manipulations at Enron and Wordlcom really illegal? Of course, they are bad in the meaning of the standards, no prudence, and so on, but is this illegal? Or is it illegal, beacause they did not show the debts / revenues in the correct matter and so lied to the investors?

Thanks for your help Professor Jensen,

with best regards,

Janko Hahn 
Kennedystr. 16 82178 Puchheim
86159 Augsburg
Germany


I watched the AICPA's excellent FBI Webcast today (Nov. 6). One segment that I really enjoyed was a video of Walter Pavlo, a former MCI executive who served prison time for fraud. This was a person with all intentions of being highly professional on a fast track to being in charge of collecting reseller bad debts for MCI. In that position, he just stumbled upon too much temptation for what is tantamount to a kiting scheme.

You can read details about Walter Pavlo's fraud at http://www.forbes.com/forbes/2002/0610/064.html  
This Forbes site was temporarily opened up for the AICPA Webcast viewers and will not be available very long. If you are interested in it, you should download now!


Meet an Ex Con Named Walter Pavlo Who Did Time in Club Fed

What you find below is a message (actually three messages and a phone call) I received  from a man involved in MCI's accounting fraud who went to prison and is now trying to apologize (sometimes for a rather high fee) to the world. 

You can read details about Walter Pavlo's fraud at http://www.forbes.com/forbes/2002/0610/064.html

I wrote the following last year at  http://faculty.trinity.edu/rjensen/fraud.htm

I watched the AICPA's excellent FBI Webcast ( Nov. 6, 2003 ). One segment that I really enjoyed was a video of Walter Pavlo, a former MCI executive who served prison time for fraud. This was a person with all intentions of being highly professional on a fast track to being in charge of collecting reseller bad debts for MCI. In that position, he just stumbled upon too much temptation for what is tantamount to a kiting scheme.

Message from Walter Pavlo on February 24, 2004

Bob,

I routinely do a search on my name over the Internet to see if there are comments on my speeches that I conduct around the country. I saw that you had a comment on a video in which I appeared but was unable to find the complete comment on your extensive web-site. Whether positive or negative I could not ascertain but am still interested in your thoughts and would appreciate them.

I did read some of your comments regarding the stashing of cash off-shore by executives who commit crimes and the easy life they have at "club fed". Here I would agree that there are a few who have such an outcome, but this is not the norm. However, I would disagree that there is a "club fed" and on that you are misinformed.

I had off-shore accounts and received a great deal of money. However, the results of story are more tragic. All of the money is gone or turned over to authorities (no complaints here, this is justice), I lost my wife of 15 years and custody of my children, I lost all of my assets (retirement, etc.) and at 41 I am starting life over with little to show of my past accomplishments (which were many). Stories like mine are more common among rank and file middle managers who find themselves on the other side of the law. There are few top executives in prison but that appears to be changing. Time will tell if they fare as well.

Prison, while deserving for a crime of the magnitude that I and others committed, is a difficult experience and one that is difficult from which to recover. In the media and in comments such as the ones your offer, it appears that this part of the story is not revealed and that it is better to appeal to the fears and anger of the general population. I would encourage you to consider other view points for reasons of understanding the full story. I feel that this is important for people to know.

Thank you for your time and would appreciate receiving your feedback.

Walt Pavlo
125 Second Avenue, #24 New York, NY 10003
Phone: (201) 362-1208

Message 2 from Walter Palvlo (after he phoned me)

Bob,

Attached is an article that appeared in Forbes magazine in the June 10, 2002 issue. I was interviewed for this article while still in prison and some six months prior to Worldcom's revelations of the multi-billion dollar fraud that we know of today.

It was a pleasure to speak with you and I hope to correspond with you more in the future.

Walt Pavlo

125 Second Avenue, #24 New York, NY 10003

Phone: (201) 362-1208

This is part of a resume that he sent to me (I think he wants me to promote him as a speaker)

Walter "Walt" Pavlo holds an engineering degree from West Virginia University and an MBA from the Stetson School of Business at Mercer University. He has worked for Goodyear Tire in its Aerospace division as a Financial Analyst, GEC Ltd. of England as a Contract Manager and as a Senior Manager in MCI Telecommunication's Division where he was responsible for billing and collections in its reseller division.

As a senior manager at MCI, and with a meritorious employment history, Mr. Pavlo was responsible for the billing and collection of nearly $1 billion in monthly revenue for MCI's carrier finance division. Beginning in March of 1996, Mr. Pavlo, one member of his staff and a business associate outside of MCI began to perpetrate a fraud involving a few of MCI's own customers. When the scheme was completed, there had been seven customers of MCI defrauded over a six-month period resulting in $6 million in payments to the Cayman Islands.

In January 2001, in cooperation with the Federal Government, Mr. Pavlo pled guilty to wire fraud and money laundering and entered federal prison shortly thereafter. His story highlights the corrupt dealings involving the manipulation of financial records within a large corporation. His case appeared as a cover story in the June 10, 2002 issue of Forbes Magazine, just weeks before Worldcom divulged that it had over $7 billion in accounting irregularities.

Currently, Mr. Pavlo is the Director of Business Development at the Young Entrepreneurs Alliance (YEA), a non-profit organization in Maynard, Massachusetts. YEA's mission is to provide at-risk and adjudicated teens with the opportunity to attain long-term economic independence by teaching them about business ownership. Mr. Pavlo's primary responsibility is to develop the business programs, raising funds through speaking engagements and charitable donations to YEA.

Mr. Pavlo has been invited to speak on his experiences by the Federal Bureau of Investigation, US Attorney's Office, major university MBA programs, corporations and various professional societies. The purpose of these speeches is to convey to audiences an understanding of the inner-workings and motivations associated with complex white-collar crimes, with an emphasis on ethical decision-making.

Walter Pavlo sent me the following information regarding my question whether he makes pro-bono presentations.  He replied as follows:

Bob,

On the note of pro-bono work, most of what I have done to date has been pro-bono.  Whenever I am in an area with a paying gig, I try to reach out to universities in the area to offer my services at no charge.  I could have done this for Trinity when I was in San Antonio last year for the Institute of Internal Auditors .  I'll be sure to look you up if I'm going to be in the area.

Walt


The Confessions of Andy Fastow

What he does not confess is how, before the scandal broke, virtually all employees of Enron who knew him hated the "arrogant little bastard"
"The confessions of Andy Fastow," by Peter Elkind, Fortune, July 1, 2013 ---
http://features.blogs.fortune.cnn.com/2013/07/01/the-confessions-of-andy-fastow/

He was an improbable Las Vegas headliner, taking the stage before a packed convention hall of 2,500 fraud examiners.

For former Enron CFO Andy Fastow, who spent more than five years in federal prison for his crimes, last week's appearance before the Association of Certified Fraud Examiners was his most public step in an uphill redemptive journey -- to explain how he became a "fraudster;" to sound provocative warnings about today's corporate practices; and even to offer a bit of revisionism on the company's 2001 collapse.

Fastow launched his talk with a broad mea culpa, introduced with a grim joke. "Several of you have commented to me that your organization has grown dramatically over the past 10 years," he said. "And they thank me. They said no other individual has been more responsible for the growth of your industry than me. So: You're welcome."

The crowd roared.

"It's not something I'm proud of," he added soberly, after the laughter had died down.

Fastow was initially charged with 78 counts of fraud, mostly connected to his central role in a web of off-balance sheet entities that did business with Enron, disguised the company's financial condition, and made Fastow tens of millions. He ultimately pled guilty to two counts, forfeited $30 million, and agreed to testify against his former bosses as a government witness.

Since leaving prison in 2011 and resuming life with his wife Lea and two sons in Houston, where Enron was based, Fastow has kept a low profile. Now 51, he works 9-to-5 as a document-review clerk at the law firm that represented him in civil litigation.

Fastow has given 14 unpaid talks, mostly at universities, usually with no press allowed. The first came at the University of Colorado-Boulder. He volunteered to speak to students after reading a column on ethics by the dean of the business school. Fastow has also spoken at Tufts, Tulane, and Dartmouth and is scheduled to address a United Nations group in the fall.

In Las Vegas, dressed in a blazer and open shirt, Fastow stood at the podium a bit grim-faced, his speech sometimes halting. "I'm not used to giving talk to groups this big," he explained. "I apologize to you if I feel nervous -- if I appear nervous."

"Why am I here?" he asked. "First of all, let me say I'm here because I'm guilty ... I caused immeasurable damage ... I can never repair that. But I try, by doing these presentations, especially by meeting with students or directors, to help them understand why I did the things I did, how I went down that path, and how they might think about things so they also don't make the mistakes I made."

"The last reason I'm here," Fastow continued, "is because, in my opinion, the problem today is 10 times worse than when Enron had its implosion ... The things that Enron did, and that I did, are being done today, and in many cases they're being done in such a manner that makes me blush -- and I was the CFO of Enron." He cited the continuing widespread use of off-balance-sheet vehicles, as well as inflated financial assumptions embedded in corporate pension plans.

MORE: Big companies don't have to lose their souls

Fastow said he was prosecuted "for not technically complying with certain securities rules" -- but that wasn't "the important reason why I'm guilty." The "most egregious reason" for his culpability, he said, was that the transactions he spearheaded "intentionally created a false appearance of what Enron was -- it made Enron look healthy when it really wasn't."

"Accounting rules and regulations and securities laws and regulation are vague," Fastow explained. "They're complex ... What I did at Enron and what we tended to do as a company [was] to view that complexity, that vagueness ... not as a problem, but as an opportunity." The only question was "do the rules allow it -- or do the rules allow an interpretation that will allow it?"

Fastow insisted he got approval for every single deal -- from lawyers, accountants, management, and directors -- yet noted that Enron is still considered "the largest accounting fraud in history." He asked rhetorically, "How can it be that you get approvals ... and it's still fraud?"

Because it was misleading, Fastow said -- and he knew it. "I knew it was wrong," he told the crowd. "I knew that what I was doing was misleading. But I didn't think it was illegal. I thought: That's how the game is played. You have a complex set of rules, and the objective is to use the rules to your advantage. And that was the mistake I made."

After speaking for about 20 minutes, Fastow took questions. He insisted on this despite the trepidations of conference organizers. "A lot of people are still angry," explained James Ratley, a former Dallas police department fraud investigator and the Austin-based group's CEO. "I was cautious that someone would create a disturbance."

The fraud group invites a "criminal speaker" to address its convention every year. But Fastow's invitation drew unusually acidic comments on a LinkedIn message board. "A total slap in the face to all of the honest and respectable investigators that could be utilized as a presenter," one person fulminated. "Just scum," was another's summary. "To be blunt," a third person wrote, "I see him as a calculating low life, as bad as an armed robber who would shoot up a bank to get the people's money."

But Ratley dismissed the criticism. "If you're a fraud examiner and you don't want to deal with a fraud perpetrator, you ought to change professions." Ratley said he had met with Fastow to screen him "for any type of evasiveness. He has not dodged, ducked, or blinked since I started talking with him." ACFE made a point of noting prominently in promotional materials that Fastow was not paid to speak. (The group did cover his travel expenses).

Among his questions, Fastow was asked about former Enron CEO Jeff Skilling's sentence reduction last month -- from 24 to 14 years. Fastow offered considerable sympathy for his former boss, against whom he had testified at trial. "Going to prison is terrible," Fastow said. "You're never comfortable. All the talk about 'Club Fed' is garbage ... You're surrounded by very violent people, very unstable people. Prisons work hard to make you uncomfortable. But that's not what's bad about going to prison. What's bad about going to prison is that you're separated from your family." (Skilling's parents and youngest son all died while he was behind bars.) Fastow added that even Skilling's reduced term is still "a devastating sentence."

Fastow went on to insist that "Enron did not have to go bankrupt when it went bankrupt ... Enron should not have gone bankrupt. It could have survived. And it was decisions made in October 2001" -- after Skilling resigned as CEO -- "that caused it go into bankruptcy" early that December. That's a highly debatable point -- but Fastow did not elaborate.

And then, the final question: "This is on a lot of people's minds. Many people vilify you for what you did at Enron, and the resulting effect on other companies, pensions, market share, people's fortunes. How do you grapple with that? How do you react to that condemnation?"

"Um, well, first of all," said Fastow, looking down, "I deserve it. It's a very difficult thing to accept that about yourself. I didn't set out to commit a crime. I certainly didn't set out to hurt anyone. When I was working at Enron, you know, I was kind of a hero, because I helped the company make its numbers every quarter. And I thought I was doing a good thing. I thought I was smart. But I wasn't."

"I wake up every morning, and I take out my prison ID card, which I have with me here today. And it makes certain that I remember all the people. I remember that I harmed so many people in what I did. It encourages me to try to do the little things that I can to make amends for what I did."

"I can't repay everyone. I can't give them jobs. I can't fix it. But I just have to try bit by bit to do that. Being here is hopefully a little contribution to that."

Continued in article

MORE: The real story behind Jeff Skilling's big sentence reduction
(Jensen:  Actually it was far less reduction than Skilling had hoped for --- he will remain in prison until 2017 while the creep Fastow milks the public speaking circuit)

Bob Jensen's threads on the enormous Enron, Worldcom, and Andersen scandals ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm

 

 

 

 

 




 

Question
What was the total of Jeff Skilling's Enron stock sales and how much was he fined in 2006?

Answer
He sold 1,307,678 shares at various times for a total of $70,687,199 --- http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales

Will they accept a Skilling's personal check for $183 million?
Federal prosecutors want former Enron Corp. CEO Jeffrey Skilling to turn over nearly $183 million for helping perpetuate one of the biggest business frauds in U.S. history - his alleged share and that of his late co-defendant, company founder Kenneth Lay.
SmartPros, August 14, 2006 --- http://accounting.smartpros.com/x54308.xml

Federal prosecutors say Jeffrey K. Skilling, the former Enron chief executive, is liable not only for his own ill-gotten gains but also for those of the late Kenneth L. Lay.
Alexei Barrionuevo, "U.S. Wants Ex-Enron Chief to Pay Lay’s Share, Too," The New York Times, August 15, 2006 ---
http://www.nytimes.com/2006/08/15/business/businessspecial3/15enron.html?_r=1&ref=business&oref=slogin


What are Ken Lay's secret recipes for looting $184,494.426 from the corporation you manage?
What was Ken Lay's defense?

Jeff Skilling and Andy Fastow may spend a few years in Club Fec, but they'll never touch Ken Lay. Here's how you can cook the books using Ken Lay's favorite recipes.

1. Hire financial sharpies (read that Skilling, Fastow, Mark, Belfert, Frevert, Pai, and others) to cook the books so that you can make a fortune on your share holdings and stock options before the bubble bursts. But don't allow them to tell you about the sneaky deals (read that derivatives in SPEs) that you probably couldn't understand in a million years if they tried to explain them --- http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm

One of many reasons Judges may be stupid and/or corrupt

"Judge Vacates Conviction of Ken Lay," by Juan A. Lozano, SmartPros, October 19, 2006 --- http://accounting.smartpros.com/x55197.xml

Enron founder Kenneth Lay's criminal record is now clean. A federal judge ruled Tuesday that Lay's death this summer vacated his conviction on fraud and conspiracy charges connected to the downfall of the once mighty energy giant.

Lay was convicted of 10 counts of fraud, conspiracy and lying to banks in two separate cases on May 25. He died of heart disease July 5 while vacationing with his wife, Linda, in Aspen, Colo.

Enron's collapse in 2001 wiped out thousands of jobs, more than $60 billion in market value and more than $2 billion in pension plans.

Lay's attorneys argued that legal precedent called for his convictions to be erased and his indictment dismissed. They cited a 2004 ruling from the 5th U.S. Circuit Court of Appeals that found that a defendant's death pending appeal extinguished his entire case because he hadn't had a full opportunity to challenge the conviction and the government shouldn't be able to punish a dead defendant or his estate.

U.S. District Judge Sim Lake agreed with them, saying prosecutors had not "raised any legal basis for denying the rule's application in this case ... ."

"On behalf of his estate, I'm really quite pleased with the ruling and glad this brings to a close the criminal proceeding against Mr. Lay," said Samuel Buffone, the attorney for Lay's estate.

Tuesday's ruling thwarts the government's bid to seek $43.5 million in ill-gotten gains prosecutors allege he pocketed by participating in Enron's fraud. The government could still pursue those gains in civil court, but they would have to compete with other litigants, if any, also pursuing Lay's estate.

"Today's ruling does not change the fact that Mr. Lay was found guilty after a four-month jury trial and a separate bench trial," said Bryan Sierra, a Department of Justice spokesman. "We will continue to pursue all remedies available for restitution on behalf of the victims of the fraud at Enron."

Kelly Kimberly, spokeswoman for Lay's family, declined comment, referring reporters to Buffone.

In his ruling, Lake also denied a request from Russell Butler, a Maryland crime victims attorney who lost $8,000 in Enron's collapse. He had asked for an order of restitution based on Lay's conviction, said his attorney, Keli Luther, with the Crime Victims Legal Assistance Project in Arizona.

Luther said Lake's ruling was "unfair for victims that have been left penniless by Mr. Lay's actions."

Prosecutors offered no counter legal argument in the case, but had asked Lake to hold off on a ruling until next week so Congress could consider legislation from the Justice Department that changes current federal law regarding the abatement of criminal convictions. Congress recessed for the elections without considering the legislation.

In their motion to Lake last month, prosecutors Sean Berkowitz and John Hueston wrote that certain provisions of the proposed legislation would apply to Lay's case, including "that the death of a defendant charged with a criminal offense shall not be the basis for abating or otherwise invalidating either a verdict returned or the underlying indictment."

"It seems like there isn't much of an argument that could have been made" by prosecutors, said Carl Tobias, a law professor at the University of Richmond School of Law in Virginia. "The judge seemed to be pretty much bound by the earlier precedent."

Enron, once the nation's seventh-largest company, crumbled into bankruptcy proceedings in December 2001 when years of accounting tricks could no longer hide billions in debt or make failing ventures appear profitable.

Lay's co-defendant, former Enron chief executive Jeffrey Skilling, is scheduled to be sentenced on Monday.

"Skilling Sentenced to 24 Years in Prison," by Juan A. Lozano, SmartPros, October 23, 2006 --- http://accounting.smartpros.com/x55231.xml

Former Enron Chief Executive Officer Jeffrey Skilling, the most vilified figure from the financial scandal of the decade, was sentenced Monday to 24 years and four months in the harshest sentence yet in the case that arose from the energy trading giant's collapse.

U.S. District Judge Sim Lake denied Skilling's request for bond and ordered him to home confinement, wearing an ankle monitor. Lake, who told the U.S. Bureau of Prisons to recommend when Skilling should report to prison, suggested that Skilling, 52, be sent to the federal facility in Butner, N.C., for his role in a case that came to symbolize corporate fraud in America.

Skilling, insisting he was innocent yet remorseful in a two-hour hearing, was the last top former official to be punished for the accounting tricks and shady business deals that led to the loss of thousands of jobs, more than $60 billion in Enron stock and more than $2 billion in employee pension plans after the company sought bankruptcy protection in December 2001.

Skilling's remaining assets, about $60 million, will be liquidated, according to an agreement among lawyers for Enron employees, the company's savings and stock ownership plans, prosecutors and Skilling's legal team.

About $45 million will be put in a restitution fund for victims. The remaining $15 million will go to Skilling's legal fees, said Lynn Sark, attorney for the Enron Corp. Savings Plan and Stock Ownership Plan. The Justice Department allowed Skilling to set aside $23 million for his defense when he was indicted; he still owed his lawyers $30 million as of Monday.

Skilling stood with his hands clasped below his waist, with attorney Daniel Petrocelli at his side. He gave no visible reaction to the sentence. After court adjourned, Skilling hugged Petrocelli.

Skilling's term is the longest received by any Enron defendant; former Chief Financial Officer Andrew Fastow was given a six-year term after cooperating with prosecutors and helping them secure Skilling's conviction. It falls just shy of the sentence imposed on Worldcom CEO Bernard Ebbers, who received 25 years for his role in the $11 billion accounting fraud that toppled the company he built from a tiny telecommunications firm to an industry giant.

Skilling's co-defendant, Enron founder Kenneth Lay, died from heart disease on July 5. Lay's convictions on 10 counts of fraud, conspiracy and lying to banks in two separate cases were wiped out with his death.

Skilling's arrogance, belligerence and lack of contriteness under questioning made him a lightning rod for the rage generated by the collapse of Enron in 2001.

"Your honor, I am innocent of these charges," Skilling told Lake Monday. "I'm innocent of every one of these charges.

"We will continue to pursue my constitutional rights and it's no dishonor to this court and anyone else in this court. But I feel very strongly about this, and I want my friends, my family to know that."

Skilling also disputed reports that he had no remorse for his role in the fraud that drove the company to seek bankruptcy protection.

"I can tell you that's just the furthest thing from the truth," he said. "It's been very hard on me, but probably, more important, incredibly hard on my family, incredibly hard on employees of Enron Corp., incredibly hard on my friends and incredibly hard on the community.

"And I want my friends, my family to know this."

Skilling's second wife, former Enron corporate secretary Rebecca Carter, was in the courtroom.

Skilling was convicted in May on 19 counts of fraud, conspiracy, insider trading and lying to auditors. He was acquitted on nine counts of insider trading.

On Monday, Lake set investor loss tied to his actions at $80 million, which he relied on to set the sentence. With that figure, Skilling faced up to 30.4 years in prison.

Skilling also faces more than $18 million in fines for his crimes.

Victims unleashed nearly five years of anger on Skilling Monday and begged Lake to send Skilling to prison for life.

"Mr. Skilling has proven to be a liar, a thief and a drunk, flaunting an attitude above the law," said 22-year Enron employee Dawn Powers Martin. "He has betrayed everyone who has trusted him. Shame on me for believing the management of Enron."

Two chose not to vilify Skilling, however.

"I can't state strongly enough, during 20 years, have I seen or heard anything that he was leading a massive conspiracy to mislead Enron shareholders and employees," said one of them, Sherri Sera, a former administrative assistant. She said she too had lost thousands in Enron stock and benefits but took blame for her own failure to diversify.

Former employee Diana Peters later called the sentence "just," but added, "I am extremely disappointed he wasn't taken into custody today."

"The people who have been harmed by the bankruptcy have very strong feelings about the subject," Skilling's attorney said. "But that does not shed much light on the reasonableness of the sentence Mr. Skilling should receive."

Jurors decided Skilling and Lay repeatedly lied about Enron's financial health when they knew of accounting maneuvers that hid debt and inflated profits.

Enron's crash and the subsequent scandals roiled Wall Street and prompted stiffened white collar penalties and upped regulatory scrutiny over publicly traded companies.

Skilling maintained his innocence before, during and even after his trial, insisting no fraud occurred at Enron other than that committed by a few executives skimming millions in secret side deals, and that bad press and poor market confidence combined to sink the company.

Prosecutors have also asked that Skilling turn over nearly $183 million, which they claim he pocketed while at Enron. The U.S. government had divided that amount between Skilling and Lay. But Lay's death has left that amount solely with Skilling.

During his trial, Skilling listed his remaining assets as including a $5 million mansion in Houston, a $350,000 condo in Dallas, a Mercedes Benz, two Land Rovers and nearly $50 million in stocks and bonds frozen by the government.

Skilling, who was born in Pittsburgh and raised in New Jersey and suburban Chicago, spent 11 years at Enron. He has three children - aged 22, 20 and 16 - from his first marriage. He and Carter have no children.

He took over as chief executive from Lay in February 2001 but abruptly quit six months later, citing a desire to spend more time with his family. Prosecutors said he left Enron because he knew the company was on the brink of bankruptcy.


 

ENRON'S CAST OF CHARACTERS AND THEIR STOCK SALES --- http://faculty.trinity.edu/rjensen/fraud.htm#StockSales

2. If word of bad dealings (read that the Watkins memo) crosses your desk, hire an unethical law firm (read that Vinson and Elkins --- http://www.businessweek.com/bwdaily/dnflash/jan2002/nf20020118_8522.htm ) and an accounting firm (read that Andersen --- http://abcnews.go.com/sections/business/DailyNews/enron_020117.html  ) to absolve you of responsibility by allowing you to claim to have passed the buck along to experts.

3. Appoint a Board of Directors made up of greedy whores (male and female) or oblivious fools (read that former professors) who will rubber stamp any of your looting deals so that you can claim that your dealings were "approved" by the Board (otherwise known as how Dennis Kowalski looted $600 million from Tyco). See http://snipurl.com/EnronBoard

4.  Have your wife do the insider trading

Laying it on the Line at Enron (or getting Layed at Enron)

"Enron Inquiry Turns to Sales by Lay's Wife," by Kurt Eichenwald, The New York Times, November 17, 2004

Federal prosecutors are investigating whether the wife of Enron's former chairman, Kenneth L. Lay, engaged in insider trading in a sale of company stock shortly before it collapsed into bankruptcy, people involved in the case said yesterday.

The sale by Mr. Lay's wife, Linda, involved 500,000 shares of Enron stock and was done through a family foundation, according to records and people involved in the case. The proceeds, totaling $1.2 million, did not go to the Lays, but were distributed to charitable organizations, which had already received pledges of contributions from the foundation.

Already, several Enron officers, including Mr. Lay; Jeffrey K. Skilling, a former chief executive; and Richard L. Causey, the former chief accounting officer, have been indicted on fraud charges. Other executives including Andrew S. Fastow, the former chief financial officer, have pleaded guilty to crimes and are serving as government witnesses.

By focusing on the transaction involving Mrs. Lay, the government could be trying to turn up the pressure on her husband in hopes of securing a guilty plea. Prosecutors used such tactics against Mr. Fastow, by starting an investigation into a comparatively minor tax violation committed by his wife, Lea.

People involved in the case said that Mr. Fastow was offered the opportunity to prevent his wife from being charged by pleading guilty; at the time he refused. Mr. Fastow did not reverse himself until his wife was indicted; she also pleaded guilty and is serving a prison term.

Andrew Weissmann, head of the Justice Department's Enron Task Force, declined to comment yesterday. A lawyer for the Lays, Michael Ramsey, confirmed the investigation, and criticized it as trying to criminalize innocent behavior to bring pressure against Mr. Lay.

"This is the last gasp of a dying prosecution,'' Mr. Ramsey said. "This is an attempt at extortion. If I tried something like this, I would be indicted.''

He said that the sale was based on information in the market and that the proceeds went to charity. Neither Ken nor Linda Lay sold any personal shares that morning, he said.

The investigation of Mrs. Lay is focusing on Nov. 28, 2001, the day investors realized that Enron was probably heading for bankruptcy.

That morning, Mrs. Lay placed an order for the foundation to sell its Enron shares sometime between 10 and 10:20, people involved in the case said. For days up until that morning, Enron had been negotiating a possible merger with a rival, Dynegy, and details of the talks had been leaking out in media reports.

The evening before, people involved said, Chuck Watson, then chairman and chief executive of Dynegy, told Mr. Lay and others at Enron that he had doubts about the merger. While Mr. Watson agreed to consult with his board and his merger team before reaching a decision, the prospects for a deal were dim.

Records show that Mr. Lay returned home that night and was in the office early the next morning. The government is investigating whether he told his wife about the falling prospects for the merger before she placed the sell order.

Before the market opened that morning, there were already rumors of problems with the deal. The news emerged at about 10:30 a.m., when Standards & Poor's announced that it was cutting its credit rating for Enron. That put Enron on the hook for making good on some $3.9 billion in debt in a matter of months.

The market reacted swiftly, knocking Enron shares down by more than $1.50 a share. Shortly after the market became aware of the downgrade, Enron shares were selling at $2.60 to $2.70, according to a transcript of a CNNfn market news broadcast that morning. Brokerage records from First Union Securities, where the foundation maintained its account, show that the shares were sold at $2.38, for proceeds of about $1.2 million. Enron shares closed at about 60 cents that day.

While the timeline of events is difficult for Mrs. Lay, the case presents numerous hurdles for the government. The largest of those is that the Lays did not profit from the sale; while their charitable group, the Linda and Ken Lay Family Foundation, did not have the assets to meet its pledges, the obligation for those commitments would remain with the foundation, not the family. Records show that, in the months after the sale, the proceeds were given away.

The second difficulty is evidentiary. If Mr. Lay did inform his wife of the imploding merger, such communication is protected as a marital confidence and its disclosure cannot be compelled. That means that the government must find a third-party witness who heard from Mr. or Mrs. Lay about any discussion to prove that she had insider knowledge at the time of the trade.

Continued in article

5. Have your company buy your wife expensive jewelry and clothing and then set her up in a resale shop (read that Jus' Stuff) to lauder the money. See http://www.fool.com/news/take/2002/take020501.htm?source=EDNWFH

Ken Lay's Wife Sets Up Shop Enron's stock may not be worth much, but the former CEO's bright-yellow pair of metal fighting cocks might be. At least that's what his wife hopes. Linda Lay, wife of ex-chief executive Ken Lay, is opening an antique and secondhand store that will feature some of the Lays' personal property. The boutique will be called Jus' Stuff (possible slogan: "We sold our souls, now we're selling our stuff"), and will hawk artwork, couches, a mahogany bed, a reproduction of an antique desk, and, of course, the fighting cocks. This led us to speculate what else might turn up in the inventory of Jus' Stuff (possible ad campaign: "10% off to people who lost their 401(k)s and can't retire"). So, here are the top items we'd like to see in the storefront window:

14. Enron stock certificates, framed and matted

13. Patents for energy-efficient appliances that Enron bought up and locked away

12. Hotline telephone connected to the Cayman Islands Better Business Bureau

11. Battery-powered laugh machine that Enron execs used when discussing shareholders

10. Humble pie, ŕ la mode

09. A racy home video, starring Linda "Love" Lay

08. Collections of souvenir silverware from restaurants and souvenir towels from hotels

07. Actual set of blindfolds worn by Andersen auditors

06. Posters from Enron's short-lived "Got Gas?" ad campaign

05. The photos from their vacation in India with the Cheneys

04. The jester cap and books Ken was given after appearing on some investing radio show

03. The cabana boy

02. Graven image of Khutspa, the god of "getting away with it"

01. Shredded paper -- lots of it


"Enron chiefs 'told lie after lie' to cash in," by Jef Feeley and Laurel Brubaker Calkins, The Age, February 2, 2006 --- http://www.theage.com.au/articles/2006/02/01/1138590568836.html

FORMER Enron executives Kenneth Lay and Jeffrey Skilling "told lie after lie" to investors about the company's financial health to make millions in stock profits, a prosecutor has told their fraud trial.

US Justice Department lawyer John Hueston said on Tuesday Lay, Enron's former chairman, and Skilling, its former chief executive, knew the energy trading company was on the brink of collapse in 2001. They hid that fact from investors while selling millions of their own shares, he said in his opening statement.

Lay and Skilling "propped up their stock holdings and deceived investors about information they needed" to decide whether to sell Enron's shares days before it collapsed, he said.

Lay, 63, and Skilling, 52, are charged with overseeing a wide-ranging financial fraud that led to the demise of what was once the nation's largest energy trader. Skilling's lawyer said Skilling was not engaged in a conspiracy and Enron collapsed because of a "liquidity crisis".

Enron had more than $US68 billion of market value before its bankruptcy filing wiped out more than 5000 jobs and at least $1 billion in retirement funds. Outside investors suing over the collapse contend accounting fraud led to at least $25 billion in losses.

Lay is charged with seven counts of fraud and conspiracy, and four of bank fraud that will be tried separately. Skilling faces 31 counts of fraud, conspiracy and insider trading. Both have pleaded innocent.

Daniel Petrocelli, Skilling's lead lawyer, said Skilling would "tell you in his own words that he never" committed any of the crimes the Government alleges.

Mr Hueston said the Government would focus on Skilling's and Lay's efforts to deceive investors and employees, not on the arcane accounting systems used to do it.

"This is a simple case," he said. "It's not about accounting. It's about lies and choices."

For example, the executives were briefed by subordinates about performance problems at several Enron subsidiaries in 2001, Mr Hueston said. Both had millions in losses that Skilling did not tell investment analysts about. Later that year, an Enron employee told Lay the company was a "ticking time bomb" because of accounting irregularities, Mr Hueston said.

He said Lay knew the company was heading to bankruptcy in December 2001. Instead of warning employees to sell shares in retirement funds, Lay sold $6 million worth of his own shares.

In his opening remarks, Mr Petrocelli accused prosecutors of seeking to criminalise normal corporate practices and searching for non-existent conspiracies.

Skilling "didn't know about any criminal conspiracy, didn't see any criminal conspiracy and didn't hear any criminal conspiracy", he said. "And the same for Mr Lay." They didn't see any conspiracy because there wasn't one, he said.

Mr Petrocelli spoke for Lay because the former executives are mounting a joint defence. The Government alleges Skilling and Lay were "consumed by greed and that's what brought down Enron", Mr Petrocelli said. But the Government' accusation "isn't true".

Enron collapsed as a result of an "unexpected liquidity crisis" caused by its trading partners. "It wasn't a crooked company. It suffered a tragedy," he said.

"The evidence in this case is that Mr Skilling did not steal one nickel. There is a man who stole a nickel — stole $25 million in nickels — and his name is Andrew Fastow." Fastow, Enron's former chief financial officer, has pleaded guilty to a fraud charge over Enron's collapse. He is expected to be the Government's star witness.

The trial before US District Court Judge Sim Lake continues.

February 2, 2006 message from Ed Scribner [escribne@NMSU.EDU]

Interesting (to us in accounting) comment by Lay/Skilling trial prosecutor:

[US Justice Department lawyer John Hueston] said the Government would focus on Skilling's and Lay's efforts to deceive investors and employees, not on the arcane accounting systems used to do it.

"This is a simple case," he said. "It's not about accounting. It's about lies and choices."

http://www.theage.com.au/articles/2006/02/01/1138590568836.html

Ed Scribner
New Mexico State University
Las Cruces, NM, USA

February 3, 2006 reply from David Albrecht [albrecht@PROFALBRECHT.COM]

I think this case is also about finding a scapegoat and seeking retribution. Of course, Lay and Skilling might actually be guilty, but it doesn't matter. It is part of our current national climate that someone must be found guilty and significantly penalized.

You can see this in other aspects. It used to be that auto/truck drivers who caused a fatal accident seldom were jailed. Jail time was reserved to egregious actions that seemed to scream out of jail-time justice. Now, it is SOP, especially if there are significant consequences.

I guess the point I'm getting at is the miscreant's need for punishment is conditional upon the action or deed, but the penalty can be magnified greatly depending on the consequences.

February 3, 2005 reply from Bob Jensen

Lay and Skilling probably are not guilty of designing the accounting deceptions and were probably not knowledgeable enough in accounting to color the books. However, they created the motives for Rick Causey and David Duncan to do so and did nothing to stop the deceptions given their fiduciary powers to do so.

Lay thought the hot air balloon could keep rising forever or at least until he was elected President of the United States. Jeff Skilling was smart enough to know better and got out with his loot before the balloon popped.

I think the legal case is more about how acceptable is it to publish deceptive annual reports to run up the stock price if you knowingly allow, or worse motivate, the accounting system to cheat. Here's where the big payoffs can be found --- http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales  All the executives and Board members benefited from stock sales in a market impacted in Enron's favor by deceptive accounting and an Andersen auditor (David Duncan) who when along with the deceptions in order to not lose his client --- http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm 

Is it acceptable for you to tell an employee that the company cannot take a downturn in eps, so go find a way to keep it going up, up and away in a beautiful balloon? "Just don't tell me how you carried out the deception."

Not one single executive at Enron had any respect whatsoever for accounting rules and reporting fairness. To them it was all a game of skating on the edge as far as one could go and then enlisting David Duncan's aid (usually through his friend Rick Causey) to skate a bit further into actual rules violations.

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

Bob Jensen


Actually the guy you have to admire the most in all of this is Lou Pai. He looted millions from Enron to buy an entire Colorado mountain and neither the SEC nor media reporters ever fishing for him for Lou Pai.

"Crimes of Others Wrecked Enron, Ex-Chief Says," by Kurt Eichenwald, The New York Times, June 27, 2004 --- http://www.nytimes.com/2004/06/27/business/27ENRO.final.html  

As Mr. Lay describes it, the Enron collapse was the outgrowth of the wrong-headed and criminal acts of the company's finance organization, and specifically its chief financial officer, Andrew S. Fastow. He says that both he and the board were misled by Mr. Fastow about the activities and true nature of a series of off-the-books partnerships that played the decisive role in the company's collapse.

Yet, Mr. Lay still argues that some of the company's most controversial decisions — including some that set up financial conflicts of interest for Mr. Fastow that could well be unprecedented in corporate America — were made for good reasons, and can be seen as mistakes only in hindsight.

The interview was conducted in Mr. Lay's office in downtown Houston. There, a picture window frames the old Enron skyscraper across town, a sight he said he rarely contemplates during his days working as a consultant for two start-up companies.

The years since the Enron collapse have transformed Mr. Lay. The changes in his financial status are stunning. At the beginning of 2001, Mr. Lay said, he had a net worth in excess of $400 million — almost all of it in Enron stock. Today, he says his worth is below $20 million, and his total available cash not earmarked for legal fees or repayment of debt is less than $1 million.

But the changes amount to more than just money. A man once celebrated in business and political circles, today he is widely vilified as bearing significant responsibility for Enron's downfall, a debacle that cost thousands of employees their jobs, millions of investors their savings, and, for a time, forced a nation to question the capital markets system. He is often portrayed as a man who bailed out of his company as it was sinking, selling millions of shares even while telling investors and employees that he believed in the company's future.

It is a portrait, he insists, that disregards the realities of Enron's last months, a time in which he describes himself as first working hard to improve the company, then struggling desperately to keep it afloat.

A Reversal of Fortune

Now, according to witnesses who have testified before the grand jury and other people involved in the investigation, prosecutors are focusing almost exclusively on Mr. Lay's actions and statements in the months preceding bankruptcy, in an effort to determine if he deceived investors about the true state of Enron before its demise even as he was selling his own stock.

However, a review of Mr. Lay's financial and trading data shows that the facts are much murkier than is generally believed, with the stock sales being forced by lenders as he took numerous actions that are consistent with someone trying to minimize his sales.

To date, numerous executives who worked for or advised Enron have pleaded guilty to crimes or been charged with wrongdoing. Virtually the entire senior management has faced legal proceedings: its treasurer, chief financial officer, primary outside accountant, corporate secretary and even a division head have all pleaded guilty to crimes. Others, including Jeffrey K. Skilling, another former chief executive, and Richard A. Causey, the former chief accounting officer, have been charged with fraud.

Mr. Lay himself has remained under investigation that entire time, and - at what he said was his legal team's insistence - invoked his Fifth Amendment right against self-incrimination in testifying before Congress.

KENNETH LAY SURRENDERED to authorities in Houston to face indictment for his role in Enron's collapse. The energy giant's former CEO was charged with being part of a wide-ranging scheme to defraud investors. 
The Wall Street Journal, July 8, 2004, July 8, 2004 --- 
http://online.wsj.com/article/0,,SB108928566380358408,00.html?mod=home_whats_news_us
 

Enron Corp. founder and former chairman Kenneth Lay has surrendered to the FBI in Houston.

Mr. Lay, accompanied by a pastor, emerged from a sport-utility vehicle driven by his wife, Linda, and walked into Houston's FBI headquarters at dawn. "Nice of you all to show up this morning," Mr. Lay told a throng of reporters.

About 20 minutes later, his hands behind him in cuffs, Mr. Lay was placed in a sedan with authorities for the drive to Houston's federal courthouse. After arriving there, he was led into the building through a back door.

A grand jury returned a sealed indictment against Mr. Lay on Wednesday, two-and-a-half years into a methodical investigation that has produced charges against some of Mr. Lay's once most highly trusted lieutenants, including his hand-picked protege, former CEO Jeffrey Skilling.

Mr. Lay said he would have additional comments later in the day.

"I have done nothing wrong, and the indictment is not justified," Lay, 62 years old, said in a statement Wednesday after learning of the indictment. The indictment was to be unsealed after Mr. Lay's surrender.

Prosecutors from the Justice Department's Enron Task Force presented an indictment to U.S. Magistrate Judge Mary Milloy in Houston on Wednesday, and at their request she sealed both the indictment and an arrest warrant, sources told the Associated Press. The specific charges remained under seal.

A hearing before Judge Milloy was scheduled for 12:30 a.m. EDT Thursday. Mr. Lay's lawyer, Michael Ramsey, didn't immediately return calls for comment.

The Securities and Exchange Commission also was expected to bring civil fraud charges against Mr. Lay on Thursday, including making false and misleading statements and insider trading, a person familiar with the case said.

Prosecutors have aggressively pursued the onetime celebrity chief executive and friend and contributor to President Bush who led Enron's rise to No. 7 in the Fortune 500 and resigned within weeks of its stunning failure. Mr. Lay is the 30th and highest-profile individual charged.

Mr. Skilling succeeded Mr. Lay as CEO in February 2001 and resigned abruptly six months later, just weeks before the scandal broke. He was indicted in February on nearly three dozen counts of fraud and other crimes.

Waiting to testify for the prosecution is former finance chief Andrew Fastow, who pleaded guilty to two conspiracy counts in January. Mr. Fastow admitted to orchestrating partnerships and financial schemes to hide Enron debt and inflate profits while pocketing millions of dollars for himself.

Enron's collapse led a series of corporate scandals that led to passage of sweeping reforms to securities laws with the Sarbanes-Oxley Act two years ago. Thousands of Enron's workers lost their jobs, and the stock fell from a high of $90 in August 2000 to just pennies, wiping out many workers' retirement savings.

The charges against Mr. Skilling and former top accountant Richard Causey, who was initially indicted a week after Mr. Fastow pleaded guilty, target actions over several years leading up to Enron's collapse. But allegations against Mr. Lay were expected to focus on his actions after he resumed the role of chief executive upon Mr. Skilling's abrupt resignation in August 2001, the sources said.

Days after Mr. Skilling's resignation, Mr. Lay met privately with Sherron Watkins, then an executive on Mr. Fastow's staff, who had sent him a lengthy memo warning of impending doom from Mr. Fastow's myriad schemes to hide debt and inflate profits.

But Mr. Lay told The New York Times last month that he didn't believe the company had serious problems and trusted other senior managers -- including Messrs. Fastow and Causey -- when they reassured him that all was fine.

Messrs. Skilling and Causey are awaiting trial on charges of conspiracy, fraud and insider trading. Both pleaded innocent and are free on bond.

The criminal indictment is expected to be unsealed Thursday morning. Additional civil charges related to alleged securities violations are expected to be filed as well.

Enron has become a symbol of the corporate excess of the Internet bubble, and the ensuing scandal helped bring down the former Arthur Andersen LLP, one of the world's largest accounting firms.

The indictments against Messrs. Skilling and Causey involve allegations that range from lying to the public about Enron's financial condition to manipulating Enron's financial statements to hide losses and create reported earnings.

If the indictment against Mr. Lay is equally broad, he could face many years in prison and multimillion-dollar penalties, if convicted. Both Mr. Skilling and Mr. Causey were expected to go to trial sometime in the first half of next year. Adding Mr. Lay to that mix could delay the proceedings.

Since Enron's downfall, Mr. Lay has steadfastly maintained that he did nothing illegal during his years at the company's helm, and his defense will probably argue that while other executives designed the complex financial deals that undid the company, he had no knowledge of the behind-the-scenes machinations.

The indictment is likely to include a raft of charges, especially after instructions issued last week by Deputy Attorney General James Comey urging prosecutors to obtain charges that include various factors that traditionally have been considered by judges in sentencing, but not presented to juries. Such factors could include the size of investor losses in white-collar crimes. The deputy attorney general's directive followed a recent Supreme Court ruling involving state sentencing guidelines stating that judges can't act alone to increase prison sentences based on facts that juries never consider or that defendants don't plead to. Some legal experts say the high court ruling could apply to the federal system as well.

The Securities and Exchange Commission also is expected to file civil charges against Mr. Lay, accusing him of various securities-law violations, including financial fraud and insider-trading stemming from stock-related transactions he engaged in months before Enron's bankruptcy filing. In past indictments against Enron executives, the SEC has also filed separate civil charges.

Continued in the article


"The Case Against Ken Lay Enron's former chief claims he was out of the loop. How prosecutors aim to show otherwise" by Julie Rawe, Time Magazine, July 19, 2004 --- http://www.time.com/time/magazine/article/0,9171,1101040719-662791,00.html 

Oct. 23, 2001, stands out as a particularly bad day for Ken Lay. As word circulated that the energy giant he founded was under investigation for balance-sheet shenanigans, the CEO tried to pull Enron's stock out of a tailspin by arranging a special conference call with analysts. "We're not trying to conceal anything," he told them. "I'm disclosing everything we've found." After Lay got off the phone, he gathered Enron's thousands of employees via a live webcast and video teleconference, and tried to reassure them too. "Our liquidity is fine," he said of the company that was about to flame out in one of the biggest accounting scandals in history. "As a matter of fact, it's better than fine. It's strong."

Those comments came back to haunt Lay last week in an 11-count indictment accusing him of conspiring to cook Enron's books even as he touted its tainted stock. For starters, prosecutors claim that Lay failed to mention to analysts several massive problems he knew about, including some $7 billion in hidden debts. And he neglected to tell employees that the company's liquidity hinged on an emergency billion-dollar loan Enron had just obtained by offering its precious pipelines as collateral. But one egregious comment Lay made that fateful October day could end up as his salvation. During the conference call with analysts, he professed the "highest faith and confidence" in the company's chief financial officer, Andrew Fastow, who the next day suddenly took what became a permanent leave of absence. Nearly three years later, Lay claims he was unaware of Fastow's misdeeds, a defense strategy casting Lay as the world's most clueless CEO, sincerely waving his pom-poms as his team got crushed.

Government prosecutors are patting one another on the back for finally hooking the biggest fish in an investigation into what U.S. Deputy Attorney General James Comey described last week as Enron's "spectacular fall from grace." Lay, 62, was the public face of the once stodgy pipeline firm that morphed into the seventh biggest U.S. company by trading natural gas and megawatts of power. A minister's son with a Ph.D. in economics, Lay was spared being charged with approving Enron's now famous off-the-books partnerships that hid so much debt for so long. And unlike the two former colleagues he will be tried with — Enron's onetime CEO Jeffrey Skilling and chief accounting officer Richard Causey — Lay wasn't charged with insider trading by the Justice Department (although last week the Securities and Exchange Commission did so in a separate, $90 million suit in civil court, where the standard of proof is less stringent). Instead, the bulk of the charges against Lay allege that he helped keep the deceit alive after he resumed his role as CEO in August 2001, when Skilling abruptly resigned. The remaining charges deal with an obscure bank-fraud rule involving Lay's personal-loan applications. "I have to go home and look up something called a Reg U," Lay's attorney griped. "That's a stretch."

The case won't be easy to win. Lay's claim that he believed the company stock was a good buy is bolstered by the fact that he kept purchasing more and sold shares only when forced to by margin calls. Jurors' heads will be spinning from all the byzantine financial data. And, says Houston securities litigator Thomas Ajamie, "the complexity of this case will work in the defense's favor."

Even before the Enron accounting scandal started to unravel, many people were calling for Lay's head. His company was suspected of wrongdoing in early 2001, during the California energy crisis. Last month, following the release of tapes in which Enron traders gleefully spoke of ripping off Golden State grandmothers, California's attorney general sued the firm for violating the state's unfair-competition and commodities-fraud laws. After Enron collapsed, smashing the nest eggs of rank-and-file employees, political pressure to build the case against Lay intensified. One of George W. Bush's top contributors during the 2000 campaign, Lay was nicknamed "Kenny Boy" by the President. As the months went by with no indictment, Democrats in Washington grumbled that he was being insulated by the White House.


Ken Lay's Defense

December 20, 2005 message from December 20, 2005

Bob,

You may have seen this already, but Ken Lay of Enron fame gave a speech last week in Houston. The title is Guilty Until Proven Innocent and in it he makes the case for why CFO Andy Fastow should be blamed for the Enron fraud and not Ken Lay. Lay , Jeff Skilling and Richard Causey of Enron are scheduled to go on trial next month. A copy of Lay's speech is available on his personal website - http://www.kenlayinfo.com/public/CYOFQ534244233.aspx 

Denny

Houston Forum December 13th, 2005

Kenneth L. Lay Speech: “GUILTY, UNTIL PROVEN INNOCENT”

Good Afternoon. I was pleased to receive the invitation to speak to the Houston Forum.

Of anything and everything that I could imagine might happen to me in my lifetime, the one thing I would have never even remotely speculated about was that some day I would become entangled in our country’s criminal justice system. Yet, that is exactly what has happened and I might add, has happened in a very extraordinary way.

I originally entitled my speech “Living in the Crosshairs of the U.S. Criminal Justice System”, which is where I believe I have been for the last four years. However, once indicted, on July 8, 2004, a more appropriate title is “Guilty, Until Proven Innocent”, which is where I believe I am today.

Contrary to popular belief today, I firmly believe that Enron was a great company. Although, like most companies, it was not without some problems, Enron was a strong, profitable, growing company even into the fourth quarter of 2001. Moreover, except for the illegal conduct of less than a handful of employees, I am convinced Enron would not have had to seek protection under the U.S. Bankruptcy Code in 2001 and would still be a great and growing company today.

Under a different corporate name, Enron was founded in 1930 to build and operate a large natural gas pipeline from West Texas to the upper Midwest. In 1985 that company purchased Houston Natural Gas, a company of which I was Chairman and CEO at the time. The new company became the largest natural gas company in the U.S. and a leader in the deregulation of wholesale natural gas and electricity markets in the U.S., as well as in many countries around the world.

By the late-1990’s, Enron’s wholesale business (involving the production, buying, selling, delivering, financing, hedging, and other services relating to natural gas, electricity, coal, and other commodities) became its largest, fastest growing and most profitable business. In the third-quarter of 2001, with the company’s sales and deliveries growing robustly, Enron’s physical volumes in its wholesale business—which had been a strong indicator of profitability for over ten years—were the energy equivalent of about one-fourth of all the oil consumed in the world—every day.

During the same quarter, Enron Online—the company’s worldwide internet trading platform—completed on average over 5,000 transactions per day, buying and selling over 1,800 separate products online that generated over $2.5 billion in business every day. Enron was clearly the market maker in natural gas worldwide and a market leader in many other energy commodities.

For the third-quarter 2001, Enron’s wholesale business generated $754 million of earnings (before interest and taxes), an increase of 35% from the previous year. This represented over 80% of Enron’s worldwide earnings. Even the Enron Task Force agrees that Enron’s wholesale business was highly profitable. Indeed, it maintains it was so profitable in the year 2000 that Enron attempted to hide some of the profits by inappropriately adding to reserves. The Enron Task Force is right about increasing reserves in 2000, but it is wrong about the reasons. It is this type of technical accounting detail that makes up a lot of the “criminal” charges in this case.

With Enron’s rapid growth, we were able to attract some of the smartest, most creative and hardest working employees in corporate America. Indeed, our major competitors for talent were companies such as General Electric, Goldman Sachs, McKinsey, JPMorgan Chase, as well as high tech companies in Silicon Valley and elsewhere. In 1999, Enron was selected as one of the 100 Best Companies to Work For in America by Fortune magazine and in 2001 we ranked 22nd on that list.

Enron recruited the best and brightest from our nation’s top universities. And, even though we relied heavily on our outside legal and accounting experts, Vinson Elkins and Arthur Anderson, we also recruited the best and brightest from local and national accounting, law, consulting, engineering, and other professional firms. I remain convinced that Enron was so successful for so many years because it had the best people, as continues to be demonstrated by the success of Enron alumni in business and industry around the world today.

In February 2001, I stepped down as CEO of Enron, having served in that position for over 15 years. I was confident that Enron was financially strong, highly profitable, growing rapidly, and had a “sustainable”—or as I referred to it, an “unassailable”—advantage over its competitors. Along with what was referred to as “old economy” assets (its extensive domestic and international pipelines, power plants, liquid plants) with Enron Online, the company had become one of the largest e-commerce or “new economy” companies in the world. (Indeed, Enron had become the Google for the energy business before most people even knew what Google was.) Enron had widened its already very substantial lead in the wholesale energy business, from being twice as big as its nearest competitors in the late 1990’s to being almost four times as big as these competitors by the second-half of 2001. In the trading/intermediation business, scale is critical because of market liquidity, market intelligence, and other competitive advantages.

Yet, in less than 10 months, on December 2, 2001, Enron would be forced to file for bankruptcy protection. This would result in thousands of employees being laid off, most of whom lived in Houston, loss of retirement benefits and savings for thousands more, substantial losses for shareholders, creditors, and suppliers, numerous other tremendous hardships and indeed, personal and business disasters.

Tragically, large numbers of employees saw their dreams evaporate—dreams about retirement, a child’s education, a new home, keeping one’s home, caring for parents, and so many other things. Having always put a high priority on valuing and honoring my employees over a 35-year business and government career, the negative effects of the bankruptcy and scandal that the Enron employees and retirees have had to endure is the most devastating and heartbreaking tragedy of my life, and will most assuredly continue to haunt me until my death.

With lightening speed, the events preceding the bankruptcy and the bankruptcy itself would not only become the biggest business story in America, but also the biggest overall story in America. Not surprisingly, this ignited strong interest in our nation’s capitol. Congressional hearings were announced almost before the ink on the bankruptcy papers was dry and, once started, continued for months. In the name of fact finding as to why Enron failed, Republicans and Democrats attempted to one-up each other with their vivid, memorable and very negative portrayals of Enron.

Most of what was and is still being said, heard or read, was and still is either grossly exaggerated, distorted, or just flat out false. But a time of political and public hysteria is not a ripe environment for truth. Those with a public voice were telling the stories they wanted to tell and the people were reading and hearing the stories that they wanted to hear—stories of powerful, greedy and soulless executives eager to trample on anyone and everyone to achieve their ruthless aims and immoral goals. Regrettably, Enron and its former employees have had no voice and no defender since late January 2002, in part because the “turnaround” specialists brought in to run Enron chose not to speak out or defend either Enron or its former employees.

Why did Enron have to file for bankruptcy protection? When our trial begins in January, we will be presenting in considerable detail, along with documentation and testimony, the chronology, events and causes that forced Enron to file for bankruptcy. Obviously, I am unable to do that here today.

Let me just summarize by saying that although a lot of events contributed to the decline in Enron’s stock price in 2001—including the bursting of what is now referred to as the stock market “bubble”, the California Energy Crisis, the meltdown of the global telecommunication and broadband business, India’s refusal to honor its contract or guarantees on a large Enron power plant and LNG facility in that country, and other things—the actual triggering event for Enron’s bankruptcy was the loss of confidence by the financial community and by Enron’s trading counter parties that began a collapse by early November 2001 that ultimately could not be arrested or reversed.

Media articles began in late October 2001, raising questions about Enron’s Chief Financial Officer, Andrew Fastow, his personal involvement in—and possible self-enrichment from—certain Enron financial transactions. In response to the mention of one transaction called “Chewco”, Enron’s internal accounting staff and Arthur Andersen discovered a mistake in the financial structure of this 1997 transaction that required Enron to take a $400 million income restatement and various other adjustments for the period 1997-2001. These and other adjustments, publicly announced on November 8, 2001, accelerated the drain on Enron’s liquidity—a real-time “run on the bank”—such that by the end of November, Enron had no alternative but to seek protection under the U.S. Bankruptcy Law. It is probably more than coincidental that the architects of the “Chewco” transaction were Andrew Fastow and Michael Kopper.

As a point of historical significance, a Citibank analysis completed in early November 2001, clearly demonstrates that Enron’s bankruptcy was caused by liquidity problems, not by solvency problems—the company’s on and off balance sheet assets exceeded its liabilities by billions of dollars.

In an April 2005 review of Kurt Eichenwald’s book “Conspiracy of Fools”, a former Wall Street analyst concluded that “…it does not seem a stretch to suggest that if someone [other than Andrew Fastow] had been CFO of Enron, the company would probably exist today. Fastow crossed the line… [allowing him]…to profit at the company’s expense. Ultimately, it was the crisis of confidence triggered by these transactions…that brought Enron down.”

This reviewer also concluded, “If nothing else, Skilling and Lay installed Fastow as CFO and trusted him—a catastrophic error in judgment (though not itself a crime).” I agree. We did trust Andy Fastow and sadly—tragically—that trust turned out to be fatally misplaced.

The amount of money that Fastow and Kopper have admitted they stole from Enron did not bring Enron down. As despicable and criminal as their deeds were, the amount they stole—tens of millions of dollars—given Enron’s size, was relatively small. It was the stench of possible misconduct by Fastow—the notion that Enron’s CFO might be involved in shady or even illegal activities that provoked the loss of confidence causing the run on the company’s treasury. Twenty-twenty hindsight pointed out the downside of becoming so big and so successful in the wholesale business. This business was dependent on trust—as is true of virtually all financial and trading/intermediation businesses in the world—and the actions of Andrew Fastow and his cohorts irreparably breached that trust. The result for Enron was catastrophic.

One of the early tragic consequences of Enron’s filing for bankruptcy was the ultimate annihilation of Arthur Andersen, at the time the largest accounting firm in the world and Enron’s auditors. In early 2002, Arthur Andersen told the Enron Task Force that they had discovered shredding of documents in their Houston office, which might be inappropriate. The Enron Task Force immediately launched an investigation. Despite repeated efforts by Arthur Andersen, as well as its newly formed and very distinguished board, chaired by former Federal Reserve Chairman Paul Volker, to negotiate a settlement that would allow the firm to survive, the Enron Task Force indicted Arthur Andersen in March 2002 and obtained a conviction three months later, resulting in an immediate death sentence for the firm.

Earlier this year, the U.S. Supreme Court in a unanimous decision, overturned that conviction. The late Chief Justice William Rehnquist, who wrote the opinion, concluded that the instructions to the jury that had been urged on the federal district court judge by Andrew Weissmann, lead attorney in the case and at that time Deputy Director of the Enron Task Force allowed the jury to find the firm guilty of criminal conduct, “…even if Arthur Andersen honestly and sincerely believed that its conduct was lawful…”, he added, “[the]…jury instructions…simply failed to convey the requisite consciousness of wrongdoing. Indeed, it is striking how little culpability the instructions required.”

Thus, Arthur Andersen was belatedly vindicated and just three weeks ago, the Enron Task Force advised the Fifth Circuit Court of Appeals, to which the Supreme Court had remanded the case, that it would not retry the case against Arthur Andersen. Additionally, the Enron Task Force allowed David Duncan, the head of the Arthur Andersen audit team for Enron, to withdraw his guilty plea agreement, but without any protection against further prosecution, which I’ll comment on later.

Despite these decisions, however, the death sentence given to an entire firm resulting from the Arthur Andersen indictment and conviction three and a half years ago cannot be reversed. One of the oldest, most respected and biggest accounting firms in the world was executed and, unlike Lazarus, cannot be brought back to life. Over 28,000 American jobs were destroyed, more than five times the number of jobs lost when Enron filed for bankruptcy, and cannot be recreated; retirement and savings were lost and cannot be restored. The “Big Five” accounting firms now became the “Big Four”, shrinking competition at the very time when there was increased demand for accounting services because of the Sarbanes/Oxley bill and other regulatory requirements.

The sordid history of this case and how it was handled clearly begs the question: Does the U.S. Justice Department or anyone else in our federal government feel any need to find out how and why this happened, and whether anyone should be held personally accountable or responsible? The Supreme Court decision very clearly concludes that Andrew Weissmann and the Enron Task Force persuaded the judge to issue instructions to the jury that as the opinion stated, “[so]…diluted the meaning of ‘corruptly’ that it covers innocent conduct [and thus] no longer was any type of dishonesty necessary to a finding of guilt.”

Our U.S. Justice Department makes no apologies for spending almost four years and by some estimates $100 million or more to investigate Enron, its executives and its outside advisors (such as Arthur Andersen). Shouldn’t the Justice Department feel at least some obligation to the American people to commit some time and money to determine how the Enron Task Force’s first indictment and first conviction caused such widespread devastation to so many, but yet was overturned by the highest court in our nation in a unanimous decision? The only response from the Justice Department following the Supreme Court’s decision overturning the Arthur Anderson conviction was a one sentence statement, “We remain convinced that even the most powerful corporations have the responsibility of adhering to the rule of law.”

This past summer, Enron Task Force Director and lead attorney in the Arthur Andersen case, Andrew Weissmann, left his post unexpectedly in the middle of the jury deliberations in the Enron Broadband trial, which resulted in 24 not-guilty verdicts and zero guilty verdicts. Indeed, thus far the Enron Task Force has been able to convict by trial exactly one former Enron employee, which was in the Nigerian Barge Trial. Andrew Weissmann’s sudden and unexpected departure occurred only months before his potentially career enhancing opportunity to try me along with Jeff Skilling and Rick Causey in what some have referred to as the biggest criminal business trial in U.S. history. Was it a coincidence that Andrew Weissmann’s decision to leave came only days after our defense team filed a motion in court claiming prosecutorial misconduct in our case?

In less than a year after Enron’s bankruptcy, Enron Task Force Director Leslie Caldwell was quoted as saying that she expected all indictments relating to Enron to be wrapped up by year-end 2002. We now know that instead of finishing the investigation after one year, it was just beginning. The original Enron grand jury completed a lengthy 18-month term, only to be extended another 18 months. Then, at the end of the second, extended term, a whole new grand jury was convened for yet another 18 months and is now over one-half way through that term. If asked, I am certain that the Enron Task Force would say they have taken so much time because the crimes at Enron are so complicated. However, I would say the Enron Task Force has taken so much time because it is complicated to find crimes where they do not exist.

The Enron Task Force investigation is largely a case about normal business activities typically engaged in on a daily basis by corporate officers of publicly held companies throughout the country. In virtually every other situation, if there were concerns that any of these business activities were not being done appropriately, these concerns would be addressed by a regulatory agency, like the SEC, or as a civil matter in the courts. However, in this case, the Enron Task Force is attempting to criminalize these very same business activities. In an article published in the National Law Journal, John Coffee, professor at Columbia Law School and director of its Center of Corporate Governance writes concerning my indictment, “to be sure, an intense political need to indict Lay may explain why prosecutors have pushed the envelope of securities and mail fraud theories to their limit. But, what happens once will predictably happen again.”

The Enron Task Force is alleging that whatever it was that happened at Enron was part of an “overarching conspiracy” among Jeff Skilling, Rick Causey and me—and about 100 other unindicted coconspirators. The advantages for the Enron Task Force of trying this case as a conspiracy case are substantial. First, by identifying 100 people (initially 114 people) as unindicted coconspirators, they are letting each one of those individuals know that they are literally only the stroke-of-a-pen away from being indicted—an enormous incentive for each of them to do everything possible to please the prosecutors and not be thrown into an expensive legal battle to defend themselves. This has caused virtually all of them to refuse to talk with our lawyers, and will almost certainly cause any of those that are subpoenaed by us to testify to assert their Fifth Amendment rights. In the Nigerian Barge Trial, there were over 20 unindicted coconspirators and none of them testified. I am sure the Enron Task Force concluded that the only thing better than 20 potential witnesses not testifying in the Barge Trial would be for about 100 potential witnesses not testifying in our trial.

Another benefit for the Task Force in a conspiracy case is that they are allowed to use “hearsay” evidence. In other words, the prosecutors don’t have to put a person under oath and on the stand to elicit their “testimony.” They can use other alleged coconspirators to say on the stand what they’ve heard another person say. This makes it virtually impossible for me or the codefendants to face our accusers—which I thought was a constitutional right—or for our defense lawyers to cross-examine or impeach the testimony of that person—who supposedly said certain incriminating things—because they are not required to be present at the trial.

So, who’s left to testify? The biggest and most critical group left to testify is the Enron Task Force cooperators, including those who have pled guilty. I personally doubt most of these individuals did anything criminal, but because they were running out of money to defend themselves or to live on, and were being threatened with being indicted, they decided they had no other good alternative but to agree to cooperate with the Enron Task Force. It is very clear to all the cooperators that the ultimate outcome for each of them is completely in the hands of the Enron Task Force.

The whole plea bargaining process allows—even encourages—blatant prosecutorial abuse. As Yale Professor John Langbein, a recognized expert on prosecutorial abuse has said, “Plea bargaining concentrates effective control of criminal procedure in the hands of a single officer…I cannot emphasize too strongly how dangerous this concentration of prosecutorial power can be.” The prosecutor becomes a human guillotine when given the power to charge an individual, act as judge and jury, as well as executioner if a “cooperating” witness does not assist the prosecutor as the prosecutor believes the “cooperating witness” should.

This brings me back to David Duncan, the Arthur Anderson partner responsible for the Enron account. The Enron Task Force allowed him to withdraw his plea agreement, but not in a way that would protect him from further prosecution by the Enron Task Force, nor was he put on the Enron Task Force’s list of 90 possible witnesses. Based on these two facts we believe that the Enron Task Force is intent on persuading him not to testify because they do not want him to reaffirm, as he did in the Arthur Anderson trial, that he was “willing to stand behind as having been done correctly” all of the accounting issues Arthur Andersen worked on at Enron during the four years he was the engagement partner, except for the three items in the November 2001 restatement, which I mentioned earlier.

Let me cut to the chase. In this trial—apparently unlike most criminal defense cases—defendants are trying to get the truth in and the prosecutors—the Enron Task Force—are trying to keep it out. The defense wants more Enron witnesses to testify, yet the Enron Task Force wants to keep Enron witnesses from testifying, except those they can control. The defense wants expert witnesses—accounting, finance, corporate governance experts—to testify, the Enron Task Force wants to keep expert witnesses out. The defense wants to get more documents and facts into the trial, and the Enron Task Force wants to keep documents and facts out of the trial.

Why do we want the truth in the case and why does the Enron Task Force want the truth out of the case? I’m sure they will argue judicial efficiency, or relevance. But, the main reason they want the truth out is because they know that is the only way they can win. I agree. This is totally contrary to what I naively thought was the role of the prosecutors. I have always thought it was their role to do everything they could to get the truth before the judge and jury. In this case, it is absolutely the opposite—they appear to be committed to keeping the truth out.

What am I charged with? Virtually from its creation in January 2002, the Enron Task Force designated specific individuals to primarily investigate me. As one very senior and highly respected former U.S. Prosecutor in Washington, D.C. observed at the time, instead of the normal practice of first determining whether a crime was committed and then determining who did it, the Enron Task Force seemed to be reversing the order by first identifying specific Enron executives as targets and then setting about to see if they could build a case to indict and convict them.

Despite this strategy, two separate Enron Task Force teams, each overseen by an experienced U.S. prosecutor and various FBI agents, spent over two years (January 2002 – February 2004) looking at everything related to me and my wife Linda (including our personal income tax returns, family foundation and philanthropic contributions, stock sales and bank loans, Linda’s 96-year old father’s bank accounts, our children (who were subpoenaed and testified before the grand jury on several occasions), and anything else the Enron Task Force thought they could use as a wedge to indict me. Apparently, these first two teams, despite exhaustive efforts, found no basis for indicting me. In my mind it was really quite simple. They did not find a crime because there was no crime.

Then in March 2004, Leslie Caldwell, the head of the Enron Task Force from its inception, stepped down and Andrew Weissmann replaced her. At about the same time, John Hueston, previously a U. S. Prosecutor with the Justice Department’s Los Angeles office was brought in apparently to lead a new “third” team to attempt to indict me. A little over four months later, this team did what the two previous teams either couldn’t do, or concluded wasn’t justified doing, and that was indict me and charge me with eleven criminal counts. If I am found guilty of these counts, I can be sentenced up to 175 years in prison.

Of the eleven criminal counts charged, seven relate to Enron, all of which the Enron Task Force say occurred between mid-September 2001 and mid-November, 2001, only weeks before Enron was forced to file for bankruptcy. One of these seven charges is a broad conspiracy charge which alleges that shortly after I stepped back in as CEO of Enron in mid-August 2001, (they say) I assumed the leadership of a conspiracy that had been ongoing for over two years, but which I was unaware of prior to resuming the CEO position on August 14, 2001. I also need to emphasize that none of these seven charges relate in any way to Andrew Fastow’s self confessed illegal financial transactions and none relate to anything that caused Enron’s bankruptcy.

As Kurt Eichenwald, author of “The Conspiracy of Fools”, shared with this same Houston Forum a few weeks ago, most of the seven charges against me could not even be brought in a civil case because they would be dismissed by the court before trial as being immaterial.

The remaining four charges in my indictment relate to personal banking charges, which are based on old arcane laws, initially enacted during the Great Depression. These four charges have nothing to do with Enron. Based on research by my legal team, in the 70-year history of these laws, we can find no record of these provisions ever being used against a bank customer, until they were used against me. Although the Enron Task Force maintains it makes no difference in this case, you should also know that every penny of principal and interest on the bank loans in question was fully repaid.

In concluding, I believe that some measure of rationality may be returning to the discussion of what happened to Enron. The problem is that it is always slower reversing a mania or hysteria than it is starting one. To paraphrase a 19th century Scottish writer, men think in herds, even go mad in herds, but return to sanity one by one. I believe the return to sanity has begun. Moreover, none other than one of the world’s most legendary leaders and observers of public lunacies, Winston Churchill said, again to paraphrase, truth is the great rock which may from time to time, be submerged by a wave but which remains nonetheless a rock.

Truth is the great rock. Whether it will continue to be submerged by a wave—a wave of terror by the Enron Task Force—will be determined by former Enron employees. It will only take a few brave individuals who are willing to stand up and say its time for the truth to come out. Either we proclaim the truth about Enron and its employees in this trial, or our friends, neighbors, potential employers, and others will continue to believe that Enron was a criminal enterprise—an enterprise that we are told by others was a “house of cards”—and its employees were criminals as well. If we don’t speak out, don’t testify to the truth, don’t let the light shine in, we will live the rest of our lives under this cloud—a cloud that covers all the good works and deeds that each of us accomplished.

Enron employees really have only two choices. Either we stand up now—and prove that Enron was a real company, a substantial company, an honest company, a company that had a vision and values, a company that changed industries and markets for the better, a company that we were all proud to work for, a company whose employees—with very few exceptions—worked hard to do the right thing each and every day they came to work, employees who cared about and gave their time and talents to make Houston a better place to live, employees who were good ambassadors as they touched lives in other cities and around the world—or we will leave this horrific legacy shaped by others for someone else to sort out. I for one do not wish to leave the responsibility for undertaking the difficult task of clearing Enron and my name to my children or my grandchildren, or those willing to dig through the rubble long after we are gone.

I will testify at my trial. I will do my very best to get the truth out. Other former Enron employees have information that I do not have. Others will be viewed more objective, more credible than I will be. We need other “Truth Sayers” to come and join in this fight. I can only do so much, but God is bigger and more powerful than any of us and with His help, I am prepared to stand and fight this battle, to never stop pursuing the truth about Enron and its employees for as long as it takes. We must create our own “wave of truth.”

Thank you and God bless you.

Ken Lay

"Lay Seeks Help From Former Enron Workers," SmartPros, December 15, 2005 --- http://accounting.smartpros.com/x50980.xml

Bob Jensen's Enron Quiz is at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm


Free Market Myths by Agency Theorists

The Enron fiasco is exceedingly complex as a test for regulation versus free market control of resource flows and pricing.  The recent video tape disclosures of Enron's energy market creators playing an extremely unfair game with energy buyers clearly shows how naive it is to expect that players in the market will play fair without sanctions and a tone at the top that will come crashing down on unfair players.  

The question is:  "What is the top?"  Clearly when the "top" has monopoly powers in unregulated markets (i.e., markets over which there are no serious and effective government watchdogs), the system easily rots to the core --- http://faculty.trinity.edu/rjensen/FraudRotten.htm 

Equally clear is that when industry controls the regulators in favor of suppliers, the system easily rots to the core.  We have countless examples of that in U.S. economic history.

Enron's executives were highly successful in removing government regulation of energy trading, largely due to the political clout of the all-powerful Senator Gramm whose wife Wendy eventually became a major player on Enron's Board of Directors before and after Enron declared bankruptcy.

Enron had done its homework in Washington. Help came largely from the husband-and-wife team of economists Senator Phil Gramm and his wife, Wendy. Before joining the Enron board, Wendy Gramm had exempted energy futures contracts from government oversight in 1992; her husband now pushed for the Commodity Futures Modernization Act in December 2000, which would deregulate energy trading. There was strong opposition to Phil Gramm's bill in the House, mainly from the President's Working Group on Financial Markets, who included Secretary of the Treasury Lawrence Summers; Alan Greenspan, the chairman of the Federal Reserve; and Arthur Levitt, chairman of the SEC. But Enron spent close to $2 million lobbying to combat that opposition, while Gramm kept the bill from floor debate in the waning days of the Clinton administration. He reintroduced it under a new name immediately after Bush assumed office and got his bill passed. Enron, in turn, got the opportunity to trade with abandon. No one needed to know--or could find out--how much power Enron owned and how or why the company moved it from place to place.
Power Failure: The Inside Story of the Collapse of Enron, by Mimi Swartz, Sherron Watkins, Page 227.  See "What was Enron getting for its political bribes?"

What world politics has a hard time doing is constructing free markets that are truly fair in preventing monopolist sellers or buyers from taking advantage of market and/or political power to rot the fairness of market pricing.  The following editorial by Jerry Taylor is arduously in line with the Chicago/Rochester/Virginia university agency defenses of free markets.  By this I mean that any breakdown of fairness in the market is always attributed to government rather than the the somewhat inevitable evolution of markets to migrate toward monopolist exploitation similar to how Rockefeller nearly destroyed energy markets early in the 20th Century.

What Taylor fails to spell out is how to truly prevent fairness rotting and monopolist exploitation in his hallowed "free markets."  The best defense we have is an aggressive media, but media defense is by definition limited to triggering controls to capture the horse after its out of the barn and the scoundrels have safely deposited their ill-gotten fortunes in secret off-shore bank accounts that "lay" in wait for the few months that the culprits spend in Club Fed.  Even the infamous scoundrel Andy Fastow is never going to survive on a minimum wage after emerging from his new Club.

"Lay Off," by Jerry Taylor, The Wall Street Journal, July 9, 2004, Page A10 --- http://online.wsj.com/article/0,,SB108932251139459024,00.html?mod=todays_us_opinion 

The grand jury indictment of former Enron CEO Ken Lay opens the final act of a political morality play that may well influence who sits in the Oval Office next January. For, in truth, the particulars of the indictment against Mr. Lay regarding the corporate governance at Enron are of little consequence compared to the particulars of the indictment against what Enron is believed to represent: unregulated markets run amuck and unrepentant corporate greed. While it's too early to say whether the indictment against Mr. Lay has merit, it's not too early to pass judgment on each of the two counts of the indictment against the economic policies of the last several years.

First, is Enron what happens when markets are unsupervised and regulators are asleep at the switch? No, Enron is what happens when politicians believe they can create robust, well-functioning markets out of whole cloth and efficiently manage competition via regulation.

California's restructured electricity market was, in fact, the furthest thing from a capitalist jungle imaginable. The government forced electric utilities to sell off most of their power plants and discouraged them from buying electricity outside of a complicated state-managed spot market. Furthermore, the electric utilities were forced to open their power lines to anyone who wanted to use them -- like Enron -- under tightly regulated terms and conditions.

The day-to-day management of the grid was likewise taken from the utilities and given to state regulators. While wholesale electricity prices were deregulated, retail prices remained tightly controlled -- a combustible combination. In sum, the state was more heavily involved in the restructured market than it was in the old system we all grew up with.

It shouldn't come as a surprise to learn that companies like Enron figured out how to game the system with colorfully named strategies such as "Death Star," "Get Shorty," "Fat Boy" and "Ricochet." All involved exploiting arbitrage opportunities offered by the fact that California's electricity market was actually four separate markets: 24 separate "day-ahead" markets (one for each hour of the day) overseen by the state managers of the spot market; a transmission congestion relief market mirroring the 24 day-ahead markets; a reserve market managed by the state grid operator; and a real-time market overseen by the same.

In a well-functioning market, the prices for day-ahead, reserve and real-time energy during each hour would be equal in all areas of the West, including California. But because of transmission congestion, price controls and the fact that each of those market auctions occurred at different times, uncertainty reigned and prices varied widely. Enron, as well as others, figured out all kinds of schemes -- most of which are perfectly legal -- to buy low and sell high within this Byzantine system.

Enron's strategies were more attractive than they otherwise might have been for two reasons. First, no matter how much they charged for power, retail prices were frozen by law and demand would thus not be affected. A market where price increases do not decrease demand is a dream walking for those selling electricity. Second, the highest-priced electricity accepted in the day-ahead market established the price for all electricity bought that hour. Because the state allowed a company's power offer to be broken down into many differentially priced increments, suppliers had an incentive to hold back some power for sale only at exorbitant prices. If the offers were rejected, fine -- the volumes of electricity typically offered at those very high prices weren't so great. If they did get their asking price for any of these small unit offers, however, it was as if everyone in that particular hourly market won the lottery.

Because Ken Lay did not eschew such strategies, most hold him out as the ultimate avatar of endemic corporate greed, the second count of the political indictment at issue. But corporate executives have a fiduciary duty to their stockholders to maximize profit. Moreover, consumers are better off in the long run when market actors exploit arbitrage opportunities because it assists in the efficient allocation of electricity assets across time and space.

Regardless, it is not clear whether Enron was either the largest or even the most aggressive firm involved in such arbitrage. It's worth noting that during the 2001-2002 crisis, Enron was charging less for electricity on average than were most of the municipally owned public utilities in the Pacific West.

No, if a charge of unconscionable greed is going to be leveled at Enron for its activities during the California electricity crisis, it ought to be leveled on two altogether different counts.

First, Enron was not a passive bystander when this bizarre market was imposed in the form of California Assembly Bill 1890. The company actively lobbied for and aggressively promoted the market structure it eventually exploited. While many well-meaning people embraced the reforms (the law, after all, passed the California legislature without a single vote in opposition and was widely embraced by academic economists and all parties to the new system), there's reason to believe that Enron at least sensed that this brave new world would provide ample profit opportunities given all its problematic imperfections.

Second, Enron apparently broke the law in pursuit of profit within the new system, but to what extent that occurred is unclear. The line between clever arbitrage and actions that violate the rules laid down for the California market is difficult to discern. Still, Enron misrepresented some of those transactions to state regulators and fraudulently reported others.

More serious is evidence found in recently released taped conversations between Enron traders suggesting that electricity was intentionally withheld from the California market to drive up wholesale prices. Now, one can make a reasonable argument that this shouldn't be against the law (if I own a power plant but can't decide when it runs and when it remains idle, who really owns the plant -- me or the government?), but the fact remains that doing so to jack up electricity prices was well understood at the time to be illegal.

Does all of this add up to a convincing indictment against the market? No. Even those economists like MIT's Paul Joskow who are most convinced that illegal market manipulation played a major role in the California meltdown continue to support the introduction of (better designed) markets to the electricity sector. Other economists are of the opinion that market design ought to be left to trial and error in the context of more complete deregulation rather than to some template drafted by experts who think they can know a priori how electricity markets could best be organized.

It's instructive to remember that the accounting shenanigans that eventually led to Enron's downfall and the indictment handed down this week were brought to light not by diligent regulators but by investors who smelled a rat. Enron survived as long as it did because those very same market forces that brought the company down were largely exiled from the California electricity market. Whether that particular narrative is as compelling as the alternative may well influence the course of politics for years to come.

Mr. Taylor is director of natural resource studies at the Cato Institute --- http://www.cato.org/ 


Rebecca Mark's Secret Recipes for Looting $100 million from corporations you manage

I accidentally stumbled on Julian Pye's Photo Diary --- http://www.photodiary.org/index.html 

At this point the diary contains 1741 entries, most of the earlier are done with Nikon Coolpixes (N950, N995, N4500), a Canon S110, and most of the later ones with a Canon D30 and a Canon 10D. The really old ones have been scanned in from older photos, mostly taken with my Nikon 801 SLR, even earlier ones with my dad's Canon F1 and my first own camera, a Minolta AF-1.... And I'll just add more and more as time goes along..... Please check back from time to time and also leave lots of comments if you want ;-)

Note the keywords at http://www.photodiary.org/keywords.html 

Actually I was looking for Websites on Enron's scandalous Rebecca Mark --- http://www.photodiary.org/ph_c_4837.shtml 

What eventually happened to Rhyolite and its past glory is similar to what happened to ENRON in 2001. Peter Cooper is now the administrator of the Houston based company which was headed by former Navy veteran Ken Lay, a swindler. Skilling made a killing. Remember Rebecca Mack.

 

Rebecca Mark's timely selling of her Enron shares yielded $82,536,737.  You can read 1997 good stuff about her in http://www.businessweek.com/1997/08/b351586.htm and 2002 bad stuff about her (with pictures) at http://www.apfn.org/enron/mark.htm 

Rebecca Mark-Jusbasche has held major leadership positions with one of the world's largest corporations.  She was chairman and CEO of Azurix from 1998 to 2000.  Prior to that time, she joined Enron Corp. in 1982, became executive vice president of Enron Power Corp. in 1986, chairman and CEO of Enron Development Corp. in 1991, chairman and CEO of Enron International in 1996 and vice chairman of Enron Corp. in 1998.  She was named to Fortune's "50 Most Powerful Women in American Business" in 1998 and 1999 and Independent Energy Executive of the Year in 1994.  She serves on a number of boards and is a member of the Young President's Organization.

She is a graduate of Baylor University and Harvard University.  She is married and has two children.
http://superwomancentral.com/panelists.htm

If Mark had taken a bitter pleasure in Skilling’s current woes—the congressional grilling, the mounting lawsuits, the inevitable criminal investigation—no one would have blamed her. And yet she was not altogether happy to be out of the game. Sure, she had sold her stock when it was still worth $56 million, and she still owns her ski house in Taos. Her battle with Skilling, however, had been a wild, exhilarating ride.
TIME TABLE AND THE REST OF THE STORY:
http://www.msnbc.com/news/718437.asp

Rebecca P. Mark-Jusbasche, now listed as a director, bagged nearly $80 million for her 1.4 million shares. Rebecca was just Rebecca P. Mark without the hyphenated flourish in 1995, though I shouldn't say "just" because she was also Enron's CEO at the time, busily trying to smooth huge wrinkles in the unraveling Dabhol power project outside Bombay. That deal, projected to run to $40 billion and said to be the biggest civilian deal ever written in India, hinged on a power purchase agreement between the Maharashtra State Electricity Board (MSEB) and Enron's Dabhol Power Corp. (a JV led with project manager Bechtel and generator supplier GE).

There had been a lot of foot-dragging on the Indian side and Becky was there to light a fire. A memorandum of understanding between Enron and the MSEB had been signed in June '92 – only two weeks, as it happened, before the World Bank said it couldn't back the project because it would make for hugely expensive electricity and didn't make sense.

According to the state chief minister's account given two years later, the phase-one $910 million 695 MW plant was to run on imported distillate oil till liquefied natural gas became available. By the time the phase-two $1.9 billion 1320 MW plant was to be commissioned, all electricity would be generated by burning LNG – a very sore point with World Bank and other critics, given the availability of much cheaper coal.

In the event, by December '93, the power purchase agreement was signed, but with an escape clause for MSEB to jump clear of the second, much bigger plant.

State and union governments in India came and went, and for every doubt that surfaced, two were assuaged long enough for Indian taxpayers to sink deeper into Enron's grip.

Soon they were bound up in agreements to go ahead with the second phase of the project -- which now promised electricity rates that would be twice those levied by Tata Power and other suppliers. Unusually for this kind of project, the state government, with Delhi acting as a back-up guarantor, backed not just project loans but actually guaranteed paying the monthly power bill forever -- all in U.S. dollars – in the event the electricity board, DPC's sole customer, defaulted.

"The deal with Enron involves payments guaranteed by MSEB, Govt. of Maharashtra and Govt. of India, which border on the ridiculous," noted altindia.net on its Enron Saga pages. "The Republic of India has staked all its assets (including those abroad, save diplomatic and military) as surety for the payments due to Enron."
http://www.asiawise.com/mainpage.asp?mainaction=50&articleid=2389 

From Pipe Dreams by Robert Bryce (NY:  Public Affairs, 2002, pp. 199-189)

It didn't work.  By the summer of 2000, Azurix's losses, once a torrent, were a geyser.  A few months earlier, an algae bloom in an AGOSBA water treatment plant had fouled the city of Buenos Aires's drinking water.  The entire city was in an uproar over the taste and smell of the tap water.  Revenues from Argentina, once a sporadic stream, were now a bare trickle.

The handwriting was on the wall.  And on August 25, 2000, Mark resigned as chairman and CEO of Azurix and gave up her seat on Enron's Board of Directors.  Her string of business failures has likely assured that she will never get another job in corporate America.  The woman who prefers clothes from Armani and Escada is all dressed up with nowhere to go.  Not that she needs to go anywhere, mind you.

Three months before she quit Azurix, she sold 104,240 Enron shares, a move that brought her total stock-sale proceeds to $82.5 million.  Counting all the salary, stock options, and no-payback loans that she got from Enron, Mark probably banked somewhere in the neighborhood of $100 million.  That's a truly staggering sum when you consider that her misguided deals in India, Argentina, and elsewhere cost investors at least $2 billion.

But those failures were in the past.  None of them mattered.  She was rich, gorgeous, and married again.  Her new husband was Michael Jusbasche, a rich Bolivian-born businessman.  The two were moving into her house in River Oaks and would continue supporting a few local causes.  The failure of Azurix was no longer a concern.  In early 2002, Mark told Vanity Fair that the company "wasn't a disaster.  We couldn't survive as a public company because we didn't have earnings sufficient to support the growth of the stock."

Oh.

So Azurix wasn't a disaster.  It just didn't have "earnings sufficient to support the growth of the stock."  That's a beautifully crafted phrase to describe a dog of a company that should never have gone public in the first place.  In the end, Mark's vision--the commoditization of water, water trading, yet more fawning profiles of her in the business press--landed with a stinging belly flop.  And Azurix, the company that was to "become a major global water company" lasted as a publicly traded entity for just twenty-one months.

The bath Enron took on Azurix would prove very costly.  Mark's debacle had been financed with--what else?--off-the-balance-sheet entities, so that Enron didn't have to reflect Azurix's debts on its balance sheet.  And those interlinked entities, called Marlin and Osprey, would play a pivotal role in drowning Enron.  There's no doubt the Azurix mess was poorly thought out, but Rebecca Mark and her team weren't really corrupt.  Misguided maybe.  They made some bad judgments and didn't pay attention to expenses.  Perhaps their idea was just ahead of its time.  But they never purposely misled investors or committed fraud.  That would not be the case at another overhyped Enron venture, Enron Broadband Services.


They do it because they can get away with it!  Even if they get caught they either live lavishly in a country that will not extradite them or they serve a few years in a country club called a prison.

"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

And how many attorneys are in this office to fight the nation's book cookers, insider traders, and other Wall Street thieves? Twenty-five--including three on loan from the SEC. The unit has a fraction of the paralegal and administrative help of even a small private law firm. Assistant U.S. Attorneys do their own copying, and in one recent sting it was Sandy--one of the unit's two secretaries--who did the records analysis that broke the case wide open. (Page 72)

----------------------------

Nevertheless, the last commission chairman, Arthur Levitt, did manage to shake the ground with the power he had. For the 1997-2000 period, for instance, attorneys at the agency's enforcement division brought civil actions against 2,989 respondents. That figure includes 487 individual cases of alleged insider trading, 365 for stock manipulation, 343 for violations of laws and rules related to financial disclosure, 196 for contempt of the regulatory agency, and another 94 for fraud against customers. In other words, enough bad stuff to go around. What would make them civil crimes, vs. actual handcuff-and-fingerprint ones? Evidence, says one SEC regional director. "In a civil case you need only a preponderance of evidence that there was an intent to defraud," she says. "In a criminal case you have to prove that intent beyond a reasonable doubt." (pp. 70-71)

----------------------------

The auditor in that case, you'll recall, was Arthur Andersen, which paid $110 million to settle a civil action. According to an SEC release in May, an Andersen partner authorized unqualified audit opinions even though "he was aware of many of the company's accounting improprieties and disclosure failures." The opinions were false and misleading. But nobody is going to jail.

At Waste Management, yet another Andersen client, income reported over six years was overstated by $1.4 billion. Andersen coughed up $220 million to shareholders to wipe its hands clean. The auditor, agreeing to the SEC's first antifraud injunction against a major firm in more than 20 years, also paid a $7 million fine to close the complaint. Three partners were assessed fines, ranging from $30,000 to $50,000, as well. (You guessed it. Not even home detention.) Concedes one former regulator familiar with the case: "Senior people at Andersen got off when we felt we had the goods." Andersen did not respond to a request for comment. (Page 63)


ENRON'S CAST OF CHARACTERS AND THEIR STOCK SALES*
Proving Once Again That White Collar Crime Pays 
http://faculty.trinity.edu/rjensen/FraudEnronCast.htm
 

Bob Jensen at Trinity University

Enron's Cast of Characters and Their Stock Sales

NAME POSITION AT ENRON

SHARES SOLD

GROSS PROCEEDS
J. Clifford Baxter Vice-Chairman 619,898 $34,734,854
Robert Belfer Member of Board of Directors 2,065,137 $111,941,200
Norman Blake Member of Board of Directors 21,200 $1,705,328
Rick Buy Chief Risk Officer 140,234 $10,656,595
Rick Causey Chief Accounting Officer 208,940 $13,386,896
Ronnie Chan Member of Board of Directors 8,000 $337,200
James Derrick General Counsel 230,660 $12,563,928
John Duncan Member of Board of Directors 35,000 $2,009,700
Andy Fastow Chief Financial Officer 687,445 $33,675,004
Joe Foy Member of Board of Directors 38,160 $1,639,590
Mark Frevert Chief Executive Office, Enron Europe 986,898 $54,831,220
Wendy Gramm Member of Board of Directors 10,328 $278,892
Kevin Hannon President, Enron Broadband Services Unknown Unknown
Ken Harrison Member of Board of Directors 1,011,436 $75,416,636
Joe Hirko CEO, Enron Communications 473,837 $35,168,721
Stan Horton CEO, Enron Transportation 830,444 $47,371,361
Robert Jaedicke Member of Board of Directors 13,360 $841,438
Steve Kean Executive Vice President, Chief of Staff 64,932 $5,166,414
Mark Koenig Executive Vice President 129,153 $9,110,466
Ken Lay Chairman, Enron Corp. 4,002,259 $184,494.426
Charles LeMaistre Member of Board of Directors 17,344 $841,768
Rebecca Mark Chief Executive Officer, Azurix 1,895,631 $82,536,737
Michael McConnell Executive Vice President 32,960 $2,506,311
Jeff McMahon Treasurer 39,630 $2,739,226
Cindy Olson Executive Vice President 83,183 $6,505,870
Lou Pai CEO, Enron Energy Services 3,912,205 $270,276,065
Ken Rice CEO, Enron Broadband Services 1,234,009 $76,825,145
Jeffrey Skilling Chief Executive Officer, Enron Corp. 1,307,678 $70,687,199
Joe Sutton Vice-Chairman 688,996 $42,231,283
Greg Whalley Chief Operating Officer, Enron Corp. Unknown Unknown
TOTALS 20,788,957 $1,190,479,472
*All listed sales occurred between October 19, 1998 and November 27, 2001. The number shown under
gross proceeds indicates the number of shares times the price of Enron stock on the day the shares were
sold. It does not reflect any costs the Enron officials incurred in exercising the sale of the stock. Therefore,
the net proceeds to the listed individuals is likely less than the amount shown.

SOURCES: Mark Newby, et al. vs. Enron Corp., et al., Securities and Exchange Commission filings,
Congressional testimony, Enron Corp. press releases.

 


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 of $6,367,500 per year for each of the ten 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 $17,445 per day plus all the accrued interest over the past 15 years.

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.


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

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

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

 

Question 1
Who owns 77,000 acres in Colorado and is the only person to own a 14,000 foot mountain? 
I wish he'd take a flying leap from it!
Who at Enron refused to commute from Sugarland on the outskirts of Houston to catch flights on Enron's corporate jets departing out of Houston's International Airport?  Instead that former Enron executive required that a corporate jet be dispatched for him to commute from Sugarland.  Mostly the longer flights out of Houston for this executive were to his vacation home.

Answer
See Page 264 of Pipe Dreams by Robert Bryce cited below.  
Pipe Dreams:  Greed, Ego, and the Death of Enron
by Robert Bryce (PublicAffairs, 2002).

One of the interesting outcomes is why top executives Rebecca Mark (stock sales of $8 million) and Lou Pai (stock sales of $270 million) escaped with fortunes and no legal repercussions like other top executives.  You can read about what they hauled home at http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales

I've commented about Rebecca Mark previously at http://faculty.trinity.edu/rjensen/FraudEnron.htm#RebeccaMark

Lou Pai seems to be the biggest winner of all the "fools" in the Conspiracy of Fools.  Why he escaped is largely a matter of what seemed like bad luck that turned into good luck.  Although married, Lou became addicted to strip tease clubs.  He ultimately became involved and impregnated one of the young entertainers.  His messy divorce settlement called for him to sell his Enron stock holdings when the stock price was very high and appeared to have a great future.  That looked like his bad luck.  However, he actually cashed in at near the high point for reasons other than clairvoyance regarding the pending collapse of share prices.  In other words he cashed in at a high.  That was his good luck, because he cashed in early for reasons other than inside information.

Lou Pai became so wealthy at Enron that he managed to purchase a Colorado ranch larger than the State of Rhode Island.  The ranch even has a mountain which he named Pai Mountain that was actually a bit higher than his pile of cash from Enron stock sales and other compensation from Enron.  To make matters worse, the operation that he actually managed while at Enron was a big money loser for the company.  Who says sin doesn't pay?

Question 2
Relative to the executive mentioned above, what woman was an even worse abuser of Enron's corporate jets?

Answer
See Page 262 of Pipe Dreams by Robert Bryce cited above.
Hint:  Her first name is Rebecca.


Sadly, one of my former professors and Dean of the Graduate School of Business Administration at Stanford University, Bob Jaedicke,  is one of those paying up (although I'm told that insurance companies will pay most of the $168 million).  Bob was both a former member of the Board of Directors and Chairman of Enron’s Audit Committee.

"Enron Directors Reach $168M Settlement," by Michael Liedtke,  FindLaw, January 7, 2004 --- http://news.corporate.findlaw.com/ap_stories/f/1310/1-7-2005/20050107180016_07.html 

Eighteen former directors of scandalized Enron Corp. have reached a $168 million settlement, including a $13 million payout out of some of their own pockets, with shareholders burned by the financial shenanigans that culminated in the company's stunning collapse.

The agreement announced late Friday requires 10 of the former Enron directors to contribute a combined $13 million from the profits that they reaped from selling company stock before Enron revealed it had been grossly exaggerating its sales and profits. The debacle foreshadowed a wave of accounting scandals that sparked an overhaul of the country's corporate governance practices.

The directors paying an unspecified amount of money are: Robert Belfer, Norman, Blake, Ronnie Chan, John Duncan, Joe Foy, Wendy Gramm, Robert Jaedicke, Charles LeMaistre, Rebecca Mark-Jubasche and Ken Harrison, according to attorneys involved in the case.

Other directors who aren't personally paying money but are nevertheless covered by the settlement are: Paulo Ferraz-Pererira, John Mendelsohn, Jerome Meyer, Frank Savage, John Urquhart, John Wakeham, Charls Walker and Herbert Winokur.

None of the directors are admitting any wrongdoing as part of the settlement, which still requires final court approval.

It represents the fourth major settlement negotiated by attorneys who filed a class action lawsuit on behalf of Enron's shareholders nearly three years ago. Including the latest settlement, the lawsuit so far has retrieved just under $500 million for shareholders in a debacle that helped spark a wave of new laws designed to improve corporate America's accounting practices.

Enron's financial meltdown wiped out tens of billions in shareholder wealth

Continued in the article

You can read more about how much the Directors and Officers made from Enron share sales at Enron's financial meltdown wiped out tens of billions in shareholder wealth at http://faculty.trinity.edu/rjensen/FraudEnron.htm#StockSales 

 

"Ex-Enron Directors Reach Settlement," by Rebecca Smith and Jonathan Weil, The Wall Street Journal, January 10, 2005, Page C3 --- http://online.wsj.com/article/0,,SB110514939934220521,00.html?mod=todays_us_money_and_investing 

Ten former Enron Corp. directors agreed to dig into their own pockets to pay $13 million of a $168 million settlement of litigation brought by shareholders whose investments were wiped out after the failed U.S. energy giant's 2001 bankruptcy filing.

Unveiled Friday, the settlement -- the burden of which falls largely on insurance companies -- follows one earlier in the week involving former Worldcom Inc. directors. Both accords resolve allegations that officials violated federal securities laws by permitting the release of public documents that contained material misstatements about company finances.

In Enron's case, 18 of 29 former directors named in a 2002 lawsuit agreed to settle civil claims against them, avoiding potentially larger judgments from a trial slated to begin in October 2006. On Wednesday, 10 former directors of telecommunications giant Worldcom agreed to pay $18 million of their own money as part of a total $54 million settlement.

Continued in the article

Probably the best explanation of what happened at Enron is in the testimony of Frank Partnoy --- http://faculty.trinity.edu/rjensen/fraudenron.htm#FrankPartnoyTestimony 


The Justice Racer Cannot Beat a Snail:  Andersen's David Duncan Finally Has Closure

"Andersen Figure Settles Charges: Former Head of Enron Team Barred From Some Professional Duties," by Kristen Hays, SmartPros, January 29, 2008 --- http://accounting.smartpros.com/x60631.xml 

The former head of one-time Big Five auditing firm Arthur Andersen's Enron accounting team has settled civil charges that he recklessly failed to recognize that the risky yet lucrative client cooked its books.

David Duncan, who testified against his former employer after Andersen cast him aside as a rogue accountant, didn't admit or deny wrongdoing in a settlement with the Securities and Exchange Commission announced Monday.

The SEC said in the settlement that he violated securities laws and barred him from ever practicing as an accountant in a role that involves signing a public company's financial statements, such as a chief accounting officer. But he could be a company director or another kind of officer and was not assessed any fines or otherwise sanctioned.

Three other former partners at the firm have been temporarily prohibited from acting as accountants before the SEC in separate settlements unveiled Monday.

Andersen crumbled amid the Enron scandal after the accounting firm was indicted, tried and found guilty -- a conviction that eventually was overturned on appeal.

The settlements came six years after Andersen came under fire for approving fudged financial statements while collecting tens of millions of dollars in fees from Enron each year.

Greg Faragasso, an assistant director of enforcement for the SEC, said Monday that the agency focused on wrongdoers at Enron first and moved on to gatekeepers accused of allowing fraud to thrive at the company.

"When auditors of public companies fail to do their jobs properly, investors can get hurt, as happened quite dramatically in the Enron matter," he said.

Barry Flynn, Duncan's longtime lawyer, said his client has made "every effort" to cooperate with authorities and take responsibility for his role as Andersen's head Enron auditor.

That included pleading guilty to obstruction of justice in April 2002, testifying against his former employer and waiting for years to be sentenced until he withdrew his plea with no opposition from prosecutors.

"After six years of government investigations and assertions, surrounding his and Andersen's activities, it was decided that it was time to get these matters behind him," Flynn said.

Duncan, 48, has worked as a consultant in recent years.

He was a chief target in the early days of the government's Enron investigation as head of a team of 100 auditors who oversaw Enron's books. In the fall of 2001, he and his staff shredded and destroyed tons of Enron-related paper and electronic audit documents as the SEC began asking questions about Enron's finances.

Andersen fired Duncan in January 2002, saying he led "an expedited effort to destroy documents" after learning that the SEC had asked Enron for information about financial accounting and reporting.

The firm also disciplined several other partners, including the three at the center of the other settlements announced Monday. They are Thomas Bauer, 54, who oversaw the books of Enron's trading franchise; Michael Odom, 65, former practice director of the Gulf region for Andersen; and Michael Lowther, 51, the former partner in charge of Andersen's energy audit division.

Their settlement agreements said that they weren't skeptical enough of risky Enron transactions that skirted accounting rules. Odom and Lowther were barred from accounting before the SEC for two years, and Bauer for three years. None was fined.

Their lawyer, Jim Farrell, declined to comment Monday.

Duncan's firing and the other disciplinary moves were part of Andersen's failed effort to avoid prosecution. But the firm was indicted on charges of obstruction of justice in March 2002, and Duncan later pleaded guilty to the same charge.

In Andersen's trial, Duncan recalled how he advised his staff to follow a little-known company policy that required retention of final audit documents and destruction of drafts and other extraneous paper.

That meeting came 11 days after Nancy Temple, a former in-house lawyer for Andersen, had sent an e-mail to Odom advising that "it would be helpful" that the staff be reminded of the policy.

Duncan testified that he didn't believe their actions were illegal at the time, but after months of meetings with investigators, he decided he had committed a crime.

Bauer and Temple invoked their 5th Amendment rights not to testify in the Andersen trial. However, Bauer testified against former Enron Chairman Ken Lay and CEO Jeff Skilling in their 2006 fraud and conspiracy trial.

Andersen insisted that the document destruction took place as required by policy and wasn't criminal, but the firm was convicted in June 2002.

Three years later the U.S. Supreme Court unanimously overturned the conviction because U.S. District Judge Melinda Harmon in Houston gave jurors an instruction that allowed them to convict without having to find that the firm had criminal intent.

That ruling paved the way for Duncan -- the only individual at Andersen charged with a crime -- to withdraw his guilty plea in December 2005.

In his plea, he said he instructed his staff to comply with Andersen's document policy, knowing the destroyed documents would be unavailable to the SEC. But he didn't say he knew he was acting wrongfully.

I draw some conclusions about David Duncan (they're not pretty) at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm

My Enron timeline is at http://faculty.trinity.edu/rjensen/FraudEnron.htm#EnronTimeline

My thread on the Enron/Worldcom scandals are at http://faculty.trinity.edu/rjensen/FraudEnron.htm

 


Some of the most notorious white collar criminals in recent history (including Enron's worst)
See History of Fraud in America --- http://faculty.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm





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


For updates go to The Saga of Auditor Professionalism and Independence  


Hi Bill,

Andersen and the other firms "shifted their focus from prestige to profits --- and thereby transformed the firm. "

The same thing happened in Morgan Stanley and other investment banking firms. Like it or not, the quote below from Frank Partnoy (a Wall Street insider) seems to fit accounting, banking, and other firms near the close of the 20th Century.

From Page 15 of the most depressing book that I have ever read about the new wave of rogue professionals. Frank Partnoy in FIASCO: The Inside Story of a Wall Street Trader (New York: Penguin Putnam, 1997, ISBN 0 14 02 7879 6)

************************************************

This was not the Morgan Stanley of yore. In the 1920s, the white-shoe (in auditing that would be black-shoe) investment bank developed a reputation for gentility and was renowned for fresh flowers and fine furniture (recall that Arthur Andersen offices featured those magnificent wooden doors), an elegant partners' dining room, and conservative business practices. The firm's credo was "First class business in a first class way."

However, during the banking heyday of the 1980s, the firm faced intense competition from other banks and slipped from its number one spot. In response, Morgan Stanley's partners shifted their focus from prestige to profits --- and thereby transformed the firm. (Emphasis added) Morgan Stanley had swapped its fine heritage for slick sales-and-trading operation --- and made a lot more money.

************************************************

Bob Jensen 

-----Original Message----- 
From: William Mister [mailto:bmister@LAMAR.COLOSTATE.EDU]  
Sent: Tuesday, February 19, 2002 11:05 PM 
To: AECM@LISTSERV.LOYOLA.EDU 
Subject: Re: Andersen again

I refer you back to the Fortune article some years ago (old timers may remember it) that referred to then AA&Co as the "Marine Corp of the accounting Profession." In those days there were no "rogue partners." I wonder what changed? 

William G. (Bill) Mister 
William.Mister@colostate.edu 

 


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 

A survey of Canadian business executives shows immense support for auditing reforms. The reforms that scored highest were:

 

  • Making it illegal to have liabilities off the balance sheet.
  • Barring accountants from providing both auditing and consulting to the same client.

This response seems somewhat surprising in view of two other findings:

 

  • Few executives feel strongly that the accounting profession is responsible for high profile collapses, such as Enron and past meltdowns in Canada.
  • Most say they have a high level of confidence in the ethics of the accounting or auditing firm employed by their own organizations. The executives ranked the ethics of their own auditors a very high 6.0 out of a possible 7.

Some press accounts attribute the seemingly contradictory results to differences between big accounting firms and smaller ones. They point out that many survey respondents typically come from small to mid-sized companies not audited by large accounting firms.

When asked how much confidence they have in the ethics of the (presumably larger) firms auditing large publicly traded companies, the executives were decidedly less kind, ranking these firms only a 4.7 out of a possible 7.

 


A Research Study On Audit Independence Prior to the Enron Scandal

External Auditing Combined With Consulting and Other Assurance Services:  Audit Independence?

TITLE:  "Auditor Independence and Earnings Quality"R
AUTHORS:  
Richard M. Frankel MIT Sloan School of Business 50 Memorial Drive, E52.325g Cambridge, MA 02459-1261 (617) 253-7084 frankel@mit.edu 
Marilyn F. Johnson Michigan State University Eli Broad Graduate School of Management N270 Business College Complex East Lansing, MI 48824-1122 (517) 432-0152 john1614@msu.edu  
Karen K. Nelson Stanford University Graduate School of Business Stanford, CA 94305-5015 (650) 723-0106 knelson@gsb.stanford.edu  
DATE:  August 2001
LINK:  http://gobi.stanford.edu/ResearchPapers/Library/RP1696.pdf 

Stanford University Study Shows Consulting Does Affect Auditor Independence --- http://www.accountingweb.com/cgi-bin/item.cgi?id=54733 

Academics have found that the provision of consulting services to audit clients can have a serious effect on a firm's perceived independence.

And the new SEC rules designed to counter audit independence violations could increase the pressure to provide non-audit services to clients to an increasingly competitive market.

The study (pdf format), by the Stanford Graduate School of Business, showed that forecast earnings were more likely to be exceeded when the auditor was paid more for its consultancy services.

This suggests that earnings management was an important factor for audit firms that earn large consulting fees. And such firms worked at companies that would offer little surprise to the market, given that investors react negatively when the auditor also generates a high non-audit fee from its client.

The study used data collected from over 4,000 proxies filed between February 5, 2001 and June 15, 2001.

It concluded: "We find a significant negative market reaction to proxy statements filed by firms with the least independent auditors. Our evidence also indicates an inverse relation between auditor independence and earnings management.

"Firms with the least independent auditors are more likely to just meet or beat three earnings benchmarks – analysts' expectations, prior year earnings, and zero earnings – and to report large discretionary accruals. Taken together, our results suggest that the provision of non-audit services impairs independence and reduces the quality of earnings."

New SEC rules mean that auditors have to disclose their non-audit fees in reports. This could have an interesting effect, the study warned: "The disclosure of fee data could increase the competitiveness of the audit market by reducing the cost to firms of making price comparisons and negotiating fees.

"In addition, firms may reduce the purchase of non-audit services from their auditor to avoid the appearance of independence problems."

A Lancaster University study in February this year found that larger auditors are less likely to compromise their independence than smaller ones when providing non-audit services to their clients.

And our sister site, AccountingWEB-UK, reports that research by the Institute of Chartered Accountants in England & Wales (ICAEW) showed that, despite the prevalence of traditional standards of audit independence, the principal fear for an audit partner was the loss of the client. 


The choice of taking on or keeping a risky client may increase all clients' cost of capital.

Loss of Reputation is a Kiss of Death for One Public Accounting Firm:  An Empirical Study
Andersen Audits Increased Clients' Cost of Capital Relative to Clients of Other Auditing Firms

"The Demise of Arthur Andersen," by Clifford F. Thies, Ludwig Von Mises Institute, April 12, 2002 --- http://www.mises.org/fullstory.asp?control=932&FS=The+Demise+of+Arthur+Andersen

From Yahoo.com, Andrew and I downloaded the daily adjusted closing prices of the stocks of these companies (the adjustment taking into account splits and dividends). I then constructed portfolios based on an equal dollar investment in the stocks of each of the companies and tracked the performance of the two portfolios from August 1, 2001, to March 1, 2002. Indexes of the values of these portfolios are juxtaposed in Figure 1.

From August 1, 2001, to November 30, 2001, the values of the two portfolios are very highly correlated. In particular, the values of the two portfolios fell following the September 11 terrorist attack on our country and then quickly recovered. You would expect a very high correlation in the values of truly matched portfolios. Then, two deviations stand out.

In early December 2001, a wedge temporarily opened up between the values of the two portfolios. This followed the SEC subpoena. Then, in early February, a second and persistent wedge opened. This followed the news of the coming DOJ indictment. It appears that an Andersen signature (relative to a "Final Four" signature) costs a company 6 percent of its market capitalization. No wonder corporate clients--including several of the companies that were in the Andersen-audited portfolio Andrew and I constructed--are leaving Andersen.

Prior to the demise of Arthur Andersen, the Big 5 firms seemed to have a "lock" on reputation. It is possible that these firms may have felt free to trade on their names in search of additional sources of revenue. If that is what happened at Andersen, it was a big mistake. In a free market, nobody has a lock on anything. Every day that you don’t earn your reputation afresh by serving your customers well is a day you risk losing your reputation. And, in a service-oriented economy, losing your reputation is the kiss of death.


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 fraudulent and incompetent auditing are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits

Bob Jensen's threads on accounting and auditing theory 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

 


From the University of Southern Califonia

Study Finds Auditors Not Compromised Over Consulting --- http://www.marshall.usc.edu/Web/Press.cfm?doc_id=4084 

Researchers Mark L. DeFond and K.R. Subramanyam at USC's Leventhal School of Accounting (part of the Marshall School of Business), with K. Raghumandan at Texas A&M International University, find no association between consulting service fees and the auditor's propensity to issue a going concern opinion. Issuing a going concern opinion means that the auditor must be able to objectively evaluate firm performance and withstand client pressure to issue a clean opinion.

The SEC recently adopted new regulations requiring public companies to disclose all fees paid to their outside auditors. The SEC suspects that accounting firms are too dependent financially on their clients that purchase both auditing and consulting services to be objective, to maintain independence and to report possible conflicts of interests.

Contradicting the SEC's concerns, DeFond and Subramanyam and their co-author also demonstrate that higher audit fees (after controlling for consulting fees) actually encourage greater auditor independence. Firms are more likely to issue going concern opinions for clients paying higher audit fees.

The study analyzes 944 financially distressed firms with proxy statements that include audit fee disclosures for the year 2000, including 86 firms receiving first-time going concern audit reports. Examining the total fees charged, the researchers find that consulting fees have no effect on the incidence of going concern reports, and that higher audit fees actually increase the propensity of auditors to issue going concern reports, contrary to SEC suspicions.

The authors conjecture that the reputation and litigation damages associated with audit failure are greater for larger clients (for example such as Enron), encouraging auditors to be more conservative with respect to their larger clients.

"The loss of reputation and litigation costs provide strong incentives for auditors to maintain their independence," says DeFond. "Our study provides evidence that these incentives outweigh the economic dependency created by higher fees."

DeFond specializes in economics-based accounting and auditing research. He serves as the Joseph A. DeBell Professorship in Business Administration at USC's Leventhal School of Accounting, part of the Marshall School of Business, and is a CPA with six years' experience at a "Big Five" firm.

K.R. Subramanyam (SU-BRA-MAN-YAM) specializes in earnings management and valuation. His research on the effects of the SEC's fair disclosure rule earned him national attention in 2001.

Click here to Download PDF Report


Message from Amy Dunbar on February 7, 2002

Yesterday (February 6, 2002) both Baruch Lev and Roman Weil testified in front of the House Committee on Energy and Commerce. You can get more details at http://energycommerce.house.gov/107/hearings/02062002Hearing483/hearing.htm 

Dunbar comment: I like Weil's contrast of the tax code with FASB rules.

"You might now think about the parallels of the above with our tax collection system, where prin­ciples alone cannot suffice. The principle: tax income. The principle re­quires thousands of pages of tax code, regulations, and court decisions to implement. Can financial accounting be different? I think yes. The tax collector and the taxpayer play a zero-sum game-what one pays, the other gets. Financial accounting doesn't have that property and in addition has the auditor to interpret the rule book."

Sometimes I do think of tax as a "game," and the best player wins. And tax is a zero-sum game in another sense if we assume that the amount of revenue to be collected is fixed: what one group of taxpayers doesn't pay, another group will pay. Thus the concern with the so-called

Amy Dunbar [ADunbar@SBA.UCONN.EDU

 


A January 2002 Message from Elliot Kamlet [ekamlet@BINGHAMTON.EDU

XXXXX (a former SEC employee) is visiting Binghamton today and in a roundtable discussion I asked him about Representational Faithfulness. He responded that at the SEC, Mr. Pitt (the current boss who formerly represented the Big 5 firms at the SEC) repeatedly made the point that the SEC could only enforce the specifics of the rules that were in place. So much for Representational Faithfulness.

He also made the point that when the ISB discussed the need to regulate SPEs about 8-10 years ago, Andersen and the other firms fought tooth and nail and successfully stopped any such ruling. He felt the WSJ piece earlier this week from Andersen's CEO was the most disingenuous piece he had ever read. All the Big 5 firms have a consulting area specifically to advise clients on how to take advantage of SPEs.

Frankly his entire roundtable was both fascinating and discouraging. If I had to sum it up in one phrase, it's that Accounting is broken. This extends beyond the big 5 to the AICPA. He related how he questioned the ethics committee of the AICPA as to enforcement action they may have taken against any Big 5 partners who were caught violating rules. There was none. They do pursue the small practitioner but not the big one. He questioned the profit made by Barry Melahnson on the CPA2Biz portal and it's value to the profession. And forget about XYZ. He believes, as so many I've spoken to that it will lead to the end of CPA's. I'll add my voice to those who have urged all CPAs to vote it down.

Elliot Kamlet 
Binghamton University


A message from Gary Kleinman GKlei49593@cs.com on January 12, 2002

Dear Dr. Jensen,

You might be interested in a book on auditor independence that Dr. Dan Palmon of the Rutgers University Graduate School of Management (Newark, NJ) and I (Dr. Gary Kleinman) recently published. The book develops a comprehensive theoretical model of auditor-client relationships. To do so, it draws very heavily on theories originating in psychology, social psychology, sociology, organizational behavior, organization theory and related literature on inter-organizational relationships and regulation. It includes theory-based discussions of influences on the independence of the auditor that range from individual personality, role set membership influences, group membership issues, control systems within the organization, a model of audit firm and client firm relationships, and so on.

The specific title and publishing information is: G. Kleinman and D. Palmon (2001). Understanding Auditor-Client Relationships: A Multi-Faceted Analysis. Markus Weiner Publications, Inc. Princeton, NJ.

The imprint is the Rutgers Series in Accounting Research.

For your information, I have taken the liberty of attaching a Word file containing the preface (here labelled abstract) and the foreword to the book. The latter was written by Dr. Jesse Dillard. I hope you find it interesting.

Sincerely,

Dr. Gary Kleinman 
Fairleigh Dickinson University Teaneck, NJ

Follow-up Note From Bob Jensen

Readers might be interested in a paper that I discovered by searching the Internet using the search word Kleinman http://accounting.rutgers.edu/raw/aaa/2001annual/cpe/cpe4/38PublicCoverSight.pdf 

A link to the Kleinman and Palmon book discussed above --- http://oasis.orst.edu/record=b2169452 

I added this material to my history treads at http://faculty.trinity.edu/rjensen/history.htm


A Very Informative Message from Roger Debreceny [rogerd@NETBOX.COM

Some years ago (1997), the AICPA mounted a research program and a "White Paper" on Auditor Independence. The documents are available at http://www.aicpa.org/members/div/secps/isb/white.htm . The White Paper was entitled "Serving The Public Interest: A New Conceptual Framework For Auditor Independence". Sections of the White Paper show a delightfully refreshing view of the profession, given recent events. Section H, for example, is entitled "The Misplaced Regulatory Focus on the Performance of Non-Audit Services" and includes the sub-section, "Insurers Today Perceive No Independence Problem Associated with Non-Audit Services." Ah, were this only so :^) .

More seriously, the report notes:

"As explained in Section III, liability is no theoretical risk. In recent years, the costs associated with actual or threatened litigation have reached staggering levels for accounting firms. While often found to have no basis, aggregate legal claims against the six largest accounting firms (the "Big Six") exceeded $30 billion at the end of 1992."

In Appendix B "An Economic Analysis of Auditor Independence for a Multi-client, Multi-service Public Accounting Firm" authored by Rick Antle, Paul A. Griffin, David J. Teece and Oliver E. Williamson, the following data is reported:

"Auditors' liability is significant and provides incentives to maintain auditor independence.

Auditors' actual and potential losses from litigation play a large role in determining auditors' incentives. Losses from litigation contributed to the 1990 bankruptcy of Laventhol & Horwath, at one time the seventh largest accounting firm. In 1993, the six largest accounting firms (hereafter, the Big Six) incurred more than $1 billion in costs of judgments, settlements and legal defense. Although rarely alleged to be a cause of loss, auditor independence is an issue in litigation. Impairing independence at the level of the accounting firm would invite an avalanche of litigation."

Later in the sub-section:

"Accounting firms invest in their reputations, part of which is a reputation for independence. Honest clients want independent auditors. A crucial feature of the modern, multi-client accounting firm is that any threat to the firm's independence threatens its entire stream of audit revenues. These revenue streams are substantial. For example, the aggregate audit revenues of the Big Six in 1996 exceeded $6 billion."

I have seen no later data on the run-rate of liability costs, but this at least gives a flavour of the liability environment.

Roger



As promised, the Securities and Exchange Commission has revisited the issues that concern publicly held companies regarding Regulation Fair Disclosure, the ruling that requires publicly held companies to provide information that could influence the purchase of shares simultaneously to every potential investor. http://www.accountingweb.com/item/65824 


Forwarded by Dave Storhaug [storhaug@BTINET.NET

Following are excerpts of a couple of paragraphs from an editorial in the 12/11/01 WSJ, by Harvey Pitt, SEC Commissioner

"Even before the Enron situation, we were working to improve and modernize our disclosure system -- to make disclosures more meaningful, and intelligible, to average investors. Our immediate concern in the wake of this tragedy should be to understand how to prevent more events like this. Of course, those with intent and creativity can override any system of checks or restraints. Believing that we can create a foolproof system is both illusory and dangerous. But investors are entitled to the best regulatory system possible, and we can achieve more than we presently do if we focus attention on finding solutions instead of scapegoats.

Our current reporting and financial disclosure system has needed improvement and modernization for quite some time. Disclosures to investors are now required only quarterly or annually, and even then are issued long after the quarter or year has ended. This creates the potential for a financial "perfect storm." Information investors receive can be stale on arrival and mandated financial statements are often arcane and impenetrable."


Reply from Roger Collins [rcollins@CARIBOO.BC.CA

I came across the following interesting historical perspective to the current debacle; check out "Corporate Financial Reporting" by Robert Chatov. Chatov is a lawyer who did a PhD at Berkeley in the 70's. The book appears to be his PhD thesis - ISBN 0-02-905410-9. Mostly, its a critique of the way he thinks the SEC let the side down by devolving power to set standards to the profession in the 30's, 40's and 50's - but its got some facinating stuff in it. For example, the following quote:

"Accountancy has thus far accumulated little technique, for it is still in the process of steady development of fundamental principles....developed as a composite of the best and most enlightened business experience"

Source? Arthur Anderson - THE Arthur Anderson.* It seems as if this little bit of philosophy has had a long lasting influence on the way that AA go about their business.

Chatov comments; "Anderson's was a typical "business precedent" orintation that assured a constant flux in accounting practice, because accounting practices would change according to corporate interests. By that standard, of course, accounting "principles" were potentially infinite".

But wait - there's more...

"In the 1970 case of United States v Simon a certain Attorney A.A. Sommer, prior to his SEC appointment offered an evaluation of what had happened:

More disturbing to the accounting profession than the conviction itself was the language in which Judge Henry J. Friendly, surely one of the most knowledgeable judges in financial and accounting matters, wrapped the affirmance. He said in effect that the first law for accountants was not compliance with generally accepted accounting principles, but rather full and fair disclosure,fair presentation, and if the principles did not produce this brand of disclosure, accountants could not hide behind the principles but had to go beyond them and make whatever additional disclosures were necessary for full disclosure.In a word, "disclosure" was a concept separate from "generally accepted accounting principles" and the latter did not necessarily result in the former ( Sommer, 1970 in "The Business Lawyer 26 - November 207-214)."

This has some interesting implications for, among other things, the European community's Fourth Directive and associated legislation, and appears to justify the UK profession's battle for "fairness" as a provision within European accounting principles.

Another quote - direct from Chatov - which may cause fluttering in a few dovecotes...

"Another serious gap in accountant professionalism is the failure of academic accountants to gain sufficient operational influence within their field. For one thing, they have been too deferential.......The effects of accounting research as published in The Accounting Review had little effect on APB opinions.......The accounting scholar's higher authority exists mostly in the form of the administrative authority present within the SEC. But the commission lacks the independence of the courts because of its political vulnerability and the limitations inherent in combining the functions of accuser and judge.Under the circumstances academic accountants, who for the most part are outside of the practitioner-client-SEC system, must play a less significant role, unless specifically assigned one legislatively.

The academics, however, have more or less acquiesced in this lesser role.....They have permitted themselves to be used by the accounting practitioners and by the financial community by holding secondary or token positions on the APB and the FASB, knowing that the real decisions would be dictated by either the AICPA or the FEI......to the extent that promotions are contingent on the publication of abstract, mathematically based papers, there will be less likelihood of academic participation in the public policy oriented issues concerned with the determination of corporate financial reporting standards"

...I think I've made someone's weekend here....

There are lots of other quotes in this volume, most of which point to the aphorism

"Those who do not know history are condemned to repeat it"

For instance, how many on the list know of Paton's criticism of the AIA's "Statement on Accounting Principles"? Of the battles accompanying the present American Accounting Association's change of name from AAUIA to AAA? Of the struggles surrounding the foundation of the SEC ? Chatov discusses all of this and more.Ironically, there appear to be many lessons just waiting to be learned from the past. I'm not sure I agree with Chatov's conclusions, most of which suggest that it is the SEC which needs to get a grip on the situation by taking regulation into its own hands, but he certainly raises many interesting points for debate.

It might also be interesting to consider what use technology might be in resolving this issue - in particular, the opportunities for users of accounting information to obtain direct access to material held on internal corporate databases, and the kind of behaviour which that kind of activity that might provoke in terms of corporate response.

Roger

Roger Collins
Associate Professor UCC
School of Business,
Kamloops, CANADA

*From "Present-Day Problems Affecting the Presentation and Interpretation of Financial Statements" - JA 60 November 1935 330-334.


Reply from Robert B Walker [walkerrb@ACTRIX.CO.NZ

I have just read Bob's latest installment in the fascinating saga of Enron - a tale that Tom Wolfe or even Tolstoy would have had difficulty scripting.

From what I could see, Andersens are now suggesting that the inability of FASB to legislate for special purpose vehicles is to blame. Bob seems to intimate that he is troubled by the sanctimony that utterance may carry.

I think two points need to made in this regard.

First, the FASB canon becomes ever more legalisitic and complex. It is not possible to second guess the sophistry of lawyers and quasi-lawyers such as the tax practitioners and their ilk who populate all accounting practices. It must then be doubtful whether it is even worth bothering to try. The mere existence of the rule predisposes the unscrupulous to find a way to circumvent it to gain advantage.

Second, all an accountant or an auditor need do is consult principle. There is the doctrine of representational faithfulness, or as I prefer, of substance over form. The accountant, as truth teller, need only err on the side of caution and present a consolidated picture if that is what is economically true. The auditor should behave likewise. If the entity is not willing to do so because they have a legal opinion then the matter should be disclosed in the audit report.

This is a bit like the issue of materiality. The moment you question yourself as to whether something is material it is. The moment you seek a legal opinion it definitely is.


The Securities & Exchange Commission has launched a formal investigation into the recent collapse of energy giant Enron Corp. and has subpoenaed records from Big Five firm Andersen in relation to that investigation. SEC Chairman Harvey Pitt plans to follow a hard line when it comes to auditors who are responsible for problems with published financial statements. http://www.accountingweb.com/item/66986 


A message from Marie XXXXX

Mr. Jensen 

I am new to the AECM@LISTSERV.LOYOLA.EDU and would like to ask you a question. I am a new instructor of accounting and I am looking at a project to incorporate into my Accounting II class. I have used a stock project in the past. Do you have any suggestions on a project for a Introductory Accounting II class. Thank You for your time. 
Marie XXXXX

Reply from Bob Jensen

In light of the recent collapse of energy giant Enron, the corporation finance division of the Securities and Exchange Commission will review the annual reports of the nation's Fortune 500 companies in an attempt to seek out accounting red flags. http://www.accountingweb.com/item/67342 

It might be a great student project to create a laundry list of what red flags to look for and provide analyses of how to find such flags. 

Seriously Marie, you might have students begin with the list that is provided by Palepu, Healy, and Bernard in the paperback version of Business Analysis & Valuation (South-Western, ISBN 0-324-01565-8). Note especially the red flags listed in Chapter 3, beginning on page 3-11.

The above book has many strong points, but is extremely weak on the latest happenings with respect to derivatives accounting and risk analysis and new concerns in the area of accounting for intangibles. For updates on those two topics, go to the following sites:

Derivative Financial Instruments --- http://faculty.trinity.edu/rjensen/caseans/000index.htm 

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

Derivative financial instruments (including credit derivatives) were the main cannons that sank Enron.

Hope this helps

Bob Jensen


The University of California (UC), the nation's largest university system, has announced plans to join a class action suit against 29 senior executives of the failed Enron Corp. and Big Five accounting firm Andersen. The University claims it lost $145 million in Enron's collapse and seeks to be the lead plaintiff in the class action suit that is forming. http://www.accountingweb.com/item/67343 


"We're The Front Line For Shareholders,"  by Phil Livingston (President of Financial Executives International), January/February 2002 --- http://www.fei.org/magazine/articles/1-2-2002_president.cfm 

At FEI's recent financial reporting conference in New York, Paul Volcker gave the keynote address and declared that the accounting and auditing profession were in a "state of crisis." Earlier that morning, over breakfast, he lamented the daily bombardment of financial reporting failures in the press.

I agree with his assessment. The causes and contributing factors are numerous, but one thing is clear: We as financial executives need to do better, be stronger and take the lead in restoring the credibility of financial reporting and preserving the capital markets.

If you didn't already know it and believe it deeply, recent cases prove the value of a financial management team that is ethical, credible and clear in its communications. A loss of confidence in that team can be a fatal blow, not just to the individuals, but to the company or institution that entrusts its assets to their stewardship. I think the FEI Code of Ethical Conduct says it best, and it is worth reprinting the opening section here. The full code (signed by all FEI members) can be found here.

FEI's mission includes significant efforts to promote ethical conduct in the practice of financial management throughout the world. Senior financial officers hold an important and elevated role in corporate governance. While a member of the management team, they are uniquely capable and empowered to ensure that all stakeholders' interests are appropriately balanced, protected and preserved. This code provides principles which members are expected to adhere to and advocate. They embody rules regarding individual and peer responsibilities as well as responsibilities to employers, the public, and other stakeholders.

All members of FEI will:

  1. Act with honesty and integrity, avoiding actual or apparent conflicts of interest in personal and professional relationships.
  2. Provide constituents with information that is accurate, complete, objective and relevant.

So how did the profession reach the state Volcker describes as a crisis?

  • The market pressure for corporate performance has increased dramatically over the last 10 years. That pressure has produced better results for shareholders, but also a higher fatality rate as management teams pressed too hard at the margin.
  • The standard-setters floundered in the issue de jour quagmire, writing hugely complicated standards that were unintelligible and irrelevant to the bigger problems.
  • The SEC fiddled while the dot-com bubble burst. Deriding and undermining management teams and the auditors, the past administration made a joke of financial restatements.
  • We've had no vision for the future of financial reporting. Annual reports, 10Ks and 10Qs are obsolete. Bloomberg and Yahoo! Finance have replaced the horse-and-buggy vehicles with summary financial information linked to breaking news.
  • We've had no vision for the future of accounting. Today's mixed model is criticized one day for recognizing unrealized fair value contractual gains and alternatively for not recognizing the fair value of financial instruments.
  • The auditors dropped their required skeptical attitude and embraced business partnering philosophies. Adding value and justifying the audit fees became the mandate. Management teams and audit committees promoted this, too.
  • Audit committees have not kept up with the challenges of the assignment. True financial reporting experts are needed on these committees, not the general management expertise required by the stock exchange rules.

The problem clearly rests with all parties. But financial executives are the front line and by far the most responsible party for protecting and enhancing the shareholders' investment. We recognize it already. The auditors are nothing but a backstop - and one with a large and frayed mesh.

We have to do better on the front line, and we have to work closely with the new team in Washington to get off the old tracks and onto to a more positive and proactive path to a modern reporting and accounting model. This is not a 10-year project. It needs to happen quickly.


"Enron Employee Told Lay Last Summer Of Concerns About Accounting Practices," by Michael Schroeder and John Emshwiller, The Wall Street Journal, January 15, 2002 --- http://interactive.wsj.com/articles/SB1011043581125393520.htm 

A House committee asked Enron Corp. for information related to a newly discovered letter written by an Enron employee last summer warning the company's chairman about its accounting practices, which prompted an internal investigation.

That inquiry, conducted by Enron's outside law firm, Vinson & Elkins, "has the appearance of a whitewash," said House Energy and Commerce Committee spokesman Ken Johnson.

A committee investigator combing through 40 boxes of documents supplied by Enron found the letter over the weekend. The author, Sherron Watkins, an Enron Global Finance executive who wasn't identified further, questioned the propriety of accounting methods, writing: "I am incredibly nervous that we will implode in a wave of accounting scandals."

Enron, suffering from a crisis of confidence by investors, filed for Chapter 11 bankruptcy-court protection on Dec. 2, shielding it from creditors as it seeks to reorganize.

In concluding its review of the matters raised in the letter, Vinson & Elkins told Enron that "further widespread investigation by independent counsel and auditors" was unwarranted. But the firm warned that "bad cosmetics" involving the transactions and the decline of Enron's stock posed the "serious risk of adverse publicity and litigation."

The internal review was dated Oct. 15, 2001 -- one day before Enron announced its big third-quarter loss and a $1.2 billion reduction in shareholder equity because of losses later associated with various partnerships involving Enron officials.

Ms. Watkins's letter and the lawyers' conclusion were quoted Monday in a request for additional documents from the House committee to Enron Chairman Kenneth Lay; the firm's outside auditor, Arthur Andersen LLP; and Vinson & Elkins. The panel is seeking additional information about the letter and Enron's response to it.

Joe Householder, a spokesman for Vinson & Elkins, said the firm had received the committee's request for information, but that "we're not prepared to respond yet to the specific questions in the letter."

An Enron spokesman didn't return a call seeking comment. Ms. Watkins, who no longer works for Enron Global, couldn't be reached for comment.

Her letter to Mr. Lay questioned special-purpose entities that Enron used to help keep its debt off its books, the adequacy of public disclosure and the financial impact of the decline of Enron's stock.

The committee said the existence of the internal investigation suggests that "senior officials at Enron and Andersen were aware of the controversial financial transactions and accounting practices that would ultimately contribute significantly to Enron's demise."

Mr. Johnson said Vinson & Elkins "had one hand tied behind its back" by Enron officials as it began its review of Ms. Watkins's warnings. "As part of Vinson & Elkins's mandate for investigating the letter, they were told [by Enron officials] not to second guess Arthur Andersen and not to analyze specific transactions," he said.

Ms. Watkins wasn't the first Enron insider to raise concerns about partnerships related to Chief Financial Officer Andrew Fastow. Sometime before the end of 2000, then-Enron Treasurer Jeffrey McMahon went to company President Jeffrey Skilling and complained about potential conflicts of interest posed by partnerships operated by Mr. Fastow, which began in 1999 and early 2000. Mr. Fastow quit the partnerships last July.

Mr. Skilling didn't share Mr. McMahon's concerns, say people familiar with the matter. Mr. McMahon requested and received reassignment to another post. In October, Mr. McMahon was named as successor to Mr. Fastow as Enron's chief financial officer in the face of rising controversy over the partnerships.

Ms. Watkins's August 2001 letter came when what now appears to be the first major crack in Enron's facade appeared. Mr. Skilling, who had been given the chief-executive post earlier in the year, unexpectedly resigned on Aug. 14. He initially cited unspecified personal reasons.

But in an interview the next day, he said that his frustration over Enron's falling stock price played a major role in his decision to quit after only six months as chief executive. That remark has since raised questions about whether Mr. Skilling saw problems ahead for Enron because some of its partnership arrangements relied heavily on the use of Enron stock and their stability could be threatened by a falling price.

Separately, Andersen issued a statement providing more details about an e-mail sent by an in-house attorney that resulted in the destruction by Andersen employees of numerous Enron-related audit documents.

Mr. Odom forwarded the e-mail to David Duncan, the partner in charge of the Enron audit as a reminder of the firm's existing policy, Andersen said. The firm added that the e-mails "are not a representation that there were no inappropriate actions" and said it is continuing to investigate the matter.

Andersen's records-retention policy goes into great detail about what documents should be kept for what periods of time and when they should be disposed of. But the policy does note, "In cases of threatened litigation, no related information will be destroyed." At the time the e-mail was sent, no subpoenas had been issued, but Enron's problems were mounting and drawing the attention of attorneys representing shareholders.

 


Betting the Farm:  Where's the Crime?

The story is as old as history of mankind.  A farmer has two choices.  The first is to squeeze out a living by tilling the soil, praying for rain, and harvesting enough to raise a family at a modest rate of return on capital and labor.  The second is to go to the saloon and bet the farm on what seems to be a high odds poker hand such as a full house or four deuces.  

When CEO Ken Lay says that the imploding of Enron was due to an economic downturn and collapse of energy prices, he is telling it like it is.  He and his fellow executives Jeff Skilling and Andy Fastow did indeed begin to bet the farm six years ago on a relatively sure thing that energy prices would rise.  They weren't betting the farm (Enron) on a literal poker hand, but their speculations in derivative financial instruments were tantamount to betting on a full house or four deuces.  And as their annual bets went sour, they borrowed to cover their losses and bet the borrowed money in increasingly large-stake hands in derivative financial instruments.

Derivative financial instruments are two-edged swords.  When used conservatively,  they can be used to eliminate certain types of risk such as when a forward contract, futures contract, or swap is used to lock in a future price or interest rate such that there is no risk from future market volatility.  Derivatives can also be used to change risk such as when a bond having no cash flow risk and high value risk is hedged so that it has no value risk at the expense of creating cash flow risk.  But if there is no hedged item when a derivative is entered into, it becomes a speculation tantamount to betting the farm on a poker hand.  The only derivative that does not have virtually unlimited risk is a purchased option.  Contracts in forwards, futures, swaps (which is really a portfolio of forwards), and written options have unlimited risks unless they are hedges.

Probably the most enormous example of betting on derivatives is the imploding of a company called Long-Term Capital (LTC).  LTC was formed by two Nobel Prize winning economists (Merton and Scholes) and their exceptionally bright former doctoral students.  The ingenious arbitrage scheme of LTC was almost a sure thing, like betting on four deuces in a poker game having no wild cards.  But when holding four deuces, there is a miniscule probability that the hand will be a loser.  The one thing that could bring LTC's bet down was the collapse of Asian markets, that horrid outcome that eventually did transpire.  LTC was such a huge farm that its gambling losses would have imploded the entire world's securities marketing system, Wall Street included.  The world's leading securities firms put up billions to bail out LTC, not because they wanted to save LTC but because they wanted to save themselves.  You can read about LTC and the other famous derivative financial instruments scandals at http://faculty.trinity.edu/rjensen/fraud.htm#DerivativesFraud 

There is a tremendous (one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova video explaining why LTC collapsed.  Go to http://www.pbs.org/wgbh/nova/stockmarket/ 

Given Enron's belated restatement of reported high earnings since 1995 into huge reported losses, it appears that Enron was covering its losses with borrowed money that its executives  threw back into increasingly larger gambles that eventually put the entire farm (all of Enron) at risk.  As one reporter stated in a baseball metaphor, "Enron was swinging for the fences."

Whether or not top executives of a firm should be allowed to bet the farm is open to question.  Since Orange County declared bankruptcy after losing over $1 billion in derivatives speculations, most corporations have written policies that forbid executives from speculating in derivatives.  Enron's Board of Directors purportedly (according to Enron news releases) knew the farm was on the line in derivatives speculations and did not prevent Skilling, Fastow, and Lay from putting the entire firm in the pot.  

So where's the crime?  

The crime lies in deceiving employees, shareholders, and investors and hiding the relatively small probability of losing the farm by betting on what appeared to be a great hand.  The crime lies in Enron executives' siphoning millions from the bets into their pockets along the way while playing a high stakes game with money put up by creditors, investors, and employees.

The crime lies is accounting rules that allow deception and hiding of risk through such things as special purpose entities (SPEs) that allow management to keep debt off balance sheets, thereby concealing risk.  

In Enron's case, the gray zone of the crime lies in how responsible the victim is in putting the letters of risk into a sentence. Enron, Andersen, security analysts, and investment banks all claim claim that they followed the "letters" of GAAP and the law. But the letters were convoluted into alphabet soup that one can argue is intended to prevent the Board of Directors, the Audit Committee, employees, shareholders, and the public at large from putting the letters into that poker sentence:  "THE ENTIRE ENRON FARM IS ANTEED INTO THE POT!"

At least one analyst, David Tice, pieced the above sentence from the Year 2000 annual report of Enron and reported the risk of implosion in his newsletter. Another short seller, Jim Chanos, did the same thing and made a fortune short selling Enron's stock while at the same time warning other investors. However, most investors and employees listened more to the glowing forecasts of Enron's management who failed to spell out how they were betting 


What was Enron getting a return from its political bribes?

Update on April 14, 2003
Enron had done its homework in Washington. Help came largely from the husband-and-wife team of economists Senator Phil Gramm and his wife, Wendy. Before joining the Enron board, Wendy Gramm had exempted energy futures contracts from government oversight in 1992; her husband now pushed for the Commodity Futures Modernization Act in December 2000, which would deregulate energy trading. There was strong opposition to Phil Gramm's bill in the House, mainly from the President's Working Group on Financial Markets, who included Secretary of the Treasury Lawrence Summers; Alan Greenspan, the chairman of the Federal Reserve; and Arthur Levitt, chairman of the SEC. But Enron spent close to $2 million lobbying to combat that opposition, while Gramm kept the bill from floor debate in the waning days of the Clinton administration. He reintroduced it under a new name immediately after Bush assumed office and got his bill passed. Enron, in turn, got the opportunity to trade with abandon. No one needed to know--or could find out--how much power Enron owned and how or why the company moved it from place to place.
Power Failure: The Inside Story of the Collapse of Enron, by Mimi Swartz, Sherron Watkins, Page 227.

 

Steven Filling sent me a link to a video history of Enron.  The video is, in various ways, a good summary, although I was turned off by the political overtones aimed at President Bush.  The video seems to be politically motivated rather than education regarding the facts.

Energy deregulation took place in 1993, seven years prior to when the Bush/Cheney team took office in Year 2000.  This seems to be a key fact overlooked in the political rhetoric of the video

Energy deregulation was forced mainly under the influence of Phil and Wendy Gramm.   It is not at all clear that Bush or Cheney played a major role in any Enron happenings after taking office.  You can read a timeline at http://faculty.trinity.edu/rjensen/fraud.htm#bribes 

Keep in mind that energy deregulation is not necessarily a bad thing in and of itself.  It was a bad thing in the way Enron abused the deregulation with political influence and bribes.  By way of analogy, commercial airplanes are good things that were turned into weapons by terrorists.  Energy deregulation can be a good thing unless turned into a weapon by greedy investment bankers and traders.

I thank Steve for the video link. His message was as follows:

Bob -

Wasn't sure if this was included in your enron links.

http://minibytes.mondominishows.com/enron/main.asp 

cheers s.


January 3, 2003
Betting the Farm in a Rigged Game:  It's Worse Than I Speculated on January 10, 2002

About a year ago on January 10, 2002,  I speculated how Enron had "bet the farm" ---   http://faculty.trinity.edu/rjensen/fraud.htm#Farm 
It turns out that the now-indicted executives of Enron bet the farm, but the game was rigged in Enron's favor.  The rigged game was making millions, but the mountain of debt in SPEs ( http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm ) backed by Enron stock price eventually exposed the energy trading fraud when Enron's share prices plummeted near the end of Year 2001.  Now we are beginning to see how Enron and other utility companies took advantage of Wendy Gramm's political success in  deregulating energy trading on the NASCENT market.  For more about Wendy Gramm and energy trading deregulation, go to http://faculty.trinity.edu/rjensen/fraud.htm#bribes 

Now we are discovering how and why previously "staid utilities" became known players in a fraudulent trading game designed to bilk both investors and energy consumers (especially in California).

"How Energy Traders Turned Bonanza Into a Historic Bust," by Paul Beckett, Jathon Sapsford, and Alexei Barrionuevo, The Wall Street Journal, Page A1, December 31, 2002 --- http://online.wsj.com/article/0,,SB1041287245721136273,00.html?mod=todays%5Fus%5Fpageone%5Fhs 

Spurred by Deregulation, Industry Greed And Deceit Unraveled the Nascent Market 

How did it happen? Regulatory rollbacks and changes in accounting rules enticed some of the biggest names in the industry to remake themselves from staid utilities and pipeline operators into high-tech traders of contracts for electricity, natural gas and other fuels. Then, things got out of hand.

It's not that energy trading was necessarily a bad idea, says Peter Fusaro, an industry consultant in New York. The trading titans recklessly ruined it. "It became a big casino of making as much money as you could."

The companies looked for extra profits by taking advantage of customers. Trading became a means for fudging financial results. And a cozy core group of traders in Houston and elsewhere colluded on sham transactions aimed at fooling investors about the volume of activity in the new market. Eventually, the scam began to unravel. In the midst of an energy crisis in 2000, California officials accused avaricious traders of ripping off the state. Questions arose about concealed liabilities at Enron Corp. and dubious gas deals at Dynegy Inc.

Continued at  http://online.wsj.com/article/0,,SB1041287245721136273,00.html?mod=todays%5Fus%5Fpageone%5Fhs 


In the 1990s, Enron made fortunes from its political pipelines. Our beloved Texas Senator Phil Gramm became an Enron pimp (behind the scenes like most pimps).  His wife was more visible on the street.

The big political prize was the deregulation of energy pricing (gas and electricity) and deregulation of energy futures trading. There are places where political markers held by Enron were called in big time for billions of dollars.

You can read more about this timeline of energy futures trading events above at http://faculty.trinity.edu/rjensen/fraud.htm#Farm 

 

Two ticks on the timeline read as follows:

1992
Enron petitions the Commodities Futures Trading Commission to exempt futures contracts from government oversight.

 

1993
Proposed rule is quickly pushed through the commission, then chaired by Wendy Gramm, the wife of Sen. Phil Gramm. Wendy Gramm resigns shortly thereafter and is asked to serve on Enron's board of directors.

 

The following is quoted from http://www.commondreams.org/views02/0102-06.htm 

****************************************************

Wendy Gramm is also mentioned in a bank lawsuit alleging insider trading as having sold $276,912 in Enron stock in November 1998. Her response is that she sold the stock to avoid the appearance of a conflict of interest, given that her husband was chairman of the Senate Banking Committee.

Yet she was still very much on the Enron board and being rewarded with future stock options when her husband last year pushed through legislation that exempted key elements of Enron's energy business from oversight by the federal government. Phil Gramm had obtained $97,350 in political contributions from Enron over the years, so perhaps he was acting on his own instincts and not his wife's urgings. The exemption was passed over the objection of the Clinton administration.

Wendy Gramm also directs the regulatory studies program at George Mason University, which has received $50,000 from Enron since 1996. Her academic institute is highly influential in arguing for deregulation, conveniently joining her corporate and academic interests.

Unfortunately for true-believer deregulators, the Enron collapse shreds their panacea. Surely no one, least of all Wendy Gramm, who has said she was kept unaware of the company's chicanery in hiding debt and conducting secret private deals to the detriment of stockholders, could argue today with a straight face that Enron was in need of less government oversight.

The fact is that there would be no Enron as we know it were it not for Republican-engineered changes in government regulation that permitted Enron its meteoric growth.

It's true that the corporation had its allies among the Democrats; campaign finance corruption and influence peddling are generally a cover-all-your-bets bipartisan activity. But in this case, the amounts given to Democrats were puny and late, and there's no doubt that Enron rode to power primarily on the strength of Lay's influence with the Bush family. This fact is not mitigated by Enron now hiring Clinton's former lawyer and various top Democratic lobbying groups, except to note that these hired guns have no shame.

****************************************************

 

The following is quote about Clinton's Omnibus Appropriations Act is quoted from http://www.uaw.org/atissue/02/012202borosage.html 

****************************************************

After Clinton's 1992 victory, Enron pushed hard to exempt its energy futures contracts from regulatory oversight before the new Administration took office. The lame-duck chairwoman of Bush's Commodity Futures Trading Commission, Wendy Gramm, wife of Texas Republican Senator Phil Gramm, brought the exemption to a final vote on January 14, 1993, six days before Clinton took office. Enron, a leading contributor to Phil Gramm's campaign coffers, then named Wendy Gramm to its board of directors, where she pocketed about $1 million in payments and stock benefits over the next nine years. She served on the company's audit committee and helpfully turned a blind eye to the shady private partnerships Enron set up off the books to hide debt and mislead investors. In 2000, as the Supreme Court was naming Bush President, Senator Phil Gramm slipped a bill exempting energy trading from regulation into Clinton's omnibus appropriations act, avoiding hearings, floor debate and notice. Enron was all set to operate in the dark.

****************************************************

 

 

Also note the module that I added at http://faculty.trinity.edu/rjensen/fraud.htm#WarningSigns 
Included is the following 1995 quotation:

*************************************************

The deal, in which Enron beat out South Africa's state petroleum company Sasol, sparked controversy in Africa following reports that the Clinton administration, including the U.S. Agency for International Development, the U.S. Embassy and even National Security adviser Anthony Lake, lobbied Mozambique on behalf of Enron.

"There were outright threats to withhold development funds if we didn't sign, and sign soon," John Kachamila, Mozambique's natural resources minister, told the Houston Chronicle. Enron spokesperson Diane Bazelides declined to comment on the these allegations, but said that the U.S. government had been "helpful as it always is with American companies." Spokesperson Carol Hensley declined to respond to a hypothetical question about whether or not Enron would approve of U.S. government threats to cut off aid to a developing nation if the country did not sign an Enron deal.

Enron has been repeatedly criticized for relying on political clout rather than low bids to win contracts. Political heavyweights that Enron has engaged on its behalf include former U.S. Secretary of State James Baker, former U.S. Commerce Secretary Robert Mosbacher and retired General Thomas Kelly, U.S. chief of operations in the 1990 Gulf War. Enron's Board includes former Commodities Futures Trading Commission Chair Wendy Gramm (wife of presidential hopeful Senator Phil Gramm, R-Texas), former U.S. Deputy Treasury Secretary Charles Walker and John Wakeham, leader of the House of Lords and former U.K. Energy Secretary.

**********************************************


Phil Gramm's Dead Peasants

As many of us vividly recall, (then) Senator Phil Gramm and his wife Wendy (on Enron’s Board of Directors) were instrumental in building up the Enron scams --- http://faculty.trinity.edu/rjensen/fraud.htm#bribes 

Now former Senator Gramm has shifted to "dead peasants."

Doing the Texas Two Step --- http://irascibleprofessor.com/comments-01-26-04.htm 

As any regular reader of Molly Ivins knows, the great state of Texas is a top-notch incubator of crazy public policy schemes. According to an article in yesterday's Los Angeles Times by staff writer Scott Gould, the latest of these is a clever variation of the "dead peasant" scam that is being foisted on the Texas Teacher Retirement System by none other than former Texas senator Phil Gramm, who now works for the UBS Investment Bank of New York. Alert readers of The Irascible Professor might recall that Phil Gramm's wife Wendy Gramm, while Chair of the Commodity Futures Trading Commission, played a key role in pushing through key regulatory exemptions that allowed Enron to game the electricity trading market without government oversight. (At the same time Phil Gramm was collecting six-figure campaign contributions from Enron.)

For those of you who might not be familiar with Russian history, the "dead peasant" scam refers to the practice of buying the ownership rights to dead serfs then selling those rights before the buyer becomes aware of the fact that the serfs are dead. Under the variation of the scheme being promoted by Phil Gramm and Texas governor Rick Perry, the state of Texas would float a bond issue using Gramm's employer -- UBS Investment Bank -- as the underwriter. The proceeds from these bonds then would be used to buy annuities through UBS PaineWebber Inc. The annuities would be used to pay the premiums on life insurance policies that would be taken out on members of the Texas Teachers Retirement System. These life insurance policies would not provide any benefits to the members or their families. Instead, upon the death of an insured member, the proceeds from the life insurance policy would be used to retire the bonds, and if anything is left over it would go to the Texas Teachers Retirement System health fund. The fund currently faces a major long-term shortfall owing to a $30 million loss they suffered when Enron went into bankruptcy and the poor investment climate from 1999 to 2002, as well as to changes in the system put into place to help cover the deficit in the Texas state budget.

. . .

It doesn't take much imagination to realize that if the Perry-Gramm scheme is adopted, the Texas taxpayers will end up footing the bill not only to shore up the retirement system health plan, but also to pay millions of dollars in commissions and fees to UBS.

Continued in the article


"The TRTA Board of Directors is opposed to the insurance arbitrage plan proposed by former U.S. Senator Phil Gramm and currently being discussed by state officials. This opposition remains until further details are known and the Board is assured that funding from any such plan is a growing source of revenue for TRS-Care to keep premiums and other costs from being increased especially at times when retirees are not receiving annuity increases.”

Press Release form the Texas Retired Teachers Association, December 18, 2003 --- http://www.trta.org/proposal.html

Over the last couple of weeks, there have been articles in certain Texas newspapers about a proposal often referred to as “dead peasants.” Both the Dallas Morning News and the Houston Chronicle reported about this in stories published on December 5, 2003. (Links to these articles can be found on the TRTA links page). Other newspapers around the state have also begun to publish these stories. The Board of Directors of the Texas Retired Teachers Association (TRTA) wants you to know about this proposal and the position of the Association.

Attached is a summary from two meetings attended by TRTA representatives. You should read all of this information to get a basic understanding of the proposal. While commonly referred to in the stories as “dead peasants,” the correct term is “insurance arbitrage.” Arbitrage is defined as “the purchase of securities on one market for immediate resale on another in order to profit from a price discrepancy.”

The proceeds from the proposed arbitrage arrangement were intended to provide funding to TRS-Care. However, no one from either the governor’s office, the Texas Department of Insurance or the Teacher Retirement System of Texas could tell TRTA how much money, or over what period of time, it would flow to TRS-Care.

The TRTA Board of Directors discussed this issue at its December 17 meeting via conference call and adopted the following position:

“The TRTA Board of Directors is opposed to the insurance arbitrage plan proposed by former U.S. Senator Phil Gramm and currently being discussed by state officials. This opposition remains until further details are known and the Board is assured that funding from any such plan is a growing source of revenue for TRS-Care to keep premiums and other costs from being increased especially at times when retirees are not receiving annuity increases.”

The TRTA Board wanted you to know its stand on this sensitive proposal. Please feel free to contact me if you have any questions.

Sincerely,
Patricia Conradt
Executive Director TRTA


As you recall, the environment for fraud greatly increased with the deregulation of energy prices and the startup of energy derivatives that became an enormous source of profit and graft at Enron.  California paid a heavy price and has been lobbying for tougher regulation once again.

From Risk News on November 8, 2003

The US Senate voted down proposed legislation this week that sought to impose tighter controls on over-the-counter energy derivatives trading. Senators voted 56 to 41 against an amendment planned for inclusion in an agriculture spending bill proposed by Democrat senator for California Dianne Feinstein. It was the third time Feinstein had pushed for stricter federal regulation in the energy and commodity derivatives markets. All three efforts have failed. The International Swaps and Derivatives Association applauded the Senate's decision. “[The senators' actions] preserve the ability of American companies to use these valuable tools to manage risk, and thereby aid economic recovery," said Pickel.


Forwarded by Dick Haar on February 11, 2002

Senator Joseph Leiberman 
706 Hart Senate Office Building 
Washington, D.C. 20510

RE: Enron Investigation

Dear Senator Leiberman,

I watched your Sunday morning appearance on Face the Nation with intense interest. Inasmuch as I own a fair amount of Enron stock in my SEP/IRA, I'm sure you can understand my curiosity relative to your investigation.

Knowing you to be an honorable man, I feel secure that you will diligently pursue the below listed matters in an effort to determine what part, if any, these matters contributed to the collapse of Enron.

1. Government records reveal the awarding of seats to Enron executives and Ken Lay on four Energy Department trade missions and seven Commerce Department trade trips during the Clinton administration's eight years.

a. From January 13, 1995 through June 1996, Clinton Commerce Secretary Ron Brown and White House Counsel Mack McLarty assisted Ken Lay in closing a $3 billion dollar power plant deal with India. Four days before India gave final approval to the deal, Enron gave $100,000 to the DNC. Any quid pro quo?

b. Clinton National Security Advisor, Anthony Lake, threatened to withhold aid to Mozambique if it didn't approve an Enron pipeline project. Subsequent to Mr. Lake's threats, Mozambique approved the project, which resulted in a further $770 million dollar electric power contract with Enron. Perhaps, if NSA Advisor Lake had not been so busy strong-arming for Enron, he might have been focused on something obliquely related to national security like, say, Mr. Bin Laden? Could it be that a different, somewhat related, investigation is warranted?

c. In 1999, Clinton Energy Secretary Bill Richardson traveled to Nigeria and helped arrange a joint, varied, energy development program which resulted in $882 million in power contracts for Enron from Nigeria. Perhaps if Energy Scretary Richardson had been more focused on domestic energy, we might have avoided:

i. The severe loss of nuclear secrets to China and concurrently ii. developed more domestic sources of energy.

d. Subsequent to leaving Clinton White House employ, Enron hired Mack McLarty (White House Counsel), Betsy Moler (Deputy Energy Secretary) and Linda Robertson (Treasury Official). Even a person without a high school diploma (no disrespect to airline security screeners) can see that this looks like Enron paying off political favors with fat-cat corporate jobs, at the expense of stockholders and Enron pension employees.

e. Democratic Mayor Lee P. Brown of Houston (Enron headquarter city), received $250,000 just before Enron filed Chapter 11 bankruptcy. Isn't that an awful lot of money to throw away right before bankruptcy?

The Democratic National Committee was the recipient of hundreds of thousands of dollars from 1990 through 2000. The above matters appear to be very troubling and look like, smack of, reek of, political favors for campaign payoffs. I know you will find out.

2. Recently, former Clinton Treasury Secretary Robert Rubin called a top U. S. Treasury official, asking on Enron's behalf, for government help with credit agencies. As you well know, Rubin is the chairman of executive committee at Citigroup, which just coincidentally, is Enron's largest unsecured creditor at an estimated $3 billion dollars.

3. As you well know, Mr. Leiberman, Citigroup is Senator Tom Daschle's largest contributor ($50,000) in addition to being your single largest contributor ($112,546). This fact brings to mind some disturbing questions I feel you must answer.

a. Have you, any member of your staff, any Senate or House colleagues, any relatives or any friends of yours, been asked by Citigroup to intercede on their behalf, in an effort to recover part or all of Citigroup's $3 billion, at the expense of Enron's shareholders, employees and or Enron pensioners?

b. Did your largest contributor, Citigroup, have anything to do with the collapse of Enron?

c. Enron has tens of thousands of employees, stockholders and pensioners who have lost their life savings. How will you answer their most obvious question? Do you represent Citigroup, your largest contributor, or do you represent the Enron employees, et al, who stand to lose if Citigroup recovers any of its $3 billion?

During Sunday's Face the Nation, both you and Senator McCain praised Attorney General Ashcroft for recusing himself from the Justice Department investigation because he had once received a contribution from Enron. I know in my heart, that, being the honest gentleman you are, you will now recuse yourself because of the glaring conflict of interest described above. I also know that you will pass this letter to your successor for his or her attention.

Very truly yours,

Robert Theodore Knalur


Hi John,

There are some activists with a much longer and stronger record of lamenting the decline in professionalism in auditing and accounting. For some reason, they are not being quoted in the media at the moment, and that is a darn shame!

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 to save the profession from what it is now going through in the wake of the Enron scandal.

I suspect that the fear of activists (other than Briloff) is that complaining too loudly will lead to a government takeover of auditing. This in, my viewpoint, would be a disaster, because it does not take industry long to buy the regulators and turn the regulating agency into an industry cheerleader. The best way to keep the accounting firms honest is to forget the SEC and the AICPA and the rest of the establishment and directly make their mistakes, deceptions, frauds, breakdowns in quality controls expensive to the entire firms, and that is easier to do if the firms are in the private sector! We are seeing that now in the case of Andersen --- in the end it's the tort lawyers who clean up the town.

The problem with most activists against the private sector is that they've not got much to rely upon except appeals for government intervention. That's like asking pimps, whores, and Wendy Gramm to clean up town.

Bob Jensen

 


An Enron Timeline Featuring Events Surrounding the Purported Suicide of Enron Executive J. Clifford Baxter

The following message was forwarded by Patrick Charles

BACKGROUND ON BAXTER
Source: Reuters Printable version

Baxter was still on the company payroll as a consultant but had stepped down as an Enron vice chairman in May 2001, several months before the companys collapse.

He was also one of 29 former and current Enron executives and board members named as defendants in a federal lawsuit. Plaintiffs lawyers said the executives made $1.1 billion by selling Enron stock between October 1998 and November 2001.

It said Baxter had sold 577,436 shares for $35.2 million.

Baxter had reportedly feuded with then-Chief Executive Officer Jeffrey Skilling over the propriety of off-balance sheet transactions that hid billions in debt and ultimately triggered the once-mighty Houston companys spiral into the largest bankruptcy in U.S. history.

Cliff Baxter complained mightily to Skilling and all who would listen about the inappropriateness of our transactions, Enron whistle-blower Sherron Watkins wrote to Chairman and CEO Ken Lay, who resigned on Wednesday, in an Aug. 14 letter. Watkins identified Baxter in a section of her letter stating there is a veil of secrecy around LJM and Raptor, another entity involved in the partnerships.

Watkins letter to Lay stated that we will implode in a wave of accounting scandals unless the company halted practices that eventually sent it into bankruptcy.

Enron in October became the focus on an investigation by the U.S.

Securities and Exchange Commission over the off-balance sheet transactions.

Separate investigations were later taken up by various committees in Congress, and the Justice and Labor departments.

| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8

1986 Ken Lay is appointed chairman and chief executive after Enron is formed from the merger of natural gas pipeline companies Houston Natural Gas and InterNorth.

1996 Jeff Skilling becomes Enrons president and chief operating officer.

1997 Enron acquires electric utility holding company Portland General Corp. in a $2.1 billion stock swap.

1998 Enron buys Britains Wessex Water for $2.2 billion.

August 1999 Enron withdraws from oil and natural gas production with divestment of its remaining stake in subsidiary Enron Oil & Gas Co. which is renamed EOG Resources.

| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8

October 1999 Enron announces launch of EnronOnline, its Internet-based system for wholesale energy trading.

January 2000 Enron outlines ambitious plans to build a high-speed broadband telecommunications network and trade network capacity, or bandwidth, in the same way it trades electricity, or natural gas.

July 2000 Enron and Blockbuster announce 20-year deal to provide video-on-demand service to consumers over high-speed Internet lines.

August 2000 Enrons stock hits an all-time high of $90.56 December 2000 Azurix board agrees to a buyout by Enron at $8.375 per share after Azurix fails to meet performance targets and its stock price plummets.

| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8

Feb. 12, 2001 Skilling becomes president and chief executive officer of Enron.

March 9, 2001 Enron and Blockbuster cancel video-on-demand deal.

May 29, 2001 Maharashtra State Electricity Board, Dabhol power plants sole customer, stops buying power in a dispute with Enron over pricing.

Aug. 14, 2001 Skilling resigns as Enron president and chief executive officer, citing personal reasons. Ken Lay returns to position of chief executive officer.

Oct. 8, 2001 Enron agrees to sell Portland General to Northwest Natural Gas Co. for $1.8 billion.

| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8

Oct. 16, 2001 Enron reports its first quarterly loss in over four years after taking charges of $1 billion on poorly performing businesses. Enron also discloses a $1.2 billion charge against shareholders equity relating to dealings with partnerships run by chief financial officer Andrew Fastow.

Oct. 22, 2001 Enron says U.S. Securities and Exchange Commission is looking into transactions between Enron and the Fastow partnerships.

Oct. 24, 2001 Fastow is replaced as chief financial officer by Jeff McMahon, head of Enrons industrial markets unit.

Nov. 1, 2001 J.P. Morgan and Salomon Smith Barney agree to provide an additional $1 billion in secured credit.

Nov. 8, 2001 Enron says it overstated earnings dating back to 1997 by almost $600 million.

| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8

Nov. 9, 2001 Enron agrees to a deal in which smaller rival Dynegy Inc. will buy Enron for some $9 billion in stock. As part of the deal Chevron Texaco agrees to inject $1.5 billion in fresh capital immediately.

Nov.20, 2001 Enron discloses that a deterioration in its credit ratings could accelerate repayment of a $690 million loan. The company subsequently negotiates an extension of the loan.

Nov. 28, 2001 Major credit rating agencies downgrade Enrons bonds to junk status.

Dynegy terminates its agreement to buy Enron. Enron temporarily suspends all payments, other than those necessary to maintain core operations.

Dec. 2, 2001 Enron files for Chapter 11 bankruptcy and hits Dynegy with a $10 billion breach of contract lawsuit.

Dec. 3, 2001 Enron fires 4,000 employees the day after filing for bankruptcy. Dynegy countersues for control of Enrons Northern Natural Gas Pipeline.

| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8

Dec. 4, 2001 Enron secures $1.5 billion in emergency financing, provided by major creditors J.P. Morgan Chase and Citigroup, so it can run a skeleton operation.

Dec. 12, 2001 Congressional hearings begin on Enrons collapse, while the company announces plans to raise up to $6 billion by selling assets.

Dec. 13, 2001 Executives from accounting firm Andersen tell Congress they warned Enron about possible illegal acts after the energy trading giant failed to provide crucial data about it finances to Andersen.

Dec. 18, 2001 Tearful Enron employees and investors tell a congressional committee how they lost their life savings in the collapse. Enron Chief Executive Kenneth Lay scheduled to appear before the Senate Commerce Committee on Feb. 4.

Jan. 9, 2002 The Justice Department opens a criminal investigation of Enron.

| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8

Jan. 10, 2002 Enrons auditor Andersen admits its employees disposed of or deleted a number of documents relating to Enrons audit. President George W. Bush, who received major campaign contributions from Enron, orders government reviews of U.S. pension rules and corporate disclosure rules.

Jan. 14, 2002 Swiss financial giant UBS emerges as the winner to acquire Enron's North American energy-trading operation. UBS wont pay anything to acquire Enrons energy trading business, wont assume any of the troubled companys debts and will share a third of its profits with Enron and its creditors.

Jan. 15, 2002 Arthur Andersen LLP, the accounting firm that approved Enrons financial statements, fires the lead partner on the Enron account and takes disciplinary action against other employees who had worked with him. The New York Stock Exchange suspends trading in Enron and moves to delist the energy company's shares from the Big Board.

Jan. 16, 2002 The fired Arthur Andersen auditor responsible for the account of Enron cooperates with a congressional investigation. In addition, the Bush administration discloses that a White House official studied the economic impact of the potential collapse of Enron.

Jan. 17, 2002 Enron fires the Arthur Andersen accounting firm in the aftermath of the auditors massive destruction of documents.

| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8

Jan. 18, 2002 The top utility regulator for Texas tells Public Utility Commission staff he is resigning. Max Yzaguirre was an executive for Enron prior to his appointment on the Utility Commission. He led the agency in its move to deregulate the electricity market, an area of great interest to Enron.

Jan. 24, 2002 A fired Arthur Andersen auditor refuses to testify before a House panel about the shredding of Enron documents. Arthur Levitt, former SEC chairman, tells a Senate panel that the financial alchemy that turned Enron from Wall Street darling to disaster exists in many other companies.

Jan. 25, 2002 Former Enron Vice Chairman J. Clifford Baxter is found dead in his car in a Houston suburb. Texas police say the cause of death is suicide.

Source: Reuters Printable version

Baxter joined Enron in 1991 and was chairman and CEO of Enron North America prior to being named chief strategy officer for Enron Corp. in June 2000 and vice chairman in October 2000, according to the companys Web site.

In May 2001, he resigned from the company but stayed on as a consultant, according to a news release issued at the time, which said the main reason for his resignation was to spend more time with his family.

Baxter, a native of Amityville, N.Y., received a bachelors degree with honors from New York University and in 1987 got an MBA from Columbia University, where he was valedictorian, according to Enron.

Baxter was 43 and is survived by his wife and two children.


A message from Linda Kidwell on January 29, 2002

A 4th article in the series on Enron has been posted at http://www.AccountingMalpractice.com . What a great series this has been! This article addresses document shredding, collusion by Anderson, involvement by KPMG and PWC as secondary auditors, internal audit outsourcing, and excessive use of tax havens.

By the way, if you are visiting the CFE site, the web site does not mention the fact that there's a 45% discount on videos for professors.

Linda K.


The following message was received (by Dr. Cooley one month after I wrote the above module) from a Trinity University student who graduated last year and went to work for Enron.  It more or less confirmed what I surmised above.   The main difference between LTC (or LTCM) and Enron was the penchant of some gamblers to cheat.  Enron executives were willing to cheat.  Enron was willing to manipulate government puppets to get a better hand if the politicians or their spouses would sing for their supper.

I hope you are doing well. I just wanted to update you with my situation. As if you hadn't already guessed, my status with Enron was compromised with some 4000 others on December 5 after the bankruptcy filing. One good thing coming out of this mess, sitting on our trading floor really developed my interest in derivative theory. Consequently, I am now looking for a position with another trading group, probably with another energy "marketing" company. The only problem is that my potential references with Enron left with me! So, I was wondering if I could have your permission to list you as one of my references for future employment applications.

The SMF portfolio seems to be up nicely from its lows. However, the portfolio's ENE holding is a real eye sore at $200, down 99%! The class should consider taking it off of the yahoo portfolio, even if they're unable to sell it. For the next few months I'm personally expecting the market to be extremely choppy, to slightly positive at best. SMF will have to be very selective! Something I've had my eye on for a while as a potential value play is a company from the forest products industry, Georgia Pacific (GP).

Far from the sexy world of fiber optics and semiconductors, GP is anything but flashy. Its products, which are very boring but well known, include brand names such as Dixie (paper cups), Quilted Northern (toilet paper) and Brawny (paper towels). The stock is down over 50% from its all-time high and has been under fire because of asbestos law suits, a joint venture that fell through, lower commodity prices, and most recently a troubled credit rating. I believe these events have already been priced into the stock, but even the slightest consideration of a turnaround has not.

Forest Product companies are considered to be highly vertically integrated and extremely capital intensive. Their heavy balance sheets contribute to a poor ROA and their shares have historically underperformed the S&P. A simple solution these companies are now realizing is that they must inevitably restructure assets to become leaner and ultimately specialize in products they have a distinct competitive advantage in. GP has also realized this, and now has a fantastic opportunity with all of the bad news out there to divest assets, restructure debt, become more specialized and ultimately much leaner.

Although no news has been made publically, we should expect management to consider some sort of asset restructuring soon as more and more scrutiny mounts. The end result should be a stronger stock price. To top it off, insiders seem to be purchasing shares of GP. Nonetheless, I really believe this stock has a very Lynch-like appeal, and would certainly be an interesting candidate for further investigation.

Other than studying the market, I've had a chance to do some reading in my time off. I just finished "Soros on Soros" and "When Genius Failed, the Rise and Fall of LTCM." These two books were very good reads after Enron. It made me realize that the seeds of failure in business are planted when individuals believe they are infallible. I believe this runs much deeper than simple hubris or arrogance. While it certainly could be argued, I thought Soros came across as being extremely arrogant but was probably successful because he always thought he could be wrong, which prompted him to constantly test and retest his ideas. Buffett and Lynch seemed similar, although their demeanor not was nearly as presumptuous.

LTCM and Enron were slightly different. LTCM believed they couldn't fail because they were smarter than the rest of the world. Enron believed they couldn't fail simply because they thought they could trick everyone! Infallibility was enormous at Enron. I remember former CEO Jeff Skilling telling us that Enron would most likely be #1 or #2 on the 2001 Fortune 500. In fact, the division I worked with was so confident that, despite the hundreds of thousands of dollars we spent on marketing, we didn't even keep an expense budget!

Enron was a great experience. I learned a tremendous amount and am a bit sad that all of the great ideas the company was developing are now lost. However, the scandal is seems to be growing extremely serious and ever deeper. Fresh off the press is a scandal involving transactional fraud at JP Morgan with Enron and ( in separate news) a mysterious former Enron executive suicide. Despite all of the bizarre news, I think there is a lot to learn coming out of this scandal. I just wonder how the markets will react to the likely sweeping government regulation that may come out of this mess.

 

Again, I hope all is well with you and SMF. Good luck with everything this semester!

Signed
XXXXX

 


So who should pay?

I hesitate to answer that, but I really like the analysis in three articles by Mark Cheffers that Linda Kidwell pointed out to me.  These are outstanding assessments of the legal situation at this point in time.

I have greatly updated my threads on this, including an entire section on the history of derivatives fraud in the world. Go to http://faculty.trinity.edu/rjensen/fraud.htm 

Note especially the following link to Mark Cheffers' articles at  --- http://www.accountingmalpractice.com.

Lessons from the Enron Collapse Part I - Old line partners wanted ... http://www.accountingmalpractice.com/res/articles/enron-1.pdf

Part II - Why Andersen is so exposed ... http://www.accountingmalpractice.com/res/articles/enron-2.pdf

Part III - An independence dilemma http://www.accountingmalpractice.com/res/articles/enron-3.pdf

I added the above links to my professionalism threads at http://faculty.trinity.edu/rjensen/fraud.htm#Professionalism 

Bob Jensen's threads on derivative financial instruments are at http://faculty.trinity.edu/rjensen/caseans/000index.htm 

Should the deceivers go to prison?

I think those most responsible for the deception should be given the same alternative as they gave to many older employees at Enron.  They should be allowed to work full-time at minimum wage jobs until they become sixty five years of age.  Then they should be forced to live only on Social Security benefits until death.


On the same day that I wrote the "Betting the Farm" explanation of Enron's fall, a surprising number of accounting professors contacted me for permission to use the above module in their intermediate accounting courses.  For all non-commercial purposes, anybody in the world is welcome, without express permission, to distribute my Web documents by any means for educational and training purposes.

I also received requests to be more specific about the types of derivatives used by Enron.  It appears that futures contracts were the derivatives of choice in Enron, although mention is also made of credit derivatives.  A brief timeline is shown below from "Who Killed Enron," Newsweek Magazine, January 21, 2002, pp. 22-23 --- http://www.msnbc.com/news/686994.asp?0dm=-12NK 

1989
Enron begins trading natural-gas commodities

1992
Enron petitions the Commodities Futures Trading Commission to exempt futures contracts from government oversight.

1993
Proposed rule is quickly pushed through the commission, then chaired by Wendy Gramm, the wife of Sen. Phil Gramm.  Wendy Gramm resigns shortly thereafter and is asked to serve on Enron's board of directors.

1994
Enron starts trading electricity.  It will eventually become the largest marketer of electricity in the United States.

1999
Enron launches EnronOnline, its first global commodity-trading site on the Web --- http://www.enrononline.com/jsp/marketing/homepage/index.html 

2000
Congress approves Commodity Futures Modernizaiion Act, futher exempting energy-derivatives from trading regulations (but not, I might add from FAS 133 and FAS 138 accounting standards)

2001 (January)
The California energy crisis leads to price spikes and blackouts --- and big profits for energy suppliers like Enron.

2001 (June)
Federal regulators impose strict price controls over Western electricity market;  Enron's profits in that business shrink. 

2001 (August)
CEO Jeff Skilling, a major force in transforming the company into a global energy trader, resigns.

2001 (August 20)
Sherron S. Watkins, an executive at Enron and former employee of Andersen, blows the whistle claiming that Enron is an accounting hoax.  This whistle blowers letter was not revealed to the public until January 16, 2002.  It was addressed to top executives in Andersen and to Enron CEO Kenneth Lay.  

2001 (October 16)
Enron announces a third-quarter loss of $618 million.

2001 (October 31)
Enron announces that the SEC has launced a formal investigation into the company.

2001 (November 8)
Enron discloses that it has overstated earning by $586 million since 1997.

Comments by Bob Jensen
In the January 15 CSPAN television replay of the testimony before a Congressional hearing, C.E. Andrews, the Head of Auditing  for Andersen, repeatedly asserted how 20% of that restatement was due to an error by Andersen in failing to book one SPE and 80% was due to Enron's failure to disclose that another SPE called Chewco Investments did not have the requisite $383 million equity investment required for keeping Chewco's debt off Enron's balance sheet.  Andersen failed to discover that Enron had loaned $132 million to Chewco four years earlier and guaranteed a $240 loan to Chewco.  Andersen says that the cash flow of $132 million and the $240 million loan guarantee went undetected for four years in its audits.  I find this audit failure to be unbelievable, and it is one of the first things investigators should look into after Andersen's managing partner on the Enron Audit was fired for ordering the destruction of audit records.

In December 8 testimony before a Senate Committee, Mr. Andrews (the Head of Auditing for Andersen) repeatedly stated the following --- http://www.c-span.org/enron/scomm_1218.asp#open 

On the larger of these, which was responsible for 80 percent of the SPE related restatement it appears that important information was not revealed to our team. We and the board's special committee are looking into why. As required by section 10(a) we have notified the audit committee of possible illegal acts within the company. We have not concluded that any illegal acts occurred.

What every commentator then asked was why Andersen sat back and waited for a voluntary disclosure by Enron of its Chewco double dealings that, after four years, resulted in disclosing a loss of 80% of $586 million.  When I was an auditor with what was then a Big Eight accounting firm, we communicated with outside parties regarding something as major as this and did not rely solely upon management's disclosures to us.  What Andersen claims happened is just unbelievable.

2001 (December 2)
Enron files for Chapter 11 bankruptcy protection.

2001 (January 9)
Justice Department announces it has begun a criminal investigation.


Bob Jensen's Tutorials on Derivative Financial Instruments

Accounting educators using my "Bet the Farm" module above, may also want to hand out photocopies of the following definitions from http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm 

Derivative Financial Instrument --- http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#DerivativeFinancialInstrument 

Futures Contract --- 
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#FuturesContract
 

The Chicago Board of Trade (CBOT) has a particularly gook "Knowledge Center" on derivatives trading, especially in futures contracts --- http://www.cbot.com/ 

 There is a special CBOT center for Academics at http://www.cbot.com/cbot/www/page/0,1398,14+61,00.html 
(although there is no help for learning FAS 133, FAS 138, and IAS 39 at that center.)

I have two cases on FAS 133 accounting for futures contracts:

MarginWHEW Bank Case (interest rate profit hedging with 30 Eurodollar futures contracts)
http://faculty.trinity.edu/rjensen/caseans/285case.htm
The Excel spreadsheet is at http://faculty.trinity.edu/rjensen/caseans/xls/285wp/285wp.xls 
This case builds on a CBOT tutorial on futures contracting and adds my implementation of FAS 133 on the basis CBOT illustration.)

Margin OOPS Bank Case (interest rate profit hedging with 75 Eurodollar futures contracts)
http://faculty.trinity.edu/rjensen/caseans/285case.htm
You can access the MarginOOPS Bank Case with buttons at the bottom of the screen.
The Excel spreadsheet is at http://faculty.trinity.edu/rjensen/caseans/xls/286wp/286wp.xls 

Although both forward and futures contracts have unbounded financial risk, futures contracts are uniquely risky due to the daily cash clearances of futures contract positions.  This means that holders of such contracts must stockpile cash and be ready to shovel more cash into margin calls of outstanding futures contracts.

Energy companies are particularly hostile about FAS 133.  You might note the particularly hostile message from Sanford Menashe at the Bonneville Power administration.   It is near the bottom of the document at  http://www.cs.trinity.edu/~rjensen/000overview/mp3/133intro.htm 

Follow-up messages from Sanford Menashe are reproduced at http://www.cs.trinity.edu/~rjensen/000overview/mp3/138intro.htm 


-----Original Message----- 
From: glan@UWINDSOR.CA [mailto:glan@UWINDSOR.CA]  
Sent: Wednesday, January 16, 2002 10:06 AM 
To: AECM@LISTSERV.LOYOLA.EDU Subject: Re: Betting the Farm: Where's the Crime?

On 15 Jan 2002, at 8:20, Jensen, Robert wrote:

 The crime is not in speculating with derivatives as long as there is > no explicit corporate policy preventing such speculation.  The crime lies in the deception of how much is at stake in the > speculation, including (as in the case of Orange county) the deceptive > acts of derivatives dealers when writing incomprehensible contracts > intended to deceive an investor (like the Treasurer of Orange County)  about the risk involved. 

Hi Bob, 
Thanks for your reply. I do still have a few questions and issues which I am raising for clarification purposes and hope that you or someone else on the list may help with. 1. The deceptive acts of derivative dealers-- I thought futures contracts are for standardised amounts and traded on organized exchanges like the CBOT and forward contracts are more formal and involved parties like the banks, which will be unlikely to engage in deceptive acts. Also while the controller of Orange County could have been fooled as the dangers of speculating with derivatives were not as evident as they are now, I find it very difficult to believe that the board of directors of Enron was not aware of the risk involved with these derivative contracts. Were they sleeping? (As someone on the late night ABC news suggested). Having served on the finance committees of small non-profit organizations, I know that almost everyone does realize the risk involved when derivatives are mentioned.

BOB JENSEN: WHEN I TALKED ABOUT DECEPTIVE ACTS, I WAS REFERRING MORE TO FORWARDS, SWAPS, AND SOME OPTIONS CONTRACTS THAT ARE CUSTOMIZED AND NOT STANDARDIZED. THESE CONSTITUTE A MAJORITY OF THE DERIVATIVES CONTRACTING IN MODERN TIMES, ESPECIALLY COMMODITY PRICE FORWARDS AND INTEREST RATE SWAPS. A GOOD EXAMPLE IS THE ORANGE COUNTY DERIVATIVE CONTRACT FEATURED IN THE CBS VIDEO AT http://www.cs.trinity.edu/~rjensen/000overview/mp3/133summ.htm#Introduction 
NO WALL STREET EXPERT COULD MAKE SENSE OUT OF THIS CONTRACT, AND MERRILL LYNCH LATER PAID MILLIONS TO ORANGE COUNTY FOR WRITING THIS AND OTHER INCOMPREHENSIBLE DERIVATIVE CONTRACTS!

2. Unfortunately, not all hedging is perfect and so there could still be huge losses even with hedging.

BOB JENSEN: THAT IS TRUE, ESPECIALLY IN FUTURES CONTRACTS. IT IS LESS SO WITH FORWARDS AND SWAPS WHERE CUSTOMIZED CONTRACTS CAN HEDGE RIGHT ON THE MARK!

3. For hedging to work, there must be speculators i.e. those willing to assume the risk that the hedgers are trying to transfer. If speculative trading is totally banned, the futures markets may not work properly (not enough liquidity...), I think.

BOB JENSEN: YOU MEAN THE BUCK MUST EVENTUALLY STOP OR GO FROM SOMEWHERE. THAT IS TRUE. WHAT HAPPENS IN PRACTICE IS THAT SOME SPECULATOR ALONG THE WAY IS HELPING A HEDGER. BUT THE SPECULATOR KEEPS A CLOSE EYE ON THE MARKET AND LAYS OFF SPECULATION RISK WHEN THE FIRE GETS TOO HOT BY TAKING OPPOSITE POSITIONS TO HEDGE OUTSTANDING RISK.

MANY RISK TRANSFERS ARE TO SPECIALISTS IN THAT RISK. FOR EXAMPLE, CORPORATIONS OFTEN LAY OFF CREDIT RISKS TO BANKS, BECAUSE BANKS HAVE MORE EXPERTISE IN MANAGING CREDIT RISKS. THIS IS A POINT THAT BOB ELLIOTT MADE IN HIS JANUARY 15 PERFORMANCE ON CSPAN.

4. How much of the losses of Enron were actually due to speculating on derivatives? Does anyone know what were the amounts involved and the terms of maturity of these contracts? Were some of the transactions unauthorized? Thanks for any help with these.

BOB JENSEN I DON'T THINK ANYBODY KNOWS THAT YET, NOT EVEN ENRON INSIDERS. WHAT IS CLEAR IS THAT MAJOR LOSSES AROSE, BECAUSE ENRON'S MAJOR BUSINESS BECAME TRADING IN ENERGY AS A COMMODITY. HOWEVER, THERE WERE BILLIONS LOST IN REALLY BAD INVESTMENTS SUCH AS THE FOLLOWING QUOTED IN NEWSWEEK, JANUARY 21 --- http://www.msnbc.com/news/686994.asp?0dm=-12NK

****************************************************************
But many of its businesses tied up lots of capital while earning very little or running in the red. In the late 1990s, by my count, Enron lost about $2 billion on telecom capacity, $2 billion in water investments, $2 billion in a Brazilian utility and $1 billion on a controversial electricity plant in India. Enron’s debt was soaring. If these harsh truths became obvious to outsiders, Enron’s stock price would get clobbered—and a rising stock price was the company’s be-all and end-all. Worse, what few people knew was that Enron had engaged in billions of dollars of off-balance-sheet deals that would come back to haunt the company if its stock price fell.
****************************************************************

I HOPE THIS HELPS!

BOB JENSEN


Hi George,

My totally off-the-wall answer to your question is that often the winners in the futures contracts were the customers of energy (such as power plants in California and elsewhere). In many such contracts, however, Enron was also a winner, particularly before the Federal capping of prices in the Western states.

I think Enron was also into derivatives of its own equity shares. I suspect the winners or losers on those deals were the investors who bet on price movements in the other direction.

Interestingly, there is a difference between international IAS 39 and U.S. FAS 133 on type settlements in a company's own equities as noted in my glossary under "Net Settlement" at http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#N-Terms 

IAS 39 If an enterprise has a contractual obligation that it can settle either by paying out a financial assets or its own equity securities, and if the number of equity securities required to settle the obligation varies with changes in their fair value so that the total fair value of the equity securities paid always equals the amount of the contractual obligation, the obligation should be accounted for as a financial liability, not as equity.

FASB standards do not require that such an obligation be classified as a liability, although it gets a bit more complicated in FAS 133 Paragraph 11(c).

But when deriviatives entail an entity's own shares, hedge accounting is denied and gains and losses must be posted to current earnings. Paragraph 29(f) reads as follows:

************************************************* 29. A forecasted transaction is eligible for designation as a hedged transaction in a cash flow hedge if all of the following additional criteria are met:

f. The forecasted transaction does not involve a business combination subject to the provisions of Opinion 16 and is not a transaction (such as a forecasted purchase, sale, or dividend) involving (1) a parent company's interests in consolidated subsidiaries, (2) a minority interest in a consolidated subsidiary, (3) an equity-method investment, or (4) an entity's own equity instruments.

*************************************************

FAS 133 Paragraph 472 reads as follows:

************************************************* Forecasted Transactions Prohibited from Designation as the Hedged Item in a Cash Flow Hedge

472. This Statement prohibits cash flow hedge accounting for forecasted transactions involving (a) an entity's interests in consolidated subsidiaries, (b) minority interests in consolidated subsidiaries, (c) investments accounted for by the equity method, or (d) an entity's own equity instruments classified in stockholders' equity. The reasons for those prohibitions are similar to those for prohibiting the same items from being hedged items in fair value hedges, as discussed in paragraphs 455-457. In addition, the Board noted that implementing cash flow hedge accounting for those items could present significant practical and conceptual problems, such as determining when to transfer to earnings amounts accumulated in other comprehensive income. Finally, certain of those items, such as issuances and repurchases of an entity's own equity instruments, would not qualify for hedge accounting because they do not present a cash flow risk that could affect earnings.

*************************************************

Bob (Robert E.) Jensen Jesse H. Jones Distinguished Professor of Business Trinity University, San Antonio, TX 78212 Voice: (210) 999-7347 Fax: (210) 999-8134 Email: rjensen@trinity.edu http://faculty.trinity.edu/rjensen

-----Original Message----- 
From: George Lan [mailto:glan@UWINDSOR.CA]  
Sent: Friday, January 18, 2002 1:59 PM 
To: AECM@LISTSERV.LOYOLA.EDU 
Subject: A Derivative Question and some Ethical Issues

1. The last course I took on derivatives was about a dozen years ago. I may be wrong but I seem to remember that derivative markets are zero-sum i.e. gains of one party are negated by losses of the other party. If that is the case, does anyone know which party (ies) has benefitted from the losses of Enron on derivatives? In the big scheme of things, does it make any difference if these parties which benefitted are companies that seem to be more ethical and better managed than Enron?

2. Prof. Ceil Pillsbury's letter of ethical conduct (in this morning's e-mail to the list) also states the ethical responsibilities of the professor. I think this is important for some students will look up to their Prof as role model. 

George Lan 
University of Windsor


May 3, 2001
Houston-based Enron took a major step on Wednesday toward bailing out of an almost complete $2.9 billion power project on the west coast of India in a bitter dispute over pricing and unpaid bills.
http://www.dailystarnews.com/200104/30/n1043005.htm 

 


The Professions of Investment Banking and Security Analysis are Rotten to the Core  
This module was moved to http://faculty.trinity.edu/rjensen/FraudRotten.htm 


 

"Biz School Blindness Sank Enron,"  by John Leboutillier, New York Daily News, January 9, 2002 --- http://www.nydailynews.com/2002-01-09/News_and_Views/Opinion/a-137617.asp 

Articles about Skilling written since the demise of his company cite his arrogance and cold-heartedness. But as I witnessed sitting in that Harvard Business School classroom nearly 24 years ago, the seeds of his destruction grew out of a gross misunderstanding about the role of a business leader in our society. In his view, it is to be "a profit center" and to "maximize return for the shareholder," no matter the peril to consumers or employees.


A Senator Complains to C.E. Andrews, the Head of Auditing at Andersen, About Enron's Related Party Disclosure in Enron's Year 2000 Annual Report

SEN. DORGAN: Should it raise a red flag for an auditor if the chief financial officer of a company is personally involved in complex financial transactions in their own firm? This was the case with Mr. Fastow who had a personal stake, as I understand it, in the success of these SPEs and was compensated in that matter. Should that concern an auditor and did it concern Andersen?

MR. ANDREWS: Senator, as it pertains to related party transactions, again, the accounting and disclosure rules require that related party transactions be reviewed and disclosed where there would be material on financial statements and, in this case, that related party transaction was disclosed in the footnotes to the Enron financial statements.

SEN. DORGAN: Do you have those footnotes with you?

MR. ANDREWS: Chairman, I do not.

SEN. DORGAN: The reason I ask is I've read some of those footnotes and I think it would have been impossible for even the most experienced analyst to understand what those footnotes meant, and that is of concern. 

The exchange above is quoted from http://www.c-span.org/enron/scomm_1218.asp#open

The footnote being referred to above is Footnote 16 from the Year 2000 Annual Report that can be downloaded from http://www.enron.com/corp/investors/annuals/2000/ar2000.pdf 

I have reproduced Footnote 16 below.  Who do you think is correct with respect to the related-party disclosure adequacy in the disputed Footnote 16 --- C.E. Andrews or Senator Dorgan?

Do the related party disclosures in the footnote below add value to you when analyzing risk?  Does this tell you that Enron's CFO made over $30 million from his limited partnership that entered into derivatives for Enron?

Footnote 16 from the Year 2000 Enron Annual Report  
http://www.enron.com/corp/investors/annuals/2000/ar2000.pdf
 

16.  RELATED PARTY TRANSACTIONS

In 2000 and 1999, Enron entered into transactions with limited partnerships (the Related Party) whose general partner's managing member is a senior office of Enron.  The limited partners of the Related Party are unrelated to Enron.  Management believes that the terms of the transactions with the Related Party were reasonable compared to those which could have been negotiated with unrelated third parties.

In 2000, Enron entered into transactions with the Related Party to hedge certain merchant investments and other assets.  As part of the transactions, Enron (i) contributed to newly-formed entities (the Entities) assets valued at approximately $1.2 billion, including $150 million in Enron notes payable, 3.7 million restricted shares of outstanding Enron common stock and the right to receive up to 18.0 million shares of outstanding Enron common stock in March 2003 (subject to certain conditions) and (ii) transferred to the Entities assets valued at approximately $309 million, including a $50 million note payable and an investment in an entity that indirectly holds warrants convertible into common stock of an Enron equity method investee.  In return, Enron received economic interests in the Entities, $309 million in notes receivable, of which $259 million is recorded at Enron's carryover basis of zero, and a special distribution from the Entities in the form of $1.2 billion in notes receivable, subject to changes in the principal for amounts payable by Enron in connection with the execution of additional derivative instruments.  Cash in these Entities of $172.6 million is invested in Enron demand notes.  In addition, Enron paid $123 million to purchase share-settled options from the Entities on 21.7 million shares of Enron common stock.  The Entities paid Enron $10.7 million to terminate the share-settled options on 14.6 million shares of Enron common stock outstanding.  In late 2000, Enron entered into share-settled collar arrangements with the Entities on 15.4 million shares of Enron common stock.  Such arrangements will be accounted for as equity transactions when settled.

In 2000, Enron entered in derivative transactions with the Entities with a combined notional amount of approximately $2.1 billion to hedge certain merchant investments and other assets.  Enron's notes receivable balance was reduced by $36 million as a result of premiums owed on derivative transactions.  Enron recognized revenues of approximately $500 million related to the subsequent change in the market value of these derivatives, which offset market value changes of certain merchant investments and price risk management activities.  In addition, Enron recognized $44.5 million and $14.1 million of interest income and interest expense, respectively, on the notes receivable from and payable to the Entities.

In 1999, Enron entered into a series of transactions involving a third party and the Related Party.  The effect of the transactions was (i) Enron and the third party amended certain forward contracts to purchase shares of Enron common stock, resulting in Enron having forward contracts to purchase Enron common shares at the market price on that day, (ii) the Related Party received 6.8 million shares of Enron common stock subject to certain restrictions and (iii) Enron received a note receivable, which was repaid in December 1999, and certain financial instruments hedging an investment held by Enron.  Enron recorded the assets received and equity issued at estimated fair value.  In connection with the transactions, the Related Party agreed that the senior officer of Enron would have no pecuniary interest in such Enron common shares and would be restricted from voting on matters related to such shares.  In 2000, Enron and the Related Party entered into an agreement to terminate certain financial instruments that had been entered into during 1999.  In connection with this agreement, Enron received approximately 3.1 million shares of Enron common stock held by the Related Party.  A put option, which was originally entered into in the first quarter of 2000 and gave the Related Party the right to sell shares of Enron common stock to Enron at a strike price of $71.31 per share, was terminated under this agreement.  In return, Enron paid approximately $26.8 million to the Related Party.

In 2000, Enron sold a portion of its dark fiber inventory to the Related Party in exchange for $30 million cash and a $70 million note receivable that was subsequently repaid.  Enron recognized gross margin of $67 million on the sale.

In 2000, the Related Party acquired, through securitizations, approximately $35 million of merchant investments from Enron.  In addition, Enron and the Related Party formed partnerships in which Enron contributed cash and assets and the Related Party contributed $17.5 million in cash.  Subsequently, Enron sold a portion of its interest in the partnership through securitizations.  See Note 3.  Also Enron contributed a put option to a trust in which the Related Party and Whitewing hold equity and debt interests.  At December 31, 2000, the fair value of the put option was a $36 million loss to Enron.

In 1999, the Related Party acquired approximately $371 million of merchant assets and investments and other assets from Enron.  Enron recognized pre-tax gains of approximately $16 million related to these transactions.  The Related Party also entered into an agreement to acquire Enron's interests in an unconsolidated equity affiliate for approximately $34 million.

 

Footnote 16 Analysis by Frank Partnoy 

Testimony of Frank Partnoy Professor of Law, University of San Diego School of Law Hearings before the United States Senate Committee on Governmental Affairs, January 24, 2002 --- http://www.senate.gov/~gov_affairs/012402partnoy.htm

Part C of the Testimony

C. Using Derivatives to Inflate the Value of Troubled Businesses A third example is even more troubling. It appears that Enron inflated the value of certain assets it held by selling a small portion of those assets to a special purpose entity at an inflated price, and then revaluing the lion’s share of those assets it still held at that higher price.

Consider the following sentence disclosed from the infamous footnote 16 of Enron’s 2000 annual report, on page 49: “In 2000, Enron sold a portion of its dark fiber inventory to the Related Party in exchange for $30 million cash and a $70 million note receivable that was subsequently repaid. Enron recognized gross margin of $67 million on the sale.” What does this sentence mean?

It is possible to understand the sentence today, but only after reading a January 7, 2002, article about the sale by Daniel Fisher of Forbes magazine, together with an August 2001 memorandum describing the transaction (and others) from one Enron employee, Sherron Watkins, to Enron Chairman Kenneth Lay. Here is my best understanding of what this sentence means:

First, the “Related Party” is LJM2, an Enron partnership run by Enron’s Chief Financial Officer, Andrew Fastow. (Fastow reportedly received $30 million from the LJM1 and LJM2 partnerships pursuant to compensation arrangements Enron’s board of directors approved.)

Second, “dark fiber” refers to a type of bandwidth Enron traded as part of its broadband business. In this business, Enron traded the right to transmit data through various fiber-optic cables, more than 40 million miles of which various Internet-related companies had installed in the United States. Only a small percentage of these cables were “lit” – meaning they could transmit the light waves required to carry Internet data; the vast majority of cables were still awaiting upgrades and were “dark.” The rights associated with those “dark” cables were called “dark fiber.” As one might expect, the rights to transmit over “dark fiber” are very difficult to value.

Third, Enron sold “dark fiber” it apparently valued at only $33 million for triple that value: $100 million in all – $30 million in cash plus $70 million in a note receivable. It appears that this sale was at an inflated price, thereby enabling Enron to record a $67 million profit on that trade. LJM2 apparently obtained cash from investors by issuing securities and used some of these proceeds to repay the note receivable issued to Enron.

What the sentence in footnote 16 does not make plain is that the investor in LJM2 was persuaded to pay what appears to be an inflated price, because Enron entered into a “make whole” derivatives contract with LJM2 (of the same type it used with Raptor). Essentially, the investor was buying Enron’s debt. The investor was willing to buy securities in LJM2, because if the “dark fiber” declined in price – as it almost certainly would, from its inflated value – Enron would make the investor whole. In these transactions, Enron retained the economic risk associated with the “dark fiber.” Yet as the value of “dark fiber” plunged during 2000, Enron nevertheless was able to record a gain on its sale, and avoid recognizing any losses on assets held by LJM2, which was an unconsolidated affiliate of Enron, just like JEDI.

As if all of this were not complicated enough, Enron’s sale of “dark fiber” to LJM2 also magically generated an inflated price, which Enron then could use in valuing any remaining “dark fiber” it held. The third-party investor in LJM2 had, in a sense, “validated” the value of the “dark fiber” at the higher price, and Enron then arguably could use that inflated price in valuing other “dark fiber” assets it held. I do not have any direct knowledge of this, although public reports and Sherron Watkins’s letter indicate that this is precisely what happened.

For example, suppose Enron started with ten units of “dark fiber,” worth $100, and sold one to a special purpose entity for $20 – double its actual value – using the above scheme. Now, Enron had an argument that each of its remaining nine units of “dark fiber” also were worth $20 each, for a total of $180.

Enron then could revalue its remaining nine units of “dark fiber” at a total of $180. If the assets used in the transaction were difficult to value – as “dark fiber” clearly was – Enron’s inflated valuation might not generate much suspicion, at least initially. But ultimately the valuations would be indefensible, and Enron would need to recognize the associated losses.

It is an open question for this Committee and others whether this transaction was unique, or whether Enron engaged in other, similar deals. It seems likely that the “dark fiber” deal was not the only one of its kind. There are many sentences in footnote 16.


On August 20, 2001, Well Before the Year End Meltdown of Enron, Its Auditors Were Warned That Enron Was an Elaborate Accounting Hoax

"Auditor Received Warning on Enron Five Months Ago," by Richard A. Oppel, Jr., The New York Times, January 17, 2002 --- http://www.nytimes.com/2002/01/17/business/17ENRO.html 

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 


Sherron (Smith) Watkins was the Enron executive credited with blowing the whistle about Andy Fastow's illegal SPE dealings.  She sent her now famous letter to both CEO Ken Lay and to the Andersen auditors where she'd been Employed before coming to Enron.  She was eventually named one of Time Magazine's 2002 "Persons of the Year" --- http://www.time.com/time/personoftheyear/2002/

From Kurt Eichenwald's Conspiracy of Fools:  A True Study, (Broadway Books, 2005, pp. 95-96).

Sherron Smith flipped through the pages of an investment presentation, her face tightening in disgust.

A former accountant, Smith had worked at Enron since October 1993, when she was hired to manage JEDI, Enron's joint venture with Calpers. At first she had enjoyed Enron and her boss, Andy Fastow, who struck her as energetic and dynamic, with occasional touches of thoughtfulness. But over time, Fastow's shortcomings as a manager had alienated her. That year he had even failed to show up at the semiannual Performance Review Committee meeting, where managers pushed to get bonuses and promotions for their staff. As a result, Smith had come away with a disappointing fourteen-thousand-dollar bonus and a simmering anger toward Fastow. She had even considered quitting.

Then, salvation. Fastow moved to retail. Rick Causey, Skilling's favorite accountant, took over, and her world brightened. Causey was a friendly, doughy man who had already promised to get raises for Smith and her colleagues. The change rekindled her good feelings for Enron.

Her job, put simply, was to act as JEDI's gatekeeper. Executives around Enron were always looking for JEDI to invest in their deals. But too many proposals were fanciful--badly thought out, badly structured, or just plain bad.

When deal makers made a sloppy presentation to Smith, she savaged them. She delighted in shocking people with uncomfortable truths--about anything at all, including herself. The knock on Smith was that she tried too hard to be one of the boys--so long as the boys were truck drivers and longshoremen. Her foul mouth at meetings was legendary, and this day, no one expected to be any different.

Smith closed up the presentation, staring hard across the table at the executives who brought it to her.

"What the fuck is this?" she snorted. "This thing looks like a circle jerk to me."

Smirks all around. Sherron was just being Sherron.

"Sherron, I know you've got strong opinions, but there's a lot of value--," one of the executives began.

"Oh, come on, Smith interrupted. "Let's not sit around blowing each other, okay?"

One side of the table, a couple of Smith's colleagues, Shirley Hudler and Bill Brown, listened to the exchange and winced. They respected Smith but thought her salty approach to business discussions damaged her.

Oh, God, Sherron, Hudler thought. Shut up.

The deal team pushed hard for Smith to change her mind. Smith countered with responses about the problems with the transaction; her arguments were strong. The case for doing the deal crumpled.

Smith quashed another proposal--but, as always, at a price. Her colleagues whispered that her coarse language was undermining her credibility, that her penchant for one-upmanship was giving her the reputation as someone who wouldn't listen. If she didn't stop, if she didn't learn how to play nice in a corporate setting, if she didn't learn to be more of a team player, they had no doubt that Sherron Smith's future at Enron would be bleak.

None of her colleagues could have imagined that Smith would be one of Enron's few executives to emerge from the company in high stead, known worldwide under her then-married name as Sherron Watkins, the Enron whistle-blower.

 


Lynn Brewer versus Sherron Watkins Whistleblowers at Enron

October 14, 2007 message from dberesfo@uga.edu

Bob,

There was a terrific story in Friday's edition of USA that unmasks a phony whistle blower at Enron who has established an "ethics institute." Sorry I'm out of town and don't have the link but I'm sure you can find it easily. Cynthia Cooper, who was a real hero in uncovering the Worldcom fraud, is coming out with a book in early December that is a grat read.

Denny

October 15. 2007 reply from Bob Jensen

Thanks Denny.

Lynn Brewer was never enough of a player to even mention in my threads on the Enron scandal --- http://faculty.trinity.edu/rjensen/FraudEnron.htm

I’m glad Brewer and her book are being discredited --- http://faculty.trinity.edu/rjensen/FraudEnronBrewer.htm
Fortunately she was not a fourth woman on the cover of Time Magazine in 2002 (see below)
Here's what USA Today did to Lynn Brewer:
          Halloween Hangman (interactive video, hit the buttons)  --- http://www.dedge.com/flash/hangman/hangman.swf

I hope Lynn Brewer is added to Jude Werra's "Liars Index" (See Below for “Executives Making It by Faking It”)
But then again Lynn Brewer even lied about being an executive at Enron

 I’m sure you know that Sherron Watkins was an executive VP whistleblower at Enron who had more dirty words in her vocabulary than a rap star. The failure of Arthur Andersen’s top brass to act on her disclosures about Fastow’s SPE frauds became a huge embarrassment all the way to the top of Andersen.

"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.

Bob Jensen's threads on the Enron and Worldcom scandals are at --- http://faculty.trinity.edu/rjensen/FraudEnron.htm 

Bob Jensen's threads on whistle blowing are at http://faculty.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

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/


"Executives: Making It by Faking It:  Wisconsin headhunter Jude Werra's "Liars Index" of faked résumé claims hit a five-year high in the first half of 2007," Business Week, by Joseph Daniel McCool, Business Week, October 4, 2007 --- Click Here 

. . . Jude Werra. The president of Brookfield (Wis.)-based Jude M. Werra & Associates has spent the better part of 25 years documenting executive résumé fraud, credentials inflation, and the misrepresentation of executive educational credentials. It's something that has kept Werra pretty busy over the years, given the prevalence of such management-level chicanery and the fact that so many ambitious and transition-minded individuals have convinced themselves that it's their credentials—real or otherwise—that matter most.

Stopping at Nothing to Get to the Top Werra's semiannual barometer of executive résumé deception—his very own "Liars Index"—hit a five-year high, based on his review of résumés he received during the first half of 2007. He figures that about 16% of executive résumés contain false academic claims and/or material omissions relating to educational experience. That was up five percentage points from the levels he witnessed between July and December of last year.

And when you account for the fudging of claims of experience unrelated to academic degrees earned, it's easy to see why executive headhunters generally acknowledge that as many as one-third of management-level résumés contain errors, exaggerations, material omissions, and/or blatant falsehoods.

Some people will stop at almost nothing to get to where they want in their career. Still, Werra wonders why otherwise experienced executives would inflate their credentials or otherwise mislead with their résumé, in light of the potential career-ending consequences.

Checking References Isn't Enough Given the alarming levels to which they do attempt to mislead, he constantly reminds hiring organizations that it's critical that they verify what they read on résumés, even at the executive level. What's even more alarming—and more prevalent than people falsifying their backgrounds and qualifications—is the number of hiring organizations who fail to conduct a rigorous background check on their new management recruits. Far too many organizations figure that checking a few references is enough.

And even the most thorough reference checks won't uncover false claims that predate those references' own professional interactions with the individual executive. It's quite possible that a fabrication of one's education, certifications, and experience is what got the executive his first management job many years ago, leaving the trail cold unless it's reopened during the course of a diligent background check.

When it comes to executive-level hiring that's going to cost the organization into the high six figures, at minimum, when you factor in headhunting fees, the new executive's salary, and benefits, it becomes a matter of caveat emptor.

Let the Hiring Company Beware And while it may be tempting to believe that an executive recruiter will uncover any issues during the courtship process, it's ultimately up to the hiring organization to know exactly who it is that's being hired. Sure, misrepresentation will cost the unscrupulous executive, but it can also wreak havoc on a company's brand, workforce, and external relations teams.

Beyond the boundaries of checking claims made by an individual on his or her résumé, the hiring organization can trust that engaging the services of a professional background-screening consultant will pay off. These consultants often come with significant experience in law enforcement, and they can help uncover such things as criminal convictions, unpaid child support, and other hidden issues that should influence the hiring decision.

A thorough background check is an important insurance policy for the recruiting process, and headhunters will tell you that your organization risks getting burned if an executive it hires has, at any time in his or her past, decided to assume the risks of playing with fire.

Given the high cost of a bad executive hire, today's organizations simply can't afford not to do their homework.


 

 

 

 

 

A message from Professor Scofield on January 18, 2002

Given the high student interest in Enron and its complexity, I have been looking for a piece of the puzzle on which Intermediate-level students could research and write. I finally decided on the stock subscriptions topic. The project is posted at my class website at http://www.utpb.edu/courses/scofield/ACCT3302/PA2.htm  and my students are about three weeks away from beginning it. I wanted to invite the scrutiny and feedback of any Intermediate instructors on AECM before students begin the assignment. Any comments are welcome.

Barbara W. Scofield, PhD, CPA 
Coordinator of Graduate Business Studies 
The University of Texas of the Permian Basin 
4901 E. University Odessa, TX 79762 915-552-2183 FAX 915-552-2174 scofield_b@utpb.edu 


Did FAS 133 Contribute to the Scandal:  The Now-Famous August 2001 Memo

Following is the text of an unsigned letter written in August to Kenneth L. Lay, the chairman of the Enron Corporation (news/quote), after Jeffrey K. Skilling resigned unexpectedly as chief executive on Aug. 14. Its author was later identified as Sherron S. Watkins, a vice president for corporate development at Enron. The House Energy and Commerce Committee released excerpts of the letter on January 14, 2002 and the full letter on January 15.  

I am only quoting three paragraphs from the full letter reported in The New York Times on January 16, 2002: --- http://www.nytimes.com/2002/01/16/business/16TEXT.html?pagewanted=1 

We have recognized over $550 million of fair value gains on stocks via our swaps with Raptor. Much of that stock has declined significantly — Avici by 98 percent from $178 million, to $5 million; the New Power Company by 80 percent from $40 a share, to $6 a share. The value in the swaps won't be there for Raptor, so once again Enron will issue stock to offset these losses. Raptor is an LJM entity. It sure looks to the layman on the street that we are hiding losses in a related company and will compensate that company with Enron stock in the future.

I am incredibly nervous that we will implode in a wave of accounting scandals. My eight years of Enron work history will be worth nothing on my résumé, the business world will consider the past successes as nothing but an elaborate accounting hoax. Skilling is resigning now for "personal reasons" but I would think he wasn't having fun, looked down the road and knew this stuff was unfixable and would rather abandon ship now than resign in shame in two years.

Is there a way our accounting guru's can unwind these deals now? I have thought and thought about a way to do this, but I keep bumping into one big problem — we booked the Condor and Raptor deals in 1999 and 2000, we enjoyed wonderfully high stock price, many executives sold stock, we then try and reverse or fix the deals in 2001, and it's a bit like robbing the bank in one year and trying to pay it back two years later. Nice try, but investors were hurt, they bought at $70 and $80 a share looking for $120 a share and now they're at $38 or worse. We are under too much scrutiny and there are probably one or two disgruntled "redeployed" employees who know enough about the "funny" accounting to get us in trouble.
Sherron S. Watkins, a vice president for corporate development at Enron, August 2002

Before and After FAS 133
Although Enron was primarily a derivatives trader in futures contracts, it appears that swaps are emerging as a major component of the accounting scandal.  Interestingly enough, FAS 133 may have contributed to the problem.  Prior to FAS 133, swaps were not booked (on the ground that their historical cost is zero in an historical-cost based system).  FAS 133 imposed a requirement that all swaps be booked at zero to begin with, but that they be adjusted to fair value at least every 90 days.  If they are qualified under FAS 133 as hedges, the offsetting debit or credit does not impact upon current earnings to the extent that the hedges are effective.  How the current earnings is bypassed depends upon the nature of the hedge.  The offset goes to Other Comprehensive Income for cash flow hedges.  If the hedged item is a booked item (such as inventory) normally carried at cost, the offset goes to the booked item and, thereby, changes the accounting for the hedged item to fair value (but only during the hedging period).  If the hedged item is an unbooked item, the offset goes to an account invented in FAS 133 called "Firm Commitment" that absorbs the offsets to fair value adjustments of a derivative (such as a swap).

But in Enron, it appears that most derivatives were not qualified as hedges under FAS 133.  Prior to FAS 133, changes in swap value would not be booked to current earnings.  Subsequent to FAS 133, changes in swap values must be booked to current earnings if they are speculations rather than hedges.

Enron's CFO Andy Fastow's insider deals between his private partnership Raptor and Enron are elaborated upon in the New York times article cited above:

Summary of Alleged Issues:

RAPTOR Entity was capitalized with LJM equity. That equity is at risk; however, the investment was completely offset by a cash fee paid to LJM. If the Raptor entities go bankrupt LJM is not affected, there is no commitment to contribute more equity.

The majority of the capitalization of the Raptor entities is some form of Enron N/P, restricted stock and stock rights.

Enron entered into several equity derivative transactions with the Raptor entities locking in our values for various equity investments we hold.

As disclosed in 2000, we recognized $500 million of revenue from the equity derivatives offset by market value changes in the underlying securities.

This year, with the value of our stock declining, the underlying capitalization of the Raptor entities is declining and credit is pushing for reserves against our MTM positions.

To avoid such a write-down or reserve in quarter one 2001, we "enhanced" the capital structure of the Raptor vehicles, committing more ENE shares.

My understanding of the third-quarter problem is that we must "enhance" the vehicles by $250 million.

I realize that we have had a lot of smart people looking at this and a lot of accountants including AA & Co. have blessed the accounting treatment. None of that will protect Enron if these transactions are ever disclosed in the bright light of day. (Please review the late 90's problems of Waste Management (news/quote) — where AA paid $130 million plus in litigation re questionable accounting practices.)

The overriding basic principle of accounting is that if you explain the "accounting treatment" to a man in the street, would you influence his investing decisions? Would he sell or buy the stock based on a thorough understanding of the facts? If so, you best present it correctly and/or change the accounting.

My concern is that the footnotes don't adequately explain the transactions. If adequately explained, the investor would know that the "entities" described in our related party footnote are thinly capitalized, the equity holders have no skin in the game, and all the value in the entities comes from the underlying value of the derivatives (unfortunately in this case, a big loss) AND Enron stock and N/P. Looking at the stock we swapped, I also don't believe any other company would have entered into the equity derivative transactions with us at the same prices or without substantial premiums from Enron. In other words, the $500 million in revenue in 2000 would have been much lower. How much lower?

Raptor looks to be a big bet if the underlying stocks did well, then no one would be the wiser. If Enron stock did well, the stock issuance to these entities would decline and the transactions would be less noticeable. All has gone against us. The stocks, most notably Hanover, the New Power Company and Avici are underwater to great or lesser degrees.

One basic question: The related party entity has lost $500 million in its equity derivative transactions with Enron. Who bears that loss? I can't find an equity or debt holder that bears that loss. Find out who will lose this money. Who will pay for this loss at the related party entity?

If it's Enron, from our shares, then I think we do not have a fact pattern that would look good to the S.E.C. or investors.

2. The equity derivative transactions do not appear to be at arms length.

a. Enron hedged New Power, Hanover and Avici with the related party at what now appears to be the peak of the market. New Power and Avici have fallen away significantly since. The related party was unable to lay off this risk. This fact pattern is once again very negative for Enron.

b. I don't think any other unrelated company would have entered into these transactions at these prices. What else is going on here? What was the compensation to the related party to induce it to enter into such transactions?

3. There is a veil of secrecy around LJM and Raptor. Employees question our accounting propriety consistently and constantly. This alone is cause for concern.

a. Jeff McMahon was highly vexed over the inherent conflicts of LJM. He complained mightily to Jeff Skilling and laid out five steps he thought should be taken if he was to remain as treasurer. Three days later, Skilling offered him the C.E.O. spot at Enron Industrial Markets and never addressed the five steps with him.

b. Cliff Baxter complained mightily to Skilling and all who would listen about the inappropriateness of our transactions with LJM.

c. I have heard one manager-level employee from the principal investments group say, "I know it would be devastating to all of us, but I wish we would get caught. We're such a crooked company." The principal investments group hedged a large number of their investments with Raptor. These people know and see a lot. Many similar comments are made when you ask about these deals. Employees quote our C.F.O. as saying that he has a handshake deal with Skilling that LJM will never lose money.

4. Can the general counsel of Enron audit the deal trail and the money trail between Enron and LJM/Raptor and its principals? Can he look at LJM? At Raptor? If the C.F.O. says no, isn't that a problem?  At Raptor? If the C.F.O. says no, isn't that a problem?

Continued at http://www.nytimes.com/2002/01/16/business/16TEXT.html?pagewanted=2 


On August, I challenged all of you on the AECM to assign a grade to Footnote 16 of the Year 2000 Enron annual report, the related-party footnote that Senator Dorgan complained was highly misleading. My challenge link and Footnote 16 are at http://faculty.trinity.edu/rjensen/fraud.htm#Senator 

Since nobody took up the challenge, I will provide a partial answer by merely quoting from the famous August 16 letter.

Following is a portion of the text of an unsigned letter written in August to Kenneth L. Lay, the chairman of the Enron Corporation (news/quote), after Jeffrey K. Skilling resigned unexpectedly as chief executive on Aug. 14. Its author was later identified as Sherron S. Watkins, a vice president for corporate development at Enron. The House Energy and Commerce Committee released excerpts of the letter on January 14, 2002 and the full letter on January 15.

Note in particular her August 2001 questioning of Footnote 16.

 

***************************************************************************************************

The overriding basic principle of accounting is that if you explain the "accounting treatment" to a man in the street, would you influence his investing decisions? Would he sell or buy the stock based on a thorough understanding of the facts? If so, you best present it correctly and/or change the accounting.

My concern is that the footnotes don't adequately explain the transactions. If adequately explained, the investor would know that the "entities" described in our related party footnote are thinly capitalized, the equity holders have no skin in the game, and all the value in the entities comes from the underlying value of the derivatives (unfortunately in this case, a big loss) AND Enron stock and N/P. Looking at the stock we swapped, I also don't believe any other company would have entered into the equity derivative transactions with us at the same prices or without substantial premiums from Enron. In other words, the $500 million in revenue in 2000 would have been much lower. How much lower?

Raptor looks to be a big bet if the underlying stocks did well, then no one would be the wiser. If Enron stock did well, the stock issuance to these entities would decline and the transactions would be less noticeable. All has gone against us. The stocks, most notably Hanover, the New Power Company and Avici are underwater to great or lesser degrees.

One basic question: The related party entity has lost $500 million in its equity derivative transactions with Enron. Who bears that loss? I can't find an equity or debt holder that bears that loss. Find out who will lose this money. Who will pay for this loss at the related party entity?

If it's Enron, from our shares, then I think we do not have a fact pattern that would look good to the S.E.C. or investors.

2. The equity derivative transactions do not appear to be at arms length.

a. Enron hedged New Power, Hanover and Avici with the related party at what now appears to be the peak of the market. New Power and Avici have fallen away significantly since. The related party was unable to lay off this risk. This fact pattern is once again very negative for Enron.

b. I don't think any other unrelated company would have entered into these transactions at these prices. What else is going on here? What was the compensation to the related party to induce it to enter into such transactions?

3. There is a veil of secrecy around LJM and Raptor. Employees question our accounting propriety consistently and constantly. This alone is cause for concern.

a. Jeff McMahon was highly vexed over the inherent conflicts of LJM. He complained mightily to Jeff Skilling and laid out five steps he thought should be taken if he was to remain as treasurer. Three days later, Skilling offered him the C.E.O. spot at Enron Industrial Markets and never addressed the five steps with him.

b. Cliff Baxter complained mightily to Skilling and all who would listen about the inappropriateness of our transactions with LJM.

c. I have heard one manager-level employee from the principal investments group say, "I know it would be devastating to all of us, but I wish we would get caught. We're such a crooked company." The principal investments group hedged a large number of their investments with Raptor. These people know and see a lot. Many similar comments are made when you ask about these deals. Employees quote our C.F.O. as saying that he has a handshake deal with Skilling that LJM will never lose money.

4. Can the general counsel of Enron audit the deal trail and the money trail between Enron and LJM/Raptor and its principals? Can he look at LJM? At Raptor? If the C.F.O. says no, isn't that a problem?  At Raptor? If the C.F.O. says no, isn't that a problem?

Sherron S. Watkins, a vice president for corporate development at Enron, August 2001

***************************************************************************************************


Reply from David G. Coy [dcoy@adrian.edu

Bob:

I'm sorry - I read the material last night, but I didn't respond.

My grade would be an "F". My reasoning is probably simplistic, but here goes:

Footnotes are supposed to enhance users' knowledge of the F/S, and their necessity is rooted in the Full-Disclosure Principle. In their drafting, one must assume that the users' have some knowledge of accounting and of the company.

In order to decipher this footnote, one would have to have an intimate and extensive knowledge of this accounting issue and of Enron itself - far beyond the level that is reasonable to expect from an average user of the F/S. And the manner in which the footnote was organized did nothing to make this process easier. The details in "the letter" suggest this may have been deliberate.

As an aside, it also seems to me that the SPE's/related party transactions were specifically constructed and deployed to strictly comply with accounting rules and thusly be kept off Enron's books. It also appears to me that fear of Rule 203 (and probably fear of losing the Enron audit) caused people to find a way to rationalize the propriety of Enron's accounting. I think someone should have stepped back and said, "Well, this stuff might be 'by the book', but, nonetheless, it is so pervasive and extensive that we must include it on Enron's F/S (or is some more highly specific supplemental disclosure schedules) simply because of the Business Entity principle." This would have caused certainly a qualified opinion, and possibly an adverse audit opinion, due to going-concern considerations. I know that we have the benefit of hindsight, but I have to believe that telling Enron they were not going to get a clean opinion, and losing the audit would be preferable to what Arthur Andersen is going through now.

I would be very curious to know what was in Andersen's management letters to Enron over the past couple of years. I wonder if this issue was spoken to in them?

In closing, I note that the accountants strictly (perhaps blindly and unthinkingly?) adhered to two of the three tenants that make accountancy a profession (adherence to a code of ethics (Rule 203), and application of a body of technical knowledge(FASB)). However, they fell far short of discharging their duty to society. As we all know, if even one leg of a three-legged stool fails, the stool topples. And to follow this metaphor - maybe this third leg didn't fail, but it would seem that, perhaps, the other two legs were disproportionately long.

Anyway, this is my reasoning for the grade of "F", plus some other observations. I would be interested in your comments.

David G. Coy CMA, CPA 
Professor of Accounting 
Adrian College Adrian, Michigan
dcoy@adrian.edu 


A message on January 16 from E. Scribner [escribne@NMSU.EDU

Bob,

The responses from Bill Dent and Denny Beresford give me a much better perspective on how Rule 203 plays out in practice. Today, in the process of looking up the Continental Vending case (United States v. Simon), which dealt with rules compliance as a defense, I stumbled across Sandy Burton's 1975 essay, "Fair Presentation: Another View," in the Saxe Lectures Series. This essay makes for interesting and timely reading once again! The link is http://newman.baruch.cuny.edu/digital/saxe/saxe_1974/burton_75.htm  in case anyone is interested.

Ed ----- 
Ed Scribner New Mexico State University

 


A Bit of Accountancy Humor Inspired by Enron and the Scandals That Follow and Follow and . . .

Humor is an important but sensitive issue in education and learning and politics and everyday life

Psychology of Humor: I never thought the Three Stooges Were Funny (What does that say about me?)
I'm not sending the following out as a political message. It does, however, discuss some serious research on the psychology of humor


Question
How was copper wire invented?

Answer
It happened when two accountants were arguing over a penny

 


Funny CPA Exam Stories ---
https://www.journalofaccountancy.com/newsletters/2017/sep/cpa-exam-memories.html?utm_source=mnl:cpald&utm_medium=email&utm_campaign=20Sep2017

"Political Stooges:  A new study of humor could spell trouble for Rand Paul," by James Taranto, The Wall Street Journal, August 12, 2010 ---
http://online.wsj.com/article/SB10001424052748704901104575423422292357524.html?mod=djemEditorialPage_t

Two lonely "psychological scientists" have been hard at work trying to understand this peculiar human phenomenon called "humor," the Association for Psychological Science tells us in a press release.

It turns out, for example, that the idea of the late Jimmy Dean hiring a rabbi as a spokesman for a new line of pork products is "more likely to make the reader laugh" than the idea of Dean hiring a farmer for the same job. That's because "having a rabbi promote pork" is a "moral violation," per Leviticus 11:7:

And the pig, though it has a split hoof completely divided, does not chew the cud; it is unclean for you.

Haha, get it?! The other characteristic that makes humor "funny" is benignity, which explains the Three Stooges. From the press release:

"We laugh when Moe hits Larry because we know that Larry's not really being hurt," says [the University of Colorado's A. Peter] McGraw, referring to humorous slapstick. "It's a violation of social norms. You don't hit people, especially a friend. But it's okay because it's not real."

One should not underestimate the importance of this scientific advance, which builds on earlier work by "a research team led by Dr. Allan L. Reiss of the Stanford University School of Medicine," which was reported by the Associated Press in 2005:

They were surprised when their studies of how the male and female brains react to humor showed that women were more analytical in their response, and felt more pleasure when they decided something really was funny.
"Women appeared to have less expectation of a reward, which in this case was the punch line of the cartoon," said Reiss. "So when they got to the joke's punch line, they were more pleased about it."
Women were subjecting humor to more analysis with the aim of determining if it was indeed funny, Reiss said in a telephone interview.
Men are using the same network in the brain, but less so, he said, men are less discriminating.
"It doesn't take a lot of analytical machinery to think someone getting poked in the eye is funny," he commented when asked about humor like the Three Stooges.

And of course it's a commonplace that women don't get the Stooges. But imagine a DVD release of their greatest hits, accompanied by analysis from A. Peter McGraw. The ladies would love it, and the gents would be grateful for the chance to find common ground with the opposite sex.

Continued in article

Reference
"People Think Immoral Behavior Is Funny -- But Only If It Also Seems Benign,"  ScienceDaily (Aug. 9, 2010) ---
http://www.sciencedaily.com/releases/2010/08/100809142042.htm

August 12, 2010 reply from Zane Swanson [ZSwanson@UCO.EDU]

As I am preparing syllabi for the fall, I am reviewing the WSJ accounting subject cartoons that are placed on the projector before class starts. When the cartoon is removed, it is the signal that serious learning is to begin. Unless I missed them, there were no funny WSJ accounting cartoons during this summer or the year for that matter. If anyone has some recent accounting cartoons to share, I would appreciate it.

Zane Swanson

August 12, 2010 reply from Bob Jensen

Hi Zane,

I prefer cartoons from The New Yorker, but there are serious copyright issues with cartoons in general and especially The New Yorker’s cartoons. Some of them are really funny --- http://www.cartoonbank.com/?affiliate=ny-cbanimation

Enter the word “accounting” in the search box.

Economics Humor --- http://alternativeinvestmentcoach.com/economics-resources/jokes/

Bob Jensen's threads on humor are added to the bottom of every edition of New Bookmarks
http://faculty.trinity.edu/rjensen/Bookurl.htm


Dilbert Cartoons on Market Manipulations
"Scott Adams Discovers Market Manipulation," by Barry Ritholtz, Ritholtz Blog, March 2013 ---
http://www.ritholtz.com/blog/2013/03/scott-adams-manipulators/

Regular readers know I am a fan of Scott Adams, creator of the comic Dilbert and occasional commentator on a variety of matters.

He has a somewhat odd blog post up, titled, Here Come the Market Manipulators. In it, he makes two interesting suggestions: The first is to decry “market manipulators,” who do what they do for fun and profit to the detriment of the rest of us. The second is to say that these manipulators are likely to cause “a 20% correction in 2013.”

Let’s quickly address both of these issues: First off, have a look at the frequency of 20% corrections in markets. According to Fidelity (citing research from Capital Research and Management Company), over the period encompassing 1900-2010, has seen the following corrections occur:

Corrections During 1900 – 2010

5%:  3 times per year

10%:  Once per year

20%:  Once every 3.5 years

Note that Fido does not specify which market, but given the dates we can assume it is the Dow Industrials. (I’ll check on that later).

Note that US market’s have not had a 20% correction since the lows in March 2009. I’ll pull up the relevant data in the office, but a prior corrective action of 19% is the closest we’ve come, followed by a ~16% and ~11%.

As to the manipulators of the market, I can only say: Dude, where have you been the past 100 years or so?

Yes, the market gets manipulated. Whether its tax cuts or interest rate cuts or federal spending or wars or QE or legislative rule changes to FASB or even the creation of IRAs and 401ks, manipulation abounds.

In terms of the larger investors who attract followers — I do not see the same evidence that Adams sees. Sure, the market is often driven by large investors. Yes, many of these people have others who follow them. We need only look at what Buffet, Soros, Dalio, Icahn, Ackman, Einhorn and others have done to see widely imitated stock trades. But that has shown itself to be a bad idea, and I doubt anyone is making much money attempting to do so. And, it hardly leads to the conclusion that any more than the usual manipulation is going on.

Will be have a 20% correction? I guarantee that eventually, we will. Indeed, we are even overdue for it, postponed as it is by the Fed’s manipulation.

But I have strong doubts it is going to be caused by a cabal manipulating markets for fun & profit. It will occur because that’s what markets do . . .

 

 

Previously:
Dilbert’s Unified Theory of Everything Financial’  (October 15th, 2006)

7 Suggestions for Scott Adams (November 27th, 2007)

Don’t Follow Wealthy Investors, Part 14 (February 17th, 2008)

"What’s Wrong with the Financial Services Industry?" by Barry Ritholtz, Ritholtz Blog, February 21, 2013 ---
http://www.ritholtz.com/blog/2013/02/whats-wrong-with-the-financial-services-industry/

Jensen Comment
You can also see a Dilbert cartoon about making up data ---
http://faculty.trinity.edu/rjensen/Theory01.htm

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

 


Accounting Humor --- See Below

Long-time subscribers to the AECM may remember my quips (years ago) about Michael Kopper ---
These inspired AECMers to write their own quips about Enron and about accounting in general.

And don't forget about the Enron home video starring some of the real players (including Jeff Skilling) befpre they got caught --- http://faculty.trinity.edu/rjensen/FraudEnron.htm#HFV

Possible headlines on the Enron saga following the guilty plea of Michael J. Kopper:
  • Kopper Wired to the Top Brass (with reference to secret conspiracies with Andy Fastow)
  • The Coppers Got Kopper
  • Kopper Cops a Plea
  • Kopper’s Finish is Tarnished
  • Kopper Caper
  • Kopper Flopper
  • Kopper in the Kettle
  • A Kopper Whopper

These are Jensen originals, although I probably shouldn’t admit it.


It's a fact that investors in Victoria Secret once sued the Andersen auditors for audit negligence.
Butt the following is Bob Jensen's fictional poem:

Sure seemed enough,
When Waste Management audits ignored smelly stuff.

And Andersen's unveilings bottomed out,
When Victoria Secret audits turned into doubt.

Now the latest criminal  issue,
Is Andersen's clean wipe of American Tissue.

AccountingWEB US - Mar-12-2003 - In yet another black mark against the now-defunct accounting firm of Arthur Andersen, LLP, a former senior auditor of the firm has been arrested in connection with the audit of American Tissue, the nation's fourth-largest tissue maker. Brendon McDonald, formerly of Andersen's Melville, NY office, surrendered Monday at the United States Courthouse in Central Islip, NY. He could face as much as 10 years in prison for his role in allegedly destroying documents related to the American Tissue audits.

Mr. McDonald is accused of deleting e-mail messages, shredding documents, and aiding the officers of American Tissue in defrauding lenders of as much as $300 million. American Tissue's chief executive officer and other executives were also arrested and charged with various counts of securities and bank fraud and conspiracy.

According to court documents, American Tissue inflated income and diverted money to subsidiaries in an attempt to make the company eligible to borrow additional money. "The paper trail of phony sales transactions, bogus supporting documentation and numerous accounting irregularities ended quite literally with the destruction of the falsified documents by American Tissue's auditor," said Kevin P. Donovan, an assistant director of the Federal Bureau of Investigation, according to a statement that appeared in The New York Times ("Paper Company Officials Charged," March 11, 2003).


AccountingWeb Humor --- http://www.accountingweb.com/humor/humor.html


Greatest hit songs of Accounting: (video) --- http://www.youtube.com/watch?v=XSranciXOvs


Video:  Accounting Done Easy (Ma and Pa Kettle) --- http://www.youtube.com/watch?v=G6vS1edTsV8&feature=related


Accountants in Hollywood

November 1, 2006 message from Ed Scribner [escribne@NMSU.EDU]

Our own Professor David Albrecht’s web site makes the big time in connection with article on “Andy Barker, PI,” new NBC series featuring a CPA.

http://www.webcpa.com/article.cfm?articleid=22144

Ed Scribner
New Mexico State University
Las Cruces, New Mexico, USA


On the Lighter Side
Martha Stewart's New Magazine and Her Latest Products --- http://www.justsaywow.com/funpages/view.cfm/2232 
Martha's Latest Press Cartoons --- http://cagle.slate.msn.com/news/MarthaStewartCONVICTED/main.asp 


Funny stories about the busy tax season for accountants --- http://www.accountingweb.com/cgi-bin/item.cgi?id=107452


Bob (George) Newhart's Early Years as a Bookkeeper
(Thank God his Loyola University-Chicago degree is in management and not accounting)

"Finding My Funny Bone," by Bob Newhart, Readers Digest, September 2006, pp. 93-94
(These are excerpts form his book entitled I Shouldn't Even Be Doing This. ISBN: 1401302467)

Salesmen would come in from the road and turn in their receipts. I'd give them cash and put the receipts in the petty-cash drawer. At the end of the day, I'd have to reconcile what was in the drawer with the receipts. It was always close, bit it never balanced. At five o'clock, when everybody else was leaving the office, I'd be tearing my hair out because petty cash was short by $1.48. Around 8 p.m., I'd find the discrepancy.

I followed this routine for a couple weeks. Finally, one day, I pulled the amount I was short from my pocket --- $1.67 --- put it in the drawer, and called it a day.

Not long after, the petty cash drawer was over by $2.11. So I took $2.11 out of petty cash and pocketed that. I was hardly stealing. Inevitably, in the next couple days, I would be under, and back the money would go.

After several weeks of this, Mr. Hutchinson, head of accounting, discovered by shortcut to balancing petty cash. "George," he lectured me, using my given name, "These are not sound accounting principles."

"You know, Mr. Hutchinson," I said, "I just don't think I'm cut out for accounting. Why would you pay me $6 an hour to spend four hours finding $1.40?"

August 19, 2006 reply from Ramsey, Donald [dramsey@UDC.EDU]

Newhart apparently learned more about internal control in his starring role in the film "Hot Millions", in which he plays a corporate controller who finally blows the whistle on embezzler Peter Ustinov. The film is jam packed with accounting issues--everything from identity theft to building security--there must have been an accountant somewhere in the screenwriting department. It's also very funny. Ustinov cracks the computer access system (learns to turn it off from a cleaning woman who knows where to bump the cabinet) and has it write checks to several mail drops around Europe. Straight out of the auditing textbook.

The film is available on the Internet. I show it on the first day of class in Principles I, when not everyone shows up, and distribute a checklist of internal control issues to look for.

There is even a surprise ending that involves corporate governance and some very heavy internal politics; but a happy ending, thanks to Dame Maggie Smith in her salad days.

My other favorite, more on finance and ethics, is Jack Lemmon in "Save the Tiger". I use that one on the first day of Principles II.

Cheers,

Donald D. Ramsey
University of the District of Columbia


Our AECM friend David Albrecht has a new blog in 2008.
The Summa Debits and credits of accounting --- http://profalbrecht.wordpress.com/
The September 2 and 3 tidbits are as follows (I'm serious):

A Copper Penny for Your Laugh

Do a google search on accounting and (humor or jokes or funnies), and you are bound to get a listing of some really awful stuff.  I’m willing to retell the following, but only to make a point that we accountants aren’t very funny.

  • What’s the difference between counting and accounting?  Accounting goes a-one, a-two, a-three, and so forth.
  • Did you know there are three types of accountants?  Those that can count, and those that can’t!
  • Says one accountant’s wife to her friend, “My husband is so accrual, he doesn’t depreciate me any more.”
  • If an accountant’s wife can’t sleep, what does she say to her husband?  “Darling, tell me about your work.”
  • How was copper wire invented?  Two accountants were arguing over a penny.

What do you think?  These are the best of the worst jokes ever created.

Why can’t accountant jokes be as funny as economist jokes?  Here are a few:

  • Economics is the only field in which two people can get a Nobel Prize for saying exactly the opposite thing.
  • Three econometricians went out hunting and came across a large deer.  The first econometricial fired, but missed by a meter to the left.  The second econometrician fired, but missed by a meter to the right.  The third econometrician didn’t fire, but shouted loudly in triumph, “We got it!  We got it!”
  • Talk is cheap, supply exceeds demand.
     

OK, so the economist jokes aren’t all that funny either.  So I decided to create my own accountant joke.  Can I do any worse?

  • America is in a war against terror.  An accountant decides to join the army.  After a month of basic training, the accountant has become the sergeant’s pet and is permitted to take the rest of the troop out for a march.  The accountant gets the men started, “Ready, set, march!”  The men start stomping left and right, stomp stomp stomp stomp stomp stomp stomp.  The accountant joins in to keep them in time, “Debit (stomp) Debit (stomp) Debit Credit Debit (Stomp)”

Over and out - - David Albrecht

In his most recent column for the Accounting Cycle (September 2008), Ed Ketz, accounting professor at Penn State University, comments on the SEC’s advisory group:  Final Report of the Advisory Committee on Improvements to Financial Reporting to the U.S. Securities and Exchange Commission (August 1, 2008) < http://www.sec.gov/about/offices/oca/acifr/acifr-finalreport.pdf>.  Ed’s complete column about it can be found at <http://accounting.smartpros.com/x63030.xml>.

Ed is a throwback to an older age of accounting professors.  Not necessarily a curmudgeon, which evokes images of ill-tempered and disagreeable, he certainly is “a crusty irascible cantankerous old person full of stubborn ideas”. Nor is he afraid to call a schmuck a schmuck.  I like that.

Continued in the blog

I'm considering sending David the following for his blog:

Accountants are so tight they can debit (stomp) the poop out of the buffalo on a nickel.

I'm guessing that David's strategy is to embed serious accountancy issues amongst his bad jokes. Why not? I think it has made him a popular and effective teacher in the classroom. But do most of the accounting jokes have to be so bad? Perhaps it wins him the sympathy vote on student evaluations.

As far as partying accountants go, let's never forget Rich Kinder's Enron Birthday Party before the meltdown of Enron (it features Jeff Skilling in the flesh speaking about Hypothetical Fair Value Accounting) --- http://www.cs.trinity.edu/~rjensen/video/windowsmedia/enron3.wmv
PS
Rich Kinder left Enron before the scandal broke and went on to become a self-made billionaire.
See Question 2 at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm


Partying Accountants (video links forwarded by David Albrecht)

As far as partying accountants go, let's never forget Rich Kinder's Enron Departure Party before the meltdown of Enron (it features Jeff Skilling in the flesh speaking about Hypothetical Future Value Accounting) --- http://www.cs.trinity.edu/~rjensen/video/windowsmedia/enron3.wmv
PS
Rich Kinder left Enron before the scandal broke and went on to become a self-made billionaire.
See Question 2 at http://faculty.trinity.edu/rjensen/FraudEnronQuiz.htm


Top Ten Accountant Pick-Up Lines (from the David Letterman Show) --- http://www.cbs.com/latenight/lateshow/top_ten/index/php/19980409.phtml#


Not good for the image of the accounting profession:  "Taxes are for Douche Bags"
July 6, 2005 message from Mike Gasior [Mike_Gasior@mail.vresp.com]

Also, I told you last month about a hysterical video that was done on The Daily Show with Jon Stewart by correspondent, Ed Helms about the Cayman Islands titled "Gimmie Shelter". Unfortunately Comedy Central had taken the clip off of their website, but a terrific reader sent me a link where you can view the video. Simply cut and paste this address into your browser and the video will play for you. Enjoy.

Mike

mms://a386.v99506.c9950.g.vm.akamaistream.net/7/386/9950/v001/comedystor.download.akamai.com/9951/dailyshow/helms/helms_10055.wmv


Cartoon archives --- http://www.thecorporatelibrary.com/cartoons/tcl_cartoons.htm

Cartoon 1:  Two kids competing on the blackboard.  One writes 2+2=4 and the other kid writes 2+2=40,000.  Which kid as the best prospects for an accounting career?

Cartoon 36:  Where the Grasso is greener (Also see Cartoon 37)


I've worked on these numbers all day, and there's just no accounting for taste.
"Cartoonist Pokes Fun at Accounting,"  SmartPros, December 8, 2004

Need a good laugh to lighten up your day? It's just one click away. Cartoonist Mark Anderson tickles the funny bone with business-theme cartoons and illustrations on his Web site, Andertoons.com ( http://www.andertoons.com/ ).

Andertoons.com is divided into categories and subcategories that include Money Cartoons and Accounting Cartoons. The site invites visitors to sign up for the weekday e-newsletter that delivers a cartoon a day to your desktop. Visitors can also search the cartoons and illustrations by keyword.

For instance, type in "accounting" in the keyword search and you'll find a cartoon with the one-line caption, "The new font is great, but I still don't like the look of these numbers."

Another one-liner that pokes fun at accounting fumbles: "Numbers don't lie. That's where we come in."

Continued in the article


New Theatrical Humor featuring Accountants (See the video links below)
"Love, Sex, and the IRS: A much-needed laugh at tax time," AccountingWeb, April 15. 2008 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=104951

Sometimes the best medicine to alleviate the pain of filing your taxes is laughter, preferably of the sidesplitting variety. Love, Sex, and the IRS, a play by William Van Zandt and Jane Milmore, provides exactly that.

Love, Sex, and the IRS is about Jon and Leslie, two men who have been living together in the Big Apple for years. Jon does the taxes for both of the out-of-work musicians and learns he could save a lot of money if he were married to Leslie. It's all fun until, you guessed it, they get audited and Leslie must play the part of Jon's wife.

Cross dressing ensues and so does hilarity when you throw in a landlord who won't permit unmarried couples to live together a la Three's Company, an IRS man who gets loaded, and Jon's mother, who shows up unexpectedly to help plan Jon's marriage to his real life fiancé Kate.

Love, Sex, and the IRS was performed earlier this month at the Laurel Mill Playhouse in Laurel, MD, and Broadwayworld.com gave the show 3 1/2 stars out of 5. The show is also playing at the Meadville Community Theater in Meadville, PA.

"The play has the normal Van Zandt-Milmore formula of twists of fate, running in and out, sight gags, mistaken identities, and Keystone Cop-type slapstick comedy," Dan Authier, who will direct the farce in Meadville, told GoErie.com.

Love, Sex, and the IRS has recently played or is playing at venues from New Hampshire to California.

Some Video Links for Love, Sex, and the IRS

You can purchase the book --- http://www.amazon.com/Love-Sex-IRS-Comedy-Three/dp/0573611963


Humor:  "The Idiot's Guide to Hedging and Derivatives" ---  http://faculty.trinity.edu/rjensen/fraud033103.htm#Idiot'sGuide


With tongue in cheek, New Yorker and writer Andy Borowitz has penned a new book that successfully captures what humor can be found in the recent rash of corporate malfeasance --- http://www.smartpros.com/x40231.xml 


What not to say to your professor/instructor
Top Ten No Sympathy Lines (Plus a Few Extra) --- http://www.uwgb.edu/dutchs/nosymp.htm

Here are some samples:

Think of it as a TOP TEN list with a few bonus items:
  1. This Course Covered Too Much Material...
  2. The Expected Grade Just for Coming to Class is a B
  3. I Disagreed With the Professor's Stand on ----
  4. Some Topics in Class Weren't on the Exams
  5. Do You Give Out a Study Guide?
  6. I Studied for Hours
  7. I Know The Material - I Just Don't Do Well on Exams
  8. I Don't Have Time For All This (...but you don't understand - I have a job.)
  9. Students Are Customers
  10. Do I Need to Know This?
  11. There Was Too Much Memorization
  12. This Course Wasn't Relevant
  13. Exams Don't Reflect Real Life
  14. I Paid Good Money for This Course and I Deserve a Good Grade
  15. All I Want Is The Diploma

RateMyProfessors has some real-world examples of comments that professors hated even worse --- http://www.ratemyprofessors.com/Funniest.jsp

A few samples are shown below:

  • You can't cheat in her class because no one knows the answers.
  • His class was like milk, it was good for 2 weeks.
  • Houston, we have a problem. Space cadet of a teacher, isn't quite attached to earth.
  • I would have been better off using the tuition money to heat my apartment last winter.
  • Three of my friends got A's in his class and my friends are dumb.
  • Emotional scarring may fade away, but that big fat F on your transcript won't.
  • Evil computer science teaching robot who crushes humans for pleasure.
  • Miserable professor - I wish I could sum him up without foul language.
  • Instant amnesia walking into this class. I swear he breathes sleeping gas.
  • BORING! But I learned there are 137 tiles on the ceiling.
  • Not only is the book a better teacher, it also has a better personality.
  • Teaches well, invites questions and then insults you for 20 minutes.
  • This teacher was a firecracker in a pond of slithery tadpoles.
  • I learned how to hate a language I already know.
  • Very good course, because I only went to one class.
  • He will destroy you like an academic ninja.
  • Bring a pillow.
  • Your pillow will need a pillow.
  • If I was tested on her family, I would have gotten an A.
  • She hates you already.

Forwarded by Paula

Uh oh! I think I know some of these!!! Disclaimer: The ones I know are VERY nice people!!! VERY NICE PEOPLE!

Q What's the definition of an accountant? A Someone who solves a problem you didn't know you had in a way you don't understand.

Q What's the definition of a good tax accountant? A Someone who has a loophole named after him.

Q When does a person decide to become an accountant? A When he realizes he doesn't have the charisma to succeed as an undertaker.

Q What does an accountant use for birth control? 
A His personality.

Q What's an extroverted accountant? 
A One who looks at your shoes while he's talking to you instead of his own.

Q What's an auditor? 
A Someone who arrives after the battle and bayonets all the wounded.

Q Why did the auditor cross the road? 
A Because he looked in the file and that's what they did last year.

Q There are three kinds of accountants in the world. 
A Those who can count and those who can't.

Q What's an accountant's idea of trashing his hotel room? 
A Refusing to fill out the guest comment card.

Q How do you drive an accountant completely insane? 
A Tie him to a chair, stand in front of him and fold up a road map the wrong way.

Q What's the most wicked thing a group of young accountants can do? 
A Go into town and gang-audit someone.

Q What do accountants suffer from that ordinary people don't? 
A Depreciation.

An accountant is someone who knows the cost of everything and the value of nothing.

An accountant is having a hard time sleeping and goes to see his doctor. "Doctor, I just can't get to sleep at night." "Have you tried counting sheep?" "That's the problem - I make a mistake and then spend three hours trying to find it"

Thanks Paula


Some old and some new accounting humor forwarded by Paula

A businessman was interviewing applicants for the position of divisional manager. He devised a simple test to select the most suitable person for the job. He asked each applicant the question, "What is two and two?" The first interviewee was a journalist. His answer was "twenty-two."

The second applicant was an engineer. He pulled out a calculator and showed the answer to be between 3.999 and 4.001.

The next person was a lawyer. He stated that in the case of Jenkins v. Commr of Stamp Duties (Qld), two and two was proven to be four.

The last applicant was an accountant. The business man asked him, "How much is two and two?"

The accountant to be got up from his chair, went over to the door, closed it then came back and sat down. He leaned across the desk and said in a low voice,

"How much do you want it to be?" He got the job.

-------------

What's the definition of an accountant?

Someone who solves a problem you didn't know you had in a way you don't understand.

-------------

What's the definition of a good tax accountant?

Someone who has a loophole named after him.

-------------

What's an extroverted accountant?

One who looks at your shoes while they talking to you instead of his own.

-------------

Why did the auditor cross the road?

Because he looked in the file and that's what they did last year.

-------------

There are three kinds of accountants in the world. Those who can count and those who can't.

-------------

An accountant is having a hard time sleeping and goes to see his doctor. "Doctor, I just can't get to sleep at night."

"Have you tried counting sheep?"

"That's the problem - I make a mistake and then spend three hours trying to find it"

--------------

Comprehending Accountants - Take One

Two accountancy students were walking across campus when one said, "Where did you get such a great bike?" The second accountant replied, "Well, I was walking along yesterday minding my own business when a beautiful woman rode up on this bike. She threw the bike to the ground, took off all her clothes and said, "Take what you want." The second accountant nodded approvingly,"Good choice; the clothes probably wouldn't have fit."

Comprehending Accountants - Take Two

An architect, an artist and an accountant were discussing whether it was better to spend time with the wife or a mistress.

The architect said he enjoyed time with his wife, building a solid foundation for an enduring relationship.

The artist said he enjoyed time with his mistress, because of the passion and mystery he found there.

The accountant said, "I like both."

"Both?"

The accountant replied "Yeah. If you have a wife and a mistress, they will each assume you are spending time with the other woman, and you can go to the office and get some work done."

Comprehending Accountants - Take Three

To the optimist, the glass is half full.

To the pessimist, the glass is half empty.

To the accountant, the glass is twice as big as it needs to be.


"IRS Agent Finds Key to New Life in 'Stranger',"  By Robert Denerstein, Rocky Mountain News via SmartPros, November 13, 2006 --- http://accounting.smartpros.com/x55486.xml

Stranger Than Fiction begins with a narrator describing the waking hours of a fastidious IRS auditor who lives alone in his appallingly clean, super-organized Washington, D.C., apartment.

Within a few minutes, Harold Crick (Will Ferrell) comes off as a poster boy for anal retention. Harold rises at the same hour every day and brushes his teeth a proscribed number of times before heading off to catch the bus that never fails to carry him to his office at precisely the same time.

At this point, my eyes were beginning to glaze over. I'm sick of movies with narrators. Narration in movies, even at its most literate, can be a terrible cheat, alleviating the need for a screenwriter to create any real drama.

OK, enough about the perils of narration. The point here is that I was developing an attitude about Stranger Than Fiction just when something happened to upset the apple cart of my emerging discontent.

I won't tell you what it was, but I will say that Stranger Than Fiction quickly establishes itself as a movie that plays around with ideas in ways that can be amusing and smart. It also allows Will Ferrell to give his best performance yet, and makes room for the always enjoyable Emma Thompson, who plays Karen Eiffel, a tormented writer who's trying to figure out how to bring her latest novel to a close.

Director Marc Forster, who directed Monster's Ball and Finding Neverland but who stumbled with his last movie, Stay, returns to form, bringing a gentle touch to proceedings that revolve around Crick's increasing awareness that his life needs a jolt. Said awakening arrives in the form of a woman (Maggie Gyllenhaal) whose tax returns Harold has been asked to audit.

Ms. Gyllenhaal's Ana Pascal, a baker, conscientiously has refused to pay the portion of her taxes that funds defense-related matters. As a result, she faces big penalties.

When Crick begins to realize that there's more to life than a sharpened pencil and a keen knowledge of tax law, his behavior modifies. Among other things, he teaches himself guitar, satisfying a long-held, secret ambition to rock out.

The supporting performances are all quite sharp. Dustin Hoffman shows up as a professor of literary theory. These days, Mr. Hoffman seems to have taken nearly all the angst out of his work, and it serves him well. Queen Latifah also distinguishes herself in a small role: She plays an assistant who's sent by Eiffel's publisher to help the stalled author overcome her writer's block.

In this moment of mostly crude comedies and overwrought drama, it's refreshing to find a movie that creates tension by keeping us guessing about whether it's going to wind up as tragedy or comedy. Mr. Forster gives this somewhat cerebral notion just enough life, providing steady amusement along the way.

If the movie suffers a bit, it's probably because screenwriter Charlie Kaufman (Being John Malkovich) has made us a little too familiar with clever comedies of the self-conscious kind. Still, Mr. Forster's sweetly engaging concoction bends our minds without too much strain, and even those moments that feel mildly familiar never breed anything close to contempt.


From David Letterman (who ain't one)
Why accountants are important (forwarded by Milt Cohen)

The Journal of Accountancy - yup - we got one of them too, celebrating its 100th anniversary with the current issue. (no, the centerfold is not a semi-completed form 1040).

Along with reflecting on the past century of public accounting there is a list of 24 reasons why someone would want to be a CPA (or accountant). Some of them are worth sharing, as follows. SO WITH APOLOGIZES TO DAVID LETTERMAN - WHO - on 2nd thought doesn't NEED ANY APOLOGY:

1. We get to work the standard 70 hour week.

2. Our debits always equal are credits. (go explain that one)

3. Mom wanted us to be a rock star and this was our way to rebel.

4. The Red Sox wouldn't meet our salary demand.

5. All the free pencils we want.

6. In Scrabble, Accountant is worth 14 points while Doctor is worth only 9 and a Lawyer is 12. go figure!

7. We got to experience the five seasons, summer, winter, fall, spring & TAX!

8. A new IRS form gives us the chills - MANY TIMES A FEVER TOO.

9. No other profession offers April 16th as a paid holiday.

AND LASTLY

1O. Nobody gets an Academy Award (Oscar) until we say so.

 


Dilbert's take on accounting complexity --- http://www.dilbert.com/comics/dilbert/archive/dilbert-20020617.html 


Creative Accountants

Forwarded by David Fordham

A friend told me the following story about a former Enron accountant who gave up his CPA position to become a farmer. The first thing he decided to do was to buy a mule.

He dickers with a local farmer at the general store, and they agree that the local will sell the accountant a mule for $100. The Enron accountant gives the man $100 cash, and the man agrees to deliver the mule the next day.

Next morning, the man shows up at the Enron accountant's place without the mule. "I'm sorry," he explains, "but the mule died last night. I guess I owe you the $100 back."

"Hey, no problem," says the accountant. "Just keep the money, and as for the mule, hey, go ahead and dump him in my barn anyway. I'll raffle him off."

"Ain't nobody around here going to buy a dead mule," says the local farmer.

"Leave that to me. I worked for Enron," replies the accountant.

A week later, the farmer meets the accountant back at the general store, and asks, "So, how'd you make out with the dead mule?"

"Great," replies the accountant. "I sold over 1000 raffle tickets for $2 each, to my former stockholders and debtholders. Nobody ever bothered to ask if the mule was alive or not."

"But didn't the winner complain when he found out?" asked the farmer.

"Yep, he sure did, and being the honest, ethical man that I am, I refunded his $2 to him promptly."

"So my profit, after deducting my $100 cost for the dead mule and the $2 sales allowance, is $1898. By the way, do you have any chickens?"


Some Accounting Humor from http://www.accountingweb.com/humor/humor.html

----------------------------------------
Chapter 11

"The job notice posted at the University placement office advertised for someone to set up a bookkeeping system for a local dinner theater that was filing for bankruptcy.

When an eager first-year accounting student inquired, the interviewer told him that the company needed an advanced student capable of handling Chapter 11 proceedings.

"I'm sure I could do it," the student proclaimed confidently. "My class is already up to chapter fourteen."

--------------------------------------------------------------------------------

An accountant is having a hard time sleeping and goes to see his doctor. "Doctor, I just can't get to sleep at night." "Have you tried counting sheep?" "That's the problem - I make a mistake and then spend three hours trying to find it."

--------------------------------------------------------------------------------

A guy in a bar leans over to the guy next to him and says, "Want to hear an accountant joke?" The guy next to him replies, "Well, before you tell that joke, you should know that I'm 6 feet tall, 200 pounds, and I'm an accountant. And the guy sitting next to me is 6'2" tall, 225 pounds, and he's an accountant. Now, do you still want to tell that joke?" The first guy says, "No, I don't want to have to explain it two times."

--------------------------------------------------------------------------------

An accountant applies for the position of Chief Financial Officer. There are a number of candidates and he is called in for an interview. They ask him a number of questions and one of the panel suddenly says "What is nine multiplied by four?"

He thinks quickly and says "Thirty five." When the interview is over he goes outside, takes out his calculator and finds the correct answer is not thirty five. He thinks "Well, I blew that" and goes home very disappointed.

Next day he is rung up and told he has got the job. "Wonderful," he says, "but what about nine multiplied by four? My answer wasn't right"

"We know, but of all the candidates you came the closest."


"Andersen takes a strike: Minor league baseball team holds 'Arthur Andersen Appreciation Night'; fans encouraged to shred" CNN Money,  July 19, 2002 --- http://money.cnn.com/2002/07/19/news/andersen_game/index.htm 

Accounting firm Arthur Andersen took another beating Thursday night, but this time it was at a minor league baseball game instead of in a Texas courtroom.

The Portland Beavers, the triple-A farm team for the San Diego Padres, held "Andersen Appreciation Night" during its game with the Edmonton Trappers at PGE Park.

While Edmonton won the game, 9-1 -- that's the real score -- the team announced record attendance of 58,667. But there were only 12,969 fans who actually attended the game. The fans bought $5 tickets but were given $10 receipts for accounting purposes as a one-time "nonrecurring charge."

The game also featured a trivia quiz, where the prize was awarded to the fan whose guess was furthest from the correct answer. The question was: "How many career pitching wins [did] Gaylord Perry have?" A woman won by guessing in the single digits -- she was off by about 320.

Fans were encouraged to bring their own documents that could be destroyed at "shredding stations" throughout the park.

In addition, the 90 people with either "Arthur" or "Andersen" in their names who attended were given free admission. Two people named Arthur Andersen were among them.

Roger Devine of Portland, who attended the game, said some fans were momentarily befuddled by inflated player stats that appeared on the scoreboard during the first inning. "The people sitting next to me were from out of town and they were going 'This guy's batting .880? What the hell?'" he said.


May 11, 2005 message from Dennis Beresford

Bob,

You may have already picked up on this amusing web site - but here's the link just in case: http://www.extreme-accounting.com/ 

Denny


Forwarded by Hossein Nouri [hnouri@TCNJ.EDU

Recognition of Pro-Formalist Movement Gets Worldcom, Andersen Off Hook; Washington, D.C. (SatireWire.com) - In a surprise decision that exonerates dozens of major companies, the U.S. Supreme Court today ruled that corporate earnings statements should be protected as works of art, as they "create something from nothing." One plus one is two. That is math. That is science. But as we have seen, earnings and revenues are abstract and original concepts, ideas not bound by physical constraints or coarse realities, and must therefore be considered art," the Court wrote in its 7-2 decision. The impact of the ruling was widespread. Investigations into hundreds of firms were canceled, and collectors began snatching up original balance sheets, audits, and P&L statements from Worldcom, Enron, and Global Crossing. Meanwhile, auditing firms such as Arthur Andersen (now Art by Andersen) were reclassified as art critics, whose opinions are no longer liable. "Before we had to go in and decide, 'Is it right, or is it wrong?'" said KPMG spokesman Dan Fischer. "Now we must only decide, 'Is it art?'" 

In Congress, all further hearings into irregularities were abandoned in favor of an abstract accounting lecture given by Scott Sullivan, former Chief Financial Artist of Worldcom, which had been charged with fraud for improperly accounting for $3.85 billion. "Art should reflect life, so what I was really trying to accomplish with this third quarter report was acknowledge that life is an illusion," said Sullivan, explaining his acclaimed work, "10Q for the Period Ending 9/30/01." U.S. Rep. Billy Tauzin of Louisiana, however, was forced to apologize, admitting he could only see a lie. "Yes, well, a man with a concretized view of the world may only be able to see numbers that 'Don't add up,'" said a haughty Sullivan. "But someone whose perceptions are not always chained to reality - a stock analyst, say - may see numbers that, like the human spirit, aspire to be greater than they are." Several Sullivan pieces are now part of a new show at New York's Museum of Modern Art entitled, "Shadows; Spreadsheets: The Origins of Pro-Formalism." Robert Weidlin, an SEC investigator and avid collector, was among the first to peruse the Enron exhibit, which takes up an entire wing of the museum. "You look at these works, and you say 'Is this a profit, or a loss? Is this firm a subsidiary, or a holding company?'" said Walden. "I have stood in front of this one balance sheet for hours, and each moment I come away with something different." Like other patrons, Weidlin said he didn't know whether to be impressed or outraged, a reaction that pleased Andrew Fastow, the former Enron CFA who is a leading proponent of the Trompe L'Shareholder style. "An artist should not be afraid to be shocking," said Fastow. "

As did the Modernists, we should fearlessly depart from tradition and embrace the use of innovative forms of expression. Like, say, 'Special Purpose Entities' and 'Pooling of Interests.'" Sullivan, meanwhile, said he was influenced by the Flemish Masters, particularly Lernout Hauspie, the Belgian speech recognition software company that collapsed last year after an audit discovered the firm had cooked its books in 1998, 1999, and 2000. "Lernout Hauspie simply invented sales figures, just willed them out of thin air and onto the paper," he said. "Me? I must live with a spreadsheet a long time before I begin to work it. You must be patient and wait until the numbers reveal themselves to you." And what about the reaction to his work? "I realize people are angry, people are hurt. But I cannot concern myself with that," he said. "As with all true artists, I don't expect to be understood during my lifetime." (The MOMA exhibit runs through Sept. 3. Admission is $8, excluding a one-time write down of deferred stock compensation and other costs associated with the carrying value of inventory.)

TIMING IS EVERYTHING in humor, but the jokes told by a few former Enron executives on a recently surfaced videotape border on bad taste in light of the events of the past year.
Home Video Uncovered by the Houston Chronicle, December 19, 2002
Skits for Enron ex-executive funny then, but full of irony now --- http://www.chron.com/cs/CDA/story.hts/metropolitan/1703624 
(The above link includes a "See it Now" link to download the video itself which played well for me.)
Question:  How does former Enron CEO Jeff Skilling define HFV?

The tape, made for the January 1997 going-away party for former Enron President Rich Kinder, features nearly 30 minutes of absurd skits, songs and testimonials by company executives and prominent Houstonians. The collection is all meant in good fun, but some of the comments are ironic in the current climate of corporate scandal.

In one skit, former administrative executive Peggy Menchaca plays the part of Kinder as he receives a budget report from then-President Jeff Skilling, who plays himself, and financial planning executive Tod Lindholm. When the pretend Kinder expresses doubt that Skilling can pull off 600 percent revenue growth for the coming year, Skilling reveals how it will be done.

"We're going to move from mark-to-market accounting to something I call HFV, or hypothetical future value accounting," Skilling jokes as he reads from a script. "If we do that, we can add a kazillion dollars to the bottom line."

Richard Causey, the former chief accounting officer who was embroiled in many of the business deals named in the indictments of other Enron executives, makes an unfortunate joke later on the tape.

"I've been on the job for a week managing earnings, and it's easier than I thought it would be," Causey says, referring to a practice that is frowned upon by securities regulators. "I can't even count fast enough with the earnings rolling in."

Texas' political elite also take part in the tribute, with then-Gov. George W. Bush pleading with Kinder: "Don't leave Texas. You're too good a man."

Former President George Bush also offers a send-off to Kinder, thanking him for helping his son reach the Governor's Mansion.

"You have been fantastic to the Bush family," he says. "I don't think anybody did more than you did to support George."

Note:  Jim Borden showed me that it is possible to download and save this video using Camtasia.  Thank you Jim.  It is not a perfect capture, but it gets the job done.



UPSKILLING: To develop new skills, generally technical ones -- often by reskilling (retraining). 
To see the full Buzzword Compliant Dictionary.  Click here. http://www.buzzwhack.com
According to Ed Scribner, former Enron employees have a different definition for "upskilling."


Humor forwarded on December 21, 2002 by Miklos A. Vasarhelyi [miklosv@andromeda.rutgers.edu]

The corporate scandals are getting bigger and bigger. In a speech on Wall Street, President Bush spoke out on corporate responsibility, and he warned executives not to cook the books. Afterwards, Martha Stewart said the correct term was to saute the books.
Conan O'Brien

Martha Stewart denied allegations that she had been given inside information to sell 4,000 shares of a stock in a biotech firm about to go under. Stewart then showed her audience how to make a festive, quick-burning yule log out of freshly-shredded financial documents.
Dennis Miller

In New York the other day, there was a pro-Martha Stewart rally. Only four people showed up ... and three of them were made out of crepe paper!
Conan O'Brien

When reached for comment on the charges, Martha didn't say much, (only) that a subpoena should be served with a nice appetizer.
Conan O'Brien

NBC is making a movie about Martha Stewart that will cover the recent stock scandal. They are thinking of calling it 'The Road To Extradition."
Conan O'Brien

Things are not looking good for Martha Stewart. Her stock was down 23 percent yesterday. Wow, that dropped quicker than Dick Cheney after a double-cheeseburger.
Jay Leno

Tom Ridge announced a new color-coded alarm system. ... Green means everything's okay. Red means we're in extreme danger. And champagne-fuschia means we're being attacked by Martha Stewart.
Conan O'Brien


The August, 2002 issue of PLAYBOY has a pictorial entitled "The Women of Enron" --- http://www.playboy.com/magazine/current/pictorial_enron.html 

Now we are anxiously awaiting "The Women of Andersen" and "The Women of Worldcom."  

However, I doubt that there will be a pictorial event for "The Women of the Baptist Foundation" or "The Women of Waste Management."


A musical tribute to "The Day Worldcom Died" --- http://home.mchsi.com/~jeffwadler/ 


From the Financial Times, 28th June 02

EBITDA Earnings Before I Tricked the Dumb Auditor 
EBIT Earnings Before Irregularities and Tampering 
CEO Chief Embezzlement Officer 
CFO Corporate Fraud Officer 
NAV Nominal Andersen's Valuation 
FRS Fantasy Reporting Standards 
P/E Parole Entitlement 
EPS Eventual Prison Sentence

Paul Zielbauer in The New York Times reports on the new Enron lexicon developing: 

  • To "enronize" means "to hide fiscal shortcomings through slick financial legerdemain and bald-faced lies." 
  • It is "enronic" when a seemingly invincible person goes down in flames. 
  • "Enronica" refers to cheap souvenirs like Enron stock certificates. 
  • "Enrontia" is the burning desire to shred things. 
  • "Enronomania" is the mania for reform sweeping the nation – the first good kind of mania the market has seen in a very long time.

Note the 1995 Year Below
The accountants at Arthur Andersen knew Enron was a high-risk client who pushed them to do things they weren’t comfortable doing. Testifying in court in May, partner James Hecker said he wrote a parody to that effect in 1995. The Financial Times of London reported: "To the tune of the Eagles hit song ‘Hotel California,’ Mr. Hecker wrote lines such as: ‘They livin’ it up at the Hotel Cram-It-Down-Ya, When the [law]suits arrive, Bring your alibis.’"
Business Ethics [BizEthics@lb.bcentral.com] on May 15, 2002

I don't know who wrote the following, but it was forwarded by a former student who is at the local office of Arthur Andersen.

A take-off from the movies "A Few Good Men"  (Some phrases are in the original script and some are altered.)

Tom Cruise: "Did you order the shredding?"

Jack Nicholson: "You want answers?"

Tom Cruise: "I think I'm entitled."

Jack Nicholson: "You want answers!!"

Tom Cruise: "I want the truth!"

Jack Nicholson: "You can't handle the truth!"

Jack Nicholson: "Son, we live in a world that has financial statements. And those financial statements have to be audited by men with calculators. Who's gonna do it? You? You, Dept. of Justice? I have a greater responsibility than you can possibly fathom. You weep for Enron and you curse Andersen. You have that luxury. You have the luxury of not knowing what I know: that Enron's death, while tragic, probably saved investors. And my existence, while grotesque and incomprehensible to you, saves investors. You don't want the truth. Because deep down, in places you don't talk about at parties, you want me on that audit. You need me on that audit! We use words like materiality, risk-based, special purpose entity...we use these words as the backbone to a life spent auditing something. You use 'em as a punchline. I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very assurance I provide, then questions the manner in which I provide it. I'd prefer you just said thank you and went on your way. Otherwise, I suggest you pick up a pencil and start ticking. Either way, I don't give a damn what you think you're entitled to!!"

Tom Cruise: "Did you order the shredding???"

Jack Nicholson: "You're damn right I did!"


Remember how the consulting divisions called Andersen Consulting split off of Aurther Andersen and became a company known as Accenture.  Now you can also read about Indenture --- http://www.indenture.ac/ 

A November 2001 message from Ken Lay, CEO of Enron

Happy Thanksgiving!

This past weekend, I was rushing around in Houston, Texas trying to do some holiday season shopping done. I was stressed out and not thinking very fondly of the weather right then. It was dark, cold, and wet in the parking lot as I was loading my car up. I noticed that I was missing a receipt that I might need later. So mumbling under my breath, I retraced my steps to the mall entrance. As I was searching the wet pavement for the lost receipt, I heard a quiet sobbing. The crying was coming from a poorly dressed boy of about 12 years old. He was short and thin. He had no coat. He was just wearing a ragged flannel shirt to protect him from the cold night's chill. Oddly enough, he was holding a hundred dollar bill in his hand. Thinking that he had gotten lost from his parents, I asked him what was wrong. He told me his sad story. He said that he came from a large family. He had three brothers and four sisters. His father had died when he was nine years old. His Mother was poorly educated and worked two full time jobs. She made very little to support her large family. Nevertheless, she had managed to skimp and save two hundred dollars to buy her children some holiday presents (since she didn't manage to get them anything during the previous holiday season).

The young boy had been dropped off, by his mother, on the way to her second job. He was to use the money to buy presents for all his siblings and save just enough to take the bus home. He had not even entered the mall, when an older boy grabbed one of the hundred dollar bills and disappeared into the night. "Why didn't you scream for help?" I asked. The boy said, "I did." "And nobody came to help you?" I queried. The boy stared at the sidewalk and sadly shook his head. "How loud did you scream?" I inquired.

The soft-spoken boy looked up and meekly whispered, "Help me!"

I realized! that absolutely no one could have heard that poor boy cry for help. So I grabbed his other hundred and ran to my car.

Happy Thanksgiving everyone!

Signed,

Kenneth Lay Enron CEO


A potential investor came to seek investment advice from a financial analyst (F.A.). The F.A. told the investor, " I have the experience, you have the money."

Several weeks later, after the investor has lost all the money from following the advice of the F.A., the investor came to see the F.A. and the F.A. said to the investor:

"You have the experience, I have the money!"


I liked the one below about Teaching Accounting in the 1970s.  It is so True!

Also forwarded by Dick Haar

Teaching Accounting in 1950:

A logger sells a truckload of lumber for $100.

His cost of production is 4/5 of the price.

What is his profit?

 

Teaching Accounting in 1960:

A logger sells a truckload of lumber for $100.

His cost of production is 4/5 of the price, or $80.

What is his profit?

 

Teaching Accounting in 1970:

A logger exchanges a set "L" of lumber for a set "M" of money.

The cardinality of set "M" is 100. Each element is worth one dollar.

Make 100 dots representing the elements of the set "M."

The set "C", the cost of production contains 20 fewer points than set "M."

Represent the set "C" as a subset of set "M" and answer the following

question: What is the cardinality of the set "P" of profits?

 

Teaching Accounting in 1980:

A logger sells a truckload of lumber for $100.

His cost of production is $80 and his profit is $20.

Your assignment: Underline the number 20.

 

Teaching Accounting in 1990:

By cutting down beautiful forest trees, the logger makes $20.

What do you think of this way of making a living?

Topic for class participation after answering the question:

How did the forest birds and squirrels feel as the logger cut down the trees?

There are no wrong answers.

 

Teaching Match in 2000:

A logger sells a truckload of lumber for $100.

His cost of production is $120.

How does Arthur Andersen determine that his profit margin is $60?

 


In an Enron tort litigation trial, the defense attorney was cross-examining a pathologist.

Attorney: Before you signed the death certificate, had you taken the pulse?

Coroner: No.

Attorney: Did you listen to the heart?

Coroner: No.

Attorney: Did you check for breathing?

Coroner: No.

Attorney: So, when you signed the death certificate, you weren't sure the man was dead, were you?

Coroner: Well, let me put it this way. The man's brain was sitting in a jar on my desk. But I guess he still managed to audit Enron.


Forwarded by George Lan

1. Enronitis : A company suffering from accounting concerns 

2. To do an "enron" : To do an end-run


One of my colleages keeps referring to "getting 'Layed.'"


Forwarded by Glen Gray

A company is interviewing candidates for a new position. 

The first candidate is an engineer. The interviewer says, "I only have one question, what is 2 plus 2?" The engineer pulls out his calculator and punches in the numbers and says, "4.000000." 

The next candidate is a lawyer. She says 4, but wraps her answer in legalize. 

The third candidate is a CPA. When asked what is 2 plus 2, he looks around and looks at the interviewer and says, "Whatever you want it to be."

 


A message from William Brent Carper [TeamCarp@aucegypt.edu

Feudalism 
You have two cows. Your lord takes some of the milk. 

Fascism 
You have two cows. The government takes both, hires you to take care of them, and sells you the milk.

Communism
You have two cows. Your neighbors help take care of them and you share the milk.

 Totalitarianism
You have two cows. The government takes them both and denies they ever existed and drafts you into the army. Milk is banned. 

Capitalism
You have two cows. You sell one and buy a bull. Your herd multiplies, and the economy grows. You sell them and retire on the income. 

Enron Venture Capitalism 
You have two cows. You sell three of them to your publicly listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows. The milk rights of the six cows are transferred via an intermediary to a Cayman Island company secretly owned by the majority shareholder who sells the rights to all seven cows back to your listed company. The annual report says the company owns eight cows, with an option on one more.

Enronism: 
You have two cows. You borrow 80% of the forward value of the two cows from your bank, then buy another cow with 5% down and the rest financed by the seller on a note callable if your market cap goes below $20B at a rate 2 times prime. You now sell three cows to your publicly listed company, using letters of credit opened by your brother-in-law at a 2nd bank, then execute a debt/equity swap with an associated general offer so that you get four cows back, with a tax exemption for five cows. The milk rights of six cows are transferred via an intermediary to a Cayman Island company secretly owned by the majority shareholder who sells the rights to seven cows back to your listed company. The annual report says the company owns eight cows, with an option on one more and this transaction process is upheld by your independent auditor and no Balance Sheet is provided with the press release that announces that Enron as a major owner of cows will begin trading cows via the Internet site COW (cows on web).


A Message from Hossein Nouri [hnouri@TCNJ.EDU

In case you were wondering how Enron came into so much trouble, here is an explanation reputedly given by an Ag Eco professor at Texas A&M, to explain it in terms his students could understand.

CAPITALISM:

You have two cows.

You sell one and buy a bull.

Your herd multiplies and you hire cowhands to help out on the ranch. You sell cattle.

The economy grows and eventually you can pass the business on and your cowhands can retire on the profits.

ENRON VENTURE CAPITALISM:

You have two cows. You sell three of them to your publicly listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows.

The milk rights of the six cows are transferred via an intermediary to a Cayman Island company secretly owned by the majority shareholder who sells the rights to all seven cows back to your listed company.

The annual report says the company owns eight cows, with an option on one more.

Now do you see why a company with $62 billion in assets is declaring bankruptcy?


"President Bush didn't help the company's image, joking over the weekend that Saddam Hussein has now agreed to weapons inspections. "The bad news is he wants Arthur Andersen to do it," Bush said."

(from: http://www.latimes.com/business/la-012902berardino.story  )

The founder-namesake of the Enron-racked accounting megafirm (Arthur Andersen) was born in 1885, the stalwart son of new Norwegian immigrants, and to his dying day in 1947 at age 61, he maintained a passion for preserving Norwegian history. He even held an honorary degree from St. Olaf College. And would you believe he straightened out the finances of a pioneering energy empire and won his reputation for honesty by keeping it from bankruptcy? Is that a cosmic joke, or what? Not if you bought Enron stock at $80 a share, it's not.
Ken Ringle Washington Post Staff Writer --- http://faculty.trinity.edu/rjensen/history.htm#AndersenHistory 
(There are some humorous and some sobering parts of this article by Ken Ringle that Don Ramsey pointed out to me.)

Fraud Follies from http://www.cfenet.com/media/follies.asp

Fraud Follies

The business of fraud isn't always serious. Below are some of our favorite funny stories. If you would like to share one with us, please send it to fraudfollies@cfenet.com.

We are neither hunters nor gatherers.  We are accountants..
New Yorker
Cartoon

It's up to you now Miller.  The only thing that can save us is an accounting breakthrough.
New Yorker
Cartoon

Money is life's report card.
New Yorker
Cartoon

Millions is craft.  Billions is art.
New Yorker
Cartoon

My strength is the strength of ten, because I'm rich.
New Yorker Cartoon

Picture a Pig Ready for Market
Basic economics --- sometimes the parts are worth more than the whole.
New Yorker
Cartoon

You drive yourself too hard.  You really must learn to take time to stop and sniff the profits.
New Yorker
Cartoon

I was on the cutting edge.  I pushed the envelope.  I did the heavy lifting.  I was the rain maker.  Then suddenly it all crashed when I ran out of metaphors.
New Yorker
Cartoon

Try as we might, sir, our team of management consultants has been unable to find a single fault in the manner in which you conduct your business.  Everything you do is a hundred per cent right.  Keep it up!  That will be eleven thousand dollars.
New Yorker Cartoon

It's kinda fun to play on words. I'm always inspired by an Anne Murray song entitled "Little Good News" --- http://www.lyricsdepot.com/anne-murray/little-good-news.html 

I rolled out this morning...ACEMers had email systems on 
AccountingWeb tells of an audit failure long after old Enron 
SmartPros shows us how accounting careers have grown dicey 
It's gonna get worse you see, we need a change in policy

There's a Wall Street Journal rolled up in a rubber band 
One more sad story's one more than I can stand 
Just once, how I'd like to see the headline say 
Not much to print about, can't find any frauds today

Because...

Nobody cheated on taxes owed 
No lawsuits filed, no investors got POed 
No new FASB rules, no unaccounted stock options in our pay 
We sure could use a little good news today

I'll come home this evening...I'll bet that the news will be the same 
Ernst & Young's fired a partner, PwC's been found to blame 
How I wanna hear the anchor man talk about a county fair 
And how we cleaned up the air...how everybody's playing fair

Whoa, tell me...

Nobody was cheated by their brokers 
And the mutual funds all played square 
And everybody loves everybody in the good old USA 
We sure could use a little good news today

Nobody embezzled a widow on the lower side of town 
Nobody OD'd, only the courthouses got burned down 
Nobody failed an exam...nobody cussed out FAS 133 
Now that would surely be good news for me

Sorry folks!

Bob Jensen

-----Original Message----- 
From: Richard C. Sansing [mailto:Richard.C.Sansing@DARTMOUTH.EDU]  
Sent: Wednesday, October 22, 2003 10:28 AM 
Subject: Re: An accounting parody

--- You wrote:

I am looking for an "accounting" song. I would like to be able to have a popular song and change some of the lyrics to include basic accounting principles but my creative juices do not flow in that way. Does anyone know of such a parody?

--- end of quote ---

Possibilities include "Enron-Ron-Ron" (on the Capital Steps CD, "When Bush comes to shove") and "When IRS Guys are Smilin'" (Capital Steps, "Unzippin' My Doodah"). Also, the first part of "I want to be a producer" (The Producers) deals with accounting.

Richard C. Sansing Associate Professor of Business Administration Tuck School of Business at Dartmouth 100 Tuck Hall Hanover, NH 03755

Office: Tuck 203A Phone: (603) 646-0392 Fax: (603) 646-0995 email: Richard.C.Sansing@dartmouth.edu  URL: http://mba.tuck.dartmouth.edu/pages/faculty/richard.sansing/  
Luck is the residue of design--Branch Rickey

KEVIN WOODWARD Free Folksongs (audio clips) --- http://www.islandnet.com/~kew/cd.html 
Includes part of the song "Henry the Accountant"
October 24, 2003 message from Dave Albrecht [albrecht@PROFALBRECHT.COM

A sound clip of Henry the Accountant can be found at --- http://www.islandnet.com/~kew/cd.html

Other songs about an accountant:

The Ballad of Kenny-Boy --- http://www.congocookbook.com/ballad.html

My Cat Accountant --- http://www.cherylwheeler.com/songs/mca.html

Somehow, Says My Accountant --- http://www.amiright.com/parody/misc/judygarland3.shtml

 

 



The Wall Street Journal's full text of what happened at Enron as of January 15, 2002 --- http://interactive.wsj.com/pages/enronpage.htm 



Frank Partnoy's Testimony on Enron's Derivative Financial Instruments Frauds

I am submitting testimony in response to this Committee’s request that I address potential problems associated with the unregulated status of derivatives used by Enron Corporation. . . . In short, Enron makes Long-Term Capital Management look like a lemonade stand.
Testimony of Frank Partnoy Professor of Law, University of San Diego School of Law Hearings before the United States Senate Committee on Governmental Affairs, January 24, 2002 --- http://www.senate.gov/~gov_affairs/012402partnoy.htm 

 

TESTIMONY   

 
   

Testimony of Frank Partnoy
Professor of Law, University of San Diego School of Law
Hearings before the United States Senate
Committee on Governmental Affairs, January 24, 2002

I am submitting testimony in response to this Committee’s request that I address potential problems associated with the unregulated status of derivatives used by Enron Corporation.

I.                Introduction and Overview

I am a law professor at the University of San Diego School of Law.  I teach and research in the areas of financial market regulation, derivatives, and structured finance.  During the mid-1990s, I worked on Wall Street structuring and selling financial instruments and investment vehicles similar to those used by Enron.  As a lawyer, I have represented clients with problems similar to Enron’s, but on a much smaller scale.  I have never received any payment from Enron or from any Enron officer or employee.

Enron has been compared to Long-Term Capital Management, the Greenwich, Connecticut, hedge fund that lost $4.6 billion on more than $1 trillion of derivatives and was rescued in September 1998 in a private bailout engineered by the New York Federal Reserve.  For the past several weeks, I have conducted my own investigation into Enron, and I believe the comparison is inapt.  Yes, there are similarities in both firms’ use and abuse of financial derivatives.  But the scope of Enron’s problems and their effects on its investors and employees are far more sweeping.

According to Enron’s most recent annual report, the firm made more money trading derivatives in the year 2000 alone than Long-Term Capital Management made in its entire history.  Long-Term Capital Management generated losses of a few billion dollars; by contrast, Enron not only wiped out $70 billion of shareholder value, but also defaulted on tens of billions of dollars of debts.  Long-Term Capital Management employed only 200 people worldwide, many of whom simply started a new hedge fund after the bailout, while Enron employed 20,000 people, more than 4,000 of whom have been fired, and many more of whom lost their life savings as Enron’s stock plummeted last fall.

In short, Enron makes Long-Term Capital Management look like a lemonade stand.
It will surprise many investors to learn that Enron was, at its core, a derivatives trading firm.  Nothing made this more clear than the layout of Enron’s extravagant new building – still not completed today, but mostly occupied – where the top executives’ offices on the seventh floor were designed to overlook the crown jewel of Enron’s empire: a cavernous derivatives trading pit on the sixth floor.

I believe there are two answers to the question of why Enron collapsed, and both involve derivatives.  One relates to the use of derivatives “outside” Enron, in transactions with some now-infamous special purpose entities.  The other – which has not been publicized at all – relates to the use of derivatives “inside” Enron.
Derivatives are complex financial instruments whose value is based on one or more underlying variables, such as the price of a stock or the cost of natural gas.  Derivatives can be traded in two ways: on regulated exchanges or in unregulated over-the-counter (OTC) markets.  My testimony – and Enron’s activities – involve the OTC derivatives markets.

Sometimes OTC derivatives can seem too esoteric to be relevant to average investors.  Even the well-publicized OTC derivatives fiascos of a few years ago – Procter & Gamble or Orange County, for example – seem ages away.
But the OTC derivatives markets are too important to ignore, and are critical to understanding Enron.  The size of derivatives markets typically is measured in terms of the notional values of contracts.  Recent estimates of the size of the exchange-traded derivatives market, which includes all contracts traded on the major options and futures exchanges, are in the range of $13 to $14 trillion in notional amount.  By contrast, the estimated notional amount of outstanding OTC derivatives as of year-end 2000 was $95.2 trillion.  And that estimate most likely is an understatement.

In other words, OTC derivatives markets, which for the most part did not exist twenty (or, in some cases, even ten) years ago, now comprise about 90 percent of the aggregate derivatives market, with trillions of dollars at risk every day.  By those measures, OTC derivatives markets are bigger than the markets for U.S. stocks. 
Enron may have been just an energy company when it was created in 1985, but by the end it had become a full-blown OTC derivatives trading firm.  Its OTC derivatives-related assets and liabilities increased more than five-fold during 2000 alone.

                And, let me repeat, the OTC derivatives markets are largely unregulated.  Enron’s trading operations were not regulated, or even recently audited, by U.S. securities regulators, and the OTC derivatives it traded are not deemed securities.  OTC derivatives trading is beyond the purview of organized, regulated exchanges.  Thus, Enron – like many firms that trade OTC derivatives – fell into a regulatory black hole.

                After 360 customers lost $11.4 billion on derivatives during the decade ending in March 1997, the Commodity Futures Trading Commission began considering whether to regulate OTC derivatives.  But its proposals were rejected, and in December 2000 Congress made the deregulated status of derivatives clear when it passed the Commodity Futures Modernization Act.  As a result, the OTC derivatives markets have become a ticking time bomb, which Congress thus far has chosen not to defuse. 

                Many parties are to blame for Enron’s collapse.  But as this Committee and others take a hard look at Enron and its officers, directors, accountants, lawyers, bankers, and analysts, Congress also should take a hard look at the current state of OTC derivatives regulation.  (In the remainder of this testimony, when I refer generally to “derivatives,” I am referring to these OTC derivatives markets.)

II.                Derivatives “Outside” Enron

The first answer to the question of why Enron collapsed relates to derivatives deals between Enron and several of its 3,000-plus off-balance sheet subsidiaries and partnerships.  The names of these byzantine financial entities – such as JEDI, Raptor, and LJM – have been widely reported. 

Such special purpose entities might seem odd to someone who has not seen them used before, but they actually are very common in modern financial markets.  Structured finance is a significant part of the U.S. economy, and special purpose entities are involved in most investors’ lives, even if they do not realize it.  For example, most credit card and mortgage payments flow through special purpose entities, and financial services firms typically use such entities as well.  Some special purpose entities generate great economic benefits; others – as I will describe below – are used to manipulate company’s financial reports to inflate assets, to understate liabilities, to create false profits, and to hide losses.  In this way, special purpose entities are a lot like fire: they can be used for good or ill.  Special purpose entities, like derivatives, are unregulated.

The key problem at Enron involved the confluence of derivatives and special purpose entities.  Enron entered into derivatives transactions with these entities to shield volatile assets from quarterly financial reporting and to inflate artificially the value of certain Enron assets.  These derivatives included price swap derivatives (described below), as well as call and put options.

                Specifically, Enron used derivatives and special purpose vehicles to manipulate its financial statements in three ways.  First, it hid speculator losses it suffered on technology stocks.  Second, it hid huge debts incurred to finance unprofitable new businesses, including retail energy services for new customers.  Third, it inflated the value of other troubled businesses, including its new ventures in fiber-optic bandwidth.  Although Enron was founded as an energy company, many of these derivatives transactions did not involve energy at all.

                A.                Using Derivatives to Hide Losses on Technology Stocks
                First, Enron hid hundreds of millions of dollars of losses on its speculative investments in various technology-oriented firms, such as Rhythms Net Connections, Inc., a start-up telecommunications company.  A subsidiary of Enron (along with other investors such as Microsoft and Stanford University) invested a relatively small amount of venture capital, on the order of $10 million, in Rhythms Net Connections.  Enron also invested in other technology companies.

                Rhythms Net Connections issued stock to the public in an initial public offering on April 6, 1999, during the heyday of the Internet boom, at a price of about $70 per share.  Enron’s stake was suddenly worth hundreds of millions of dollars.  Enron’s other venture capital investments in technology companies also rocketed at first, alongside the widespread run-up in the value of dot.com stocks.  As is typical in IPOs, Enron was prohibited from selling its stock for six months.

                Next, Enron entered into a series of transactions with a special purpose entity –apparently a limited partnership called Raptor (actually there were several Raptor entities of which the Rhythms New Connections Raptor was just one), which was owned by a another Enron special purpose entity, called LJM1 – in which Enron essentially exchanged its shares in these technology companies for a loan, ultimately, from Raptor.  Raptor then issued its own securities to investors and held the cash proceeds from those investors.

                The critical piece of this puzzle, the element that made it all work, was a derivatives transaction – called a “price swap derivative” – between Enron and Raptor.  In this price swap, Enron committed to give stock to Raptor if Raptor’s assets declined in value.  The more Raptor’s assets declined, the more of its own stock Enron was required to post.  Because Enron had committed to maintain Raptor’s value at $1.2 billion, if Enron’s stock declined in value, Enron would need to give Raptor even more stock.  This derivatives transaction carried the risk of diluting the ownership of Enron’s shareholders if either Enron’s stock or the technology stocks Raptor held declined in price.  Enron also apparently entered into options transactions with Raptor and/or LJM1.

                Because the securities Raptor issued were backed by Enron’s promise to deliver more shares, investors in Raptor essentially were buying Enron’s debt, not the stock of a start-up telecommunications company.  In fact, the performance of Rhythms Net Connections was irrelevant to these investors in Raptor.  Enron got the best of both worlds in accounting terms: it recognized its gain on the technology stocks by recognizing the value of the Raptor loan right away, and it avoided recognizing on an interim basis any future losses on the technology stocks, were such losses to occur.

                It is painfully obvious how this story ends: the dot.com bubble burst and by 2001 shares of Rhythms Net Communications were worthless.  Enron had to deliver more shares to “make whole” the investors in Raptor and other similar deals.  In all, Enron had derivative instruments on 54.8 million shares of Enron common stock at an average price of $67.92 per share, or $3.7 billion in all.  In other words, at the start of these deals, Enron’s obligation amounted to seven percent of all of its outstanding shares.  As Enron’s share price declined, that obligation increased and Enron’s shareholders were substantially diluted.  And here is the key point: even as Raptor’s assets and Enron’s shares declined in value, Enron did not reflect those declines in its quarterly financial statements.

                B.                Using Derivatives to Hide Debts Incurred by Unprofitable Businesses
                A second example involved Enron using derivatives with two special purpose entities to hide huge debts incurred to finance unprofitable new businesses.  Essentially, some very complicated and unclear accounting rules allowed Enron to avoid disclosing certain assets and liabilities.

                These two special purpose entities were Joint Energy Development Investments Limited Partnership (JEDI) and Chewco Investments, L.P. (Chewco).  Enron owned only 50 percent of JEDI, and therefore – under applicable accounting rules – could (and did) report JEDI as an unconsolidated equity affiliate.  If Enron had owned 51 percent of JEDI, accounting rules would have required Enron to include all of JEDI’s financial results in its financial statements.  But at 50 percent, Enron did not.

                JEDI, in turn, was subject to the same rules.  JEDI could issue equity and debt securities, and as long as there was an outside investor with at least 50 percent of the equity – in other words, with real economic exposure to the risks of Chewco – JEDI would not need to consolidate Chewco.

                One way to minimize the applicability of this “50 percent rule” would be for a company to create a special purpose entity with mostly debt and only a tiny sliver of equity, say $1 worth, for which the company easily could find an outside investor.  Such a transaction would be an obvious sham, and one might expect to find a pronouncement by the accounting regulators that it would not conform to Generally Acceptable Accounting Principles.  Unfortunately, there are no such accounting regulators, and there was no such pronouncement.  The Financial Accounting Standards Board, a private entity that sets most accounting rules and advises the Securities and Exchange Commission, had not – and still has not – answered the key accounting question: what constitutes sufficient capital from an independent source, so that a special purpose entity need not be consolidated?

Since 1982, Financial Accounting Standard No. 57, Related Party Disclosures, has contained a general requirement that companies disclose the nature of relationships they have with related parties, and describe transactions with them.  Accountants might debate whether Enron’s impenetrable footnote disclosure satisfies FAS No. 57, but clearly the disclosures currently made are not optimal.  Members of the SEC staff have been urging the FASB to revise No. 57, but it has not responded.  In 1998, FASB adopted FAS No. 133, which includes new accounting rules for derivatives.  Now at 800-plus pages, FAS No. 133’s instructions are an incredibly detailed – but ultimately unhelpful – attempt to rationalize other accounting rules for derivatives.

                As a result, even after two decades, there is no clear answer to the question about related parties.  Instead, some early guidance (developed in the context of leases) has been grafted onto modern special purpose entities.  This guidance is a 1991 letter from the Acting Chief Accountant of the SEC in 1991, stating: “The initial substantive residual equity investment should be comparable to that expected for a substantive business involved in similar [leasing] transactions with similar risks and rewards.  The SEC staff understands from discussions with Working Group members that those members believe that 3 percent is the minimum acceptable investment.  The SEC staff believes a greater investment may be necessary depending on the facts and circumstances, including the credit risk associated with the lessee and the market risk factors associated with the leased property.” 

Based on this letter, and on opinions from auditors and lawyers, companies have been pushing debt off their balance sheets into unconsolidated special purpose entities so long as (1) the company does not have more than 50 percent of the equity of the special purpose entity, and (2) the equity of the special purpose entity is at least 3 percent of its the total capital.  As more companies have done such deals, more debt has moved off balance-sheet, to the point that, today, it is difficult for investors to know if they have an accurate picture of a company’s debts.  Even if Enron had not tripped up and violated the letter of these rules, it still would have been able to borrow 97 percent of the capital of its special purpose entities without recognizing those debts on its balance sheet. 

Transactions designed to exploit these accounting rules have polluted the financial statements of many U.S. companies.  Enron is not alone.  For example, Kmart Corporation – which was on the verge of bankruptcy as of January 21, 2002, and clearly was affected by Enron’s collapse – held 49 percent interests in several unconsolidated equity affiliates.  I believe this Committee should take a hard look at these widespread practices.

                In short, derivatives enabled Enron to avoid consolidating these special purpose entities.  Enron entered into a derivatives transaction with Chewco similar to the one it entered into with Raptor, effectively guaranteeing repayment to Chewco’s outside investor.  (The investor’s sliver of equity ownership in Chewco was not really equity from an economic perspective, because the investor had nothing – other than Enron’s credit – at risk.)  In its financial statements, Enron takes the position that although it provides guarantees to unconsolidated subsidiaries, those guarantees do not have a readily determinable fair value, and management does not consider it likely that Enron would be required to perform or otherwise incur losses associated with guarantees.  That position enabled Enron to avoid recording its guarantees.  Even the guarantees listed in the footnotes are recorded at only 10 percent of their nominal value.  (At least this amount is closer to the truth than the amount listed as debt for unconsolidated subsidiaries: zero.)

                Apparently, Arthur Andersen either did not discover this derivatives transaction or decided that the transaction did not require a finding that Enron controlled Chewco.  In any event, the Enron derivatives transaction meant that Enron – not the 50 percent “investor” in Chewco – had the real exposure to Chewco’s assets.  The ownership daisy chain unraveled once Enron was deemed to own Chewco.  JEDI was forced to consolidate Chewco, and Enron was forced to consolidate both limited partnerships – and all of their losses – in its financial statements.

                All of this complicated analysis will seem absurd to the average investor.  If the assets and liabilities are Enron’s in economic terms, shouldn’t they be reported that way in accounting terms?  The answer, of course, is yes.  Unfortunately, current rules allow companies to employ derivatives and special purpose entities to make accounting standards diverge from economic reality.  Enron used financial engineering as a kind of plastic surgery, to make itself look better than it really was.  Many other companies do the same.

                Of course, it is possible to detect the flaws in plastic surgery, or financial engineering, if you look hard enough and in the right places.  In 2000, Enron disclosed about $2.1 billion of such derivatives transactions with related entities, and recognized gains of about $500 million related to those transactions.  The disclosure related to these staggering numbers is less than conspicuous, buried at page 48, footnote 16 of Enron’s annual report, deep in the related party disclosures for which Enron was notorious.  Still, the disclosure is there.  A few sophisticated analysts understood Enron’s finances based on that disclosure; they bet against Enron’s stock.  Other securities analysts likely understood the disclosures, but chose not to speak, for fear of losing Enron’s banking business.  An argument even can be made – although not a good one, in my view – that Enron satisfied its disclosure obligations with its opaque language.  In any event, the result of Enron’s method of disclosure was that investors did not get a clear picture of the firm’s finances. 

                Enron is not the only example of such abuse; accounting subterfuge using derivatives is widespread.  I believe Congress should seriously consider legislation explicitly requiring that financial statements describe the economic reality of a company’s transactions.  Such a broad standard – backed by rigorous enforcement – would go a long way towards eradicating the schemes companies currently use to dress up their financial statements.

                Enron’s risk management manual stated the following: “Reported earnings follow the rules and principles of accounting.  The results do not always create measures consistent with underlying economics.  However, corporate management’s performance is generally measured by accounting income, not underlying economics.  Risk management strategies are therefore directed at accounting rather than economic performance.”  This alarming statement is representative of the accounting-driven focus of U.S. managers generally, who all too frequently have little interest in maintaining controls to monitor their firm’s economic realities.

                C.                Using Derivatives to Inflate the Value of Troubled Businesses
A third example is even more troubling.  It appears that Enron inflated the value of certain assets it held by selling a small portion of those assets to a special purpose entity at an inflated price, and then revaluing the lion’s share of those assets it still held at that higher price. 

Consider the following sentence disclosed from the infamous footnote 16 of Enron’s 2000 annual report, on page 49: “In 2000, Enron sold a portion of its dark fiber inventory to the Related Party in exchange for $30 million cash and a $70 million note receivable that was subsequently repaid.  Enron recognized gross margin of $67 million on the sale.”  What does this sentence mean?

It is possible to understand the sentence today, but only after reading a January 7, 2002, article about the sale by Daniel Fisher of Forbes magazine, together with an August 2001 memorandum describing the transaction (and others) from one Enron employee, Sherron Watkins, to Enron Chairman Kenneth Lay.
Here is my best understanding of what this sentence means:

First, the “Related Party” is LJM2, an Enron partnership run by Enron’s Chief Financial Officer, Andrew Fastow.  (Fastow reportedly received $30 million from the LJM1 and LJM2 partnerships pursuant to compensation arrangements Enron’s board of directors approved.)

Second, “dark fiber” refers to a type of bandwidth Enron traded as part of its broadband business.  In this business, Enron traded the right to transmit data through various fiber-optic cables, more than 40 million miles of which various Internet-related companies had installed in the United States.  Only a small percentage of these cables were “lit” – meaning they could transmit the light waves required to carry Internet data; the vast majority of cables were still awaiting upgrades and were “dark.”  The rights associated with those “dark” cables were called “dark fiber.”  As one might expect, the rights to transmit over “dark fiber” are very difficult to value.

Third, Enron sold “dark fiber” it apparently valued at only $33 million for triple that value: $100 million in all – $30 million in cash plus $70 million in a note receivable.  It appears that this sale was at an inflated price, thereby enabling Enron to record a $67 million profit on that trade.  LJM2 apparently obtained cash from investors by issuing securities and used some of these proceeds to repay the note receivable issued to Enron.

What the sentence in footnote 16 does not make plain is that the investor in LJM2 was persuaded to pay what appears to be an inflated price, because Enron entered into a “make whole” derivatives contract with LJM2 (of the same type it used with Raptor).  Essentially, the investor was buying Enron’s debt.  The investor was willing to buy securities in LJM2, because if the “dark fiber” declined in price – as it almost certainly would, from its inflated value – Enron would make the investor whole.
In these transactions, Enron retained the economic risk associated with the “dark fiber.”  Yet as the value of “dark fiber” plunged during 2000, Enron nevertheless was able to record a gain on its sale, and avoid recognizing any losses on assets held by LJM2, which was an unconsolidated affiliate of Enron, just like JEDI.

As if all of this were not complicated enough, Enron’s sale of “dark fiber” to LJM2 also magically generated an inflated price, which Enron then could use in valuing any remaining “dark fiber” it held.  The third-party investor in LJM2 had, in a sense, “validated” the value of the “dark fiber” at the higher price, and Enron then arguably could use that inflated price in valuing other “dark fiber” assets it held.  I do not have any direct knowledge of this, although public reports and Sherron Watkins’s letter indicate that this is precisely what happened.

For example, suppose Enron started with ten units of “dark fiber,” worth $100, and sold one to a special purpose entity for $20 – double its actual value – using the above scheme.  Now, Enron had an argument that each of its remaining nine units of “dark fiber” also were worth $20 each, for a total of $180. 

Enron then could revalue its remaining nine units of “dark fiber” at a total of $180.  If the assets used in the transaction were difficult to value – as “dark fiber” clearly was – Enron’s inflated valuation might not generate much suspicion, at least initially.  But ultimately the valuations would be indefensible, and Enron would need to recognize the associated losses.

It is an open question for this Committee and others whether this transaction was unique, or whether Enron engaged in other, similar deals.  It seems likely that the “dark fiber” deal was not the only one of its kind.  There are many sentences in footnote 16.

                D.                The “Gatekeepers”
These are but three examples of how Enron’s derivatives dealings with outside parties resulted in material information not being reflected in market prices.  There are others, many within JEDI alone.  I have attempted to summarize this information for the Committee.  Clearly it is important that investigators question the Enron employees who were directly involved in these transactions to get a sense of whether my summaries are complete.

Moreover, a thorough inquiry into these dealings also should include the major financial market “gatekeepers” involved with Enron: accounting firms, banks, law firms, and credit rating agencies.  Employees of these firms are likely to have knowledge of these transactions.  Moreover, these firms have a responsibility to come forward with information relevant to these transactions.  They benefit directly and indirectly from the existence of U.S. securities regulation, which in many instances both forces companies to use the services of gatekeepers and protects gatekeepers from liability. 

Recent cases against accounting firms – including Arthur Andersen – are eroding that protection, but the other gatekeepers remain well insulated.  Gatekeepers are kept honest – at least in theory – by the threat of legal liability, which is virtually non-existent for some gatekeepers.  The capital markets would be more efficient if companies were not required by law to use particular gatekeepers (which only gives those firms market power), and if gatekeepers were subject to a credible threat of liability for their involvement in fraudulent transactions.  Congress should consider expanding the scope of securities fraud liability by making it clear that these gatekeepers will be liable for assisting companies in transactions designed to distort the economic reality of financial statements.

With respect to Enron, all of these gatekeepers have questions to answer about the money they received, the quality of their work, and the extent of their conflicts of interest.  It has been reported widely that Enron paid $52 million in 2000 to its audit firm, Arthur Andersen, the majority of which was for non-audit related consulting services, yet Arthur Andersen failed to spot many of Enron’s losses.  It also seems likely that at least one of the other “Big 5” accounting firms was involved at least one of Enron’s special purpose entities. 

Enron also paid several hundred million dollars in fees to investment and commercial banks for work on various financial aspects of its business, including fees for derivatives transactions, and yet none of those firms pointed out to investors any of the derivatives problems at Enron.  Instead, as late as October 2001 sixteen of seventeen the securities analysts covering Enron rated it a “strong buy” or “buy.” 
Enron paid substantial fees to its outside law firm, which previously had employed Enron’s general counsel, yet that firm failed to correct or disclose the problems related to derivatives and special purpose entities.  Other law firms also may have been involved in these transactions; if so, they should be questioned, too.

Finally, and perhaps most importantly, the three major credit rating agencies – Moody’s, Standard & Poor’s, and Fitch/IBCA – received substantial, but as yet undisclosed, fees from Enron.  Yet just weeks prior to Enron’s bankruptcy filing – after most of the negative news was out and Enron’s stock was trading at just $3 per share – all three agencies still gave investment grade ratings to Enron’s debt.  The credit rating agencies in particular have benefited greatly from a web of legal rules that essentially require securities issuers to obtain ratings from them (and them only), and at the same time protect those agencies from outside competition and liability under the securities laws.  They are at least partially to blame for the Enron mess.

                An investment-grade credit rating was necessary to make Enron’s special purpose entities work, and Enron lived on the cusp of investment grade.  During 2001, it was rated just above the lowest investment-grade rating by all three agencies: BBB+ by Standard & Poor’s and Fitch IBCA, and Baa1 by Moody’s.  Just before Enron’s bankruptcy, all three rating agencies lowered Enron’s rating two notches, to the lowest investment grade rating.  Enron noted in its most recent annual report that its “continued investment grade status is critical to the success of its wholesale business as well as its ability to maintain adequate liquidity.”  Many of Enron’s debt obligations were triggered by a credit ratings downgrade; some of those obligations had been scheduled to mature December 2001.  The importance of credit ratings at Enron and the timing of Enron’s bankruptcy filing are not coincidences; the credit rating agencies have some explaining to do.

                Derivatives based on credit ratings – called “credit derivatives” – are a booming business and they raise serious systemic concerns.  The rating agencies seem to know this.  Even Moody’s appears worried, and recently asked several securities firms for more detail about their dealings in these instruments.  It is particularly chilling that not even Moody’s – the most sophisticated of the three credit rating agencies – knows much about these derivatives deals.

III.                Derivatives “Inside” Enron

The derivatives problems at Enron went much deeper than the use of special purpose entities with outside investors.  If Enron had been making money in what it represented as its core businesses, and had used derivatives simply to “dress up” its financial statements, this Committee would not be meeting here today.  Even after Enron restated its financial statements on November 8, 2001, it could have clarified its accounting treatment, consolidated its debts, and assured the various analysts that it was a viable entity.  But it could not.  Why not?

This question leads me to the second explanation of Enron’s collapse: most of what Enron represented as its core businesses were not making money.  Recall that Enron began as an energy firm.  Over time, Enron shifted its focus from the bricks-and-mortar energy business to the trading of derivatives.  As this shift occurred, it appears that some of its employees began lying systematically about the profits and losses of Enron’s derivatives trading operations.  Simply put, Enron’s reported earnings from derivatives seem to be more imagined than real.  Enron’s derivatives trading was profitable, but not in the way an investor might expect based on the firm’s financial statements.  Instead, some Enron employees seem to have misstated systematically their profits and losses in order to make their trading businesses appear less volatile than they were.

                First, a caveat.  During the past few weeks, I have been gathering information about Enron’s derivatives operations, and I have learned many disturbing things.  Obviously, I cannot testify first hand to any of these matters.  I have never been on Enron’s trading floor, and I have never been involved in Enron’s business.  I cannot offer fact testimony as to any of these matters.

                Nonetheless, I strongly believe the information I have gathered is credible.  It is from many sources, including written information, e-mail correspondence, and telephone interviews.  Congressional investigators should be able to confirm all of these facts.  In any event, even if only a fraction of the information in this section of my testimony proves to be correct, it will be very troubling indeed.

                In a nutshell, it appears that some Enron employees used dummy accounts and rigged valuation methodologies to create false profit and loss entries for the derivatives Enron traded.  These false entries were systematic and occurred over several years, beginning as early as 1997.  They included not only the more esoteric financial instruments Enron began trading recently – such as fiber-optic bandwidth and weather derivatives – but also Enron’s very profitable trading operations in natural gas derivatives.

                Enron derivatives traders faced intense pressure to meet quarterly earnings targets imposed directly by management and indirectly by securities analysts who covered Enron.  To ensure that Enron met these estimates, some traders apparently hid losses and understated profits.  Traders apparently manipulated the reporting of their “real” economic profits and losses in an attempt to fit the “imagined” accounting profits and losses that drove Enron management.

                A.                Using “Prudency” Reserves
                Enron’s derivatives trading operations kept records of the traders’ profits and losses.  For each trade, a trader would report either a profit or a loss, typically in spreadsheet format.  These profit and loss reports were designed to reflect economic reality.  Frequently, they did not.

                Instead of recording the entire profit for a trade in one column, some traders reportedly split the profit from a trade into two columns.  The first column reflected the portion of the actual profits the trader intended to add to Enron’s current financial statements.  The second column, ironically labeled the “prudency” reserve, included the remainder.

                To understand this concept of a “prudency” reserve, suppose a derivatives trader earned a profit of $10 million.  Of that $10 million, the trader might record $9 million as profit today, and enter $1 million into “prudency.”  An average deal would have “prudency” of up to $1 million, and all of the “prudency” entries might add up to $10 to $15 million.

                Enron’s “prudency” reserves did not depict economic reality, nor could they have been intended to do so.  Instead, “prudency” was a slush fund that could be used to smooth out profits and losses over time.  The portion of profits recorded as “prudency” could be used to offset any future losses. 

                In essence, the traders were saving for a rainy day.  “Prudency” reserves would have been especially effective for long-maturity derivatives contracts, because it was more difficult to determine a precise valuation as of a particular date for those contracts, and any “prudency” cushion would have protected the traders from future losses for several years going forward.

                As luck would have it, some of the “prudency” reserves turned out to be quite prudent.  In one quarter, some derivatives traders needed so much accounting profit to meet their targets that they wiped out all of their “prudency” accounts. 

                Saving for a rainy day is not necessarily a bad idea, and it seems possible that derivatives traders at Enron did not believe they were doing anything wrong.  But “prudency” accounts are far from an accepted business practice.  A trader who used a “prudency” account at a major Wall Street firm would be seriously disciplined, or perhaps fired.  To the extent Enron was smoothing its income using “prudency” entries, it was misstating the volatility and current valuation of its trading businesses, and misleading its investors.  Indeed, such fraudulent practices would have thwarted the very purpose of Enron’s financial statements: to give investors an accurate picture of a firm’s risks.

                B.                Mismarking Forward Curves
                Not all of the misreporting of derivatives positions at Enron was as brazen as “prudency.”  Another way derivatives frequently are used to misstate profits and losses is by mismarking “forward curves.”  It appears that Enron traders did this, too.

                A forward curve is a list of “forward rates” for a range of maturities.  In simple terms, a forward rate is the rate at which a person can buy something in the future. 

                For example, natural gas forward contracts trade on the New York Mercantile Exchange (NYMEX).  A trader can commit to buy a particular type of natural gas to be delivered in a few weeks, months, or even years.  The rate at which a trader can buy natural gas in one year is the one-year forward rate.  The rate at which a trader can buy natural gas in ten years is the ten-year forward rate.  The forward curve for a particular natural gas contract is simply the list of forward rates for all maturities.

                Forward curves are crucial to any derivatives trading operation because they determine the value of a derivatives contract today.  Like any firm involved in trading derivatives, Enron had risk management and valuation systems that used forward curves to generate profit and loss statements.

                It appears that Enron traders selectively mismarked their forward curves, typically in order to hide losses.  Traders are compensated based on their profits, so if a trader can hide losses by mismarking forward curves, he or she is likely to receive a larger bonus.

                These losses apparently ranged in the tens of millions of dollars for certain markets.  At times, a trader would manually input a forward curve that was different from the market.  For more complex deals, a trader would use a spreadsheet model of the trade for valuation purposes, and tweak the assumptions in the model to make a transaction appear more or less valuable.  Spreadsheet models are especially susceptible to mismarking.

                Certain derivatives contracts were more susceptible to mismarking than others.  A trader would be unlikely to mismark contracts that were publicly traded – such as the natural gas contracts traded on NYMEX – because quotations of the values of those contracts are publicly available.  However, the NYMEX forward curve has a maturity of only six years; accordingly, a trader would be more likely to mismark a ten-year natural gas forward rate. 

                At Enron, forward curves apparently remained mismarked for as long as three years.  In more esoteric areas, where markets were not as liquid, traders apparently were even more aggressive.  One trader who already had recorded a substantial profit for the year, and believed any additional profit would not increase his bonus much, reportedly reduced his recorded profits for one year, so he could push them forward into the next year, which he wasn’t yet certain would be as profitable.  This strategy would have resembled the “prudency” accounts described earlier.

                C.                Warning Signs
                Why didn’t any of the “gatekeepers” tell investors that Enron was so risky?  There were numerous warning signs related to Enron’s derivatives trading.  Yet the gatekeepers either failed utterly to spot those signs, or spotted those signs and decided not to warn investors about them.  Either way, the gatekeepers failed to do their job.  This was so even though there have been several recent and high-profile cases involving internal misreporting of derivatives.

                Enron disclosed that it used “value at risk” (VAR) methodologies that captured a 95 percent confidence interval for a one-day holding period, and therefore did not disclose worst-case scenarios for Enron’s trading operations.  Enron said it relied on “the professional judgment of experienced business and risk managers” to assess these worst-case scenarios (which, apparently, Enron ultimately encountered).  Enron reported only high and low month-end values for its trading, and therefore had incentives to smooth its profits and losses at month-end.  Because Enron did not report its maximum VAR during the year, investors had no way of knowing just how much risk Enron was taking.

                Even the reported VAR figures are remarkable.  Enron reported VAR for what it called its “commodity price” risk – including natural gas derivatives trading – of $66 million, more than triple the 1999 value.  Enron reported VAR for its equity trading of $59 million, more than double the 1999 value.  A VAR of $66 million meant that Enron could expect based on historical averages that on five percent of all trading days (on average, twelve business days during the year) its “commodity” derivatives trading operations alone would gain or lose $66 million, a not trivial sum.

                Moreover, because Enron’s derivatives frequently had long maturities – maximum terms ranged from 6 to 29 years – there often were not prices from liquid markets to use as benchmarks.  For those long-dated derivatives, professional judgment was especially important.  For a simple instrument, Enron might calculate the discounted present value of cash flows using Enron’s borrowing rates.  But more complex instruments required more complex methodologies.  For example, Enron completed over 5,000 weather derivatives deals, with a notional value of more than $4.5 billion, and many of those deals could not be valued without a healthy dose of professional judgment.  The same was true of Enron’s trading of fiber-optic bandwidth.

                And finally there was the following flashing red light in Enron’s most recent annual report: “In 2000, the value at risk model utilized for equity trading market risk was refined to more closely correlate with the valuation methodologies used for merchant activities.”  Enron’s financial statements do not describe these refinements, and their effects, but given the failure of the risk and valuation models even at a sophisticated hedge fund such as Long-Term Capital Management – which employed “rocket scientists” and Nobel laureates to design various sophisticated computer models – there should have been reason for concern when Enron spoke of “refining” its own models.

                It was Arthur Andersen’s responsibility not only to audit Enron’s financial statements, but also to assess Enron management’s internal controls on derivatives trading.  When Arthur Andersen signed Enron’s 2000 annual report, it expressed approval in general terms of Enron’s system of internal controls during 1998 through 2000.

                Yet it does not appear that Arthur Andersen systematically and independently verified Enron’s valuations of certain complex trades, or even of its forward curves.  Arthur Andersen apparently examined day-to-day changes in these values, as reported by traders, and checked to see if each daily change was recorded accurately.  But this Committee – and others investigating Enron – should inquire about whether Arthur Andersen did anything more than sporadically check Enron’s forward curves.

                To Arthur Andersen’s credit as an auditor, much of the relevant risk information is contained in Enron’s financial statements.  What is unclear is whether Arthur Andersen adequately considered this information in opining that Enron management’s internal controls were adequate.  To the extent Arthur Andersen alleges – as I understand many accounting firms do – that their control opinion does not cover all types of control failures and necessarily is based on management’s “assertions,” it is worth noting that the very information Arthur Andersen audited raised substantial questions about potential control problems at Enron.  In other words, Arthur Andersen has been hoisted by its own petard.

                But Arthur Andersen was not alone in failing to heed these warning signs.  Securities analysts and credit rating agencies arguably should have spotted them, too.  Why were so many of these firms giving Enron favorable ratings, when publicly available information indicated that there were reasons for worry?  Did these firms look the other way because they were subject to conflicts of interest?  Individual investors rely on these institutions to interpret the detailed footnote disclosures in Enron’s reports, and those institutions have failed utterly.  The investigation into Arthur Andersen so far has generated a great deal of detail about that firm’s approach to auditing Enron, but the same questions should be asked of the other gatekeepers, too.  Specifically, this Committee should ask for and closely examine all of the analyst reports on Enron from the relevant financial services firms and credit rating agencies.

                Finally, to clarify this point, consider how much Enron’s businesses had changed during its last years.  Consider the change in Enron’s assets.  Arthur Andersen’s most recent audit took place during 2000, when Enron’s derivatives-related assets increased from $2.2 billion to $12 billion, and Enron’s derivatives-related liabilities increased from $1.8 billion to $10.5 billion.  These numbers are staggering. 

                Most of this growth was due to increased trading through EnronOnline.  But EnronOnline’s assets and revenues were qualitatively different from Enron’s other derivatives trading.  Whereas Enron’s derivatives operations included speculative positions in various contracts, EnronOnline’s operations simply matched buyers and sellers.  The “revenues” associated with EnronOnline arguably do not belong in Enron’s financial statements.  In any event, the exponential increase in the volume of trading through EnronOnline did not generate substantial profits for Enron.

                Enron’s aggressive additions to revenues meant that it was the “seventh-largest U.S. company” in title only.  In reality, Enron was a much smaller operation, whose primary money-making business – a substantial and speculative derivatives trading operation – covered up poor performance in Enron’s other, smaller businesses, including EnronOnline.  Enron’s public disclosures show that during the past three years the firm was not making money on its non-derivatives businesses.  Gross margins from these businesses were essentially zero from 1998 through 2000.

                To see this, consider the table below, which sets forth Enron’s income statement separated into its non-derivatives and derivatives businesses.  I put together this table based on the numbers in Enron’s 2000 income statement, after learning from the footnote 1, page 36, that the meaning of the “Other revenues” entry on Enron’s income statement is – as far as I can tell – essentially “Gain (loss) from derivatives”:

Enron Corp. and Subsidiaries 2000 Consolidated Income Statement (in millions)

 

2000

1999

1998

Non-derivatives revenues

93,557

34,774

27,215

Non-derivatives expenses

94,517

34,761

26,381

Non-derivatives gross margin

(960)

13

834

 

 

 

 

Gain (loss) from derivatives

7,232

5,338

4,045

 

 

 

 

Other expenses

(4,319)

(4,549)

(3,501)

 

 

 

 

Operating income

1,953

802

1,378

                This chart demonstrates four key facts.  First, the recent and dramatic increase in Enron’s overall non-derivatives revenues – the statistic that supposedly made Enron the seventh-largest U.S. company – was offset by an increase in non-derivatives expenses.  The increase in revenues reflected in the first line of the chart was substantially from EnronOnline, and did not help Enron’s bottom line, because it included an increase in expenses reflected in the second line of the chart.  Although Enron itself apparently was the counterparty to all of the trades, EnronOnline simply matched buyers (“revenue”) with sellers (“expenses”).  Indeed, as non-derivatives revenues more than tripled, non-derivatives expenses increased even more.

                Second, a related point: Enron’s non-derivatives businesses were not performing well in 1998 and were deteriorating through 2000.  The third row, “Non-derivatives gross margin,” is the difference between non-derivatives revenues and non-derivatives expenses.  The downward trajectory of Enron’s non-derivatives gross margin shows, in a general sense, that Enron’s non-derivatives businesses made some money in 1998, broke even in 1999, and actually lost money in 2000. 

                Third, Enron’s positive reported operating income (the last row) was due primarily to gains from derivatives (the fourth row).  Enron – like many firms – shied from using the word “derivatives” and substituted the euphemism “Price Risk Management,” but as Enron makes plain in its public filings, the two are the same.  Excluding the gains from derivatives, Enron would have reported substantially negative operating income for all three years.

                Fourth, Enron’s gains from derivatives were very substantial.  Enron gained more than $16 billion from these activities in three years.  To place the numbers in perspective, these gains were roughly comparable to the annual net revenue for all trading activities (including stocks, bonds, and derivatives) at the premier investment firm, Goldman Sachs & Co., during the same periods, a time in which Goldman Sachs first issued shares to the public.
                The key difference between Enron and Goldman Sachs is that Goldman Sachs seems to have been upfront with investors about the volatility of its trading operations.  In contrast, Enron officials represented that it was not a trading firm, and that derivatives were used for hedging purposes.  As a result, Enron’s stock traded at much higher multiples of earnings than more candid trading-oriented firms.

                The size and scope of Enron’s derivatives trading operations remain unclear.  Enron reported gains from derivatives of $7.2 billion in 2000, and reported notional amounts of derivatives contracts as of December 31, 2000, of only $21.6 billion.  Either Enron was generating 33 percent annual returns from derivatives (indicating that the underlying contracts were very risky), or Enron actually had large positions and reduced the notional values of its outstanding derivatives contracts at year-end for cosmetic purposes.  Neither conclusion appears in Enron’s financial statements.

IV.                Conclusion

                How did Enron lose so much money?  That question has dumbfounded investors and experts in recent months.  But the basic answer is now apparent: Enron was a derivatives trading firm; it made billions trading derivatives, but it lost billions on virtually everything else it did, including projects in fiber-optic bandwidth, retail gas and power, water systems, and even technology stocks.  Enron used its expertise in derivatives to hide these losses.  For most people, the fact that Enron had transformed itself from an energy company into a derivatives trading firm is a surprise.

                Enron is to blame for much of this, of course.  The temptations associated with derivatives have proved too great for many companies, and Enron is no exception.  The conflicts of interest among Enron’s officers have been widely reported.  Nevertheless, it remains unclear how much top officials knew about the various misdeeds at Enron.  They should and will be asked.  At least some officers must have been aware of how deeply derivatives penetrated Enron’s businesses; Enron even distributed thick multi-volume Derivatives Training Manuals to new employees.  (The Committee should ask to see these manuals.)

                Enron’s directors likely have some regrets.  Enron’s Audit Committee in particular failed to uncover a range of external and internal financial gimmickry.  However, it remains unclear how much of the inner workings at Enron were hidden from the outside directors; some directors may very well have learned a great deal from recent media accounts, or even perhaps from this testimony.  Enron’s general counsel, on the other hand, will have some questions to answer.

                But too much focus on Enron misses the mark.  As long as ownership of companies is separated from their control – and in the U.S. securities market it almost always will be – managers of companies will have incentives to be aggressive in reporting financial data.  The securities laws recognize this fact of life, and create and subsidize “gatekeeper” institutions to monitor this conflict between managers and shareholders. 

                The collapse of Enron makes it plain that the key gatekeeper institutions that support our system of market capitalism have failed.  The institutions sharing the blame include auditors, law firms, banks, securities analysts, independent directors, and credit rating agencies.

                All of the facts I have described in my testimony were available to the gatekeepers.  I obtained this information in a matter of weeks by sitting at a computer in my office in San Diego, and by picking up a telephone.  The gatekeepers’ failure to discover this information, and to communicate it effectively to investors, is simply inexcusable.

                The difficult question is what to do about the gatekeepers.  They occupy a special place in securities regulation, and receive great benefits as a result.  Employees at gatekeeper firms are among the most highly-paid people in the world.  They have access to superior information and supposedly have greater expertise than average investors at deciphering that information.  Yet, with respect to Enron, the gatekeepers clearly did not do their job. 

                One potential answer is to eliminate the legal requirements that companies use particular gatekeepers (especially credit rating agencies), while expanding the scope of securities fraud liability and enforcement to make it clear that all gatekeepers will be liable for assisting companies in transactions designed to distort the economic reality of financial statements.  A good starting point before considering such legislation would be to call the key gatekeeper employees to testify.

                Congress also must decide whether, after ten years of steady deregulation, the post-Enron derivatives markets should remain exempt from the regulation that covers all other investment contracts.  In my view, the answer is no. 

                A headline in Enron’s 2000 annual report states, “In Volatile Markets, Everything Changes But Us.”  Sadly, Enron got it wrong.  In volatile markets, everything changes, and the laws should change, too.  It is time for Congress to act to ensure that this motto does not apply to U.S. financial market regulation.
 


Committee Members
| Subcommittees | Hearings | Key Legislation | Jurisdiction
 
Press Statements | Current Issues | Video of Select Hearings | Sites of Interest

 

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

Frank Partnoy is best known as a whistle blower at Goldman Sachs who blew the lid on the financial graft and sexual degeneracy of derivatives instruments traders and analysts who ripped the public off for billions of dollars and contributed to mind-boggling worldwide frauds.  He is a Yale University Law School graduate who shocked the world with  various books include the following:

  • FIASCO: The Inside Story of a Wall Street Trader
  • FIASCO: Blood in the Water on Wall Street
  • FIASCO:  Blut an den weiĂźen Westen der Wall Street Broker.
  • FIASCO: Guns, Booze and Bloodlust: the Truth About High Finance
  • Infectious Greed : How Deceit and Risk Corrupted the Financial Markets
  • Codicia Contagiosa

His other publications include the following highlight:

"The Siskel and Ebert of Financial Matters: Two Thumbs Down for the Credit Reporting Agencies" (Washington University Law Quarterly)

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


Bob Jensen's threads on Derivative Financial Instruments Fraud are at http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds 

Also note http://faculty.trinity.edu/rjensen/Fraud.htm#FrankPartnoyTestimony 


How Enron Used SPEs and Derivatives Jointly is Explained at http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm

 

Bob Jensen’s threads on derivatives accounting are at  http://faculty.trinity.edu/rjensen/caseans/000index.htm

In the end, derivatives are like antibiotics.  It's dangerous to live with them, but the world is better off because of them.  The same can be said about FAS 133 and its many implementation guides and amendments.  Booking derivatives at fair value is dangerous, but the economy would be worse off without it.  What we have to do is to strive night and day to improve upon reporting of value and risk in a world that relies more and more on derivative financial instruments to manage risks.


How Enron Used SPEs and Derivatives Jointly is Explained at http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm 


Enron Auditor Carl Bass Disclosures in 1999

"Andersen auditor questioned Enron:  Carl Bass raised accounting issues with Enron in 1999, documents show." CNNMoney,  April 2, 2002 --- http://money.cnn.com/2002/04/02/news/companies/andersen_bass/ 

Arthur Andersen auditor Carl Bass questioned Enron Corp.'s accounting practices as far back as December 1999, documents released Tuesday by congressional investigators show.

Bass expressed his discomfort in December 18, 1999, with Enron's aggressive hedging strategy for derivatives. In a message to John Stewart, an Andersen partner in Chicago, Bass said he told colleague David Duncan that he objected to using one derivative to hedge another derivative. Duncan was the lead audit partner on the Enron account.

Derivatives cannot hedge derivatives for accounting purposes -- now or under FASB 133," Bass said. "Does Dave [Duncan] think his accounting works even under FASB 133? No way."

Both Bass and Duncan reportedly are in talks with federal prosecutors and their testimony could be used in the obstruction case against Andersen.

Andersen in January fired Duncan for instigating the destruction of Enron Corp. documents. Houston-based Enron allegedly used off-the-book transactions to hide $1 billion in debt and to inflate profits. Enron, once the nation's seventh-largest company, filed the largest bankruptcy in U.S. history last December.

Arthur Andersen, Enron's auditor for 16 years, was hit with a federal indictment March 14 for allegedly obstructing justice when it destroyed Enron documents. Andersen is now near collapse and called off merger negotiations Tuesday with KPMG International. The proposed Andersen-KPMG transaction would have combined the two firms's non-U.S. partnerships.

In a February 1, 2000 e-mail to Stewart, Bass laid out issues he had with a "complicated series of Enron derivatives." Three days later, Bass sent another message stating he was "still bothered" with a partnership, SPE, and believed it to be non-substantive.

Because of such complaints, a senior Enron executive asked Duncan to remove Bass from any review responsibility for the Enron account, the Wall Street Journal reported Tuesday. Bass was removed in 2000, the WSJ said.


More Absurd Dictatorial and Counterproductive Behavior of Big Brother (read that the  Texas State Board of Public Accountancy)
Courtesy of his former doctoral student Bill Kinney, Bob Jensen was contacted by Danny and was then briefly quoted in this one ---
"Accountants, Texas board still at odds over Enron," by Danny Robbins, Bloomberg, December 24, 2010 ---
http://www.bloomberg.com/news/2010-12-24/accountants-texas-board-still-at-odds-over-enron.html 

To many in the accounting world, Carl Bass is a hero. Long before Enron became a worldwide symbol of scandal, Bass told his supervisors at Arthur Andersen LLP that something was amiss with the Houston energy giant.

But the Texas state board that licenses accountants sees Bass differently — as unfit to continue in his profession.

Nearly a decade after Enron collapsed and took Arthur Andersen with it, the work of Bass and another former Andersen partner, Thomas Bauer, as Enron auditors is still being debated in a highly contentious and costly proceeding.

The Texas State Board of Public Accountancy has stripped Bass and Bauer of their CPA licenses after determining they violated professional standards in their audits. But the pair has pushed back with a legal challenge that led a judge to rule that the license revocations should be voided because the board violated the Texas Open Meetings Act.

The revocations remain in effect while the matter is under appeal, which could take at least a year.

The upshot is a standoff playing out after most of the figures in the Enron scandal have had their days in court and raising questions about a little-known state agency that doesn't rely on the Legislature for funding.

William Treacy, the board's executive director, said it's in the public interest for Bass and Bauer to be barred from working as CPAs. He cited the depth of the Enron scandal, which led to more than $60 million in lost company stock value and more than $2 billion in losses from employee pension plans.

"There's a lot more than two licenses at stake," Treacy said. "Let's not forget the thousands of people who lost their life savings, their jobs and their pensions."

The board argues that Bass and Bauer should have their licenses revoked because they failed to follow accepted accounting practices in conducting Enron audits in 1997 and 1998.

But some observers believe the case is more one of overzealousness by the agency than insufficient audits.

Wayne Shaw, a professor of corporate governance at SMU's Cox School of Business in Dallas, said it's unusual to see licenses revoked over flawed audits unless the accountants were complicit or showed total disregard for accepted procedures. That's particularly true for audits like those involved with Enron, he said.

"I don't think people comprehend how complex Enron was, the mathematics behind some of these transactions," Shaw said.

Some experts contacted by The Associated Press were stunned to learn that the state was taking such drastic action against Bass. Documents released by a U.S. House committee in 2002 showed that he challenged Enron's accounting practices as early as 1999 and was later removed from Andersen's Professional Standards Group because of complaints from Enron over his criticism.

"Instead of punishing Carl Bass, he should be given a medal," said Bob Jensen, a former accounting professor at Trinity University in San Antonio.

Jensen said the Texas accounting board has gained a reputation as "Big Brother."

"What's happening (with Bass and Bauer) strikes me as absolutely absurd, but it doesn't surprise me," he said.

The two former accountants, both of whom still live in the Houston area, declined interview requests through their attorneys.

The state board voted to revoke the licenses in June 2008 even after a panel of administrative law judges recommended that the accountants merely be fined and admonished. But State District Judge Rhonda Hurley kept the issue alive in April when she agreed with Bass, Bauer and another plaintiff that the board engaged in a "charade of deliberation" when it went into executive session four times while considering the panel's recommendations.

The board contends that it went into executive session only to discuss potential litigation with its attorney, a scenario that would make the meetings legal.

Arthur Andersen, once one of the so-called "Big Five" accounting firms, was found guilty of obstructing justice in 2002 for the shredding of Enron-related documents. Although the conviction was reversed by the U.S. Supreme Court, the damage to the Chicago-based firm's reputation was enough to put it out of business.

The document destruction occurred in the Houston office, where both Bass and Bauer worked, but neither one was involved.

Records obtained by the AP show that the Texas board has spent $3.1 million over the last eight years to investigate and prosecute Bass, Bauer and five other former Andersen employees for their work on Enron audits related to the company's now-famous spinoffs with Star Wars-inspired names, Chewco and Jedi.

Documents that came to light when Enron filed for bankruptcy showed Andersen auditors failed to uncover that the company was using the entities to hide its debt illegally.

Bauer was barred from practicing before the Securities and Exchange Commission for three years because he didn't exercise due professional care despite "numerous red flags" associated with the transactions. Bass wasn't disciplined by the SEC.

Treacy said the expenditures aren't out of line because the board is one of Texas' seven self-directed, semi-independent regulatory agencies. That means its funding comes strictly from fees, fines and other revenue it generates.

"We're not subsidized by the state of Texas, and the (accounting) profession wants it that way," he said. "If we need to raise our license fees to prosecute cases, the profession supports us."

 



From The Wall Street Journal Educators' Reviews on January 17, 2002

TITLE: Paper Trail: Andersen Fires Partner It Says Led Shredding of Enron Documents; It Claims Disposal Effort Started After SEC Asked Energy Firm for Data; Was He Following Orders? 
REPORTER: Ken Brown, Gregg Hitt, Steve Liesman, and Jonathan Weil 
DATE: Jan 16, 2002 PAGE: A1 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1011096414335724680.djm  
TOPICS: Auditing

SUMMARY: This article describes the series of events involving the shredding of documents associated with the Enron audit. The WSJ Interactive edition provides a link to the Andersen policy on document retention and destruction.

QUESTIONS: 
1.) Access the Andersen policy on document retention and destruction linked to this article on the WSJInteractive Search website (http://interactive.wsj.com/documents/search.htm). Why does Andersen have such a policy?

2.) Could it have been typical Andersen policy to shred documents such as the ones which were shredded between the time that Enron received a request from the SEC for information about financial accounting and reporting and the date that Andersen received a subpoena?

3.) What do you think the partner in charge of the Enron audit should have done if the AA policy on document destruction were not followed on a timely basis, following each audit? Should the Andersen partner then have gone into old files to shred documents it didn't originally intend to keep? Based on AA's policy document, do you think the Andersen partner could have felt justified in destroying documents as he directed staff to do?

4.) Do you think that the Andersen partner acted alone in directing staff to destroy Enron associated documents?

5.) The related article discusses two statements regarding Andersen's review of Enron's complex financial transactions and establishment of special purpose entities to hide losses on stock holdings and to keep debt off the balance sheet. In recent congressional testimony, Andersen Chief Executive Joseph Berardino stated that "Andersen made a mistake in accepting Enron's accounting for one of the partnerships, and wouldn't have approved of another if it had know all the details." Isn't it Andersen's job to have "known all the details"? To what liability do these two admissions expose Andersen because of this case?

6.) According to GAAS, what is management's responsibility for the representations made in the financial statements? What is the auditor's responsibility? Based on the descriptions given in the related article, how did each of the parties in this case-Enron management and Andersen auditors-apparently fail to fulfill their responsibilities?

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: Politics & Policy: Law Firm Reassured Enron on Accounting; Vinson & Elkins Discounted Warnings by Employee About Dubious Dealings REPORTER: Jeanne Cummings, Tom Hamburger, and Kathryn Kranhold PAGE: A18 ISSUE: Jan 16, 2002 LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1011138485584391040.djm 


In a $2.1 billion action against accounting firm Grant Thornton, a Baltimore Circuit Court is investigating a possible violation involving the withholding and willful destruction of audit records in a manner likened to the contemporary but more- publicized Enron case. A court action also alleges that a former director of risk management and senior partner of the firm, "willfully, knowingly, and intentionally destroyed (client) documents with the full understanding that litigation was imminent." http://www.accountingweb.com/item/69042 


Big Five firm Ernst & Young has been hit with a lawsuit by Bull Run Corp., a company that provides, among other things, marketing and event management services to universities, athletic conferences, associations, and corporations. The lawsuit alleges that E&Y failed to discover material errors in its audit of a company that Bull Run acquired in late 1999. http://www.accountingweb.com/item/69888 


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.html 

See also:
New IPO Rallying Cry: This is War
Bankrupt? So What? Lawyers Ask

Forwarded by Patrick Charles

Arthur Andersen: The Enron Scandal's Other Big Donor

By Holly Bailey

During the record-breaking 1999-2000 fund-raising cycle, very few companies outpaced Enron's prolific giving to George W. Bush. In fact, only 11 companies gave more money to the Bush-Cheney ticket, and one of them was Arthur Andersen, the embattled energy giant's now equally troubled auditor.

Andersen was the fifth biggest donor to Bush's White House run, contributing nearly $146,000 via its employees and PAC. Furthermore, Andersen fielded one of Bush's biggest individual fund-raisers that year. D. Stephen Goddard, who until yesterday was the managing partner of Andersen's Houston office, was one of the "Pioneers," individuals who raised at least $100,000 for the Bush campaign during 1999-2000. (Goddard was among the employees "relieved of their duties" Tuesday by Andersen.)

But that's only the tip of the iceberg when it comes to Andersen's political ties to Washington. As Congress prepares to launch hearings into the Enron collapse, lawmakers will be examining two companies whose political giving has affected the bottom line of nearly every campaign on Capitol Hill. Since 1989, Andersen has contributed nearly $5 million in soft money, PAC and individual contributions to federal candidates and parties, more than two-thirds to Republicans.

While Enron's giving was concentrated mainly in big soft money gifts to the national political parties, Andersen's generosity often was targeted directly at members of Congress. For instance, more than half the current members of the House of Representatives were recipients of Andersen cash over the last decade. In the Senate, 94 of the chamber's 100 members reported Andersen contributions since 1989.

Among the biggest recipients, members of Congress now in charge of investigating Andersen's role in the Enron debacle-a list that includes House Energy and Commerce Committee chairman Billy Tauzin (D-La.), who, with $47,000 in contributions, is the top recipient of Andersen contributions in the House.

In the fall of 2000, Tauzin helped broker a deal between the Securities and Exchange Commission and the Big Five accounting firms, including Andersen, which essentially dropped the SEC's push to restrict auditors from selling consulting services to their clients. The provision had been aimed at ending what the SEC had deemed a major conflict of interest between accountant's duties as an auditor and the money they earn to consult on behalf of that same client.

Before the SEC could act, however, the accounting industry unleashed a massive lobbying campaign to block the proposed rule. In Andersen's case, it nearly doubled its campaign contributions-going from $825,000 in overall spending during the 1997-98 election cycle to more than $1.4 million in 1999-2000. In lobbying expenditures alone, Andersen spent $1.6 million between July and December 2000-compared to $860,000 for the first six months of that year.

It's unclear what kind of impact, if any, the proposed rule might have had on the Enron collapse. Andersen, according to press reports, collected $25 million in auditing fees and $27 million in consulting fees from Enron during 2001.

Click here for a breakdown of Andersen contributions, including contributions to members of Congress and presidential candidates, as well as information on the company's lobbying expenditures and other money in politics stats:

http://www.opensecrets.org/alerts/v6/alertv6_38.asp 

 


Corporate America's accounting problems raise the question: Can the public depend on the auditors?

Washington Post Article:  Part 1
"THE NUMBERS CRUNCH After Enron, New Doubts About Auditors," Part 1 of 2 Articles, by David S. Hilzenrath, The Washington Post,  December 5, 2001 --- 
http://www.washingtonpost.com/wp-dyn/articles/A58165-2001Dec4.html
 

This article is much too long to do justice to in a few quotes.  I did, however, extact the quotes connected with Andersen, the firm that audited and certified the Enron financial statements prior to Enron's meltdown.

The collapse came swiftly for Enron Corp. when investors and customers learned they could not trust its numbers. On Sunday, six weeks after Enron disclosed that federal regulators were examining its finances, the global energy-trading powerhouse became the biggest bankruptcy in U.S. history.

Like all publicly traded companies in the United States, Enron had an outside auditor scrutinize its annual financial results. In this case, blue-chip accounting firm Arthur Andersen had vouched for the numbers. But Enron, citing accounting errors, had to correct its financial statements, cutting profits for the past three years by 20 percent -- about $586 million. Andersen declined comment and said it is cooperating in the investigation.

The number of corporations retracting and correcting earnings reports has doubled in the past three years, to 233, an Andersen study found. Major accounting firms have failed to detect or have disregarded glaring bookkeeping problems at companies as varied as Rite Aid Corp., Xerox Corp., Sunbeam Corp., Waste Management Inc. and MicroStrategy Inc.

Corporate America's accounting problems raise the question: Can the public depend on the auditors?

"Financial fraud and the accompanying restatement of financial statements have cost investors over $100 billion in the last half-dozen or so years," said Lynn E. Turner, who stepped down last summer as the Securities and Exchange Commission's chief accountant.

The shareholder losses resulting from accounting fraud or error could rival the cost to taxpayers of the savings-and-loan bailout of the early 1990s, he said. Enron investors, including employees who held the company's stock in their retirement accounts, lost billions.

Accounting industry leaders deny they are to blame. They say that the number of failed audits is tiny in relation to the many thousands performed successfully, and that it's often impossible for auditors to see through a sophisticated fraud.

Quotations Relating to the Andersen Accounting Firm

Quote 01
Accounting firms cite a number of reasons for the rise in corrections. It's tough to apply standards that are nearly 70 years old to the modern economy, they say. And the SEC has made matters worse by issuing new interpretations of complex standards. "The question is not how does this reflect on the auditors," Arthur Andersen said in a written statement. Instead, the firm asked: "How is it that auditors are able to do so well in today's environment?"

Quote 02
A case study posted on Arthur Andersen's Web site under "Success Stories" shows how the firm sees itself. As auditor for TheStreet.com Inc., a financial news service, Arthur Andersen said, it helped its client prepare for an initial public offering of stock, develop a global expansion strategy and secure a weekly television show through another client, News Corp.

One of Arthur Andersen's "greatest strengths . . . is developing full-service relationships with emerging companies and then using all of our capabilities to find inventive ways to help them continue to grow," auditor Tom Duffy is quoted as saying.

Quote 03
Last year, Gene Logic Inc., a Gaithersburg biotechnology firm, fired Arthur Andersen, saying it was disappointed with the outside auditor's level of service and cost. Andersen said in a letter included in an SEC filing that, before Andersen was fired, the accounting firm had told the company it thought it was trying to book $1.5 million of revenue from new contracts prematurely. Gene Logic spokesman Robert Burrows said the revenue disagreement had nothing to do with the auditor's dismissal.

Arthur Andersen said it quickly resigned or refused to accept more than 60 auditing jobs last year after its background checks turned up questions about the integrity of the clients' management.

Quote 04
Some industry veterans say audits have become loss leaders -- a way for firms to get their foot in a client's door and win consulting contracts.

Arthur Andersen disagreed, telling The Post that audits are among the more profitable services the firm provides, adding that "lower pricing in some years" is "made up over time."

Indeed, accounting firms say that if the audit becomes more complicated than initially expected, their contracts generally allow them to go back to their clients and adjust the fee.

In a long-running lawsuit, Calpers, the giant pension fund for California public employees accused Arthur Andersen of doing such a superficial job auditing a finance company that the "purported audits were nothing more than 'pretended audits.' "

Andersen assigned a young, inexperienced auditor "who has candidly testified he did not even know what a Contract Receivable was, then or now," consultants for Calpers wrote in a September 2000 report prepared in support of the lawsuit.

Andersen didn't test any of those accounts while the unpaid balances soared, and it failed to recognize that a substantial amount was uncollectible, the report said.

Andersen declined to comment on the case, which was settled confidentially

Quote 05
Few cases illustrate the potential conflicts in the accounting business as vividly as the one involving Arthur Andersen and Waste Management.

Many investors may not realize they were victims because they held Waste Management stock indirectly, through mutual funds and retirement plans. Lolita Walters, an 80-year-old retired New York City government employee who suffers from diabetes and a heart condition, can count what she lost -- more than $2,800, enough money to pay for almost a year of prescription drugs.

"I think it's unconscionable," Walters said of Andersen's role.

According to the SEC, Andersen lent its credibility to Waste Management's annual reports even though it had documented that they were deeply flawed.

Waste Management eventually admitted that, over several years, it had overstated its pretax profits by $1.4 billion.

In a civil suit filed in June, the SEC accused Arthur Andersen of fraud for signing off on Waste Management's false financial statements from 1993 through 1996. For example, during the 1993 audit, the SEC said, the auditors noted $128 million of cumulative "misstatements" that would have reduced the company's earnings, before including special items, by 12 percent. But Andersen partners decided the misstatements were not significant enough to require correction, the SEC said.

An Andersen memorandum showed the accounting firm disagreed with the approach Waste Management used "to bury charges" and warned Waste Management that the practice represented "an area of SEC exposure," but Andersen did not stop it, the SEC said.

An SEC order noted that, from 1971 until 1997, all of Waste Management's chief financial officers and chief accounting officers were former Andersen auditors. The Andersen partner assigned to lead the disputed audits coordinated marketing of non-audit services, and his compensation was influenced by the volume of non-audit fees Andersen billed to Waste Management, the SEC said.

Over a period of years, Andersen and an affiliated consulting firm billed Waste Management about $18 million for non-audit work, more than double the $7.5 million it was paid in audit fees, which were capped, the SEC said. Andersen said some of the non-audit work was related to auditing.

Andersen, which continues to serve as Waste Management's auditor, agreed to pay a $7 million fine to the SEC, and joined with Waste Management to settle a class-action lawsuit on behalf of shareholdersfor a combined $220 million. Andersen did not admit wrongdoing in either settlement.

"There are important lessons to be learned from this settlement by all involved in the financial reporting process," Terry E. Hatchett, Andersen's managing partner for North America, said in a statement after the SEC action. "Investors can continue to rely on our signature with confidence."


Washington Post Article:  Part 2
"THE NUMBERS CRUNCH Auditors Face Scant Discipline Review Process Lacks Resources, Coordination, Will," Part 2 of 2 Articles, by David S. Hilzenrath, The Washington Post,  December 6, 2001 --- 
http://www.washingtonpost.com/wp-dyn/articles/A64556-2001Dec5.html
 

Starting in the mid-1980s, he oversaw the outside audits of JWP Inc., an obscure New York company that bought a string of businesses and transformed itself into a multibillion-dollar conglomerate. The job required LaBarca, a partner at the big accounting firm Ernst & Young LLP, to scrutinize the work of JWP's chief financial officer, Ernest W. Grendi, a running buddy and former colleague.

In 1992, a new president at JWP discovered rampant accounting manipulations, and the company's stock sank. When the numbers were corrected, the 1991 earnings were slashed from more than $60 million to less than $30 million.

After hearing extensive evidence in a bondholders' lawsuit, a federal judge criticized "the seeming spinelessness" of LaBarca.

"Time and again, Ernst & Young found the fraudulent accounting at JWP, but managed to 'get comfortable' with it," Judge William C. Conner wrote in a 1997 opinion. "The 'watchdog' behaved more like a lap dog."

Today, LaBarca is senior vice president of financial operations and acting controller at the media conglomerate AOL Time Warner Inc., where his duties include overseeing internal audits.

The Securities and Exchange Commission filed and settled fraud charges against Grendi but took no action against LaBarca. Neither did the American Institute of Certified Public Accountants (AICPA), a 340,000-member professional organization charged with disciplining its own, or the state of New York, which licensed LaBarca.

LaBarca declined to discuss the JWP case but maintainedduring thetrial that the accounting was "perfectly within the guidelines."

An Ernst & Young spokesman said the firm was confident it upheld a tradition "of integrity, objectivity and trust." Grendi declined comment.

A Washington Post analysis of hundreds of disciplinary cases since 1990 found that, when things go wrong, accountants face little public accountability.

"The deterrent effect that's necessary is just not there," said Douglas R. Carmichael, a professor of accountancy at the City University of New York's Baruch College. That "makes investing like Russian roulette," he added.

In theory, the system has several complementary layers of review. In practice, it is undermined by a lack of resources, coordination and will.

The SEC can bar accountants from auditing publicly traded companies for unprofessional conduct. The agency, however, has the personnel to investigate only the most egregious examples of auditing abuse, officials say. It typically settles its cases without an admission of wrongdoing, often years after the trouble surfaced.

Between 1990 and the end of last year, the SEC sanctioned about 280 accountants, evenly divided between outside auditors and corporate financial officers, The Post's review found.

The AICPA can expel an accountant from its ranks, whichcan prompt the accountant's firm to reassign or fire him. The trade grouptook disciplinary action in fewer than a fifth of the cases in which the SEC imposed sanctions, The Post found. About one-third of the accountants the SEC sanctioned weren't AICPA members and thus were beyond its reach.

Even when the AICPA determined that accountants sanctioned by the SEC had committed violations, it closed the vast majority of ethics cases without disciplinary action or public disclosure.

President Bill Clinton's SEC chairman, Arthur Levitt Jr., a frequent critic of the industry, said the AICPA "seems unable to discipline its own members for violations of its own standards of professional conduct."

The membership group works as a lobbying force for accountants and often battles SEC regulatory efforts.

State regulators have the ultimate authority. They can take away an accountant's license. But some state authorities acknowledge that their efforts are hit-or-miss.

"We only find out about violations on the part of regulants [licensees] in two ways: One, somebody complains, or two, we get lucky," said David E. Dick,assistant director of Virginia's Department of Professional and Occupational Regulation, which until recently administered discipline for the state's accountants.

When the SEC settles without a court judgment or an admission of culpability, state authorities must build their case from scratch, said regulators in New York, where many corporate accountants are licensed.

"You could probably fault both state boards and the SEC for not having worked cooperatively enough with one another over the years," said Lynn E. Turner, who stepped down this summer as the SEC's chief accountant. He added that the agency has tried harder over the past year and a half to share investigative records with state regulators.

As of June, the state of New York had taken disciplinary action against about a third of the New York accountants The Post culled from 11 years of SEC professional-misconduct cases.

While prosecutors occasionally file criminal charges against corporate officials in financial fraud case, they hardly ever bring criminal cases against independent auditors, in part because the accounting rules are so complex. The AICPA's general counsel could recall only a handful of prosecutions.

"From my perspective, this was very hard stuff," said a federal prosecutor who investigated a major accounting fraud. "The prospect of litigating a case against people who actually do this stuff for a living and at least in theory are the world's experts . . . is a daunting prospect."

Investor lawsuits sometimes lead to multimillion-dollar settlements. But they rarely shed light on the performance of individual auditors because accounting firms generally get court records sealed and settle before trial, limiting public scrutiny.

The accounting firms say they discipline those who violate professional standards, including removing them from audits or terminating their employment.

Barry Melancon, president of the AICPA, said "you cannot look at discipline alone" when assessing accountability in the accounting profession.

The profession's emphasis is on preventing rather than punishing mistakes, he added. Thus, it invests heavily in quality-control efforts, such as periodic "peer reviews" of the paperwork accounting firms generate during audits.

In disciplinary cases, the AICPA's goal is to rehabilitate accountants, not to expel them, officials said. "While it may feel good and it may give somebody something to write about when somebody is disciplined, the most important thing is whether or not this profession does a good job doing audits or not," Melancon said.

Continued at  http://www.washingtonpost.com/wp-dyn/articles/A64556-2001Dec5.html  


"Watchdogs and Lapdogs," by Burton Malkiel, Editorial in The Wall Street Journal, January 16, 2002 --- 
http://interactive.wsj.com/articles/SB1011145236418110120.htm
 
Dr. Malkiel, professor of economics at Princeton, is author of "A Random Walk Down Wall Street," 7th ed. (W.W. Norton, 2000).

The bankruptcy of Enron -- at one time the seventh-largest company in the U.S. -- has underscored the need to reassess not only the adequacy of our financial reporting systems but also the public watchdog mission of the accounting industry, Wall Street security analysts, and corporate boards of directors. While the full story of what caused Enron to collapse has yet to be revealed, what is clear is that its accounting statements failed to give investors a complete picture of the firm's operations as well as a fair assessment of the risks involved in Enron's business model and financing structure.

Enron is not unique. Incidents of accounting irregularities at large companies such as Sunbeam and Cendant have proliferated. As Joe Berardino, CEO of Arthur Andersen, said on these pages, "Our financial reporting model is broken. It is out of date and unresponsive to today's new business models, complex financial structures, and associated business risks."

Blind Faith

It is important to recognize that losses suffered by Enron's shareholders took place in the context of an enormous bubble in the "new economy" part of the stock market during 1999 and early 2000. Stocks of Internet-related companies were doubling, then doubling again. Past standards of valuation like "buy stocks priced at reasonable multiples of earnings" had given way to blind faith that any company associated with the Internet was bound to go up. Enron was seen as the perfect "new economy" stock that could dominate the market for energy, communications, and electronic trading and commerce.

I have sympathy for the Enron workers who came before Congress to tell of how their retirement savings were wiped out as Enron's stock collapsed and how they were constrained from selling. I have long argued for broad diversification in retirement portfolios. But many of those who suffered were more than happy to concentrate their portfolios in Enron stock when it appeared that the sky was the ceiling.

Moreover, for all their problems, our financial reporting systems are still the world's gold standard, and our financial markets are the fairest and most transparent. But the dramatic collapse of Enron and the rapid destruction of $60 billion of market value has shaken public trust in the safeguards that exist to protect the interests of individual investors. Restoring that confidence, which our capital markets rely on, is an urgent priority.

In my view, the root systemic problem is a series of conflicts of interest that have spread through our financial system. If there is one reliable principle of economics, it is that individual behavior is strongly influenced by incentives. Unfortunately, often the incentives facing accounting firms, security analysts, and even in some circumstances boards of directors militate against their functioning as effective guardians of shareholders' interests.

While I will concentrate on the conflicts facing the accounting profession, perverse incentives also compromise the integrity of much of the research product of Wall Street security analysts. Many of the most successful research analysts are compensated largely on their ability to attract investment banking clients. In turn, corporations select underwriters partly on their ability to present positive analyst coverage of their businesses. Security analysts can get fired if they write unambiguously negative reports that might damage an existing investment banking relationship or discourage a prospective one.

Small wonder that only about 1% of all stocks covered by street analysts have "sell" recommendations. Even in October 2001, 16 out of 17 securities analysts covering Enron had "buy" or "strong buy" ratings on the stock. As long as the incentives of analysts are misaligned with the needs of investors, Wall Street cannot perform an effective watchdog function.

In some cases, boards of directors have their own conflicts. Too often, board members have personal, business, or consulting relationships with the corporations on whose boards they sit. For some "professional directors," large fees and other perks may militate against performing their proper function as a sometime thorn in management's side. Our watchdogs often behave like lapdogs.

But it is on the independent accounting profession that we most rely for assurance that a corporation's financial statements accurately reflect the firm's condition. While we cannot expect independent auditors to detect all fraud, we should expect we can rely on them for integrity of financial reporting. While public accounting firms do have reputations to maintain and legal liability to avoid, the incentives of these firms and general auditing practices can sometimes combine to cloud the transparency of financial statements.

In my own experience on several audit committees of public companies, the audit fee was only part of the total compensation paid to the public accounting firm hired to examine the financial statements. Even after the divestiture of their consulting units, revenues from tax and management advisory services comprise a large share of the revenues of the "Big Five" accounting firms. In some cases auditing services may be priced as a "loss leader" to allow the accounting firm to gain access to more lucrative non-audit business.

In such a situation, the audit partner may be loath to make too much of a fuss about some gray area of accounting if the intransigence is likely to jeopardize a profitable relationship for the accounting firm. Indeed, audit partners are often compensated by how much non-audit business they can capture. They may be incentivized, then, to overlook some particularly aggressive accounting treatment suggested by their clients.

Outside auditors also frequently perform and review the inside audit function within the corporation, as was the case with Andersen and Enron. Such a situation may weaken the safeguards that exist when two independent organizations examine complicated transactions. It's as if a professor let students grade their own papers and then had the responsibility to hear any appeals. Auditors may also be influenced by the prospect of future employment with their clients.

Unfortunately, our existing self-regulatory and standard-setting organizations fall short. The American Institute of Certified Public Accountants has neither the resources nor the power to be fully effective. The institute may even have contributed to the problem by encouraging auditors to "leverage the audit" into advising and consulting services.

The Financial Accounting Standards Board has often emphasized the correct form by which individual transactions should be reported rather than the substantive way in which the true risk of the firm may be obscured. Take "Special Purpose Entities," for example, the financing vehicles that permit companies such as Enron to access capital and increase leverage without adding debt to the balance sheet. Even if all of Enron's SPEs had met the narrow test for balance sheet exclusion (which, in fact, they did not), our accounting standard would not have illuminated the effective leverage Enron had undertaken and the true risks of the enterprise.

Given the complexity of modern business and the way it is financed, we need to develop a new set of accounting standards that can give an accurate picture of the business as a whole. FASB may have helped us measure the individual trees but it has not developed a way to give us a clear picture of the forest. The continued integrity of the financial reporting system and our capital markets must be insured. We need to modernize our accounting system so financial statements give a clearer picture of what assets and liabilities on the balance sheet are at risk. And we must find ways to lessen the conflicts facing auditors, security analysts, and even boards of directors that undermine checks and balances our capital markets rely on.

Change Auditors

One possibility is to require that auditing firms be changed periodically the way audit partners within each firm are rotated. This would incentivize auditors to be particularly careful in approving accounting transactions for fear that leniency would be exposed by later auditors.

And, in the end, we need to create a powerful and effective self-regulatory organization with credible disciplinary authority to enforce accounting rules and standards. It would be far better for the industry to respond itself to the current crises than to await the likelihood that the political process will do so for them.


Qwest Engaged in Fraud, SEC Says"  Regulator Claims Misdeeds Were Led by Top Officials
Firm to Pay $250 Million
by Shawn Young, Deborah Solomon, and Dennis Berman
The Wall Street Journal, October 22, 2004 http://online.wsj.com/article/0,,SB109836893305151847,00.html?mod=technology%5Fmain%5Fwhats%5Fnews 

Qwest Communications International Inc. engaged in pervasive fraud led by top management that extended to almost every part of its business, according to a complaint by the Securities and Exchange Commission.

The complaint, filed in federal court yesterday as Qwest agreed to pay a $250 million penalty, said the telecommunications company was riddled with accounting fraud between 1999 and 2002. The fraud included generating phony revenue through sham transactions, booking inflated results for its phone-directory business and even the way Qwest accounted for employee vacation time, according to the complaint. The SEC said Qwest fraudulently recognized more than $3.8 billion in revenue and excluded $231 million in expenses as part of a multifaceted accounting scheme. (Read the full text of the complaint.)

The 56-page document depicts Qwest as a company so desperate to satisfy Wall Street that it used any means necessary to meet "outrageously optimistic revenue projections." As its financial condition deteriorated, the SEC says Qwest began to rely on one-time sales contracts that one employee described as a kind of fiscal "heroin" that filled revenue gaps but were increasingly difficult to maintain.

"This was definitely orchestrated from the top down," said Mary Brady, assistant regional director for the SEC's Denver office. The SEC said the fraud was "directed by Qwest's senior management" and implemented by "numerous" other managers and employees.

Though the SEC didn't name specific Qwest executives, the agency continues to investigate former top officials, including Joseph P. Nacchio, the tough-talking executive who led Qwest until 2002. Mr. Nacchio recently received a so-called Wells notice from the SEC, indicating it soon may file civil charges against him, people familiar with the matter have said.

A spokesman for Mr. Nacchio said in a statement that "Mr. Nacchio never did anything improper or illegal -- nor instructed anyone else to do anything improper or illegal -- during his tenure as CEO of Qwest."

A few other former top executives also have received Wells notices, according to people familiar with the matter. In addition, a dozen former Qwest executives have faced either civil or criminal charges or have settled allegations.

The $250 million penalty, which Qwest agreed to without admitting or denying wrongdoing, is the second-largest resulting from a SEC action, following only the mammoth $750 million levied against the former Worldcom Inc., now MCI Inc., after that company's $11 billion accounting fraud, the largest in U.S. history.

Continued in the article


QWEST AUDITOR MAY HAVE DESTROYED FILES SOME RELATED TO CONTROVERSIAL DEALS, ATTORNEYS INDICATE

Former Qwest Communications auditor Arthur Andersen may have destroyed documents including those related to the Denver telco's controversial fiber-optic capacity swaps, a prosecutor and defense attorneys indicated Tuesday. A discussion about the possible destruction of documents by Arthur Andersen emerged after the government turned over hundreds of pages of additional discovery in connection with the trial of four former midlevel Qwest executives accused of conspiring to inflate revenue.
Denver Rocky Mountain News, March 10, 2004 --- http://static.highbeam.com/d/denverrockymountainnews/march102004/qwestauditormayhavedestroyedfilessomerelatedtocont/

 


From the Free Wall Street Journal Educators' Reviews for December 6, 2001 

TITLE: Audits of Arthur Andersen Become Further Focus of Investigation 
SEC REPORTER: Jonathan Weil 
DATE: Nov 30, 2001 PAGE: A3 LINK: 
     http://interactive.wsj.com/archive/retrieve.cgi?id=SB1007059096430725120.djm
  
TOPICS: Advanced Financial Accounting, Auditing

SUMMARY: This article focuses on the issues facing Arthur Andersen now that their work on the Enron audit has become the subject of an SEC investigation. The on-line version of the article provides three questions that are attributed to "some accounting professors." The questions in this review expand on those three provided in the article.

QUESTIONS: 
1.) The first question the SEC might ask of Enron's auditors is "were financial statement disclosures regarding Enron's transactions too opaque to understand?" Are financial statement disclosures required to be understandable? To whom? Who is responsible for ensuring a certain level of understandability?

2.) Another question that the SEC could consider is whether Andersen auditors were aware that certain off-balance-sheet partnerships should have been consolidated into Enron's balance sheet, as they were in the company's recent restatement. How could the auditors have been "unaware" that certain entities should have been consolidated? What is the SEC's concern with whether or not the auditors were aware of the need for consolidation?

3.) A third question that the SEC could ask is, "Did Andersen auditors knowingly sign off on some 'immaterial' accounting violations, ignoring that they collectively distorted Enron's results?" Again, what is the SEC's concern with whether Andersen was aware of the collective impact of the accounting errors? Should Andersen have been aware of the collective amount of impact of these errors? What steps would you suggest in order to assess this issue?

4.) The article finishes with a discussion of expected Congressional hearings into Enron's accounting practices and into the accounting and auditing standards setting process in general. What concern is there that the FASB "has been working on a project for more than a decade to tighten the rules governing when companies must consolidate certain off-balance sheet 'special purpose entities'"?

5.) In general, how stringent are accounting and auditing requirements in the U.S. relative to other countries' standards? Are accounting standards in other countries set in the same way as in the U.S.? If not, who establishes standards? What incentives would the U.S. Congress have to establish a law-based system if they become convinced that our private sector standards setting practices are inadequate? Are you concerned about having accounting and reporting standards established by law?

6.) The article describes revenue recognition practices at Enron that were based on "noncash unrealized gains." What standard allows, even requires, this practice? Why does the author state, "to date, the accounting standards board has given energy traders almost boundless latitude to value their energy contracts as they see fit"?

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

From the Free Wall Street Journal Educators' Reviews for December 20, 2001

TITLE: Enron Debacle Spurs Calls for Controls
REPORTER: Michael Schroeder
DATE: Dec 14, 2001
PAGE: A4
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1008282666768929080.djm 
TOPICS: Accounting Fraud, Accounting, Accounting Irregularities, Auditing, Auditing Services, Disclosure, Disclosure Requirements, Fraudulent Financial Reporting, Securities and Exchange Commission

SUMMARY: In light of Enron's financial reporting irregularities and subsequent bankruptcy filing, Capitol Hill and the SEC are considering new measures aimed at improving financial reporting and oversight of accounting firms. Related articles discuss additional regulation that is being considered as a result of this reporting debacle.

QUESTIONS:
1.) Briefly describe Enron's questionable accounting practices. What accounting changes are being proposed in light of the Enron case? Certainly this is not the first incidence of questionable financial reporting. Why is the reaction to the Enron case so extreme?

2.) Discuss Representative Paul Kanjorski's view of regulation of the accounting profession. What system of accounting regulation is currently in place? Discuss the advantages and disadvantages of both private-sector and public-sector regulation.

3.) What changes are proposed in the related article, "The Enron Debacle Spotlights Huge Void in Financial Regulation?" Do these changes strictly relate to financial reporting issues? Are operational decisions or financial reporting decisions responsible for Enron's current financial position?

4.) In the related article, "Enron May Spur Attention to Accounting at Funds," it is argued that fund managers will "start taking a more skeptical view of annual reports or footnotes . . . they don't understand." Are you surprised by this comment? Do you blame accounting for producing confusing financial reports or the fund managers for investing in companies with confusing financial reports?


TITLE: Double Enron Role Played by Andersen Raises Questions 
REPORTER: Michael Schroeder 
DATE: Dec 14, 2001 
PAGE: A4 LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1008289729306300000.djm  
TOPICS: Accounting, Auditing, Auditing Services, Auditor Independence, Consulting, Internal Auditing

SUMMARY: In addition to auditing Enron's financial statements, Arthur Andersen LLP also provided internal-auditing and consulting services to Enron. Providing additional services to Enron raises questions about Andersen's independence.

QUESTIONS: 
1.) What is independence-in-fact? What is independence-in-appearance? Did Andersen violate either independence-in-fact or independence-in-appearance? Why or why not?

2.) If Enron had made good business decisions and had continued reporting positive financial results, would we be discussing Andersen's independence with respect to Enron? Why do we wait until something bad happens to become concerned?

3.) Do you think providing internal auditing and consulting services gave Andersen a better understanding of Enron's business and operations? Should additional understanding of the business and operations enable Andersen to provide a "better" audit? What was wrong with Andersen providing consulting and internal-audit services to 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: The Enron Debacle Spotlights Huge Void in Financial Regulation 
REPORTERS: Michael Schroeder and Greg Ip 
PAGE: A1 
WSJ ISSUE: Dec 13, 2001 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1008202066979356000.djm 

TITLE: When Bad Stocks Happen to Good Mutual Funds: Enron Could Spark New Attention to Accounting 
REPORTER: Aaron Lucchetti 
PAGE: C1 
WSJ ISSUE: Dec 13, 2001 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1008196294985520800.djm 

 



Can Internal Auditors truly be independent while being employed by the entity and seen as working for the management to achieve organizational goals? In theory, External Auditors are more likely to be perceived as independent, but is it not the case that Internal Auditors appear to have little or no independence? http://www.accountingweb.com/item/65704 


Arthur Andersen's Virtual CPE Course on Fraud --- http://www.arthurandersen.com/website.nsf/content/ResourcesVirtualLearningNetworkProducts!OpenDocument 

Bob Jensen's threads on the Enron scandal are at http://faculty.trinity.edu/rjensen/fraud.htm#Enron 



A Message to My Students in the Wake of Recent Auditing Scandals

I am forwarding a reply that I sent out to Curt and the rest of our accounting graduate students at Trinity University. I am certain that Curt was trying to be facetious is suggesting that outlook for accounting careers is becoming so gloomy that graduates should consider forming rock bands such as the Butthole Surfers (see his message below).

The Enron mess could not have happened at a worse time when accounting majors are on the decline nationwide and auditing is no longer viewed by many U.S. students as a profession of choice. The Enron publicity, especially following the forthcoming December 2, 2001 Washington Post series (starting tomorrow), will only make it more difficult for us to draw our top talent into majoring in accounting.

Perhaps every accounting educator should consider communicating some of the good news to students along with the recent bad news in the press. Perhaps we should also try to get some of our good news into the media.

In any case, this is my reply to Curt.

Bob

-----Original Message----- 
From: Jensen, Robert [mailto:rjensen@trinity.edu]  
Sent: Saturday, December 01, 2001 8:25 AM 
To: Jensen-B Subject: RE: Having second thoughts about accounting?

Hi Curt and your fellow accounting majors,

I don't know if you know that one of the founders of the band you refer to was Paul Walthall's son (the son who dropped out of Trinity's MBA program to join Gibby in forming the band). His name was Paul Walthall Jr., although his name somewhere along the line apparently was changed to Paul Leary. I think "Leary" was his middle name and was his mother's maiden name. Paul "Leary" graduated in Art from Trinity and then went part way into the MBA program back in the days when Trinity University had an MBA program. Paul "Leary" was never an accountant (I'm not sure he ever completed a course in accounting). Gibby Haynes did indeed major in and excel in accounting at Trinity. He subsequently worked for a short time as a staff accountant with KPMG.

The senior Paul Walthall was a highly dedicated professor of accounting for over 30 years at Trinity University. I once asked Paul and Doris Walthall if they ever recited the name of the BHS Band out loud. They said they spoke of it often during prayers at church.

The funny part of the history of this band is that none of the four founders could read music or play a musical instrument. They hammered out songs by rote. The main appeal seemed to be some of the outrageous lyrics put to some really awful music. The songs were rarely, if ever, broadcast in the U.S., because radio stations were not allowed to say the name of the band on the air. The main success, and it was never a big success, of the band came from European tours. On many occasions, parents of the band members had to send money to whatever town the band was stranded in at the time.

My son Marshall in his early teenage years bought every record produced by the band --- sigh! After Marshall grew up, he tossed all of those records in the trash and is now into classical music and dances with a ballet company. The BHS Band mainly appealed to young teenagers in the rebellion stage of life.

My advice is to stay with accounting. For the most part, accounting is the path to success in a business career. There are occasional scandals such as the Enron audit, but we must give credit to the thousands upon thousands of auditors worldwide who do their jobs with diligence and laudable ethics. There are scandals in medicine, law, engineering, the clergy, academe, and government, but this is what being human is all about. It's about being human with human frailties in any vocation.

What we have to do is shore up professional systems to discourage falling from grace. The vexing problem at the moment is that multinational firms have become so huge that it is very hard for auditors to part ways with gigantic clients when intractable disputes arise during the audit.

On December 2, the Washington Post will run a two-part series that challenges whether the auditing profession continues to serve in the public's best interest. I am certain that the articles will rehash some old wounds. I just hope the articles give equal time to the successes where auditors can hold their heads high and point to where they truly did serve the investing public.

The ultimate fate of any profession lies not in its rules, regulations, and controls. The fate lies in the will and dedication of the majority of people who serve in that profession --- the honest cops, the devoted doctors, the dedicated professors, the faithful clergy, and the ardent auditors. These are the kinds of students we hope to continue to graduate from Trinity University.

Hang in there and hold your heads high!

Dr J

-----Original Message----- 
From: Curt 
Sent: Saturday, December 01, 2001 4:18 AM 
To: Jensen-B (a listserv) 
Subject: Having second thoughts about accounting?

Hey guys, I was just surfing around some sites researching Trinity's famous band, the Butthole Surfers and I found this quote in an article about them:

"But the artistic grit and slime are only part of the Gibby Haynes story. In fact, his squeaky clean past is as much a part of the Buttholes' lore as their albums and shows. When he hooked up with guitarist Paul Leary at Trinity University in the early eighties, Haynes was an ace student. Among his distinctions were tenures as president of his fraternity and captain of the basketball team, and the award for accounting student of the year."

Anyway, some of y'all might have already knew about this, but if not, rest assured that if the accounting profession fails us, we can always resort to showbusiness.

-curt

p.s. here's the website address of the article: http://www.addict.com/issues/2.08/html/lofi/Features/Butthole/BH-Story/ 


Another Message from a Student

Just wanted to share a link to a recent speech made by Chairman of the SEC Arthur Levitt, concerning what it means to be an auditor and where auditors derive their value.

This speech compliments my presentation, but in my mind it describes the issue in a more eloquent fashion.

It is a little lengthy, but I highly recommend that all of you at least skim through it, especially paragraphs 5-13. The message is one not of despair but of striving for betterment of the profession.

http://www.sec.gov/news/speech/spch399.htm 

-Mike


My reply to a message from a former student.

Your message below makes my day.

Thank you YiJing.

Bob Jensen

-----Original Message----- 
From: YiJing.Wu@ey.com [mailto:YiJing.Wu@ey.com]  
Sent: Monday, December 03, 2001 8:48 AM 
To: rjensen@trinity.edu  
Subject: Enron 

It's unfortunate about what is happening to Enron, but it is really fascinating to see what we have learned in the classroom applied to real companies.  I still remember in our Accounting Theory class how you were talking about companies using off-balance sheet accounting.  I wonder how much accounting regulations will change after closely examining what happened to Enron?  This will definitely have a significant impact on the public accounting profession.  It will be interesting to see how much Andersen will be impacted by this unfortunate fallout.  I just wanted to let you know how much that class we took can now be applied to the clients I work on and in the business world.

Yi-Jing Wu 
Ernst & Young LLP 


A message from Ed Scribner at New Mexico State University at Las Cruces

Bob--You inspired me to send a brief note of encouragement to our accounting students, which I forwarded to some alumni. Here's a thoughtful response from one of them.

Ed

Raymond Bachert wrote:

 Hi Ed, good job! In my experience in industry I couldn't agree more. I  work with SAP, the largest ERP Company in the world, and MS, the largest  software company; and in my experience what you say is absolutely true.  In industry most of the manual tasks of "bookkeeping" are virtually  eliminated with EDI, the web and other forms of automation. The key to  being successful in this environment is to have high quality folks  that understand business problems and the proper application of  accounting principles to new situations.  

While at NMSU I recall there being some discussion about preparing  students to pass the CPA exam vs. preparing them to understand the  principles of accounting. The later was chosen and I think this is  absolutely the right course of learning for new business professionals.  

Industry is very competitive and the time to make changes is smaller than  ever. The key is competent, reliable professionals working with  integrity. In my experience, companies that don't have this go out of  business. The application of technology only makes this process happen  in a more spectacular way.  

Let me know if there's anything I can do for you.  
Best regards, 
Ray Bachert  

-----Original Message----- 
From: Ed Scribner [mailto:escribne@NMSU.Edu]  
Sent: Tuesday, December 04, 2001 8:59 AM 
Subject: Encouragement  

Dear Alumni and Friends,   FYI, here's a copy of a message recently sent to our accounting student  listserv:  

Dear Accounting Students,   I hope you're following the Enron scandal in the business news. There  are some severe accounting problems, among other problems at Enron, that  might discourage you about the profession. Remember, though, that these  problems only underscore the need for competent, reliable information  professionals working with integrity to make sure such occurrences are  minimized. These are the kinds of professionals the employers  consistently tell us are coming out of New Mexico State.

Hang in there!  

Ed Scribner 
Accounting & BCS, NMSU


Say What?  An Accounting Professor?

But the omissions on the Web sites, with their whiff of shame, seem to go beyond that. Accountants are clearly out of style, even among accountants. School admissions dropped 25 percent in the last four years. Some speak of a ''crisis in accounting.'' W. David Albrecht, a professor of accounting at Bowling Green State University in Ohio, who runs a Web site, is among them. It's not hard to make him for a member of the profession -- skinny, stooped, with russet hair and mustache, he peers into a computer screen with the words ''I love acctng'' on it. He knows that the culture has turned against him. Even the admissions committee at Bowling Green, he says, avoids the stereotypical accounting candidate in its search for future titans of economies yet unborn: ''In the current environment, people think they don't need bookkeepers. They don't need number crunchers.'' They want financial leaders that ''people who come into contact with will respect.'' But ''accounting students tend to be the same kinds of people as always, people who were attracted to bookkeeping in high school,'' Albrecht says. ''They like keeping track of things.'' He considers the talent ''essential.'' 

Source:  This Doesn't Add Up, by D.T. Max, The New York Times, January 28, 2002 --- http://www.nytimes.com/2002/01/27/magazine/27WWLN.html 


An article in Business Week entitled "How Governance Rules Failed at Enron" questions the effectiveness of today's audit committees. The article draws three lessons from the Enron collapse in an effort to help guide future regulation. http://www.accountingweb.com/item/69330 


The SEC will not tolerate a pattern of growing restatements, audit failures, corporate failures and massive investor losses," Pitt said in a news conference. "Somehow we have got to put a stop to the vicious cycle that has now been in evidence for far too many years."

"SEC seeks accounting reform:  Chairman Harvey Pitt says restoring public confidence is goal No. 1," CNN Money, January 17, 2002 --- http://money.cnn.com/2002/01/17/news/sec_pitt/ 

Securities & Exchange Commission Chairman Harvey Pitt called Thursday for reform of the way accounting firms are monitored and regulated in the United States in an effort to restore public confidence in the profession in the wake of scandals involving Enron Corp. and other companies.

"This commission cannot and will not tolerate a pattern of growing restatements, audit failures, corporate failures and massive investor losses," Pitt said in a news conference. "Somehow we have got to put a stop to the vicious cycle that has now been in evidence for far too many years."

Pitt proposed the creation of a new body, composed mostly of representatives from the public sector, to oversee and discipline accounting firms, and he called for a reform of the triennial peer review process, which has been criticized "with some merit," Pitt said.

His suggestions were prompted mostly by the recent collapse of energy trader Enron and the revelations of accounting irregularities that led to it. Its auditor, Arthur Andersen, has come under intense scrutiny for failing to discover or disclose problems with Enron's books that hid massive debt and helped the company avoid paying taxes.

Enron's shares lost almost all their value as the disclosures came to light, the company filed for bankruptcy and investor confidence in the accuracy of companies' financial disclosures was shaken.

"I place restoring the public's confidence in the auditing profession to be immediate goal number one," Pitt said

Pitt said he and others in the SEC were still trying to work out the details of the new oversight group, which would have the power to compel testimony and the production of documents, and were investigating the circumstances of Enron's collapse.

Despite Pitt's proposals, Sen. Jon Corzine, D - New Jersey, told CNNfn's The Money Gang that the SEC should be policing the accounting firms. (WAV 597KB) (AIFF 597KB).

Pitt did say he thought the SEC should have oversight of the new body's decisions and actions.

Of particular interest to the SEC may be the actions of Andersen, which admitted to intentionally destroying Enron documents -- excepting the important "work papers" associated with an audit -- and recently fired the partner heading up its work on Enron.

Andersen's actions were only the latest in a series of stumbles by accounting firms. Andersen was recently fined $7 million by the SEC, the largest penalty ever, for irregularities connected with its work on Waste Management Inc. Other venerable firms like PricewaterhouseCoopers and Ernst & Young have also had their share of trouble.

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.  


In a surprise response to last week's SEC announcement, the Public Oversight Board, the independent body that oversees the self-regulatory function for auditors of companies registered with the Securities & Exchange Commission, passed a resolution stating its intent to close its doors no later than March 31, 2002. http://www.accountingweb.com/item/69876 

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.  


Enron is Yet Another Example of a Typical Audit Committee Failing

My message to Professor Charles Horngren at Stanford University on February 7, 2002
(Bob Jaedicke was the head of Enron's Audit Committee and on the Board of Directors for for over 15  years.  I guess he is still head of that Committee and on the Board.  He is an Emeritus Professor of Accounting and former Associate Dean and Dean of the Graduate School of Business at Stanford University.)

Hi Chuck,

If its any consolation, I pretty much said the same thing as you said about Bob in our NPR interviews. Bob taught the first accounting course (a doctoral seminar) that I ever took in accounting. He was an excellent teacher, a man who questioned before he answered, and a man of the highest morals and integrity.

I said all of that in the interview, but those parts were left on the cutting room floor in favor of your remarks to the same effect.

I was, however, critical of Enron's Audit Committee. You only have to look at Enron's published financial statements to see glaring red flags that the Audit Committee should have challenged. I think that both the Audit Committee and Enron's Board of Directors got bedazzled by the slickest con artists of the 21st Century.

Bob Jensen

The NPR program did a great job in showing how Enron executives compensated the Audit Committee in various ways. Bob had a straight salary of $60,000. But some of the other Audit Committee members received benefits beyond their straight salaries (e.g., consulting fees and grants to their institutions). This just reinforces my lack of respect for the audit committees allowed by the SEC. In fact it reinforces my lack of respect for the SEC, but what's new?


Ed Scribner called my attention to Bob Jaedicke's testimony on February 7, 2002 --- http://energycommerce.house.gov/107/hearings/02072002Hearing485/Jaedicke798.htm 

My critical, truly gut wrenching in this instance, comment is at the end of this module!

Although I am skeptical of much of the testimony and press statement of Enron insiders, I tend to believe Bob Jaedicke given my long history of knowing him, taking a doctoral seminar from him, having dinners in his house in my post-doctorate years, and respecting his "sterling contributions" (Dr. Horngren's words) to the Stanford Graduate School of Business both as a senior professor, Associate Dean, and eventually as its highly respected Dean..

Conclusion 

The Board recognizes that these transactions had catastrophic consequences for Enron—in an environment already made difficult by investments that were otherwise performing poorly in its broadband, retail energy and water businesses. In retrospect, and with the knowledge of the duplicity of its employees and the failures of its advisers, the Board deeply wishes that it had never agreed to these transactions. The Board, however, did not – and could not -- have foreseen that significant information about these transactions would be withheld from it.

The Board cannot be faulted for failing to respond to information that was concealed from them, or that was actively misrepresented to them. It is not accurate to suggest that the Board “did not effectively meet its obligation with respect to the LJM transactions” when the record is replete with evidence that—without Board approval—the most senior management of Enron was willing to enrich itself at company expense, to deceive the Board and to disregard its fiduciary obligations of candor to the Company and its shareholders. Indeed, it seems evident—from a review of the Chewco, Raptor and Southhampton transactions—that no amount of process or oversight would or could have prevented the actions of these employees.

Of equal importance, there is absolutely no suggestion that the Board was in any way personally interested in these transactions. The Board acted at all times with a good faith belief that these transactions—though they presented risks—were in the company’s best interests and were being carefully structured and reviewed by internal and external professionals to ensure that they were done properly.

Finally, the Board did consider these transactions carefully, attended to the risks created by Mr. Fastow’s conflict of interests, and was repeatedly assured by company management and by the company’s advisers that these transactions were appropriate and in the Company’s best interests. While others may differ with that business judgment, it is incorrect to imply that the Board’s decision to authorize the transactions was reached carelessly or without considered attention to, and good faith reliance upon, the information made available to us at the time. This is the proper role of a board of directors—but it simply was not adequate to prevent the deliberate and improper actions of certain of the Company’s employees.

What happened at Enron has been described as a systemic failure. As it pertains to the Board, I see it instead as a cautionary reminder of the limits of a director’s role. We served as directors of what was then the seventh largest corporation in America. Our job as directors was necessarily limited by the nature of Enron’s enterprise—which was worldwide in scope, employed more than 20,000 people, and engaged in a vast array of trading and development activities. By force of necessity, we could not know personally all of the employees. As we now know, key employees whom we thought we knew proved to be dishonest or disloyal.

The very magnitude of the enterprise requires directors to confine their control to the broad policy decisions. That we did this is clear from the record. At the meetings of the Board and its committees, in which all of us participated, these questions were considered and decided on the basis of summaries, reports and corporate records. These we were entitled to rely upon. Directors are also, as the Report recognizes, entitled to rely on the honesty and integrity of their subordinates and advisers until something occurs to put them on suspicion that something is wrong.

We did all of this, and more. Sadly, despite all that we tried to do, in the face of all the assurances we received, we had no cause for suspicion until it was too late.

Thank you

Robert Jaedicke 
Enron Board of Directors Chairman of Audit and Compliance Committee

Bob Jensen's Comment
I tend to believe and agree with what Bob says about the role of the Board of Directors. What is left unsaid is the difference between the role of the Board of Directors and the role of the Audit Committee. It would seem that the Audit Committee, under Dr. Jaedicke's leadership, failed badly on its intended mission. But then what's new with Audit Committees in most corporations?

The National Public Radio revelations of possible conflicts of interest among some of the Audit Commmittee members (other than Dr. Jaedicke) are contained in the following document:

http://search.npr.org/cf/cmn/cmnpd01fm.cfm?PrgDate=02/07/2002&PrgID=3  
Under Enron Hearings Report on February 7, 2002

Warren Buffett 
Three years ago the Berkshire Hathaway CEO proposed three questions any audit committee should ask auditors: 

(1) If the auditor were solely responsible for preparation of the company's financial statements, would they have been done differently, in either material or nonmaterial ways? If differently, the auditor should explain both management's argument and his own. 

(2) If the auditor were an investor, would he have received the information essential to understanding the company's financial performance during the reporting period? 

(3) Is the company following the same internal audit procedure the auditor would if he were CEO? If not, what are the differences and why? Damn good questions. 
http://www.fortune.com/articles/206334.html
  


Andersen Was Not Forthcoming to the Audit and Compliance Committee

"Web of Details Did Enron In as Warnings Went Unheeded," by Kurt Eichenwald and Diana Henriques, The New York Times, February 10, 2002 --- http://www.nytimes.com/2002/02/10/business/10COLL.html?ex=1013922000&en=9d7bdc3f0778ea09&ei=5040&partner=MOREOVER 

The opportunity to cross to-do's off the list came just one week later, on Feb. 12. That day, the Enron board's audit and compliance committee held a meeting, and both Mr. Duncan and Mr. Bauer from Andersen attended. At one point, all Enron executives were excused from the room, and the two Andersen accountants were asked by directors if they had any concerns they wished to express, documents show.

Subsequent testimony by board members suggests the accountants raised nothing from their to-do list. "There is no evidence of any discussion by either Andersen representative about the problems or concerns they apparently had discussed internally just one week earlier," said the special committee report released last weekend.


Tone at the Top

AUDIT COMMITTEE MEMBERS AND BOARDS of directors are taking a fresh look at potential risks within their organizations following the Enron debacle. What financial reporting red flags and key risk factors should your organization know? Read more in Tone at the Top, The IIA’s corporate governance newsletter for executive management, boards of directors, and audit committees.  http://www.theiia.org/ecm/newsletters.cfm?doc_id=739 

Note especially the February 2002 edition at http://www.theiia.org/iia/publications/newsletters/ToneAtTheTop/ToneFeb02.pdf 

In response to the Enron situation, The Institute of Internal Auditors (IIA) is conducting Internet-based “flash surveys” of directors and chief audit executives (CAEs). The purpose of these surveys is gaining information — and sharing it in an upcoming Tone at the Top — on how audit committees and other governance entities monitor complex financial transactions. We encourage you to participate by typing in www.gain2.org/enrontat  


Hi John,

There are some activists with a much longer and stronger record of lamenting the decline in professionalism in auditing and accounting. For some reason, they are not being quoted in the media at the moment, and that is a darn shame!

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 Dr, Briloff was trying to save the profession from what it is now going through in the wake of the Enron scandal.

I suspect that the fear of activists (other than Briloff) is that complaining too loudly will lead to a government takeover of auditing. This in, my viewpoint, would be a disaster, because it does not take industry long to buy the regulators and turn the regulating agency into an industry cheerleader. The best way to keep the accounting firms honest is to forget the SEC and the AICPA and the rest of the establishment and directly make their mistakes, deceptions, frauds, breakdowns in quality controls expensive to the entire firms, and that is easier to do if the firms are in the private sector! We are seeing that now in the case of Andersen --- in the end its the tort lawyers who clean up or clean out the town.

The problem with most activists against the private sector is that they've not got much to rely upon except appeals for government intervention. That's like asking pimps, whores, and Wendy Gramm to clean up town.  You can read more about how Wendy Gramm sold her soul to Enron at http://faculty.trinity.edu/rjensen/fraud.htm#Farm 

Bob Jensen


On Account of Enron an Industry Changes 
As Enron rages, the call for stricter oversight is reaching a crescendo among legislators, regulators and shareholders. Looking to avoid the taint of financial impropriety, real or imagined, many companies aren't waiting for revised rules. http://www.newmedia.com/default.asp?articleID=3371 


Message from Roger on February 5, 2002

The Enron mess appears to have prompted the UK government to initiate its own review of accounting practices --- see http://www.thetimes.co.uk/article/0,,5-2002060957,00.html  

Maybe this will spread to other countries

Roger

Roger Collins 
Associate Professor 
UCC School of Business

 


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
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
Bottom-Line Commentary of Bob Jensen:  Systemic Problems That Won't Go Away  
http://faculty.trinity.edu/rjensen/FraudConclusion.htm


Fraud Detection and Reporting --- http://faculty.trinity.edu/rjensen/FraudReporting.htm

Selected Scandals in the Largest Remaining Public Accounting Firms

Large Public Accounting Firm Lawsuits

Accounting Education Shares Some of the Blame --- http://faculty.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation 

Corporate Fraud Reporting

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

Tax Fraud and Scams 

How Technology Can Be Used to Reduce Fraud  

Health Care and Medical Billing Fraud  

Online (Internet) Frauds, Consumer Frauds, and Credit Card Scams

Corporate Governance is in a Crisis 

U.S. Government Accountability (Governmental Accounting) 

The Professions of Investment Banking and Security Analysis are Rotten to the Core   This module was moved to http://faculty.trinity.edu/rjensen/FraudRotten.htm 

Derivative Financial Instruments Fraud --- http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds 

FAS 133 Trips of Freddie Mac --- http://faculty.trinity.edu/rjensen/caseans/000index.htm#FreddieMac 

Are Women More Ethical and Moral?  

Bob Jensen's threads on ecommerce and revenue reporting tricks and frauds --- http://faculty.trinity.edu/rjensen/ecommerce.htm 
For revenue reporting frauds --- http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm 

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

Resources to prevent and discover fraud from the Association of Fraud Examiners --- http://www.cfenet.com/resources/resources.asp 

Self-study training for a career in fraud examination --- http://marketplace.cfenet.com/products/products.asp

Fraud Detection and Reporting --- http://faculty.trinity.edu/rjensen/FraudReporting.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 

Future of Auditing --- http://faculty.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing

Source for United Kingdom reporting on financial scandals and other news --- http://www.financialdirector.co.uk

International Corruption Surveys and Indices --- http://www.transparency.org/cpi/ 

  • TI Bribe Payers Survey 
  • TI Corruption Perceptions Index 
  • TI-Kenya Urban Bribery Index 
  • TI-Mexicana Encuestra Nacional de Corrupcion y Buen Gobierno 
  • National Survey on corruption and Governance (NSCG) (in Spanish)
  • Transparęncia Brasil Survey

 

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 is at http://faculty.trinity.edu/rjensen/