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 5½ 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.


     
  • Quote:  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.


     
  • Quote:  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.


     
  • 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 São 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 5½ 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.

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

April 2, 2007 --- "Enron Pays Out $1.47B to Creditors," SmartPros, April 3, 2007 ---
http://accounting.smartpros.com/x57146.xml

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

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)

Save & Share Article What's This?

DiggGoogle del.icio.usYahoo! RedditFacebook

"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 célèbre 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