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


Bob Jensen's Threads on Accounting Fraud
Bob Jensen at Trinity University



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

Please Note:  This document became too large and was subdivided into other documents.  
Links to those other documents are shown below.

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 ---


Daily News Sites for Accountancy, Tax, Fraud, IFRS, XBRL, Accounting History, and More ---

Chronological Journal
Fraud Updates --- 

More Like Ledger Account Postings
Archive of Accounting Firm Frauds and Lawsuits --- 
Also has modules on audit professionalism and independence

A Timeline of Financial Scandals and Accounting Standards Development ---

The Enron, Andersen, and Worldcom Scandal Modules Have Been Moved to  ---  

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

Journal of Accountancy's Fraud Frequency Charts, September 2007 ---

Anti-Fraud Collaboration Launches Website with Access to Anti-Fraud Tools
Center for Audit Quality
January 24, 2013
News Release ---

Anti-Fraud Collaboration Site ---

Higher Education Frauds and Controversies ---

Plagiarism and Cheating ---

Bob Jensen's Threads ---

Bob Jensen's Summary of Accounting History and Accounting Theory ---

From CNN:  Clark Howard's Informative Advice About Shopping, Financial Planning, and Warnings About Scams ---

Bob Jensen's warnings about scams ---

Bob Jensen's shopping helpers ---

The Worst Fraudsters
"Who's the Worst? Expanded to More Categories," Dennis Elam, Elam Blog, October 30, 2013 ---

Notable Fraudsters ---

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

Creative Earnings Management, Agency Theory, and Accounting Manipulations to Cook the Books ---

Richard Campbell notes a nice white collar crime blog edited by some law professors --- 

Identity Theft Information and Tools from the AICPA and IRS ---

Tax practitioners and their clients are concerned about the growing epidemic of tax-related identity theft in America - both refund theft and employment theft. At the end of fiscal 2013, the IRS had almost 600,000 identity theft cases in its inventory, according tothe IRS National Taxpayer Advocate. 

The AICPA shares members' concerns about the impact of identity theft and offers the resources below to help them learn more about this issue and advise clients. We have provided recommendations to Congress and the IRS Oversight Board on ways to further protect taxpayers and preparers.

IRS Identity Protection Specialized Unit at 800-908-4490

Identity Theft Resource Center ---
Note the tab for State and Local Resources

The IRS has an Identity Theft Web Page at

FTC Identity Theft Center ---

"IRS is overwhelmed by identity theft fraud:   Billions wrongly paid out as scammers find agency an easy target," by Michael Kranish, Boston Globe, February 16, 2014 ---



"Corporate Filers Beware: New “RoboCop” Is On Patrol (detecting fraud)," by John Carney and Francesca Harker, BakerHostetler, Forbes, August 9, 2013 ---

It may not be the superhuman robotic police officer who patrolled the lawless streets of Detroit in the 1987 sci-fi thriller, but corporate filers should be every bit as concerned about the Securities and Exchange Commission’s (“SEC”) new Accounting Quality Model (“AQM”), labeled not-so-affectionately by some in the financial industry as “RoboCop.” Broadly speaking, the AQM is an analytical tool which trawls corporate filings to flag high-risk activity for closer inspection by SEC enforcement teams. Use of the AQM, in conjunction with statements by recently-confirmed SEC Chairman Mary Jo White and the introduction of new initiatives announced July 2, 2013, indicates a renewed commitment by the SEC to seek out violations of financial reporting regulations. This pledge of substantial resources means it is more important than ever for corporate filers to understand SEC enforcement strategies, especially the AQM, in order to decrease the likelihood that their firm will be the subject of an expensive SEC audit.

The Crack Down on Fraud in Accounting and Financial Reporting

In his speech nominating Mary Jo White to take over as chairman of the SEC, President Obama issued a warning: “You don’t want to mess with Mary Jo.”  That statement now seems particularly true for corporate filers given the direction of the SEC under her command. Previously a hallmark of the SEC, cases of accounting and financial-disclosure fraud made up only 11% of enforcement actions brought by the Commission in 2012.  Since taking over as chairman, Ms. White has renewed the SEC’s commitment to the detection of fraud in accounting and financial disclosures.

“I think financial-statement fraud, accounting fraud has always been important to the SEC,” Ms. White said during a June interview “It’s certainly an area that I’m interested in and you’re going to see more targeted resources in that area going forward.” She has backed that statement up with a substantial commitment of resources. In July, the commission announced new initiatives which aim to crack down on financial reporting fraud through the use of technology and analytical capacity, including the Financial Reporting and Audit Task Force and the Center for Risk and Quantitative Analytics (“CRQA”).  These initiatives will put financial reports under the microscope through the use of technology-based tools, the most important of which is RoboCop.

RoboCop: Corporate Profiler

RoboCop’s objective – to identify earnings management – is not a novel one; rather, it is the model’s proficiency that should worry filers.  Existing models on earnings management detection generally attempt to estimate discretionary accrual amounts by regressing total accruals on factors that proxy for non-discretionary accruals.  The remaining undefined amount then serves as an estimate of discretionary accruals.  The fatal flaw in this approach is the inevitable high amount of “false-positives”, rendering it useless to SEC examiners.

The AQM extends this traditional approach by including discretionary accrual factors in its regression.  This additional level of analysis further classifies the discretionary accruals as either risk indicators or risk inducers. Risk indicators are factors that are directly associated with earnings management while risk inducers indicate situations where strong incentives for earnings management exist. Based on a comparison with the filings of companies in the filer’s industry peer group, the AQM produces a score for each filing, assessing the likelihood that fraudulent activities are occurring.

While the SEC will be keeping their factor-composition cards close to the chest, the “builder of RoboCop”, Craig Lewis, Chief Economist and Director of the Division of Risk, Strategy, and Financial Innovation (“RSFI”) at the SEC, has offered several clues about the types of information most likely to catch RoboCop’s attention (Is it just a coincidence that RoboCop’s movie partner was an Officer Lewis?).

“An accounting policy that could be considered a risk indicator (and consistently measured) would be an accounting policy that results in relatively high book earnings, even though firms simultaneously select alternative tax treatments that minimize taxable income,” said Mr. Lewis. “Another accounting policy risk indicator might be a high proportion of transactions structured as ‘off-balance sheet.’”

Frequent conflicts with independent auditors, changes in auditors, or filing delays could also be risk indicators.  Examples of risk inducers include decreasing market share or lower profitability margins. This factor-based analysis allows for model flexibility, meaning examiners are able to add or remove factors to customize the analysis to their specific needs. The SEC will be able to continually update the model to account for the moves filers are taking to conceal their frauds.

Next Generation RoboCop

One of the perceived weaknesses of RoboCop is its dependence on financial comparisons between filers within an industry peer group.  As Lewis points out, “most firms that are probably engaging in earnings management or manipulation aren’t doing it in a way that allows them to stand out from everybody else. They’re actually doing it so they blend in better with their peer group.”

To account for this, the SEC’s current endeavor is expanding the model’s capabilities to include a scan of the “Management Discussion & Analysis” (“MD&A”) sections of annual reports. Through a study of past fraudulent filings, analysts at RSFI have developed lists of words and phrasing choices which have been common amongst fraudulent filers in the past. These lists have been turned into factors and incorporated into the AQM

“We’re effectively going in and we’re saying: what are the word choices that filers make that maximize our ability to differentiate between fraudsters in the past and firms that haven’t had fraud action brought against them yet?” Mr. Lewis explained during a June conference in Ireland.

“So what we’re doing is taking the MDNA section, we’re comparing them to other firms in the same industry group, and we’re finding that in the past, fraudsters have tended to talk a lot about things that really don’t matter much and they under-report all the risks that all the other firms that aren’t having these same issues talk quite a bit about.”

Firms engaged in fraudulent activity have tended to overuse particular words and phrasing choices which are associated with relatively benign activities.  They have also tended to under-disclose risks which are prevalent among a peer group.  When a filer has engaged in similar behavior, RoboCop will flag these types of unusual choices for examiner review.

How the SEC Uses RoboCop

Although the SEC has cautioned that the AQM is not the “robot police coming out and busting the fraudsters,” filers would be wise to understand the power of this tool.  RoboCop is a fully automated system.  Within 24 hours from the time a filing is posted to EDGAR, it is processed by the AQM and the results are stored in a database.  The AQM outputs a risk score which informs SEC auditors of the likelihood that a filing is fraudulent.  The SEC then uses this score to prioritize its investigations and concentrate review efforts on portions of the report most likely to contain fraudulent information.

The results of RoboCop’s analysis will likely become the basis for enforcement scheduling and direction of resources in the near future.  A filing’s risk score will determine whether a filing is given a quick, unsuspecting review, or whether it is thoroughly dissected by an SEC exam team, possibly leading to an expensive audit.  The SEC has also said it plans to use the risk scores as a means of corroborating (or invalidating) the approximately 30,000 tips, complaints, and referrals submissions it estimates will be received each year through its Electronic Data Collection Systems or completed forms TCR.

Continued in article



Lexis Nexis Fraud Prevention Site ---
The phrase “Anti-Money Laundering” should be the clickable link to:

Foreign Corrupt Practices Act Compliance Guidebook: Protecting Your Organization from Bribery and Corruption
Martin T. Biegelman and Daniel R. Biegelman
Wiley, 2010
ISBN: 978-0-470-52793-1

Investor Protection Trust ---
This site provides teaching materials.

The Investor Protection Trust provides independent, objective information to help consumers make informed investment decisions. Founded in 1993 as part of a multi-state settlement to resolve charges of misconduct, IPT serves as an independent source of non-commercial investor education materials. IPT operates programs under its own auspices and uses grants to underwrite important initiatives carried out by other organizations.

Bob Jensen's threads on fraud prevention and fraud reporting ---

Bob Jensen's personal finance helpers ---

What I like about Gina's site is that it does not avoid programs in major colleges and universities.

August 8, 2011 message from Gina

Hi Bob Jensen,
I maintain I have spent many
years as a law enforcement officer, and love my field of work. I decided to
make a website to help up and coming law enforcement students explore
schools that offer this degree degree. Do you mind taking a look and adding
it to your resource page of : ? has become a fun passion
project of mine, and I think it serves as a great resource for anyone looking
to get a degree and start a career in law enforcement.  I would greatly
appreciate any feedback, and hope you will find it as a useful addition to your

Thanks for taking a look!

Bob Jensen's threads on careers ---

Bob Jensen's threads on online training and education alternatives ---

AICPA Fraud Resource Center --- Click Here

Summary of Major Accounting Scandals ---

Bob Jensen's threads on such scandals:

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

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

Enron ---

Rotten to the Core ---

American History of Fraud ---

Bob Jensen's fraud conclusions ---

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

Bob Jensen's threads on corporate governance are at 

Forensic Accounting Helper Site

December 7, 2011 message from Emma

Hi Bob,

Thanks for getting back to me!

When I graduated from college I realized that forensic accounting was something that a lot of fellow students were really interested in. However, people knew very little about what it was or how their skills could be applied to a career in the field. Basically, I'm trying to create something that acts as both an educational resource and a primer/gateway for people who want to learn more about the academic and professional nature of forensic accounting. The site is located here: , and I'd really appreciate any feedback you might have. If you like it, I'd be great if you could include it on your site as a resource for others.

Thanks again!


Jensen Comment
The University of West Virginia now has a "Graduate Certificate in Forensic Accounting and Fraud Investigation (FAFI)" --- 

Forensic accountants in demand

The widespread growth in white-collar crime and the increased need for homeland security have greatly raised the demand for forensic accountants, fraud investigators and for auditors who posses those skills. Federal, state, and local governmental agencies, such as the Securities and Exchange Commission, the Internal Revenue Service, and the Offices of Inspector General all need accountants with forensic investigation skills. In the private sector, recent legislation (Sarbanes-Oxley Act of 2002) and auditing standards (Statement on Auditing Standard No. 99) require companies and their auditors to be more aggressive in detecting and preventing fraud.

A unique program to answer the need

The Division of Accounting has responded to this demand by developing an academic program designed to prepare entry-level accountants and others for forensic accounting and fraud investigative careers. Although many schools have added a single graduate or undergraduate course to their curricula, very few offer a multi-course graduate certificate program. This program is the only one in the region.

The 12-credit graduate Certificate Program in Forensic Accounting and Fraud Investigation (FAFI) is offered during the summer. Students may take two paths to earn this certificate:

  • Option 1: Complete a four course stand-alone non-degree graduate certificate program curriculum, or
  • Option 2: Complete a Master of Professional Accountancy (MPA) degree plus two additional certificate courses.

WVU developed the National Curriculum

Drs. Richard Riley and Bonnie Morris led the effort to develop national curriculum guidelines for fraud and forensic accounting programs for the National Institute of Justice.

Journal of Forensic Accounting ---

Journal of Forensic & Investigative Accounting ---

Association of Certified Fraud Examiners ---

A Simple Guide to Understanding Forensic Accounting ---
Thank you Jim Martin for the heads up.

Bob Jensen's threads on fraud are at



Introductory Quotations  ---

Creative Earnings Management, Agency Theory, and Accounting Manipulations to Cook the Books ---

Fraud Updates and Other Updates to the Accounting and Finance Scandals ---

Commercial Scholarly Journals and Monopoly Publishers Are Ripping Off Libraries and Scholars 

Rotten to the Core:  Mutual Fund, Investment Banking Scandals, and Security Analysis Frauds --- 

The Andersen, Enron, and WorldCom Scandals -

The Saga of Auditor Professionalism and Independence -

Risk-Based Auditing Under Attack  ---  

What's Right and What's Wrong With (SPE, SPEs), SPVs, and VIEs ---

Future of Auditing ---

Peter, Paul, and Barney: An Essay on 2008 U.S. Government Bailouts of Private Companies ---

Fraud Detection and Reporting ---

Daily News Sites for Accountancy, Tax, Fraud, IFRS, XBRL, Accounting History, and More ---

"What’s Your Fraud IQ?  Think you know enough about corruption to spot it in any of its myriad forms? Then rev up your fraud detection radar and take this (deceptively) simple test." by Joseph T. Wells, Journal of Accountancy, July 2006 ---

What Accountants Need to Know ---

Revenue Accounting and Fraud ---

American History of Fraud ---

From the AICPA
Overview of Certified in Financial Forensics (CFF) Credential --- Click Here Certified in Financial Forensics Credential.aspx 

"Spotting a hoax using statistics," Understanding Uncertainty, August 3, 2011 --- Click Here


Assessing Fraud Risk

Accounting Humor -

Selected Scandals in the Largest Remaining Public Accounting Firms

Large Public Accounting Firm Lawsuits


Accounting Education Shares Some of the Blame --- 

Daily News Sites for Accountancy, Tax, Fraud, IFRS, XBRL, Accounting History, and More ---

Corporate Fraud Reporting

Bob Jensen's threads on the importance of whistle blowing are at

Bob Jensen's PowerPoint files on fraud are

The Consumer Fraud Portion of this Document Was Moved to 

Labor Unions Resist Efforts to Require Truthful Financial Disclosures  

Tax Fraud and Scams

How Technology Can Be Used to Reduce Fraud  

Health Care and Medical Billing Fraud  

Online (Internet) Frauds, Consumer Frauds, and Credit Card Scams

Corporate Governance is in a Crisis -

U.S. Government Accountability (Governmental Accounting) 

The Professions of Investment Banking and Security Analysis are Rotten to the Core   This module was moved to 

Derivative Financial Instruments Fraud --- 

FAS 133 Trips up Fannie Mae Twice ---

FAS 133 Trips of Freddie Mac --- 

What is initial public offering (IPO) spinning and why is it illegal? 

Are Women More Ethical and Moral? ---

Example from the Stanford Law School Database -

Future CPA --- 

Also see 

"The AICPA's Prosecution of Dr. Abraham Briloff: Some Observations," by Dwight M. Owsen ---
I think Briloff was trying to save the profession from what it is now going through in the wake of the Enron scandal.

In December of 2013 Abe Briloff passed away. He was one of my all-time heros. It is shameful that he was not admitted to the Accounting Hall of Fame when he was still alive.


Bob Jensen's threads on ecommerce and revenue reporting tricks and frauds --- 
For revenue reporting frauds --- 

Bob Jensen's threads on accounting theory ---

Resources to prevent and discover fraud from the Association of Fraud Examiners --- 

Self-study training for a career in fraud examination ---

Fraud Detection and Reporting ---

Source for United Kingdom reporting on financial scandals and other news ---

International Corruption Surveys and Indices --- 

  • TI Bribe Payers Survey 
  • TI Corruption Perceptions Index 
  • TI-Kenya Urban Bribery Index 
  • TI-Mexicana Encuestra Nacional de Corrupcion y Buen Gobierno 
  • National Survey on corruption and Governance (NSCG) (in Spanish)
  • Transparência Brasil Survey


"Keeping Fraud in the Cross Hairs." by Joseph T. Wells (Interviewed) , Journal of Accountancy, June 2010 ---

Bob Jensen's threads on fraud are linked at

August 12, 2011 message from Edith Orenstein

I thought this group may find a couple FEI blog posts of interest on the anti-fraud front.
Thank you,

COSO Exposure Draft, Updating Internal Control Framework, Expected Oct/Nov.

SEC’s New Whistleblower Program Open For Business; Takes Effect Today

"Crooked CFO: KPMG knows nothing about the character traits of criminals,” by Calib Newquist, Going Concern, August 19, 2011 ---

Earlier this week we shared with you the latest analysis from KPMG that listed “key fraudster traits” and some of them seemed to describe a lot of the people you have worked or are currently working for. Things like “volatile,” “unreliability,” “unhappy,” and “self-interested” describes everyone I’ve ever been in around in the corporate world to one extent or another.

Since I was skeptical of this list, I asked Sam Antar what he thought of it. If you’ve been reading us for awhile, you’re familiar with Sam. If you’re new, I’ll do a quick refresher. Sam was the CFO of Crazy Eddie’s and was one of the masterminds behind one of the biggest financial frauds of the 1980s. While you (and I) were eating cereal in front of the TV on Saturday morning, Sam and his cousin Eddie were selling electronics and home appliances to our parents for rock bottom prices, while ripping off the government and investors for untold millions of dollars. In other words, the guy is a crook and knew/knows lots of crooks and knows their hopes (read: money), their dreams (read: money) all that crap (read: more money) and what they’ll do to get them. With that, Sam told me what he thought of KPMG’s analysis:

Continued in article

"Guest Post: Fraud Girl – Can We Detect Lying From Nonverbal Cues?" Simoleon Sense, June 20, 2010 ---
 This includes a video of Jeff Skilling's testimony:  Can you detect his lies?

"Spotting a hoax using statistics," Understanding Uncertainty, August 3, 2011 --- Click Here

Bob Jensen's threads on fraud are at

Forensic Accounting Course Materials

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

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

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

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

Any suggestions would be helpful -

Thank you,

November 3, 2009 reply from Bob Jensen

Hi Eileen,

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

I also look for real world cases and illustrations.

Financial Statement Fraud: Prevention and Detection, 2nd Edition Zabihollah Rezaee, Richard Riley ISBN: 978-0-470-45570-8 Hardcover 332 pages September 2009

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

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

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

Accounting and Auditing

Computers and Technology

Criminology and Ethics

Fraud Investigation

Fraud Schemes

Interviewing and Reporting

Legal Elements of Fraud

Spanish Titles

Bob Jensen

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

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

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

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

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

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

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

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

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

FBI Corporate Fraud Chart in August 2008 ---

A great blog on securities and accounting fraud ---

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


The Enron, Andersen, and Worldcom Scandal Modules Are At --- 

ou 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

Accounting Education Shares Some of the Blame --- 

Some of the most notorious white collar criminals in recent history:  
See History of Fraud in America --- 

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

Bob Jensen's threads on the Enron and Worldcom frauds are at

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."

Suggested Reforms
Suggested Reforms (Including those of Warren Buffet and the Andersen Accounting Firm)

Major New Law in the Wake of the Accounting and Finance Scandals

Bottom-Line Commentary of Bob Jensen
Bottom-Line Commentary of Bob Jensen:  Systemic Problems That Won't Go Away


Background Links on Accounting and Business Fraud
Main Document on the accounting, finance, and business scandals --- 

Bob Jensen's threads on professionalism and independence are at

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

The Saga of Auditor Professionalism and Independence ---

Incompetent and Corrupt Audits are Routine ---

Bob Jensen's threads on accounting theory are at 

Future of Auditing ---

Bob Jensen's threads on pro forma frauds are at 

Bob Jensen's threads on accounting theory are at 

Future of Auditing ---



The Consumer Fraud Portion of this Document Was Moved to 


January 29, 2008 message from Sikka, Prem N []

Dear Bob,

Here is an item for your website.

I have been writing regular blogs for The Guardian, a UK national newspaper. The articles are available at and offer a critical commentary on business and accountancy matters. For three days after each article the website takes readers' comments and colleagues are welcome to add comments, critical or otherwise. The most recent article appeared on 29 January 2008.

There is now also an extensive database of corporate and accountancy misdemeanours on the AABA website ( <> ) and may interest scholars, students, journalists and citizens concerned about the abuse of power.


Prem Sikka
Professor of Accounting
University of Essex
Colchester, Essex CO4 3SQ
Office Tel: +44(0)1206 873773
Office Fax: +44 (01206) 873429

Jensen Comment
I added Professor Sikka's message to the following sites:


"Assessing Fraud Risk," by Joseph T. Wells and John D. Gill, Journal of Accountancy, October 2007 ---

Every organization faces some risk of fraud from within. Fraud exposure can be classified into three broad categories: asset misappropriation, corruption and fraudulent financial statements.

Answering the following 15 questions is a good starting point for sizing up a company’s vulnerability to fraud and creating an action plan for lessening the risks. The questions are based on information from the 2007 edition of the Fraud Examiners Manual published by the Association of Certified Fraud Examiners.

1. Do one or two key employees appear to dominate the company?

If control is centered in the hands of a few key employees, those individuals should be under heightened scrutiny for compliance with internal controls and other policies and procedures.

2. Do any key employees appear to have a close association with vendors?

Employees with a close relationship to a vendor should be prohibited from approving transactions with that vendor. Alternatively, transactions between these parties should be reviewed on a regular basis for compliance with internal controls.

3. Do any key employees have outside business interests that might conflict with their job duties?

Take the example of a 32-year-old sales representative who started a software company using his employer’s time, equipment and facilities. The software company he worked for discovered that the employee demonstrated his own products to the company’s customers. Ultimately, the employee diverted $500,000 in business away from his employer.

The example illustrates why key employees should provide annual financial disclosures that list outside business interests. Many companies, particularly publicly traded companies, require such disclosures. Interests that conflict with the organization’s interests should be prohibited. Organizations should implement an explicit policy that forbids employee business activities that directly compete with the operations of the organization.

Employees who have something to hide may lie or omit key facts on the disclosure form, but requiring the step still has advantages, such as making it easier to fire workers who fail to reveal potential conflicts. If an employer can show that an employee had such an interest and failed to disclose it on an annual reporting form, the employee can be fired simply for failing to follow company policy.

4. Does the organization conduct pre-employment background checks to identify previous dishonest or unethical behavior?

Organizations should conduct pre-employment background checks before offering employment to any key applicant. The scope of a background check varies by position, but a general list to consider includes: criminal records and convictions; Social Security number verification; credit history; previous employment; employment references; personal references; education verification; professional license verification; driver’s license verification and driving history check; and civil records and judgments. Employers should ensure that legal requirements are met for the use of and access to the information.

For companies that have failed to do background checks, post-hire screenings may be appropriate in some cases, but should be conducted on the advice of legal counsel. A number of legal issues come into play when employers consider screening workers who are already on the job.

5. Does the organization educate employees about the importance of ethics and anti-fraud programs?

All employees should receive training on the ethics and anti-fraud policies of the organization. The employees should sign an acknowledgement that they have received the training and understand the policies.

6. Does the organization provide an anonymous way to report suspected violations of the ethics and anti-fraud policies?

Organizations should provide employees, vendors and customers with a confidential system for reporting suspected violations of the ethics and anti-fraud policies. According to the 2006 ACFE Report to the Nation on Occupational Fraud and Abuse, frauds are most commonly detected by a tip. The greatest percentage of those tips comes from employees of the victim organization.

In one instance, an anonymous tip received by a fraud hotline thwarted a fraud scheme that had drained approximately $580,000 from a business. The caller reported that the company’s accounts payable manager was approving fictitious invoices from his own outside company. The tip clued in company management to the scheme and brought an abrupt end to the manager’s windfall. The fraudster was terminated and arrested. The company ultimately recouped most of its losses.

7. Is job or assignment rotation mandatory for employees who handle cash receipts and accounting duties?

Job or assignment rotation should be considered for employees who work with cash receipts and accounting duties. The frequency of the rotation depends on the individual’s responsibilities and the number of people available for the revolving duties.

8. Has the company established positive pay controls with its bank by supplying the bank with a daily list of checks issued and authorized for payment?

One method for a company to help prevent check fraud is to establish positive pay controls by supplying its banks with a daily list of checks issued and authorized for payment. Banks verify items presented for payment against the company’s list and reject items that don’t appear on the list.

The use of those controls foiled a fraud attempt by an employee and his accomplice, who worked for a check-printing company. The accomplice printed blank checks with the account number belonging to the perpetrator’s employer. The perpetrator then wrote more than $100,000 worth of forgeries on the counterfeit checks.

When the checks were presented to the bank for payment, they did not appear on the organization’s list of expected payments. The bank refused to cash them. The organization was notified, and the fraudsters were arrested.

9. Are refunds, voids and discounts evaluated on a routine basis to identify patterns of activity among employees, departments, shifts or merchandise?

Companies should routinely evaluate those transactions to search for patterns of activity that might signal fraud.

10. Are purchasing and receiving functions separate from invoice processing, accounts payable and general ledger functions?

Segregation of duties is an important control. The failure to segregate these duties allowed one large, publicly traded company to be duped by a member of its managerial staff. The individual managed a remote location of the company and was authorized to order supplies and approve vendor invoices for payment. For more than a year, the manager routinely added personal items and supplies for his own business to orders made on behalf of his employer. The orders often included a strange mix of items. For instance, technical supplies and home furnishings were purchased in the same order.

In addition to ordering personal items, the employee changed the delivery address for certain supplies so they were shipped directly to his home or side business. Because the manager was in a position to approve his own purchases, he could get away with such blatantly obvious frauds. The scheme cost his employer approximately $300,000 in unnecessary purchases.

11. Is the employee payroll list periodically reviewed for duplicate or missing Social Security numbers?

Organizations should check the employee payroll list periodically for duplicate or missing Social Security numbers that may indicate a ghost employee or overlapping payments to current employees.

12. Are there policies and procedures addressing the identification, classification and handling of proprietary information?

To help prevent the theft and misuse of intellectual property, the company should implement policies and procedures addressing the identification, classification and handling of proprietary information.

13. Do employees who have access to proprietary information sign nondisclosure agreements?

All employees who have access to proprietary information should sign nondisclosure agreements. It is easier to sue for breach of a nondisclosure agreement than it is to sue for theft of information. Nondisclosure agreements afford companies legal options for the use of nonpublic information, not simply for information that is considered a trade secret.

In most states, companies without nondisclosure agreements may be limited to suing for theft of trade secret information.

14. Is there a company policy that addresses the receipt of gifts, discounts and services offered by a supplier or customer?

Organizations should implement a policy that sets ground rules about employees accepting gifts, discounts and services offered by a supplier or customer. If no explicit policy is in place, employees may find themselves in ambiguous situations without clear ethical guidelines.

For example, a city commissioner negotiated a land development deal with a group of private investors. After the deal was approved, the commissioner and his wife were rewarded by one of the investors with an all-expenses-paid international vacation.

While the promise of the trip may have influenced the commissioner’s negotiations, this would be difficult to prove. However, had a clear policy regarding the receipt of gifts been implemented and enforced, the commissioner would have known that accepting the free vacation was a violation of the rules. The ambiguity of the situation would have been avoided.

15. Are the organization’s financial goals and objectives realistic?

Closely monitor compliance with internal controls over financial reporting if the financial goals and objectives appear to be unrealistic. Establish realistic financial goals and objectives for the organization. Common justifications for financial statement fraud include a desire to obtain bonuses linked to goals or frustration with objectives that were unachievable through normal means.

Joseph T. Wells, CPA, CFE, is founder and chairman of the Association of Certified Fraud Examiners and a contributing editor to the JofA. His e-mail address is
 John D. Gill, J.D., CFE, is research director for the Association of Certified Fraud Examiners. His e-mail address is 

Bob Jensen's Fraud Updates are at

"Fraud Cases Nab Scads of Corporate Heads," by Lara Jakes Jordan, SmartPros, July 18, 2007 --- 

Hundreds of high-ranking company officials have been convicted in corporate fraud schemes since 2002, the Justice Department said Tuesday - a day after a federal judge threw out charges in one of the largest criminal tax cases in U.S. history.

Attorney General Alberto Gonzales called the U.S. District Court ruling, in favor of 13 former KPMG employees, disappointing and said he was "quite confident" the government would appeal.

"Obviously, we're disappointed, and we won't be discouraged or deterred from pursuing wrongdoing where we think it exists and following the evidence where it takes us," Gonzales told reporters following the long-planned Justice Department announcement regarding its efforts to curb corporate fraud. "So we're disappointed but we're going to stay focused on this very important issue."

In all, federal prosecutors have won 1,236 convictions in corporate fraud cases and reaped hundreds of millions in payback for victims over the last five years, said Deputy Attorney General Paul McNulty.

At least one-third of the convictions came against company CEOs, presidents, counsel and other high-ranking officials, said McNulty, who chaired a government task force aimed at curbing corporate corruption in the aftermath of the Enron scandal that wiped out thousands of jobs, more than $60 billion in market value and more than $2 billion in employee pension plans.

McNulty, who is leaving the Justice Department by summer's end, last year authored changes to rules for prosecutors in corporate fraud cases. The result, known as the "McNulty Memo," bars prosecutors from charging businesses solely for refusing to hand over corporate attorney-client communications. It also prohibits the government from penalizing firms that pay attorneys' fees for employees - except in rare cases where the payments result in blocking the investigation.

Critics say that leaves open the possibility of firms that pay attorneys fees being publicly viewed as hindering investigations - a death knell in an ethics-sensitive business era. Last week, Rep. Bobby Scott, D-Va., introduced legislation to bar prosecutors from pressuring corporations against paying legal fees or demanding attorney-client information. The bill is similar to one filed last year by Sen. Arlen Specter, R-Pa.

In the KPMG case Monday, U.S. District Judge Lewis A. Kaplan in New York said the government coerced the giant tax firm to limit and then cut off its payment of the employees' legal fees - stripping the 13 defendants' constitutional right to legal representation. The former KPMG employees were accused of participating in a fraud that helped the wealthy escape $2.5 billion in taxes. (Charges are still pending against several higher ranking KPMG executives.)

The case was not mentioned during Tuesday's hour-long ceremony, which doubled as a public send-off for McNulty. The memo, McNulty said, should encourage firms "to engage in more robust self-assessment of their internal controls."

Bob Jensen's threads on fraud are at

Bob Jensen's threads on why white collar crime often pays even if you know you're going to get caught are at

Why they do it is hypothesized at


"Combating Corporate Fraud," AccountingWeb, January 13, 2006 ---

The number of companies around the world that reported incidents of fraud increased 22 percent in the last two years, according to the 2005 biennial survey by PricewaterhouseCoopers (PwC), which interviewed more than 3,000 corporate officers in 34 countries. In England, a recent Ernst & Young survey of the Times Top 1000 indicated the average cost of each fraud exceeded $200,000. But fraud is not the only problem. There's also misconduct, unethical behavior, lying, falsification of records, sexual harassment, and drug and alcohol abuse.

PwC found that “accidental” ways of detecting fraud, such as calls to hotlines or tips from whistleblowers, accounted for more than a third of the cases. Internal audits were responsible for detecting fraud about 26 percent of the time.

Steven Skalak, Global Investigations Leader at PwC, told Reuters: "I think the investment in control systems is paying off and detecting more crime." The study found that companies with a larger number of controls could better determine the full impact of the fraud, uncovering three times as many losses as companies with fewer controls.

Many of the new and increased controls were generated through the passage of The Sarbanes-Oxley (SOX) Act of 2002, which made having confidential, anonymous reporting mechanisms a legal requirement for any publicly traded company. But private, government and non-profit organizations would be well advised to also create and implement this important tool.

While executives get the headlines, 43 percent of surveyed people admit to having engaged in at least one unethical act in the workplace in the last year, and 75 percent observed such an act and did nothing about it. Not spoken to the employee in question, not reported it, nothing. As much as we do not like to admit it, theft, fraud and malfeasance are common occurrences in companies. Unfortunately these practices exist in every level of the organization and irrespective of size or sector. Non-profits are stolen from in equal measure.

The Association of Certified Fraud Examiners 2002 Report to the Nation indicates, "the most common method for detecting occupational fraud is by a tip from an employee, customer, vendor or anonymous source." It additionally comments, "the presence of an anonymous reporting mechanism facilitates the reporting of wrongdoing and seems to have a recognizable effect in limiting fraud and losses."

The report concludes, "organizations with hotlines can cut their fraud losses by approximately 50 percent per scheme." To be effective, a confidential, anonymous reporting mechanism must be operated by an independent, third party. Employees are understandably hesitant and reluctant to report another employee. There is not only the fear of retaliation; there is the fear of retribution and of being ostracized by co-workers. In fact, in an independent survey, 54 percent gave this as the main reason for their silence.

There is also a concern if the incident involves management, or the person required to take the report or initiate the investigation. Employees must be confident in knowing they can report an incident effectively, confidentially and anonymously. Furthermore, statistics prove that an internal hotline or reporting mechanism is rarely perceived as truly anonymous.

You can become aware of and build upon the positive aspects of employee relations while proactively addressing and heading off potentially negative issues with Ethical Advocate’s confidential, anonymous reporting mechanisms and feedback system.

Confidential, anonymous reporting mechanisms serves as an early warning system, enabling organizations to react quickly to investigate issues, and often resolve problems prior to increased malfeasance, costly stealing, litigation, or negative publicity. Spending a few dollars early on can save untold dollars and valuable time. It also creates a culture of ethical behavior that over time will diminish the prospects of these actions.

When installed properly, confidential, anonymous reporting mechanisms can uncover a variety of information that can improve processes, resolve issues, and prevent catastrophic financial losses. Like a computer network and a website, an employee hotline was once just a good idea that top companies had adopted. Now it's a mandatory part of doing business.

Bob Jensen's threads on fraud are at

Bob Jensen's threads on the importance of whistle blowing are at

Bob Jensen's PowerPoint files on fraud are

PwC 2005 Global Annual Review

January 25, 2006 message from

We'd like to make the Annual Review available to you, so that you may explore the contents in an interactive manner via the link below. 

PricewaterhouseCoopers Global Economic Crime Survey 2005

The threat of fraud from apparently simple cases of bribery to complex financial misrepresentation is more prominent than ever on the agendas of company directors and financial regulators. PwC's third biennial Economic Crime Survey is based on interviews with more than 3,600 senior executives in 34 countries, and reveals their experiences with fraud, its causes and losses, their responses and recovery actions and the effectiveness of fraud prevention measures. Please click to the link below to access the full survey. 

Protecting International Trade

How can we reduce the risk that terrorists will exploit legitimate trade to attack the United States? One answer is described in PwC's "Cargo Security White Paper." It provides an example of the application of internal control processes to increase protection and expedite cargo. Please click to the link below to access the white paper. 

PwC on Fortune "100 Best Companies to Work For"

As we communicated to you in the past, we have placed a significant focus on our people initiatives. As a result of these efforts, we have seen a substantial reduction in turnover; and as external validation of our focus we were pleased to hear the recent announcement that PwC is on the Fortune "100 Best Companies to Work For" in 2006. Our emphasis on the development and retention of our people continues to be a top priority for us.

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


Brent Inman and Jean Wyer


Are Women More Ethical and Moral?

One interesting sidebar on this was an NBC News feature last night on February 6, 2003.   It was pointed out that most of the bad deeds in the Enron scandal were committed by men (e.g., Skilling, Lay, Fastow, and Duncan). Most of the white knights in whistle blowing have been women (the show featured three of those women). The implication was that we should place more trust in the feminine gender. Sounds good to me!

What NBC News overlooked was the the Mata Hari of the Enron Scandal --- Wendy Gramm --- 

Reply from Roger Collins []

Bob, I was turning out what passes for my "home office" earlier today and came across the Winter 1997 issue of Contemporary Accounting Research (Vol 14, #4). One of the articles therein (page 653) is entitled:

"An Examination of Moral Development within Public Accounting by Gender, Staff Level and Firm" by Bernardi, R and Arnold, D F (Sr)

The authors' dataset covers 494 managers and seniors from five "Big Six" firms.

According to the abstract;

"The results indicate a difference in the average level of moral development among firms.....Second, female managers are at a significantly higher average level of moral development than male managers. In fact, average scores for male managers fell between those expected for senior high school and college students.  The data suggest that a greater percentage of high-moral-development males and a low-moral development females are leaving public accounting than their respective opposites.  These results indicate that the profession has retained, through advancement, males who are potentially less sensitive to the ethical implications of various issues."

- all of which leads me to wonder whether your comments (about Enron) re our needing more female executives wasn't right on target - and also, which accounting firms ranked where in "average level of moral development".

Associate Professor 
UCC School of Business

"Study Reveals Financial Performance Higher for Companies with Women at the Top," AccountingWeb, January 30, 2004 --- 

A new study released today by Catalyst demonstrates that companies with a higher representation of women in senior management positions financially outperform companies with proportionally fewer women at the top. These findings support the business case for diversity, which asserts companies that recruit, retain, and advance women will have a competitive advantage in the global marketplace.

In the study The Bottom Line: Connecting Corporate Performance and Gender Diversity, sponsored by BMO Financial Group, Catalyst used two measures to examine financial performance: Return on Equity (ROE) and Total Return to Shareholders (TRS). After examining the 353 companies that remained on the F500 list for four out of five years between 1996 and 2000, Catalyst found:


  • The group of companies with the highest representation of women on their senior management teams had a 35-percent higher ROE and a 34- percent higher TRS than companies with the lowest women's representation.


  • Consumer Discretionary, Consumer Staples, and Financial Services companies with the highest representation of women in senior management experienced a considerably higher ROE and TRS than companies with the lowest representation of women.

"Business leaders increasingly request hard data to support the link between gender diversity and corporate performance. This study gives business leaders unquestionable evidence that a link does exist," said Catalyst President Ilene H. Lang. "We controlled for industry and company differences and the conclusion was still the same. Top-performing companies have a higher representation of women on their leadership teams."

"The Catalyst study confirms my own long-held conviction that it makes the best of business sense to have a diverse workforce and an equitable, supportive workplace," said Tony Comper, Chairman and CEO of BMO Financial Group, sole sponsor of the research.

A Note on Methodology

Catalyst divided the 353 companies into four roughly equal quartiles based on the representation of women in senior management. The top quartile is the 88 companies with the highest gender diversity on leadership teams. The bottom quartile is the 89 companies with the lowest gender diversity. Catalyst then compared the two groups based on overall ROE and TRS.

"It is important to realize that our findings demonstrate a link between women's leadership and financial performance, but not causation," said Susan Black, Catalyst Vice President of Canada and Research and Information Services. "There are many variables that can contribute to outstanding financial performance, but clearly, companies that understand the competitive advantage of gender diversity are smart enough to leverage that diversity."

From The Wall Street Journal's Accounting Educators' Reviews on February 14, 2002

TITLE: SEC Still Investigates Whether Microsoft Understated Earnings 
REPORTER: Rebecca Buckman 
DATE: Feb 13, 2002 
LINK:,,SB1013558932799654480.djm,00.html  T
OPICS: Financial Accounting

SUMMARY: Microsoft is undergoing a continuing SEC investigation into whether the company has understated its revenues. Questions relate to issues in unearned revenue.


1.) What is conservatism in accounting? Is it an accepted practice?

2.) In general, what is unearned revenue? How is it presented in the financial statements? When is this balance recognized as earned? What accounting adjustment is made at that time?

3.) Why must Microsoft record some unearned revenues from software sales? Could that practice be supported through reserves of some cash accounts?

4.) Given Microsoft's recent experiences in testifying against allegations of violating federal antitrust laws, why might the company want to understate its income?

5.) Why does the former Microsoft employee, Mr. Pancerzewski, say that "he disagrees that there is no harm in a company understating its income"? Do you think there could be problems in understating income even for companies that are not facing charges of earning excess profits through anti-competitive practices?

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

The Enron Scandal on Creative Accounting and Audit Independence

Message to Valero on April 17, 2004
Hi Pepper,

I request that you print this message for all participants of the workshop that I will present at Valero.

Of all the many documents and books that I have read about derivative financial instruments, the most important have been the books and documents written by Frank Partnoy. Some of his books are listed at the bottom of this message.

The single most important document is his Senate Testimony. More than any other single thing that I've ever read about the Enron disaster, this testimony explains what happened at Enron and what danger lurks in the entire world from continued unregulated OTC markets in derivatives. I think this document should be required reading for every business and economics student in the world. Perhaps it should be required reading for every student in the world. Among other things it says a great deal about human greed and behavior that pump up the bubble of excesses in government and private enterprise that destroy the efficiency and effectiveness of what would otherwise be the best economic system ever designed.

It would be neat if you could print his entire testimony as advance reading (15 pages) for the audience ---  
Please print my message as well since it lists some of his other writings.

The CD I sent you contains only a miniscule fraction of the helper documents and videos on derivatives and derivatives accounting that I have linked at 

I appreciate this opportunity to meet with Valero specialists in derivatives and derivatives accounting.



Frank Partnoy is best known as a whistle blower at Morgan Stanley who blew the lid on the financial graft and sexual degeneracy of derivatives instruments traders and analysts who ripped the public off for billions of dollars and contributed to mind-boggling worldwide frauds.  He is a Yale University Law School graduate who shocked the world with  various books include the following:

  • FIASCO: The Inside Story of a Wall Street Trader
  • FIASCO: Blood in the Water on Wall Street
  • FIASCO:  Blut an den weißen Westen der Wall Street Broker.
  • FIASCO: Guns, Booze and Bloodlust: the Truth About High Finance
  • Infectious Greed : How Deceit and Risk Corrupted the Financial Markets
  • Codicia Contagiosa

His other publications include the following highlight:

"The Siskel and Ebert of Financial Matters: Two Thumbs Down for the Credit Reporting Agencies" (Washington University Law Quarterly)


Bob Jensen's threads on Enron (See below)

Bob Jensen's threads on Derivative Financial Instruments Fraud are at 

Also note 

How Enron Used SPEs and Derivatives Jointly is Explained at


Bob Jensen’s threads on derivatives accounting are at

In the end, derivatives are like antibiotics.  It's dangerous to live with them, but the world is better off because of them.  The same can be said about FAS 133 and its many implementation guides and amendments.  Booking derivatives at fair value is dangerous, but the economy would be worse off without it.  What we have to do is to strive night and day to improve upon reporting of value and risk in a world that relies more and more on derivative financial instruments to manage risks.

Selected works of FRANK PARTNOY
Bob Jensen at Trinity University

1.  Who is Frank Partnoy?

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 --- 

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.

For more on Frank Partnoy's testimony, click here.

3.  What are some of Frank Partnoy’s best-known books?

Frank Partnoy, FIASCO: Blood in the Water on Wall Street (W. W. Norton & Company, 1997, ISBN 0393046222, 252 pages). 

This is the first of a somewhat repetitive succession of Partnoy’s “FIASCO” books that influenced my life.  The most important revelation from his insider’s perspective is that the most trusted firms on Wall Street and financial centers in other major cities in the U.S., that were once highly professional and trustworthy, excoriated the guts of integrity leaving a façade behind which crooks less violent than the Mafia but far more greedy took control in the roaring 1990s. 

After selling a succession of phony derivatives deals while at Morgan Stanley, Partnoy blew the whistle in this book about a number of his employer’s shady and outright fraudulent deals sold in rigged markets using bait and switch tactics.  Customers, many of them pension fund investors for schools and municipal employees, were duped into complex and enormously risky deals that were billed as safe as the U.S. Treasury.

His books have received mixed reviews, but I question some of the integrity of the reviewers from the investment banking industry who in some instances tried to whitewash some of the deals described by Partnoy.  His books have received a bit less praise than the book Liars Poker by Michael Lewis, but critics of Partnoy fail to give credit that Partnoy’s exposes preceded those of Lewis. 


Frank Partnoy, FIASCO: Guns, Booze and Bloodlust: the Truth About High Finance (Profile Books, 1998, 305 Pages)

Like his earlier books, some investment bankers and literary dilettantes who reviewed this book were critical of Partnoy and claimed that he misrepresented some legitimate structured financings.  However, my reading of the reviewers is that they were trying to lend credence to highly questionable offshore deals documented by Partnoy.  Be that as it may, it would have helped if Partnoy had been a bit more explicit in some of his illustrations.

Frank Partnoy, FIASCO: The Inside Story of a Wall Street Trader (Penguin, 1999, ISBN 0140278796, 283 pages). 

This is a blistering indictment of the unregulated OTC market for derivative financial instruments and the devious million and billion dollar deals conceived by drunken sexual deviates in investment banking.  Among other things, Partnoy describes Morgan Stanley’s annual drunken skeet-shooting competition. 

This is also one of the best accounts of the “fiasco” caused by Merrill Lynch in which Orange Counting lost over a billion dollars and was forced into bankruptcy.

Frank Partnoy, Infectious Greed: How Deceit and Risk Corrupted the Financial Markets (Henry Holt & Company, Incorporated, 2003, ISBN: 0805072675, 320 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.


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 Graam) 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.

"How Enron Ran Out of Gas," by Paul Kedrosky (Professor of Business at the University of British Colombia, The Wall Street Journal, October 29, 2001, Page A22 --- Click Here

Is troubled Enron Corp. the Long Term Capital Management of the energy markets, or merely yet another mismanaged company whose executives read too many of their own press releases? Or is poor Enron just misunderstood? Those are the questions after another week of Chinese water torture financial releases from the beleaguered Houston-based energy concern.

A year ago Enron was the hottest of the hot. While tech stocks were tanking, Enron's shares gained 89% during 2000. Even die-hard Enron skeptics -- of which there are many -- had to concede that last year was a barnburner for the company. Earnings were up 25%, and revenues more than doubled.

Not bad, considering where the company came from. A decade ago 80% of Enron's revenues came from the staid (and regulated) gas-pipeline business. No longer. Enron has been selling those assets steadily, partly fueling revenues, but also expanding into new areas. By 2000, around 95% of its revenues and more than 80% of its profits came from trading energy, and buying and selling stakes in energy producers.

The stock market applauded the move: At its peak, Enron was trading at around 55 times earnings. That's more like Cisco's once tropospheric valuation than the meager 2.5 times earnings the market affords Enron competitor Duke Energy.

But Enron management wanted more. It was, after all, a "new economy" Web-based energy trader where aggressive performers were lucratively rewarded. According to Enron Chairman and CEO Ken Lay, the company deserved to be valued accordingly. At a conference early this year he told investors the company's stock should be trading much higher -- say $126, more than double its price then.

Then the new economy motor stalled. The company's president left under strange circumstances. And rumors swirled about Enron's machinations in California's energy markets. Investors pored over Enron's weakening financial statements. But Enron analysts must have the energy and persistence of Talmudic scholars to penetrate the company's cryptic financials. In effect, Enron's troubles were hiding in plain sight.

It should have been a warning. Because of the poor financial disclosure there was no way to assess the damage the economy was doing to the company, or how it was trying to make its numbers. Most analysts blithely concede that they really didn't know how Enron made money -- in good markets or bad.

Not that Enron didn't make money, it did -- albeit with a worrisomely low return on equity given the capital required -- but sometimes revenues came from asset sales and complex off-balance sheet transactions, sometimes from energy-trading revenues. And it was very difficult to understand why or how -- or how likely it was Enron could do it again next quarter.

Enron's financial inscrutability hid stranger stuff. Deep inside the company filings was mention of LJM Cayman, L.P., a private investment partnership. According to Enron's March 2000 10-K, a "senior officer of Enron is the managing member" of LJM. Well, that was a puzzler. LJM was helping Enron "manage price and value risk with regard to certain merchant and similar assets by entering into derivatives, including swaps, puts, and collars." It was, in a phrase, Enron's house hedge fund.

There is nothing wrong with hedging positions in the volatile energy market -- it is crucial for a market-maker. But having an Enron executive managing and benefiting from the hedging is something else altogether, especially when the Enron executive was the company's CFO, Andrew Fastow. While he severed his connection with LJM (and related partnerships) in July of this year -- and left Enron in a whirl of confusion last week -- the damage had been done.

As stories in this paper have since made clear, Mr. Fastow's LJM partnership allegedly made millions from the conflict-ridden, board-approved LJM-Enron relationship. And recently Enron ended the merry affair, taking a billion-dollar writedown against equity two weeks ago over some of LJM's wrong-footed hedging. Analysts, investors, and the Securities & Exchange Commission were left with many questions, and very few answers.

To be fair, I suppose, Enron did disclose the LJM arrangement more than a year ago, saying it had erected a Chinese wall between Fastow/LJM and the company. And in a bull market, no one paid much attention to what a bad idea that horribly conflicted relationship was -- or questioned the strength of the wall. Now it matters, as do other Enron-hedged financings, a number of which look to have insufficient assets to cover debt repayments due in 2003.

We didn't do anything wrong is Mr. Lay's refrain in the company's current round of entertainingly antagonistic conference calls. That remains to be seen, but at the very least the company has shown terrible judgment, and heroic arrogance in its dismissal of shareholders interests and financial transparency.

Where has Enron's board of directors been through all of this? What kind of oversight has this motley collection of academics, government sorts, and retired executives exercised for Enron shareholders? Very little, it seems. It is time Enron's board did a proper investigation, and then cleaned house -- perhaps neatly finishing with themselves.

Then I discovered the "tip of the iceberg" article below:

"Enron Troubles Only the Tip of the Iceberg?," by Peter Eavis, --- 

Dealings with a related party have tarnished Enron's (ENE:NYSE - news - commentary - research - analysis) reputation and crushed its stock, but it looks like that case is far from unique.

The battered energy trader has done business with at least 15 other related entities, according to documents supplied by lawyers for people suing Enron. Moreover, Enron's new CFO, who has been portrayed by bulls as opposing the related-party dealings of his predecessor, serves on 12 of these entities. And Enron board members are listed as having directorships and other roles at a Houston-based related entity called ES Power 3.

The extent of Enron's dealings with these companies, or the value of its holdings in them, couldn't be immediately determined. But the existence of these partnerships could feed investors' fears that Enron has billions of dollars of liabilities that don't show up on its balance sheet. If that's so, the company's financial strength and growth prospects could be much less than has generally been assumed on Wall Street, where the company was long treated with kid gloves.

Enron didn't immediately respond to questions seeking details about ES Power or about the role of the chief financial officer, Jeff McMahon, in the various entities. Enron's board members couldn't immediately be reached for comment.

Ten Long Days

Enron's previous CFO, Andrew Fastow, was replaced by McMahon Wednesday after investors criticized Fastow's role in a partnership called LJM, which had done complex hedging transactions with Enron. As details of this deal and two others emerged, Enron stock cratered.

The turmoil that resulted in Fastow's departure began two weeks ago, when Enron reported third-quarter earnings that met estimates. However, the company failed to disclose in its earnings press release a $1.2 billion charge to equity related to unwinding the LJM transactions. Since then, investors and analysts have been calling with increasing vehemence for the company to divulge full details of its business dealings with other related entities. Enron stock sank 6% Friday, meaning it has lost 56% of its value in just two weeks.

Enron's End Run?
New financial chief's involvement in Enron business partners
Enron-Related Entity Creation Date McMahon Involved?
ECT Strategic Value Corp. 4/18/1985 Yes
JILP-LP Inc. 9/27/1995 Yes
ECT Investments Inc. 3/1/1996 Yes
Kenobe Inc. 11/8/1996 Yes
Enserco LLC 1/7/1997 Yes
Obi-1 Holdings LLC 1/7/1997 Yes
Oilfield Business Investments - 1 LLC 1/7/1997 Yes
HGK Enterprises LP Inc. 7/29/1997 Yes
ECT Eocene Enterprises III Inc. 2/20/1998 Yes
Jedi Capital II LLC 9/4/1998 Yes
E.C.T. Coal Company No. 2 LLC 12/31/1998 Yes
ES Power 3 LLC 1/7/1999 Yes
Enserco Inc. 3/25/1999 No
LJM Management LLC 7/2/1999 No
Blue Heron I LLC 9/17/1999 No
Whitewing Management LLC 2/28/2000 No
Jedi Capital II LLC 4/16/2001 No
Source: Detox

However, Enron has yet to break out a full list of related entities. The company has said nothing publicly about McMahon's participation in related entities, nor has it mentioned that its board members were directors or senior officers in ES Power 3. (Nor has it explained the extensive use of Star Wars-related names by the related-party companies.) It's not immediately clear what ES Power 3 is or does. So far, subpoenas issued by lawyers suing Enron have determined the names of senior officers of ES Power 3 and its formation date, January 1999.

Among ES Power 3's senior executives are Enron CEO Ken Lay, listed as a director, and McMahon and Fastow, listed as executive vice presidents. A raft of external directors are named as ES Power 3 directors, including Comdisco CEO Norman Blake and Ronnie Chan, chairman of the Hong Kong-based Hang Lung Group. A Comdisco spokeswoman says Blake isn't commenting on matters concerning Enron and a call to the Hang Lung group wasn't immediately returned.

Demands, Demands

Rating agencies Moody's, Fitch and S&P recently put Enron's credit rating on review for a possible downgrade after an LJM deal that led to the $1.2 billion hit to equity. Enron still has a rating three notches above investment grade. But its bonds trade with a yield generally seen on subinvestment grade, or junk, bonds, suggesting the market believes downgrades are likely.

If Enron's rating drops below investment grade, it must find cash or issue stock to pay off at least $3.4 billion in off-balance sheet obligations. In addition, many of its swap agreements contain provisions that demand immediate cash settlement if its rating goes below investment grade.

Friday, the company drew down $3 billion from credit lines to pay off commercial paper obligations. Raising cash in the CP market could be tough when investors are jittery about Enron's condition.

This week, a number of energy market players reduced exposure to Enron. However, in a Friday press release, CEO Lay said that Enron was the "market-maker of choice in wholesale gas and power markets." He added: "It is evident that our customers view Enron as the major liquidity source of the global energy markets."

McMahon reportedly objected to Fastow's role in LJM, allegedly believing it posed Fastow with a conflict of interests. But he will need to convince investors that the 12 entities he's connected to don't do the same. Enron has said that its board fully approved of the LJM deals that Fastow was involved in. Now, board members will have to comment on their own roles in a related entity.

Related Links

Selected quotations from "Why Enron Went Bust:  Start with arrogance.  Add greed, deceit, and financial chicanery.  What do you get?  A company that wasn't what it was cracked up to be." by Benthany McLean, Fortune Magazine, December 24, 2001, pp. 58-68.

Why Enron Went Bust:  Start with arrogance.  Add greed, deceit, and financial chicanery.  What do you get?  A company that wasn't what it was cracked up to be."

In fact , it's next to impossible to find someone outside Enron who agrees with Fasto's contention (that Enron was an energy provider rather than an energy trading company).  "They were not an energy company that used trading as part of their strategy, but a company that traded for trading's sake," says Austin Ramzy, research director of Principal Capital Income Investors.  "Enron is dominated by pure trading," says one competitor.  Indeed, Enron had a reputation for taking more risk than other companies, especially in longer-term contracts, in which there is far less liquidity.  "Enron swung for the fences," says another trader.  And it's not secret that among non-investment banks, Enron was an active and extremely aggressive player in complex financial instruments such as credi8t derivatives.  Because Enron didn't have as strong a balance sheet as the investment banks that dominate that world, it had to offer better prices to get business.  "Funky" is a word that is used to describe its trades.

In early 2001, Jim Chanos, who runs Kynikos Associates, a highly regarded firm that specializes in short-selling, said publicly what now seems obvious:  No one could explain how Enron actually made money ... it simply didn't make very much money.  Enron's operating margin had plunged from around 5% in early 2000 to under 2% by early 2001, and its return on invested capital hovered at 7%---a figure that does not include Enron's off-balance-sheet debt, which, as we now know, was substantial.  "I wouldn't put my money in a hedge fund earning a 7% return," scoffed Chanos, who also pointed out that Skilling (the former Enron CEO who mysteriously resigned in August prior to the December 2 meltdown of Enron) was aggressively selling shares---hardly the behavior of someone who believed his $80 stock was really worth $126.

Enron's executives will probably claim that they had Enron's auditor, Arthur Andersen, approving their every move.  With Enron in bankruptcy, Arthur Andersen is now the deepest available pocket, and the shareholder suits are already piling up.

Enron's belated FAQ statement on "related party transactions" --- 
Exclusive Reports --- 
Enron Keeps Bleeding --- 
Enron Corporation homepage --- 
Enron Corporation's Financial Statements

Annual Information





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 
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,", December 16, 2002 --- 

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.  

1995'S 10 WORST


ENRON <--------------

by Russell Mokhiber and Andrew Wheat 


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
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.


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



TITLE: Heard on the Street: Most Analysts Remain Plugged In to Enron
REPORTER: Susanne Craig and Jonathan Weil
ISSUE: Oct 26, 2001

TITLE: Enron Officials Sell Shares Amid Stock-Price Slump
REPORTER: Theo Francis and Cassell Bryan-Low
ISSUE: Oct 26, 2001

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 

TITLE: Arthur Andersen Could Face Scrutiny On Clarity of Enron Financial Reports 
REPORTER: Jonathan Weil 
DATE: Nov 05, 2001 
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.


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

Mayo Clinic's accounting called into question
Court documents pertaining to a suit brought against the Mayo Foundation by a former accounting employee under the False Claims Act and settled in May for $6.5 million, were released Monday to the Rochester, Minnesota, Post-Bulletin, according to the Associated Press. The documents had been under seal until the Post-Bulletin challenged the settlement order, according to the Associated Press. These documents show that federal investigators alleged that the Mayo Clinic had serious problems accounting for research grants, according to the Associated Press. “The audit team from the Department of Health and Human Services and the National Institutes of Health, whose job it is to routinely audit grants, has never seen an accounting system with such basic failures. Nor have they ever previously confronted an institution incapable of being audited in this way,” the Associated Press quotes from one document, signed by Assistant U.S. Attorney Robyn Millenacker.
"Harsh Criticism for the Mayo Foundation's Accounting Practices," AccountingWeb, July 21, 2005 ---


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

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 

TITLE: Behind Shrinking Deficits: Derivatives? 
REPORTER: Silvia Ascarelli and Deborah Ball 
DATE: Nov 06, 2001 PAGE: A22 
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.


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 . 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 

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 

TITLE: Basic Principle of Accounting Tripped Enron 
REPORTER: Jonathan Weil 
DATE: Nov 12, 2001 
TOPICS: Accounting, Auditing, Auditing Services, Auditor Independence

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.

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

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 

TITLE: Arthur Andersen Could Face Scrutiny On Clarity of Enron Financial Reports 
REPORTER: Jonathan Weil 
DATE: Nov 05, 2001 
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 ---  
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 

Bob Jensen

Modernization of the (CPA) Profession's Independence Rules 

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 --- 

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. 

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. 

"Andersen Passes Peer Review Accounting Firm Cleared Despite Finding of Deficiencies," by David S. Hilzenrath,  The Washington Post, January 3, 2002 --- 

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 --- 

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 --- 

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.


From The Washington Post, December 2, 2001 ---

"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 ---
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  link number 1

Incidentally, if you haven't been to my site recently (or at all), you can see my latest news at . 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  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 --- 

"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 

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  , and the Energy and Commerce Committee at 

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 --- 

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?
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?
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?
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: 

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 



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 --- 

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.

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. 

An Allan Sloan quotation from Newsweek Magazine, December 10, 2001, Page 51 --- 

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 --- 

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

Pitt: Elevating the Accounting Profession
By: SmartPros Editorial Staff 

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


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: 

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 ---!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 

    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 

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 

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 --- 



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

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 


Ernst & Young changes its mind
Firm reported to reverse its stance on how companies account for stock options. 
CNN Money, February 14, 2003 --- 
Also see Bob Jensen's threads on this topic at 



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 ---,,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,,SB1045188334874902183,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs 

Bob Jensen's threads on stock compensation controversies are at 

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

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 ---,,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

Also note 

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


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 

Be aware that articles only stay freely available for about a week at the Philadelphia Inquirer.

Jim Borden Villanova University

Also see 

My first Philadelphia Inquirer Interview --- 
"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.",8599,193520,00.html 

The Time Magazine link above is at,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 ... 

Part II - Why Andersen is so exposed ... 

Part III - An independence dilemma 

Main link ---

Dingell Takes Pitt to Task in Wake Of Enron Debacle; Full Investigation Sought --- 

Bob Jensen's threads on SPEs are at

"The Big Five Need to Factor in Investors," Business Week, December 24, 2001, Page 32 --- (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 --- (not free to download for non-subscribers)

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.)

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 --- (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. 

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." --- 

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 --- 
Also see 

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." 

Message 1 (January 5, 2002) from a former Chairman of the Financial Accounting Standards Board (Denny Beresford)


You might be interested in the following link to an article in the Atlanta newspaper that mentions my own economic setback re: Enron. 


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 --- 

"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


In response to Enron, the major accounting firms have developed some new audit "tools" that can be accessed at:

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:

I understand the SEC will probably also tell companies that they need to enhance their MD&A disclosures about special purpose entities.


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 
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.

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  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,'s Double Entries 

[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  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  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 . 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 

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 

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 

Note especially the following link to Mark Cheffers' articles at  ---

Lessons from the Enron Collapse Part I - Old line partners wanted ...

Part II - Why Andersen is so exposed ...

Part III - An independence dilemma

Bob Jensen's threads on derivative financial instruments are at 



"First WorldCom Accountants Sentenced," AccountingWeb, August 8, 2005 ---

Two of the lowest ranking officials participating in the conspiracy responsible for the $11 billion fraud that brought down WorldCom were sentenced on Friday, August 5. Three more former WorldCom executives, accounting director Buford Yates, controller David Myers and chief financial officer Scott Sullivan, will be sentenced this week. Betty Vinson, a former mid-level accounting manager at WorldCom, was sentenced to five months in prison to be followed by five months of house arrest. Vinson testified for the government in the trial of Bernard Ebbers, WorldCom’s former Chief Executive Officer (CEO).

“Had Ms. Vinson refused to do what she was asked, it’s possible this conspiracy might have been nipped in the bud,” U.S. District Judge Barbara Jones said in handing down the sentence, the Associated Press reports.

Judge Jones ordered Vinson to begin serving her sentence on November 7, according to Reuters. Although federal probation officials will make the final determination regarding where Vinson will serve her time, Reuters reports her lawyer requested she be sent to a prison near Jackson, Mississippi so she could be close to family and friends.

In a separate proceeding in Judge Jones court, Troy Normand, another former WorldCom accounting official, was sentenced to three years probation. Prosecutor David Anders asked for leniency, telling the court that Normand’s role was simply to see that WorldCom’s books had been changed and required no independent thought, according to the Associated Press. Normand also testified against Ebbers. The Associated Press reports Normand apologized to the thousands of WorldCom employees who lost jobs and investors who lost money in the collapse before he was sentenced.



Worldcom Fraud

The WorldCom/Andersen Scandal 

I watched the AICPA's excellent FBI Webcast today (Nov. 6). One segment that I really enjoyed was a video of Walter Pavlo, a former MCI executive who served prison time for fraud. This was a person with all intentions of being highly professional on a fast track to being in charge of collecting reseller bad debts for MCI. In that position, he just stumbled upon too much temptation for what is tantamount to a kiting scheme.

You can read details about Walter Pavlo's fraud at  
This Forbes site was temporarily opened up for the AICPA Webcast viewers and will not be available very long. If you are interested in it, you should download now!

Meet an Ex Con Named Walter Pavlo Who Did Time in Club Fed

What you find below is a message (actually three messages and a phone call) I received  from a man involved in MCI's accounting fraud who went to prison and is now trying to apologize (sometimes for a rather high fee) to the world. 

You can read details about Walter Pavlo's fraud at

I wrote the following last year at

I watched the AICPA's excellent FBI Webcast ( Nov. 6, 2003 ). One segment that I really enjoyed was a video of Walter Pavlo, a former MCI executive who served prison time for fraud. This was a person with all intentions of being highly professional on a fast track to being in charge of collecting reseller bad debts for MCI. In that position, he just stumbled upon too much temptation for what is tantamount to a kiting scheme.

Message from Walter Pavlo on February 24, 2004


I routinely do a search on my name over the Internet to see if there are comments on my speeches that I conduct around the country. I saw that you had a comment on a video in which I appeared but was unable to find the complete comment on your extensive web-site. Whether positive or negative I could not ascertain but am still interested in your thoughts and would appreciate them.

I did read some of your comments regarding the stashing of cash off-shore by executives who commit crimes and the easy life they have at "club fed". Here I would agree that there are a few who have such an outcome, but this is not the norm. However, I would disagree that there is a "club fed" and on that you are misinformed.

I had off-shore accounts and received a great deal of money. However, the results of story are more tragic. All of the money is gone or turned over to authorities (no complaints here, this is justice), I lost my wife of 15 years and custody of my children, I lost all of my assets (retirement, etc.) and at 41 I am starting life over with little to show of my past accomplishments (which were many). Stories like mine are more common among rank and file middle managers who find themselves on the other side of the law. There are few top executives in prison but that appears to be changing. Time will tell if they fare as well.

Prison, while deserving for a crime of the magnitude that I and others committed, is a difficult experience and one that is difficult from which to recover. In the media and in comments such as the ones your offer, it appears that this part of the story is not revealed and that it is better to appeal to the fears and anger of the general population. I would encourage you to consider other view points for reasons of understanding the full story. I feel that this is important for people to know.

Thank you for your time and would appreciate receiving your feedback.

Walt Pavlo
125 Second Avenue, #24 New York, NY 10003
Phone: (201) 362-1208

Message 2 from Walter Palvlo (after he phoned me)


Attached is an article that appeared in Forbes magazine in the June 10, 2002 issue. I was interviewed for this article while still in prison and some six months prior to WorldCom's revelations of the multi-billion dollar fraud that we know of today.

It was a pleasure to speak with you and I hope to correspond with you more in the future.

Walt Pavlo

125 Second Avenue, #24 New York, NY 10003

Phone: (201) 362-1208

This is part of a resume that he sent to me (I think he wants me to promote him as a speaker)

Walter "Walt" Pavlo holds an engineering degree from West Virginia University and an MBA from the Stetson School of Business at Mercer University. He has worked for Goodyear Tire in its Aerospace division as a Financial Analyst, GEC Ltd. of England as a Contract Manager and as a Senior Manager in MCI Telecommunication's Division where he was responsible for billing and collections in its reseller division.

As a senior manager at MCI, and with a meritorious employment history, Mr. Pavlo was responsible for the billing and collection of nearly $1 billion in monthly revenue for MCI's carrier finance division. Beginning in March of 1996, Mr. Pavlo, one member of his staff and a business associate outside of MCI began to perpetrate a fraud involving a few of MCI's own customers. When the scheme was completed, there had been seven customers of MCI defrauded over a six-month period resulting in $6 million in payments to the Cayman Islands.

In January 2001, in cooperation with the Federal Government, Mr. Pavlo pled guilty to wire fraud and money laundering and entered federal prison shortly thereafter. His story highlights the corrupt dealings involving the manipulation of financial records within a large corporation. His case appeared as a cover story in the June 10, 2002 issue of Forbes Magazine, just weeks before WorldCom divulged that it had over $7 billion in accounting irregularities.

Currently, Mr. Pavlo is the Director of Business Development at the Young Entrepreneurs Alliance (YEA), a non-profit organization in Maynard, Massachusetts. YEA's mission is to provide at-risk and adjudicated teens with the opportunity to attain long-term economic independence by teaching them about business ownership. Mr. Pavlo's primary responsibility is to develop the business programs, raising funds through speaking engagements and charitable donations to YEA.

Mr. Pavlo has been invited to speak on his experiences by the Federal Bureau of Investigation, US Attorney's Office, major university MBA programs, corporations and various professional societies. The purpose of these speeches is to convey to audiences an understanding of the inner-workings and motivations associated with complex white-collar crimes, with an emphasis on ethical decision-making.

Walter Pavlo sent me the following information regarding my question whether he makes pro-bono presentations.  He replied as follows:


On the note of pro-bono work, most of what I have done to date has been pro-bono.  Whenever I am in an area with a paying gig, I try to reach out to universities in the area to offer my services at no charge.  I could have done this for Trinity when I was in San Antonio last year for the Institute of Internal Auditors .  I'll be sure to look you up if I'm going to be in the area.




Ken Lay's secret recipes for legally looting $184,494.426 from the corporation you manage --- 
The Enron, Andersen, and Worldcom Scandal Modules Moved to ---  

The Saga of Auditor Professionalism and Independence

E&Y Suspended for Lack of Auditor Independence

"Big Auditing Firm Gets 6-Month Ban on New Business," by Floyd Morris, The New York Times, April 17, 2004 --- 

Ernst & Young, the big accounting firm, was barred yesterday from accepting any new audit clients in the United States for six months after a judge found that the firm acted improperly by auditing a company with which it had a highly profitable business relationship.

The unusual order, which included a $1.7 million fine, brought to an end a bitter fight in which the Securities and Exchange Commission had contended that Ernst violated rules on auditor independence by jointly marketing consulting and tax services with an audit client, PeopleSoft Inc.

The overwhelming evidence," wrote Brenda P. Murray, the chief administrative law judge at the S.E.C., is that Ernst's "day-to-day operations were profit-driven and ignored considerations of auditor independence." She said the firm "committed repeated violations of the auditor independence standards by conduct that was reckless, highly unreasonable and negligent."

The rebuke to Ernst, which said it would not appeal the decision, is the latest embarrassment for one of the Big Four accounting firms, which have come under heavy criticism and increased regulation as a result of accounting scandals in recent years. Those scandals led to the demise of Arthur Andersen, which had formerly been among the Big Five.

The judge was harshly critical of the Ernst partner who was in charge of independence issues, saying he kept no written records and had failed to learn enough facts before saying the relationships between Ernst and PeopleSoft were proper. That partner, Edmund Coulson, was chief accountant of the S.E.C. before he joined Ernst in 1991.

Ernst's consulting and tax practices used PeopleSoft software in their business, and the two companies participated in some joint promotion activities. Ernst contended that it should be viewed as a customer of PeopleSoft in the relationship, but the judge said it went far beyond that.

She noted that Ernst had billed itself in marketing materials as an "implementation partner" of PeopleSoft and had earned $500 million over five years from installing PeopleSoft programs at other companies, which use the software to manage payroll, human resources and accounting operations.

She issued a cease-and-desist order against the firm, saying it had refused to admit it had done anything wrong and that there was no reason to believe it would not violate the rules again. She also fined it $1,686,500, the total amount of audit fees the company received from PeopleSoft in the years that were involved, plus interest of $729,302, and ordered that an outside monitor be brought in to assure the firm complied with the rules in the future.

S.E.C. officials said the decision would send a message to other firms. "Auditor independence is one of the centerpieces of ensuring the integrity of the audit process," said Paul Berger, an associate director of the commission's enforcement division, adding that the judge's decision "vindicates our view that Ernst & Young engaged in a business relationship that clearly violated" the rules.

Ernst, based in New York, had previously denounced the commission for seeking a ban on new business, saying any such punishment was completely unwarranted. But last night the firm said it would accept the ruling and would not appeal. It had the right to appeal to the full S.E.C. and then to federal courts if the commission ruled against it.

"Independence is the cornerstone of our practice and our obligation to the public," said Charlie Perkins, a spokesman for Ernst & Young. "We are fully committed to working closely with an outside consultant in the review of our independence policies and procedures."

Mr. Perkins said the firm had decided not to appeal because it wanted to put the matter behind it, and emphasized that it would be able to continue serving its existing clients.

The six-month suspension appears to match the longest suspension on signing new business ever imposed on a leading accounting firm.

In 1975, Peat Marwick, a predecessor of KPMG, agreed to accept a similar six-month suspension as part of a settlement of charges it had failed to properly audit five companies, including Penn Central, the railroad that went bankrupt.

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.

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.

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 

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

Surprise!  Surprise!
I have long contended criticisms of auditing firm ethics due to consulting practices were are overblown relative to the much larger problem of local firm dependence on the proportion of revenue generated from their largest audit clients. --- 

This is also implied in the by Jonathon Weil's 2001 article about Andersen's dependence upon the $1 million dollar per week fees from Enron.

TITLE: Basic Principle of Accounting Tripped Enron 
REPORTER: Jonathan Weil 
DATE: Nov 12, 2001 
PAGE: C1 in The Wall Street Journal
TOPICS: Accounting, Auditing, Auditing Services, Auditor Independence

2003 Update
You might watch for a forthcoming paper in the November/December issue of the Journal of Accounting and Public Policy --- 

From the AccountingWeb on October 28, 2003

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

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

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

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

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

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

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

"Staggering Lawsuits Hit CPA Firms," AccountingWEB, December 27, 2002 --- 

04/12/02 Xerox to Pay Record Financial Fraud Penalty, Investigation Turns to KPMG

04/26/02 Three Big Five Firms Get Sued over 'McScandal'

05/07/02 Andersen Reaches Settlement in Baptist Foundation Lawsuit

06/11/02 PwC Finds Accounting Lawsuits Broke Records in 2001

06/24/02 BDO Seidman Nears End of Case Involving Criminal Charges

07/18/02 PwC Settles Rash of Auditor-Independence Violations

07/29/02 KPMG Gets Probation For Bungling Orange County Audit

08/28/02 Andersen Worldwide To Pay $60 Million in First Enron Settlement

08/29/02 Andersen Worldwide Faces $350 Million RICO Action

09/24/02 Peregrine Files For Bankruptcy, Sues Andersen For $1 Billion

10/22/02 PwC Named in $100 Million Lawsuit

10/29/02 PwC Pays $21.5M to Settle Case With Anicom

11/08/02 H&R Block Slapped With $75 Million Kickback Ruling

12/24/02 E&Y Slapped With $1 Billion Lawsuit

August 3, 2003 excerpt from a speech by Art Wyatt (See the link below that Tracey provides)

The firms need to consider a number of initiatives.  The tone at the top of the firms needs to change.  As a starting point, leadership of the major firms might require that their managing partners meet the standards established by Sarbanes-Oxley for the individual on SEC-registrant audit committees that is designated as a qualified financial expert.  Recent managing partners have too often been chief cheerleaders promoting revenue growth or individuals with more administrative expertise than accounting and auditing expertise.  The policies established at the top of the firms must be approved by and articulated by individuals who have the professional respect of the managers and staff.  The challenge to restore the primacy of professional behavior in the conduct of services rendered will not be easily met.  Such restoration likely will not be met at all if the chief messenger is known throughout the firm as being primarily an advocate of revenue growth even when that growth may be at the expense of the firm's reputation for outstanding professionalism in the delivery of its services.

The top leadership in the firms also needs to consider whether the four largest firms are really effectively unmanageable.  In smaller accounting firms (or when the current four large firms were smaller), a key partner is able to monitor partner performance and be able to assess the strengths and weaknesses of the individual partners.  As the large firms have grown to their current size, the challenge to have such effective monitoring is substantial.  Maybe some consideration should be given to whether a split-up of a big firm would enhance the firm's quality control and permit more effective delivery of quality service.  While such a thought will no doubt be draconian to some, one only has to consider what might be the end result if one of the current four large firms meets the same fate as Andersen.  Firm break-ups might then be at the mercy of legislative or regulatory intervention--an even more draconian thought.  The bottom line, however, is, are the large firms able to manage their practices effectively to assure top quality service to their clients and the public?

The firms need to place greater internal emphasis on quality control in audit performance.  More effort should be devoted to assuring that clients have met the intent of the applicable accounting standards, and less effort should be devoted to assisting clients to structure transactions to avoid the intent (and sometimes the letter) of the standards.  In working with the FASB the focus of the firms should be on pressuring the FASB to develop standards that are conceptually sound and that avoid compromises that are designed to keep one segment of society happy at the expense of sound financial reporting.  Too often the accounting firms have acted at the direction of their clients in lobbying the FASB on specific technical issues and have not met the standards of professionalism that the public can rightfully expect from the leading accounting firms.  Too many of the FASB standards contain conceptual impurities that encourage gaming the system, and too many firms are active participants in the gaming activity.  Lobbying the FASB on behalf of particular client interests is not professional on its face and casts as much of a cloud on the firm's independence as does providing a range of consulting services to audit clients.

As a side note, I have seen comments by leaders of several of the Big 4 firms recently suggesting that the real cause of recent financial statement shortcomings is the failure of existing accounting standards to reflect the underlying economics of reporting companies.  These statements seem to be self-serving attempts to deflect criticism from accounting firm performance to the adequacy of the current set of generally accepted accounting principles.  To test the sincerity of these comments, I suggest one analyze the recent firm submission to the FASB on proposed standards that have emphasized economic reality over "backward-looking historical cost."  I suspect such analysis would suggest the several firms have missed numerous opportunities to encourage the FASB in its efforts to adopt standards that reflect better economic reality and, in fact, have often taken strongly contrary positions, at least in part at the urging of their clients.

While on the subject of the FASB, we need to recognize that the Board fared well in the Sarbanes-Oxley legislation.  Going forward, the Board needs to do a better job in educating congressmen and senators on their proposed standards and why the lobbying efforts of constituents are often far more self-serving than desirable from the perspective of fair financial reporting.  The Board needs to attack a significant number of its existing standards that are conceptually unsound and that embody a series of arbitrary boundaries that attempt to prevent users from misapplying the standard.  We should have learned by now that standards that contain arbitrary rules in the attempt to circumvent aberrant behavior really act to encourage that very behavior.  Firm leaders should recognize that their audit personnel will be far better off in dealing with aggressive client behavior if the standards that are operational are soundly based and consistent with the Board's conceptual framework.  Isn't it more important to provide your staff with the best possible tools to meet their challenges than it is to gain some short-term warm feelings by bowing to a client's wishes?  The big firms need to decide that the FASB is their ally, not their opponent, and become more statesmanlike in pursuing sound accounting standards.  This will require leaders who understand the nuances of technical accounting requirements and who are able to grasp that acceptable levels of profitability will flow from delivering top quality professional service to clients.

September 10, 2003 message from Tracey Sutherland [

The 88th Annual Meeting of the American Accounting Association was held August 3-6, 2003, in Honolulu, Hawaii. Opening speaker Arthur R. Wyatt's presentation garnered a standing ovation. So that his comments can be shared beyond those able to attend the meeting the full text of his challenging speech, "Accounting Professionalism--They Just Don't Get It!" is available online at 

This paper reviews, examines, and interprets the events and developments in the evolution of the U.S. accounting profession during the 20th century, so that one can judge "how we got where we are today."  While other historical works study the evolution of the U.S. accounting profession,1 this paper examines two issues: (1) the challenges and crises that faced the accounting profession and the big accounting firms, especially beginning in the mid-1960s, and (2) how the value shifts inside the big firms combined with changes in the earnings pressures on their corporate clients to create a climate in which serious confrontations between auditors and clients were destined to occur.  From available evidence, auditors in recent years seem to be more susceptible to accommodation and compromise on questionable accounting practices, when compared with their more stolid posture on such matters in earlier years.
"How the U.S. Accounting Profession Got Where It Is Today: Part I," by Stephen A. Zeff, Accounting Horizons, September 2003, pp. 189-205.

Note from Bob Jensen
Steve's main points are consistent with Art Wyatt's remarks at the 2003 AAA Annual Meetings in Hawaii.  However, Steve fleshes in more of the historical detail.  I am really looking forward to Steve's forthcoming Part II continuation.

I might elaborate a bit on Steve's assertion that:  "From available evidence, auditors in recent years seem to be more susceptible to accommodation and compromise on questionable accounting practices, when compared with their more stolid posture on such matters in earlier years."  Out of context, this implies that auditors of old were more moral, ethical, and professional.  But such behavior in context is relative to the changing pressures, temptations, and opportunities of a changed auditing environment.

Just because all the "stolid" male (virtually all were male before the 1970s) auditors decades earlier never committed adultery with Elizabeth Taylor does not mean that they were above temptation.  Such temptation never came their way, because Elizabeth Taylor in her prime never had any inclination toward auditors (sigh).  Along a similar vein, these "stolid" auditors only appeared to be less "susceptible to accommodation and compromise on questionable accounting practices" because temptations, pressures, and opportunities in the 1960s and earlier were totally unlike the auditing climate of the 1980s and 1990s.  My point is that auditors are human beings who have changed much less than the temptation environments and contractual complexities within which the audits take place.  The same thing has happened in the profession of journalism in the age of technology, and I highly recommend the professionalism concerns voiced at .  Journalists have not changed nearly so much as the journalism environment in the age of technology and civil strife around the world.

I also get riled when some analysts (not Steve) suggest that accounting principles today are too complex and that the simpler standards of the 1960s and earlier are all we need for current financial reporting purposes (e.g., see Scott McNealy's recommendations below ).  Those simpler standards never envisioned contractual complexities of the 1990s when newer types of derivative financial instruments (e.g., swaps), newer types of off balance sheet ploys (e.g., variable interest entities), and compound debt/equity instruments were invented.  Old standards are no more effective in modern accounting any more than battleships are effective in an age of nuclear submarines, laser-guided missiles, and satellite tracking systems.  My point here is that the FASB and IASB standards of the 1990s and later are complex because the contracts being accounted for became so complex.  There are no simple solutions to complex contracting except for simplistically naive fair value solutions that are out of touch with reality.  

November 6, 2003 reply from Gerald Trites [gtrites@STFX.CA

I recently read with great interest the Zeff paper in Horizons, the first part of a two part paper on the slow decline of the profession - or perhaps more accurately, its transition from profession to industry - during the 20th century.

Having lived through a good part of the period he covered in the first part, I can say it does a remarkable job of capturing the essence of the events during the period - a period characterized by by the inexorable forces on the profession by its publics, and the abandonment of professionalism for commercialism.

The papers should be required reading for every young person who wishes to obtain a professional accounting designation and the subject of discussion and debate in classrooms.

There was a recent cartoon in the New Yorker where an executive was sitting at a boardroom table with other executives and saying "The auditors are not team players any more." We can only hope. I hope this is the beginning of a return to professionalism. Maybe educators can help to make it so.

And congratulations to Professor Zeff.

Jerry Trites

November 6, 2003 reply from Amy Dunbar [Amy.Dunbar@BUSINESS.UCONN.EDU

Zeff's piece is great, and I look forward to the second part. The blinders came off my eyes with respect to our profession (I previously thought it was a few bad apples) when I listened to the tax shelter testimony live on Oct. 21 via Realplayer (ah, the wonder of technology). The testimony is available on . In particular, the PCAOB testimony is interesting. I now think that public accounting firms should not be able to audit clients that have purchased a "no business purpose" tax shelter from the audit firm. Perhaps the solution is to say that if the corporation is a tax client, you can't audit the company. That solution is overkill, but I no longer trust the firms to judge "business purpose." I have asked my graduate tax students to write their last memo on what Congress should do to address the tax shelter issue. The memos should be interesting reading.

Sansing, ever the terse analytic, would agree with the former IRS Chief Counsel, B. John Williams, who said the following, "One of the foundation stones of the credibility of the Service with the American public is that the Service proceed analytically rather than emotively. 'Abusive' reflects the indignation that the Service feels about a transaction, but the Service's feelings about a transaction do not state a legal basis for disallowing the tax benefits from a transaction. 'Abusive' is not an analytical term, it is an emotive term, and the mission of the Service is to apply the law fairly and impartially, not to apply the law in a manner that is biased toward a result the government wants."

Dunbar, ever the emotional observer, would encourage a little righteous indignation. Good heavens! Read the testimony of Henry Camferdam (someone said he was on 60 Minutes). When did our profession lose its way? Read Zeff!

Amy Dunbar 

November 6, 2003  Reply from Paul Williams [williamsp@COMFS1.COM.NCSU.EDU

For those of you are members of the Public INterest Section of the AAA and have free access to the section journal, Accounting and the Public Interest, there is an excellent article by Tony Tinker that sheds considerable light on this notion of the "decline of the profession." It's a myth because it presumes there was a golden era of the profession when it performed in some ideal, Durkheimian sense. But the profession of accounting was never very high up in a place it could decline from. Tom Lee documents that the first chartered accountants (ever) in Scotland (the primordial swamp from which all CPAs emerged) garnered their "charter" in order to restrain trade for their services -- they were a rather unsavory bunch whose motivation for creating the "profession" was hardly to serve the public interest. The only way accounting could ever be a profession in the classical sense in which we seem to be speaking of it as a service to mankind is that its service be performed in the employee of mankind, not in the employee of sizable private interests that are not nearly as politically and socially benign as Adam Smith's baker.

November 6 reply from Bob Jensen

Hi Paul,

With due respect, I think there was a "Golden Age" period where professionalism was quite high. I would argue that it was in the early part of the 20th Century when the large firms were formed by high integrity professionals with names like Andersen, Ernst, Haskins, Sells, Ross, Lybrand, etc. These were extremely high integrity professionals who set tough tones at the top for their employees, especially the outstanding Norwegian (my hero) named Arthur Andersen.  Read part of the eulogy for Arthur Andersen, delivered on January 13, 1947 the Rev. Dr. Duncan E. Littlefair --- 

Interestingly, the early public accounting firms may have had the highest integrity between 1900 and 1933 when auditing was not required by the U.S. Government, and CPA's did not have an auditing monopoly. I think that the early firms really believed their futures depended upon integrity and quality of service since the decision to have an audit was discretionary in the sense of agency theory where having an audit generally added value to share prices vis-à-vis not having an audit. 

As I have indicated elsewhere, however, this does not mean that "stolid" (Zeff's term) auditors of the 1950s, 1960s, and 1070s who seemingly remained highly professional would have blown the whistle on Enron, Worldcom, Xerox, Sunbeam, etc. in recent years. My comments on this are given at 

We have also had some outstanding auditors who worked public servants in government. But in the U.S., the least professional and most greedy leaders are generally in the top tiers of government (Congress, Senate, Executive Cabinet, etc.) These powerful individuals, in turn, exert pressure on agencies like the FDA, FTC, FPC, FAS, SEC, etc. to serve the interest of the companies rather than the public.

Where are the biggest crooks in most nations? Generally in high levels of government. Hence, I would prefer not to look to government for people committed to "service (as) an employee of mankind."

Where does one find an "employee of mankind?" (a Tony Tinker term) In my opinion, an employee of mankind is a high integrity professional who is driven by inner morality forces no matter where she/he happens to be employed (public or private). Public accounting in theory is neat, because the integrity is more necessary to survival of the profession than in other professions that sell more than integrity.

The problem is really not one of organizational structure. It is one of slight moral decay in the midst of enormous increases in temptation. I suspect the rise in temptation and opportunity are the main culprits.

In the next edition of New Bookmarks, I will have more to say about how this problem will be corrected. Look for the heading "1984+50: Screwed and Tattooed" in the forthcoming edition of New Bookmarks (probably around October 20).

I just finished watching the AICPA's excellent FBI Webcast today (Nov. 6). One segment that I really enjoyed was a video of Walter Pavlo, a former MCI executive who served prison time for fraud. This was a person with all intentions of being highly professional on a fast track to being in charge of collecting reseller bad debts for MCI. In that position, he just stumbled upon too much temptation for what is tantamount to a kiting scheme.

You can read details about Walter Pavlo's fraud at  This Forbes site was temporarily opened up for the AICPA Webcast viewers and will not be available very long. If you are interested in it, you should download now!

The FBI agents in the Webcast made a careful distinction between career con artists (who jump from con to con before and after prison because they seem to be inherently addicted to the game) versus others who commit fraud as a result of opportunity and temptation that exceeds their will power. These agents suggested an analogy of a bag of money being found where there appears to be no possibility of being detected. People who would never steal might succumb to "finders keepers" temptations, especially if they thought the money was lost by drug dealers who had no legitimate claim to the money in the first place and needed to somehow be punished.

Morality has not declined in the professions nearly as much as temptations and opportunities have created new environments that test morality. An analogy here is pornography. Playboy Magazine thrived in the 1960s when there was little else boys could easily get their hands on to hide under the mattress (yeah I did that). These boys were more curious than addicted. In the 21st Century with millions of free pictures of the hardest core imaginable only a few mouse clicks away, temptations and opportunities have created an entirely new addiction environment for both young people and pedophiles that prey on the young.

The obvious solutions are to do our best to convince others (e.g., auditors) not to succumb to opportunity, but it is difficult to raise the morality bar. Another solution is to reduce the temptations by increasing the probability of getting caught (e.g., better controls). At this precarious juncture in the life of our profession, we need to concentrate on both alternatives. 

But it will be a sad day when we go too far, and I will have more to say about that in the next edition of New Bookmarks.

Bob Jensen

November 8, 2003 Reply from Paul Williams [williamsp@COMFS1.COM.NCSU.EDU

Bob, I appreciate your thoughtful response. My response to that is that we would tragically remiss if we simply dismiss what we have observed as the "decline of the profession" as simply a matter of a few bad apples. It is a structural/ organizational problem. As the philospher Colin McGinn noted, "The sure mark of an ideology, in science and philosophy as in politics, is the denying of obvious facts." When you attribute the highest period of auditor integrity to the period 1900 to 1933 how is it that we experienced the market bubble that led to the passage of the securities acts? Didn't the profession fail then? You always demonize government -- it's always the government's fault. The most corrupt are always at the top of the government (yet it is the "tops" of multinational corporations who are being carted off to jail). That is simply naive and untrue. How many of us participating on this network have the good life we have today as the result of the construction and support of universities operated by the state that gave many of us of humble background access to education, and experiment unique in the history of the world (an experement we are, by the way dismantling). Of course we all deserve what we have by virtue of only our individual virtue and hard work. I certainly resent being taxed to afford the same opportunity given to me to someone elses' grandchildren. 

For citizens of a democracy to despise their government is hardly a healthy sign; after all, who elected these corrupt people? What we need is a healthy dose of self-reflection; we need to stop blaming "them." If the profession has declined and we are members of the profession as its teachers, then we are certainly part of the problem. Your hero, Arthur Andersen was perhaps the leading proponent of expanding services to clients to include consulting; he, more than anyone else, transformed the profession into one of full service for clients (i.e. management consulting). Andersen also pioneered the organizational structure of mass produced services, which certainly contributed to the severing from the "profession" of the notion (that is being so romantically bandied about in this discussion) of the dedicated small practitioner diligently serving his or her small business client. The AIA is preparing a white paper on accounting education that is nearly ready for public consumption. A central theme of that paper is de-mythologizing accounting instruction. Perhaps it isn't a coincidence that the ascendance during the 1960s in the academy of the "Chicago School" corresponds to the beginning of the decline of the profession according to many contributors to this conversation. 

If, as you say, accounting is about integrity (accounting education is first of all a moral one?) what might be the consequences of supplanting the "golden era of accounting" discourse (that of Andersen, Ernst, Haskins, etc) with one glorifying the imaginary world of efficient markets, opportunistic "agents", the sanctity of disembodied property, and the complete irrelevance of such "naive notions as fairness." (this is a direct quote from one of the intellectual leaders of our modern academy). The accounting you are nostalgic for is an accounting we haven't taught for at least 25 years. Accounting textbooks today are little more than dumbed down finance and microeconomics books. 

The rationales we provide for why we do what we do are exclusively rationalized on neo-classical grounds. The FASB justifies its existence as producing information that leads to more efficient allocations of capital, yet we have absolutely no idea whether anything the FASB does actually produces such a result. We just believe the myth. We serve "investors," which is really a euphemism for "a disembodied structure of technology called capitalism" (I thank Ed Arrington for this eloquent phrase). And even if this is hat we are about, recent events should certainly cause us to doubt that the way we are going about it is working. Wall Street is rigged. It always has been. The regulations that emerged out of the market crash were not simply some malicious attempt on the part of corrupt politicians to frustrate the magical working of the invisible hand (careful readers of Adam Smith will know that he never imagined this simple metaphor would become a priniciple for organizing every aspect of human life, a prospect he would have found appalling). There were reasons for those regulations, a lesson we are now relearning. The free market is, after all, the most carefully constructed and heavily regulated institution in human history (Andrew Abbott, Chaos of disciplines). For us academics in accounting, the current plight of the profession is an excellent opportunity for us to bring some intellectual coherence to the activity of accounting. Paton and Littleton certainly understood the significance for accounting of the corporate form of business and that significance lay in its power (made all the more significant by the Supreme Court bestowing "personhood" on them). As they noted the humble role of accounting is to implement social controls. That probably means that the role of accounting is not to leverage those controls for the benefit of only a small percentage of the people on the planet.

November 8, 2003 reply from Bob Jensen

Hi Paul,

As usual you provide an extremely thoughtful and academic counterargument. It is too involved to respond to quickly without more time.

However, I still must ask the question as to why white crime is such good business in every nation? I contend that it's because business firms and the lawyers who benefit from business dealings in so many ways literally control the power centers in government. Certainly this is the case in Washington DC and all our state legislatures. Serious reforms are either blocked or watered down with loopholes. The new SOX legislation is costly for business firms, but nearly half the respondents in an AICPA poll during yesterday's FBI Webcast did not have much faith that SOX will deter white collar crime.

I'm always looking for an example in a large nation where the government really can be trusted any more than the executives of industry and labor leaders within that nation. This just does not seem to evolve in the governance of nations. Even when an honest white knight like Jimmy Carter is placed in power, the other power centers will merely checkmate him/her in some way.

Focusing too much upon structural changes, such as government takeover of industry, overlooks real issue which is how to improve morality within any structure. Anecdotally, the upheaval of the KGB in the Soviet Union did not do much to improve morality as long as members of the old KGB merely took on new titles when running a seemingly "more democratic" government. My simplistic solution is either to replace the people who cannot change their stripes with better people or to make it more difficult for old crooks still in power to get away with what they used to get away with in the older structure.

Certainly there are no easy answers, but I am still looking for a government that seriously makes white collar crime such a serious offense that such crime is seriously deterred in the private and public sectors.

Free speech probably does more to deter white collar crime than any government or corporate ethics charter in history. Put the KGB and Kozlowski types in any power structure and the system will be corrupted.

What we need is more referendum power. For example, I would call for a referendum that never opens the door of a prison any person who intends to live in a luxurious lifestyle before making all reparations to victims of his/her crime. This should then be backed by enforcement since laws are meaningless unless they are enforced.

November 8, 2003 reply from David Fordham

Much of the discussion (including that in Zeff's article) seems to be perpetuating, rather than clarifying and eliminating, a basic misunderstanding.

That misunderstanding is the confusion between the field of "Accounting" and the field of "Auditing". Take a close look at the posts so far on this topic, and most of what is said applies to auditing, but only peripherally (if at all) to many other facets of the profession of "accounting".

Having been "raised" in the area of industry accounting (cost accountant, cost analyst, etc. eventually ending up as Corporate Controller for Paperboard Industries), I see accounting as being much more than mere auditing. In fact, I see auditing as a specialty within the field of accounting, where the term accounting also encompasses cost, tax, systems design, forecasting, interpretation, and yes, even advising.

It is the field of auditing which the public (and regulators) tend to focus on, so that is what the public seems to equate with accounting. I see very little of the current controversy applying to most of what I consider "accounting".

Perhaps the term CPA should be renamed "Certified public auditor"?

We as accountants have done an absolutely pitiful job of informing the public of the true nature of our profession, and these misunderstandings are what is, in my opinion, causing some of the problems for us. If we begin differentiating ourselves and explaining the differences between bookkeeping, accounting, auditing, tax advising, etc. and begin clarifying the many myriad and diverse services we provide as a profession, the public (and even our own prognosticators and pundits) can better debate our efficacy and the need for additional (or decremented) oversight of our profession, or even the posited decline of the profession.

E.g., let's use the term "accounting profession" to really mean the "accounting" profession, and not just the "auditing" profession.


David R. Fordham 
PBGH Faculty Fellow 
James Madison University

November 8, 2003 reply from Amy Dunbar [Amy.Dunbar@BUSINESS.UCONN.EDU

Tax accountants are out there are selling "no-business-purpose" shelters. And I certainly don't think our corporate accountants are blameless. I think this is about power, and whether the person is an auditor, consultant or industry accountant, once the person develops an appetite for power and the money that goes with power, ethics frequently becomes a dispensable good.

Amy Dunbar 

A presentation Stanford University accounting professor Maureen McNichols on the subject of
"What Led to Enron, WorldCom and the Like?"
Top Stories, Graduate School of Business, October 2003 ---

The ending of the presentation went as follows:

Discretion as the Better Part of Accounting

Arising out of the governance mayhem of the past decade are key lessons for regulators, auditors, investors, analysts, managers, and directors, McNichols said. Due to the large and complex nature of the checks and balances of an evolving system, it is imperative that each member of the governance system understands how the role he play fits into the big picture.

For regulators, there is the sobering fact that redundancy in governance systems do not preclude failures and that the oversight processes and self-regulation of auditors, analysts, and boards of directors are "only as strong as the weakest links." The focus of the Sarbanes-Oxley Act of 2002 on financial statements and auditors and strengthening the role of the audit committee is a move in the right direction, she said.

The key lesson for auditing firms is to provide auditors with incentives to convey all relevant information to the board of directors or audit committee. Regulators will respond to audit failures and obstruction of justice with very significant penalties.

She argued that for analysts to generate truly independent research, they must be rewarded for the quality of the research they provide, and they must examine the quality of corporate earnings and financial statements diligently.

Corporate managers, for their part, must understand that distorting financial statements imposes huge costs on the rest of the economy. Furthermore, she said, financial statements that provide a misleadingly-glowing view of future growth may provide incentives for the company itself to act inappropriately by making excessive capital investments, as the telecom bubble illustrates.

Managers, instead, need to understand that they are best serving investors by presenting credible financial statements—and that firms with better reporting will be valued more highly by investors. Not insignificantly, managers must also take to heart that "misleading investors can lead to civil and criminal prosecution," said McNichols.

She argued it is neither possible nor desirable to turn preparation of financial statements into a mechanical process. Indeed, the level of discretion and judgment required to prepare financial statements that represent the economic state of the organization fairly and transparently will increase, not decrease, in coming years.

Finally, McNichols outlined a number of critical lessons for directors. First, the oversight role of directors has increased substantially, though the advisory role is no less important. Secondly, the legal standard for a director is to demonstrate good faith judgment, and this requires that decisions are arrived at through a sound process. A critical aspect of a good process is ensuring that directors receive all relevant information.

McNichols recommended the "TV test" described by faculty colleague Bill Miller, who attributes it to the Business School's Dean Emeritus Arjay Miller. His test for good decision-making was whether he would feel comfortable explaining the board's decision on the evening news. "If you're not comfortable with that, you probably need to go back and examine your process for arriving at judgments," said McNichols.


From SmartPros --- 

SEC: Ernst & Young Violated Rules

Nov. 15, 2002 (Associated Press) — Federal regulators, after an initial failure, alleged for a second time Wednesday that Ernst & Young violated rules designed to keep accountants independent from the companies they audit when it engaged in business with a software company client.

The Securities and Exchange Commission took the action again against the big accounting firm now that there are enough SEC commissioners without a conflict of interest in the case. An administrative law judge at the SEC dismissed it several months ago because only one commissioner had voted to authorize the action.

New York-based Ernst & Young disputed the SEC's allegations, as it did when they were first raised in May. "Our position has remained the same throughout: Our conduct was entirely appropriate and permissible under the profession's rules," firm spokesman Les Zuke said in a statement.

"It did not affect our client, its shareholders or the investing public, nor has the SEC claimed any error in our audits or our client's financial statements as a result of them. The commission's proceedings are focused on consulting, which, because we sold our consulting business in May 2000, is now a moot point," the statement said.

The issue of auditor independence was among those at the heart of the Enron affair, which raised questions about Enron's longtime accountant, Arthur Andersen, having done both auditing and consulting work for the energy-trading company.

Andersen was convicted in June of obstruction of justice for destroying Enron audit documents.

In its administrative proceeding, the SEC said that Ernst & Young was auditing the books of business software maker PeopleSoft Inc. at the same time it was developing and marketing a software product in tandem with the company. Ernst & Young engaged in the dual activities from 1993 through 2000, according to the SEC.

The SEC said the product, named EY/GEMS, incorporated some components of PeopleSoft's proprietary source code into software previously developed and marketed by Ernst & Young's tax department. The SEC alleged that Ernst & Young tried to gain a competitive advantage by putting the source code into its product and agreed to pay PeopleSoft royalties of 15 percent to 30 percent from each sale of the product.

When the case arose in May, there were only three commissioners on the five-member SEC: Chairman Harvey Pitt, Cynthia Glassman and Isaac Hunt. Pitt and Glassman removed themselves from voting on whether to take the action against Ernst & Young because Pitt had represented the firm as a private securities lawyer and Glassman had been an Ernst & Young executive.

That left only Hunt to authorize the SEC attorneys to proceed, prompting the administrative law judge's dismissal.

A new hearing will be scheduled before a law judge to determine whether any sanctions should be imposed on Ernst & Young, the SEC said.

It was the second time the SEC had brought an auditor independence action against Ernst & Young. The firm settled a 1995 action by agreeing to comply with independence guidelines.

Robert Herdman, who resigned as the SEC's chief accountant last Friday in the controversy over the selection of former FBI director William Webster to head a special accounting oversight board, also had been an executive of Ernst & Young before coming to the SEC.

In a similar case, the SEC in January censured another Big Five accounting firm, KPMG, for allegedly violating the auditor independence rules. The agency said KPMG invested $25 million in a mutual fund at the same time it was auditing the fund's books.

KPMG, which was not fined, agreed to the SEC's censure without admitting or denying the allegations and agreed to take measures to prevent future violations.

The SEC adopted the independence rules in November 2000 after a bitter fight between the accounting industry and Arthur Levitt, then the SEC chairman. He and others worried that accountants in some cases had become too cozy with the companies they audited, threatening the integrity of financial reports and undermining investor confidence.

The rules identified several services as inconsistent with auditor independence, including bookkeeping, financial systems design and implementation, human resources and legal services.


Packers Versus the Giants: A Great Ethics Video Clip

A very short video clip mentioned below concerns an incident instigated by Green Bay Packer quarterback Brett Favre in the Green Bay's last regular season game this season. What is neat is that students will probably never forget the video clip if you show it in class.

The video clip plays a scene from the last game between the Packers and the New York Giants. The commentator, George Wills, then points out that all a star defensive player for the Giants, Michael Strahan, only needed one sack of the quarterback to set an NFL record. Near the end of the game, the Packers were certain to win, and both teams were going through the agonizing necessity of playing the game out.

On a snap of the ball, all-pro Brett Favre runs straight at Strahan and allows himself to be easily tackled. This gives Strahan the record, and Brett Favre is roundly patted on the back as a "Great Guy" by players from both teams while Strahan appears to be bowed in a prayer of gratitude. The questionable "sack" was allowed to stand on the record books --- 

In the videotaped commentary, George Wills raises a serious question of whether what Favre did was ethical. Was it fair to the current record holder who, possibly, earned every sack the hard way? Did it make a mockery out of the NFL, and make it more like the phony game of professional wrestling where virtually everything is staged?

The video clip then very briefly questions other great records. For example, opposing teams bent over backwards one year to give Joe DiMaggio his hitting record.

I find this video clip fascinating. It is at the end of an ABC video on the Enron scandal. Enron takes up most of the half-hour video, and the George Wills NFL commentary is about five minutes at the end of the tape. What I am saying is that the George Wills piece is very short, but it is very powerful about the importance integrity and independence. Geroge Wills is most certainly opposed to what Brett Favre did by openly giving Strahan an easy sack. One might say that it sacked the integrity of the NFL.

As a faculty member, I wonder if professors sometimes do the same thing when bumping "good guy" grades upward. It may be applauded by most other students, but does it compromise the integrity of the grading system?  I have overlooked some matters of student integrity recently, and it is now bothering my conscience.

In accountancy, I wonder if auditors sometimes do the same thing when "overlooking" certain discrepancies, because it is applauded by clients and current shareholders even though it compromises the integrity of the auditing system.

Video Ordering Details
Sam Donaldson's Sunday Morning (January 13) ABC show called "This Week." You can purchase it for $30 at <>
The show and video are entitled "The Collapse of Enron." The unrelated NFL ethics issue takes up about five minutes near the end of the tape.

Contextual Integrity and Contextual Ethics

The major problem with integrity is that there is nearly always a time when integrity either is or should be compromised in certain situations, usually situations where there is no harm done by a "white lie" or a "silence" about something that otherwise would cause harm or embarrassment.  What is confusing is that second order effects are not always taken into account!  For example, the direct effects of what Brett Favre did for Michael Strahan (see the above module) on surface seemed like a good thing to do at the time.  But think of those second order effects:

  1. The record set will always be demeaning to Strahan, because it was not earned fair and square in good sportsmanship.  His record becomes known as a sham throughout history.

  2. If the former record holder earned the record the hard way, the loss of that record to Strahan is an injustice.

  3. The NFL's system of designating records is put into question and no longer trusted.

  4. Brett Favre will always be mistrusted as if he is hoping for the return of a favor.  If he is approaching an NFL passing record, will NY Giants defensive backs ease off of receivers in future games to repay Brett for the favor he did for Strahan?  Respect for his motives and accomplishments may in fact be demeaned because of what he did for Strahan.

What students must learn is that situational integrity/ethics compromise the system, degrade the legitimate achievements of their peers, and become inherently unfair.  Questions regarding those situations include the following:

  • Is what you are doing something you would proudly admit to your parents, your minister, and your best friend?

  • Does your breach of integrity directly or indirectly harm any person now or in the future?

  • Does your breach of integrity potentially harm trust and faith in the system and its reputation?

  • Does your breach of integrity, however small, pave the way to similar actions in the future by you or by others who follow your precedent?  For example, if only one person ever shoplifted the loss to society is virtually zero.  If one person gets away with shoplifting and, thereby, inspires others to do so, the loss to society becomes enormous.

  • Why should it be up to you whether more good than bad comes from your breach of integrity?  For example, a leading executive at Trinity University justifies what Brett Favre did as follows:  "The new record holder, Michael Strahan, is a nearly perfect role model whereas the former record holder was a drug-dealing junkie even while he was playing defensive end for the New York Jets."  In other words, good guys deserve to be helped when attempting to beat the records of bad guys.  If this how Brett Favre also reasoned when helping Strahan break the record, I would contend that Brett Favre has no right to make such a judgment and in doing so may do more harm than good.
  • If other persons are getting away with a breach of integrity, say by copying homework, does this justifying your joining in on their misdeeds?

Message from Steven Bachrach (Department of Chemistry at Trinity University)

The Sunday New York Times this past weekend (1/13/02) has a very interesting article on the "integrity" of sports records that clearly indicates that the Favre-Strahan controversy is not unprecedented.

A few examples:

Nykesha Sales, opened up the last game of her college career hobbling onto the floor due to a ruptured Achilles tendon and was allowed to unopposedly sink a basket to set a career scoring mark.

Gordie Howe skates for 47 seconds in a minor league hockey game to set the "record" for being the first athlete to compete in 6 decades.

Denny McLain grooves 3 pitches to Mickey Mantle so that Mantle can hit a home run, passing Jimmie Foxx into 3rd place all time.

Our own David Robinson scores 71 points (thanks to exclusive feeding of the ball) in the last game of the 1993-1994 season to pass Shaq as the scoring leader. A similar situation lead to Wilt Chamberlin's famous 100 point game.

One begins to wonder whether there is any point to a discussion of ethics when it comes to sports records, especially those involved in team sports.


Thank you for the update Barbara.

It is interesting to juxtapose the Tribune's article on E&Y (my former employer) against "How Accounting Can Get Back Its Good Name," by Jim Turley, Chairman, Ernst & Young which you can read near the very bottom of 

We expect professions to fail, but why is our profession failing so badly and so often?

A message from Barbara Leonard on February 8, 2002

Hi Bob,

This story (from the Chicago Tribune) may be of possible interest in the discussion on "independence".

-------------------- Superior's auditor also consulted --------------------

Ernst & Young's dual role at bank called a conflict

By Melissa Allison Tribune staff reporter

February 8, 2002

WASHINGTON -- Ernst & Young LLP, the auditing firm accused of inadequately overseeing the books of now-failed Superior Bank FSB, also received consulting fees from the bank that totaled at least twice as much as the fees it received for its accounting services, a federal regulator said.

"It was a direct conflict," said Gaston Gianni, inspector general for the Federal Deposit Insurance Corp., in testimony to the Senate Banking Committee Thursday.

At the hearing, the FDIC, the Treasury Department and the General Accounting Office placed the blame for Superior's failure on poor management, lax oversight by regulators and inadequate oversight by Ernst & Young.

The only committee member present was its chairman, Sen. Paul Sarbanes (D-Md.), who likened Superior's downfall to another corporate failure attracting close congressional scrutiny.

"It's a little bit like Enron, isn't it?" Sarbanes quipped after hearing about the shortcomings of Superior's management, auditors and regulators. He later suggested that Congress might need to more closely oversee the activities of bank regulators to prevent future failures.

The July 2001 failure of Oakbrook Terrace-based Superior, which was owned equally by the Pritzker family of Chicago and the Dworman family in New York, could cost the Savings Association Insurance Fund $300 million to $350 million, making it the most expensive thrift failure since 1992.

In its consulting capacity, Ernst & Young approved of the method Superior used to value certain complex assets. As the bank's auditor, the accounting firm for years affirmed that those same assets had been properly valued, Gianni said. The FDIC did not disclose the amount of fees paid by Superior to Ernst & Young.

In fact, those so-called "residual" assets--generated by portions of loans the bank kept for itself after selling the rest of the loans to investors--were so overvalued on Superior's books that, when they were adjusted in 2001 to meet regulators' requirements, the bank became significantly undercapitalized and eventually failed.

Ernst & Young spokesman Les Zuke said, "We're surprised by the description of our fees." He would not confirm or deny that the firm did consulting work for Superior, but said the firm continues to work with regulators investigating Superior's failure.

In a statement, the accounting firm blamed Superior's failure on three factors: a substantial high-risk loan portfolio, multiple and rapid declines in interest rates beginning early in 2001, and a quickly deteriorating economy that had a disproportionate impact on borrowers to whom Superior catered.

Red flags missed

Gianni and others blamed the Office of Thrift Supervision, Superior's primary regulator and an agency of the Treasury Department, for not acting sooner to remedy the bank's problems, which they said were evident beginning in the mid-1990s.

"Superior exhibited many of the same red flags and indicators reminiscent of problem thrifts of the 1980s and early 1990s," said Jeffrey Rush Jr., inspector general of the Treasury Department.

Rush later said his office is working with regulators and the Department of Justice to determine whether there were violations of federal law in connection with Superior's failure. OTS examiners were aware of unusual methods the bank used to value its so-called residual assets, but continued to believe that Superior officials and Ernst & Young knew what they were doing.

Rush attributed the lack of regulatory skepticism to an OTS belief that "the owners would never allow the bank to fail, Superior management was qualified ... and external auditors could be relied on to attest to Superior's residual asset valuations. All of these assumptions proved to be false."

No one at the OTS has been fired because of Superior's failure, OTS spokesman Sam Eskenazi said, but there have been personnel moves among people involved with the case. He would not elaborate on those changes.

Panelists praised the FDIC for reaching an agreement recently with other bank regulators that allows the agency to take part more frequently in financial institution examinations. The OTS had denied an FDIC request to participate in a 1999 exam of Superior.

Whatever the shortcomings of Superior's auditors and regulators, the people most to blame were its management, directors and owners, according to the panelists Thursday.

Subprime lending a culprit

They pointed particularly to Superior's 1993 move into subprime lending, a riskier form of lending that targets customers with poor credit histories, and its overvaluation of assets connected to loans that were sold to investors.

The failure "was directly attributable to the bank's board of directors and executives ignoring sound risk management principles," Gianni said. "Numerous recommendations contained in various OTS examination reports beginning in 1993 were not addressed by the board of directors or executive management."

A Pritzker family spokesman had no comment about that accusation, and a Dworman spokesman did not return telephone calls.

In November, the FDIC approved the sale of $1.1 billion in deposits and about $45 million in assets from the defunct Superior to Cleveland-based Charter One. It is expected to sell the rest of Superior's old business, the subprime lender Alliance Funding, soon.

"The History and Rhetoric of Auditor Independence Concepts," by Sara Ann Reiter and Paul F. Williams --- 

This paper presents an historical and rhetorical analysis of auditor independence concepts. This analysis is relevant as the newly formed Independence Standards Board in the U.S. is beginning work on a conceptual framework of audit independence to use as a basis for regulation. Debate about independence concepts has a long history and some elements of the accounting profession are suggesting that a radical turn away from historical and philosophical conceptions of independence is currently needed. Independence concepts are both defined and limited by the metaphors used to convey them. These metaphors in turn reflect culturally significant narratives of legitimation. Both the metaphors and legitimating narratives surrounding auditor independence are historically rooted in the moral philosophy framework of the ethics of rights. Current independence proposals represent a shift from the profession=s traditional moral philosophy grounding to a basis in economic concepts and theory. The character of the independent auditor is changing from "judicial man” to "economic man.” A number of consequences to the standing of the profession in the public's eyes, as well as to its internal character, may arise from the changing narrative of auditor independence

Messages from Paul Williams and Elliot Kamlot on January 11, 2002

-----Original Message----- 
From: Paul Williams [mailto:williamsp@COMFS1.COM.NCSU.EDU]  
Sent: Friday, January 11, 2002 7:40 AM 
Subject: Re: Professionals 
Has the time finally arrived when serious discussion needs to occur about the absurdity of "independence" and having profit motivated individuals perform an activity that they apparently have no spirit for? The classic functionalist notion of professional connoted someone who performed an activity for its own sake and performing it excellently was the objective (MacIntyre's notion of the excellence of a practice). Doing it only for the money, though it is the model of human nature that dominates our discourse, is not conducive to one becoming a "classic" professional. And if classic professionalism is indeed an impossiblity in a world jaded by "wealth creation," then, since the audit function is essentially a regulatory activity, let regulators do it. On 10 Jan 02, at 17:04,

Elliot Kamlet wrote: 
> If Andersen doesn't quit it, we accountants will go from professionals to 
> clowns. I'm ready to sue them for their impact on the profession of which
 > I am a member! >

Reply from Bob Jensen on January 11, 2002

Try to sue the government for a bad audit or a bad investigation. At least when the Big Five lets investors down, investors can unleash tort vultures that hover over the Big Five offices daily waiting for a chance to swoop down. Investors like the University of California are suing Andersen big time at the moment, but try suing the SEC if it should happen to conduct a bad investigation of Andersen and Enron.

What we have to keep in mind is how easy it is for large industries (whether or not they are oligopolies) to manipulate government watchdogs in virtually all types of government in any part of the world. I am not at all in favor of turning audits over to bureaucrats directly under the thumbs of government leaders --- bureaucrats  immune from lawsuits because they work for the government. How many of our present watchdog agencies such as the FPC, the FDA, etc. are more like chearleaders than regulators for the industries they are supposed to be watching over?

Consider the Enron scandal. It is still unclear, at the start of the investigation, just how "independent" Andersen was in its internal and external auditing performance. It is clear, however, that many top government officials in both the Executive and Legislative branches of U.S. government were directly involved as employees of Enron, its industry friends, or its auditor.

The Vice-President of the U.S. is a very close friend of Enron's CEO Ken Lay, and President Bush admits to a rather long friendship dating back to his days as Governor of Texas. Our Attorney General Ashcroft has had to bow out of the Justice Department's new criminal investigation of Enron because of large donations to Ashcroft by Enron and his close ties with Enron executives. It turns out that many of our top government bureaucrats are former Enron employees who probably got their appointments because of Enron's ties with top government leaders. Even the new Chairman of the SEC, Harvey Pitt, was a Lawyer for Enron's internal and external auditors (Andersen).

My point is that investors should not sleep easier if the SEC or some other government agency becomes the auditor of business firms. If fact, I think it will become an even bigger nightmare of influence peddling, because elected officials sell out so easily and cheaply. The present system has huge flaws, but I think it works better than the Agriculture Department works in preventing frauds in farm subsidy programs.

Try to sue the government for a bad audit or a bad investigation. At least when the Big Five lets investors down, investors can unleash tort vultures that hover over the Big Five offices daily waiting for a chance to swoop down. Investors like the University of California are suing Andersen big time at the moment, but try suing the SEC if it should happen to conduct a bad investigation of Andersen and Enron.

Perhaps independence is the wrong goal. Possibly public accounting auditors should someday "insure" their audits and cut out the tort lawyers.

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: 

Note from Bob Jensen:  You may want to find related materials on auditor independence at the following two links:

Bob Jensen's Threads on Accounting, Business, Economic, and Related History

A message from Paul Williams on January 21, 2001

For a more thoughtful and analytical discussion of "moral breakdown" (the current one about which the rant below laments began in the 19th century) see Chapter 7 of Andrew Abbott's, Chaos of disciplines (University of Chicago Press, 2001).

In all, "about 18,000 to 20,000 employees lost money because their retirement accounts were invested in Enron stock," says Karl Barth, an attorney for Hagens and Berman, a Seattle law firm that's suing the energy trader on behalf of the employees. Chances for quick recovery appear nonexistent; the lawsuits won't be completed for years, corporate bankruptcy filings typically send shareholders to the back of the creditors line and, on Jan. 15, the New York Stock Exchange delisted Enron's stock. --- 

Note especially the following link at  ---

Lessons from the Enron Collapse Part I - Old line partners wanted ...

Part II - Why Andersen is so exposed ...

Part III - An independence dilemma

This message contains two messages from Steve Zeff (Rice University) and one from me. I will begin with my message. Dr. Zeff, former President of the American Accounting Association, is one of our most dedicated accounting historians. In November 2001, Stephen A. Zeff received the Hourglass Award from the Academy of Accounting Historians. His homepage is at 

Steve's first message below deals with the "state of professional decline" in public accountancy.

His second message (at the bottom) was prompted by my appeal to him to bring more of his vast knowledge of history to bear upon our exchanges on the AECM.

I think both of his messages tell us a lot about the state of affairs that led up to the Enron scandal (which sadly centers in his own home town.)

The only thing that I take exception with is his statement that I am one of the few who really cares about the state of professional decline. There are, in fact, many who have been far more courageous than me to document the decline in professionalism in accounting practice, scholarship, and research, headed by such critical scholars as Steve Zeff, Abraham Briloff, Eli Mason, Tony Tinker, Paul Williams, and others willing to speak out over the past three decades. See 

Joel Demski's pessimistic remarks are resounding louder after the fall of Enron ---  I tried to consistently take a more optimistic stance, but the melt down of Enron has taken its toll on my view of my profession.

I hope you will carefully read the two messages from Dr. Zeff that follow my message below.

Bob Jensen

-----Original Message----- 
From: Jensen, Robert 
Sent: Sunday, December 30, 2001 2:13 PM 
To: 'Stephen A. Zeff' 
Subject: RE: threads on accounting fraud

Hi Steve,

What a nice message to encounter in my message box. Thank you for the kind words.

I think your remarks should be shared with accounting educators. Would you mind if I place your remarks in my next (probably January 5) edition of New Bookmarks? The archives are at 

I hear from you so rarely that it is really a pleasure when I get a message from you. I have more respect for your dedication to our craft than you can ever imagine. I wish that you, like Denny Beresford, would share your vast storehouse of accounting knowledge and history with accounting educators on the AECM --- 

Our younger accounting educators communicating on the AECM are very bright and skilled in technology, but they are usually a mile wide and an inch deep when it comes to accounting history.

I don't recall if I ever told you this, but your efforts to find Marie in the Rice alumni database led to the subsequent marriage between her and my friend Billy Bender. Both were well into their eighties on the wedding day. They were engaged while both attended Rice University in the 1940s, but the war called Billy away to be a Navy pilot. They had no subsequent contact for over 50 years until you helped Billy find Marie.


Bob Jensen

-----Original Message----- 
From: Stephen A. Zeff []  
Sent: Sunday, December 30, 2001 1:36 PM 
Subject: threads on accounting fraud

Dear Bob:

Yesterday I happened across your Threads on Accounting Fraud, etc. (the Enron case) at  , and I found it to be fascinating reading. I had already seen quite a few of the items, but I knew I could count on you to pull everything--and I mean everything--together. You do wonders on the Internet.

I don't know if you recall seeing my short article, "Does the CPA Belong to a Profession?" (Accounting Horizons, June 1987). The previous year, I was invited by the chairman of the Texas State Board of Public Accountancy to give a 15-minute address to newly admitted CPAs at the Erwin Center in Austin in November. Even though I am not a CPA, I accepted. I asked if they would mind if I were to say something controversial. They said no. Some 2,500 candidates, relatives and friends, and elders of the profession were in attendance, the largest audience to which I have ever spoken. Typically at such gatherings, the speaker enthuses about the greatness of the profession the candidates are about to enter. Instead, I opted to discuss whether the CPA actually belongs to a profession, and my view came down heavily on the skeptical side. Some of the questions I raised are being raised today about the supposedly independent posture of auditors and about the teaching of accounting. Fifteen years have passed, and things don't seem to have changed.

My address raised the question of whether the CPA certification constitutes a union card, a license to practice a trade, or admission to a profession. I reviewed a number of recent trends, including the growing commercialization of the practice of accounting, the increasing number of points of possible conflict between the widening scope of services and the attest function, the decline in the vitality of the professional literature, and the even greater emphasis on the rule-bound approach to teaching accounting in the universities. My conclusion was that accounting was in a state of professional decline that should concern all of its leaders.

Following the address, I expected to be taken to task for using such a solemn occasion, at which speakers are normally heard to celebrate the profession, to deliver a pessimistic message. I was, however, astonished that not one of the professional leaders in attendance uttered a word of criticism. When I pointedly asked several of the senior practitioners for their reaction to my remarks, the general response was a shrug of their shoulders. Yes, professionalism is not what it once was, but there seemed to be little that one could, or should, do to attempt to reverse the trend. This wholly unexpected reaction led me to conclude that I had underestimated the depth and pervasiveness of the malaise in the profession.

I wish you and Erika a Happy New Year.

Steve. --

Subsequent Message received from Steve Zeff


It's always a delight to hear from you. Yes, of course you have my permission to place my remarks in your Bookmarks.

In fact, a lot of what I know about accounting history was packed into my recent book, Henry Rand Hatfield: Humanist, Scholar, and Accounting Educator (JAI Press/Elsevier, 2000).

For some years in the early 1990s, I wrote to successive directors of the AAA's doctoral consortium to persuade them that a session should be provided on the history of accounting thought. When the directors replied (which was less than half the time), they said that their planned programs were already full with the standard people and the standard subjects. They typically do bring a standard setter in (usually Jim Leisenring), but the last time someone held a session on accounting history at the consortium was in 1987 (I was the presenter, and the students told me that the subject I treated was entirely new to them.).Virtually no top doctoral programs in the country treat accounting history or even accounting theory. They deal only with how to conduct analytical or empirical research, and the references given to the students are, with a few exceptions (Ball and Brown, and Watts and Zimmerman), from the last six or eight years. Small wonder that tyro assistant professors struggle to learn what accounting is all about once they start teaching the subject. Our emerging doctoral students, for years, have had no knowledge of the evolution of the accounting literature, even the theory that is now finding its way in the work of Stephen Penman and Jim Ohlson.

I think that one of the aims of the consortium should be to "round out" the intellectual preparation of the doctoral students. Instead, the consortium goes deeper in the areas already studied.

Keep up the good work. You are one of the very few people in our field who really cares. And you have done a great deal--more than anyone else I know--to broaden the vision and knowledge base of our colleagues.

Steve. --

Stephen A. Zeff 
Herbert S. Autrey Professor of Accounting 
Jesse H. Jones Graduate School of Management 
Rice University 6100 Main Street Houston, TX 77005 

One of the most prominent CPAs in the world sent me the following message and sent the WSJ link:

Bob, More on Enron. 
It's interesting that this matter of performing internal audits didn't come up in the testimony Joe Beradino of Andersen presented to the House Committee a couple of days ago

"Arthur Andersen's 'Double Duty' Work Raises Questions About Its Independence," by Jonathan Weil, The Wall Street Journal, December 14, 2001 --- 

In addition to acting as Enron Corp.'s outside auditor, Arthur Andersen LLP also performed internal-auditing services for Enron, raising further questions about the Big Five accounting firm's independence and the degree to which it may have been auditing its own work.

That Andersen performed "double duty" work for the Houston-based energy concern likely will trigger greater regulatory scrutiny of Andersen's role as Enron's independent auditor than would ordinarily be the case after an audit failure, accounting and securities-law specialists say.

It also potentially could expose Andersen to greater liability for damages in shareholder lawsuits, depending on whether the internal auditors employed by Andersen missed key warning signs that they should have caught. Once valued at more than $77 billion, Enron is now in proceedings under Chapter 11 of the U.S. Bankruptcy Code.

Internal-audit departments, among other things, are used to ensure that a company's control systems are adequate and working, while outside independent auditors are hired to opine on the accuracy of a company's financial statements. Every sizable company relies on outside auditors to check whether its internal auditors are working effectively to prevent fraud, accounting irregularities and waste. But when a company hires its outside auditor to monitor internal auditors working for the same firm, critics say it creates an unavoidable conflict of interest for the firm.

Still, such arrangements have become more common over the past decade. In response, the Securities and Exchange Commission last year passed new rules, which take effect in August 2002, restricting the amount of internal-audit work that outside auditors can perform for their clients, though not banning it outright.

"It certainly runs totally contrary to my concept of independence," says Alan Bromberg, a securities-law professor at Southern Methodist University in Dallas. "I see it as a double duty, double responsibility and, therefore, double potential liability."

Andersen officials say their firm's independence wasn't impaired by the size or nature of the fees paid by Enron -- $52 million last year. An Enron spokesman said, "The company believed and continues to believe that Arthur Andersen's role as Enron's internal auditor would not compromise Andersen's role as independent auditor for Enron."

Andersen spokesman David Tabolt said Enron outsourced its internal-audit department to Andersen around 1994 or 1995. He said Enron began conducting some of its own internal-audit functions in recent years. Enron, Andersen's second-largest U.S. client, paid $25 million for audit fees in 2000, according to Enron's proxy last year. Mr. Tabolt said that figure includes both internal and external audit fees, a point not explained in the proxy, though he declined to specify how much Andersen was paid for each. Additionally, Enron paid Andersen a further $27 million for other services, including tax and consulting work.

Following audit failures, outside auditors frequently claim that their clients withheld crucial information from them. In testimony Wednesday before a joint hearing of two House Financial Services subcommittees, which are investigating Enron's collapse, Andersen's chief executive, Joseph Berardino, made the same claim about Enron. However, given that Andersen also was Enron's internal auditor, "it's going to be tough for Andersen to take that traditional tack that 'management pulled the wool over our eyes,' " says Douglas Carmichael, an accounting professor at Baruch College in New York.

Mr. Tabolt, the Andersen spokesman, said it is too early to make judgments about Andersen's work. "None of us knows yet exactly what happened here," he said. "When we know the facts we'll all be able to make informed judgments. But until then, much of this is speculation."

Though it hasn't received public attention recently, Andersen's double-duty work for Enron wasn't a secret. A March 1996 Wall Street Journal article, for instance, noted that a growing number of companies, including Enron, had outsourced their internal-audit departments to their outside auditors, a development that had prompted criticism from regulators and others. At other times, Mr. Tabolt said, Andersen and Enron officials had discussed their arrangement publicly.

Accounting firms say the double-duty arrangements let them become more familiar with clients' control procedures and that such arrangements are ethically permissible, as long as outside auditors don't make management decisions in handling the internal audits. Under the new SEC rules taking effect next year, an outside auditor impairs its independence if it performs more than 40% of a client's internal-audit work. The SEC said the restriction won't apply to clients with assets of $200 million or less. Previously, the SEC had imposed no such percentage limitation.

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 --- 

Hi Bill,

Andersen and the other firms "shifted their focus from prestige to profits --- and thereby transformed the firm. "

The same thing happened in Morgan Stanley and other investment banking firms. Like it or not, the quote below from Frank Partnoy (a Wall Street insider) seems to fit accounting, banking, and other firms near the close of the 20th Century.

From Page 15 of the most depressing book that I have ever read about the new wave of rogue professionals. Frank Partnoy in FIASCO: The Inside Story of a Wall Street Trader (New York: Penguin Putnam, 1997, ISBN 0 14 02 7879 6)


This was not the Morgan Stanley of yore. In the 1920s, the white-shoe (in auditing that would be black-shoe) investment bank developed a reputation for gentility and was renowned for fresh flowers and fine furniture (recall that Arthur Andersen offices featured those magnificent wooden doors), an elegant partners' dining room, and conservative business practices. The firm's credo was "First class business in a first class way."

However, during the banking heyday of the 1980s, the firm faced intense competition from other banks and slipped from its number one spot. In response, Morgan Stanley's partners shifted their focus from prestige to profits --- and thereby transformed the firm. (Emphasis added) Morgan Stanley had swapped its fine heritage for slick sales-and-trading operation --- and made a lot more money.


Bob Jensen 

-----Original Message----- 
From: William Mister [mailto:bmister@LAMAR.COLOSTATE.EDU]  
Sent: Tuesday, February 19, 2002 11:05 PM 
Subject: Re: Andersen again

I refer you back to the Fortune article some years ago (old timers may remember it) that referred to then AA&Co as the "Marine Corp of the accounting Profession." In those days there were no "rogue partners." I wonder what changed? 

William G. (Bill) Mister 


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

A survey of Canadian business executives shows immense support for auditing reforms. The reforms that scored highest were:


  • Making it illegal to have liabilities off the balance sheet.
  • Barring accountants from providing both auditing and consulting to the same client.

This response seems somewhat surprising in view of two other findings:


  • Few executives feel strongly that the accounting profession is responsible for high profile collapses, such as Enron and past meltdowns in Canada.
  • Most say they have a high level of confidence in the ethics of the accounting or auditing firm employed by their own organizations. The executives ranked the ethics of their own auditors a very high 6.0 out of a possible 7.

Some press accounts attribute the seemingly contradictory results to differences between big accounting firms and smaller ones. They point out that many survey respondents typically come from small to mid-sized companies not audited by large accounting firms.

When asked how much confidence they have in the ethics of the (presumably larger) firms auditing large publicly traded companies, the executives were decidedly less kind, ranking these firms only a 4.7 out of a possible 7.


A Research Study On Audit Independence Prior to the Enron Scandal
External Auditing Combined With Consulting and Other Assurance Services:  Audit Independence?

TITLE:  "Auditor Independence and Earnings Quality"R
Richard M. Frankel MIT Sloan School of Business 50 Memorial Drive, E52.325g Cambridge, MA 02459-1261 (617) 253-7084 
Marilyn F. Johnson Michigan State University Eli Broad Graduate School of Management N270 Business College Complex East Lansing, MI 48824-1122 (517) 432-0152  
Karen K. Nelson Stanford University Graduate School of Business Stanford, CA 94305-5015 (650) 723-0106  
DATE:  August 2001

Stanford University Study Shows Consulting Does Affect Auditor Independence --- 

Academics have found that the provision of consulting services to audit clients can have a serious effect on a firm's perceived independence.

And the new SEC rules designed to counter audit independence violations could increase the pressure to provide non-audit services to clients to an increasingly competitive market.

The study (pdf format), by the Stanford Graduate School of Business, showed that forecast earnings were more likely to be exceeded when the auditor was paid more for its consultancy services.

This suggests that earnings management was an important factor for audit firms that earn large consulting fees. And such firms worked at companies that would offer little surprise to the market, given that investors react negatively when the auditor also generates a high non-audit fee from its client.

The study used data collected from over 4,000 proxies filed between February 5, 2001 and June 15, 2001.

It concluded: "We find a significant negative market reaction to proxy statements filed by firms with the least independent auditors. Our evidence also indicates an inverse relation between auditor independence and earnings management.

"Firms with the least independent auditors are more likely to just meet or beat three earnings benchmarks – analysts' expectations, prior year earnings, and zero earnings – and to report large discretionary accruals. Taken together, our results suggest that the provision of non-audit services impairs independence and reduces the quality of earnings."

New SEC rules mean that auditors have to disclose their non-audit fees in reports. This could have an interesting effect, the study warned: "The disclosure of fee data could increase the competitiveness of the audit market by reducing the cost to firms of making price comparisons and negotiating fees.

"In addition, firms may reduce the purchase of non-audit services from their auditor to avoid the appearance of independence problems."

A Lancaster University study in February this year found that larger auditors are less likely to compromise their independence than smaller ones when providing non-audit services to their clients.

And our sister site, AccountingWEB-UK, reports that research by the Institute of Chartered Accountants in England & Wales (ICAEW) showed that, despite the prevalence of traditional standards of audit independence, the principal fear for an audit partner was the loss of the client. 

From the University of Southern Califonia

Study Finds Auditors Not Compromised Over Consulting --- 

Researchers Mark L. DeFond and K.R. Subramanyam at USC's Leventhal School of Accounting (part of the Marshall School of Business), with K. Raghumandan at Texas A&M International University, find no association between consulting service fees and the auditor's propensity to issue a going concern opinion. Issuing a going concern opinion means that the auditor must be able to objectively evaluate firm performance and withstand client pressure to issue a clean opinion.

The SEC recently adopted new regulations requiring public companies to disclose all fees paid to their outside auditors. The SEC suspects that accounting firms are too dependent financially on their clients that purchase both auditing and consulting services to be objective, to maintain independence and to report possible conflicts of interests.

Contradicting the SEC's concerns, DeFond and Subramanyam and their co-author also demonstrate that higher audit fees (after controlling for consulting fees) actually encourage greater auditor independence. Firms are more likely to issue going concern opinions for clients paying higher audit fees.

The study analyzes 944 financially distressed firms with proxy statements that include audit fee disclosures for the year 2000, including 86 firms receiving first-time going concern audit reports. Examining the total fees charged, the researchers find that consulting fees have no effect on the incidence of going concern reports, and that higher audit fees actually increase the propensity of auditors to issue going concern reports, contrary to SEC suspicions.

The authors conjecture that the reputation and litigation damages associated with audit failure are greater for larger clients (for example such as Enron), encouraging auditors to be more conservative with respect to their larger clients.

"The loss of reputation and litigation costs provide strong incentives for auditors to maintain their independence," says DeFond. "Our study provides evidence that these incentives outweigh the economic dependency created by higher fees."

DeFond specializes in economics-based accounting and auditing research. He serves as the Joseph A. DeBell Professorship in Business Administration at USC's Leventhal School of Accounting, part of the Marshall School of Business, and is a CPA with six years' experience at a "Big Five" firm.

K.R. Subramanyam (SU-BRA-MAN-YAM) specializes in earnings management and valuation. His research on the effects of the SEC's fair disclosure rule earned him national attention in 2001.

Click here to Download PDF Report


The Professions of Investment Banking and Security Analysis are Rotten to the Core  
This module was moved to 


A Bit of Accountancy Humor Inspired by Enron and the Scandals That Follow and Follow and . . .

Possible headlines on the Enron saga following the guilty plea of Michael J. Kopper:
  • Kopper Wired to the Top Brass (with reference to his promise to rat on his bosses)
  • 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.


Andersen audits got "behind!"

Sure seemed enough,
When Waste Management audits ignored smelly stuff.

And Andersen's unveilings bottomed out,
When Victoria Secret audits turned into doubt.

Now the latest criminal  issue,
Is Andersen's clean wipe of American Tissue.

AccountingWEB US - Mar-12-2003 - In yet another black mark against the now-defunct accounting firm of Arthur Andersen, LLP, a former senior auditor of the firm has been arrested in connection with the audit of American Tissue, the nation's fourth-largest tissue maker. Brendon McDonald, formerly of Andersen's Melville, NY office, surrendered Monday at the United States Courthouse in Central Islip, NY. He could face as much as 10 years in prison for his role in allegedly destroying documents related to the American Tissue audits.

Mr. McDonald is accused of deleting e-mail messages, shredding documents, and aiding the officers of American Tissue in defrauding lenders of as much as $300 million. American Tissue's chief executive officer and other executives were also arrested and charged with various counts of securities and bank fraud and conspiracy.

According to court documents, American Tissue inflated income and diverted money to subsidiaries in an attempt to make the company eligible to borrow additional money. "The paper trail of phony sales transactions, bogus supporting documentation and numerous accounting irregularities ended quite literally with the destruction of the falsified documents by American Tissue's auditor," said Kevin P. Donovan, an assistant director of the Federal Bureau of Investigation, according to a statement that appeared in The New York Times ("Paper Company Officials Charged," March 11, 2003).


On the Lighter Side
Martha Stewart's New Magazine and Her Latest Products --- 
Martha's Latest Press Cartoons --- 

Cartoon archives ---

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)

Humor:  "The Idiot's Guide to Hedging and Derivatives" ---'sGuide

With tongue in cheek, New Yorker and writer Andy Borowitz has penned a new book that successfully captures what humor can be found in the recent rash of corporate malfeasance --- 

Dilbert's take on accounting complexity --- 

Creative Accountants

Forwarded by David Fordham

A friend told me the following story about a former Enron accountant who gave up his CPA position to become a farmer. The first thing he decided to do was to buy a mule.

He dickers with a local farmer at the general store, and they agree that the local will sell the accountant a mule for $100. The Enron accountant gives the man $100 cash, and the man agrees to deliver the mule the next day.

Next morning, the man shows up at the Enron accountant's place without the mule. "I'm sorry," he explains, "but the mule died last night. I guess I owe you the $100 back."

"Hey, no problem," says the accountant. "Just keep the money, and as for the mule, hey, go ahead and dump him in my barn anyway. I'll raffle him off."

"Ain't nobody around here going to buy a dead mule," says the local farmer.

"Leave that to me. I worked for Enron," replies the accountant.

A week later, the farmer meets the accountant back at the general store, and asks, "So, how'd you make out with the dead mule?"

"Great," replies the accountant. "I sold over 1000 raffle tickets for $2 each, to my former stockholders and debtholders. Nobody ever bothered to ask if the mule was alive or not."

"But didn't the winner complain when he found out?" asked the farmer.

"Yep, he sure did, and being the honest, ethical man that I am, I refunded his $2 to him promptly."

"So my profit, after deducting my $100 cost for the dead mule and the $2 sales allowance, is $1898. By the way, do you have any chickens?"

Exodus of Enron employees carrying all their worldly possessions.

"Andersen takes a strike: Minor league baseball team holds 'Arthur Andersen Appreciation Night'; fans encouraged to shred" CNN Money,  July 19, 2002 --- 

Accounting firm Arthur Andersen took another beating Thursday night, but this time it was at a minor league baseball game instead of in a Texas courtroom.

The Portland Beavers, the triple-A farm team for the San Diego Padres, held "Andersen Appreciation Night" during its game with the Edmonton Trappers at PGE Park.

While Edmonton won the game, 9-1 -- that's the real score -- the team announced record attendance of 58,667. But there were only 12,969 fans who actually attended the game. The fans bought $5 tickets but were given $10 receipts for accounting purposes as a one-time "nonrecurring charge."

The game also featured a trivia quiz, where the prize was awarded to the fan whose guess was furthest from the correct answer. The question was: "How many career pitching wins [did] Gaylord Perry have?" A woman won by guessing in the single digits -- she was off by about 320.

Fans were encouraged to bring their own documents that could be destroyed at "shredding stations" throughout the park.

In addition, the 90 people with either "Arthur" or "Andersen" in their names who attended were given free admission. Two people named Arthur Andersen were among them.

Roger Devine of Portland, who attended the game, said some fans were momentarily befuddled by inflated player stats that appeared on the scoreboard during the first inning. "The people sitting next to me were from out of town and they were going 'This guy's batting .880? What the hell?'" he said.

Forwarded by Hossein Nouri [hnouri@TCNJ.EDU

Recognition of Pro-Formalist Movement Gets WorldCom, Andersen Off Hook; Washington, D.C. ( - In a surprise decision that exonerates dozens of major companies, the U.S. Supreme Court today ruled that corporate earnings statements should be protected as works of art, as they "create something from nothing." One plus one is two. That is math. That is science. But as we have seen, earnings and revenues are abstract and original concepts, ideas not bound by physical constraints or coarse realities, and must therefore be considered art," the Court wrote in its 7-2 decision. The impact of the ruling was widespread. Investigations into hundreds of firms were canceled, and collectors began snatching up original balance sheets, audits, and P&L statements from WorldCom, Enron, and Global Crossing. Meanwhile, auditing firms such as Arthur Andersen (now Art by Andersen) were reclassified as art critics, whose opinions are no longer liable. "Before we had to go in and decide, 'Is it right, or is it wrong?'" said KPMG spokesman Dan Fischer. "Now we must only decide, 'Is it art?'" 

In Congress, all further hearings into irregularities were abandoned in favor of an abstract accounting lecture given by Scott Sullivan, former Chief Financial Artist of WorldCom, which had been charged with fraud for improperly accounting for $3.85 billion. "Art should reflect life, so what I was really trying to accomplish with this third quarter report was acknowledge that life is an illusion," said Sullivan, explaining his acclaimed work, "10Q for the Period Ending 9/30/01." U.S. Rep. Billy Tauzin of Louisiana, however, was forced to apologize, admitting he could only see a lie. "Yes, well, a man with a concretized view of the world may only be able to see numbers that 'Don't add up,'" said a haughty Sullivan. "But someone whose perceptions are not always chained to reality - a stock analyst, say - may see numbers that, like the human spirit, aspire to be greater than they are." Several Sullivan pieces are now part of a new show at New York's Museum of Modern Art entitled, "Shadows; Spreadsheets: The Origins of Pro-Formalism." Robert Weidlin, an SEC investigator and avid collector, was among the first to peruse the Enron exhibit, which takes up an entire wing of the museum. "You look at these works, and you say 'Is this a profit, or a loss? Is this firm a subsidiary, or a holding company?'" said Walden. "I have stood in front of this one balance sheet for hours, and each moment I come away with something different." Like other patrons, Weidlin said he didn't know whether to be impressed or outraged, a reaction that pleased Andrew Fastow, the former Enron CFA who is a leading proponent of the Trompe L'Shareholder style. "An artist should not be afraid to be shocking," said Fastow. "

As did the Modernists, we should fearlessly depart from tradition and embrace the use of innovative forms of expression. Like, say, 'Special Purpose Entities' and 'Pooling of Interests.'" Sullivan, meanwhile, said he was influenced by the Flemish Masters, particularly Lernout Hauspie, the Belgian speech recognition software company that collapsed last year after an audit discovered the firm had cooked its books in 1998, 1999, and 2000. "Lernout Hauspie simply invented sales figures, just willed them out of thin air and onto the paper," he said. "Me? I must live with a spreadsheet a long time before I begin to work it. You must be patient and wait until the numbers reveal themselves to you." And what about the reaction to his work? "I realize people are angry, people are hurt. But I cannot concern myself with that," he said. "As with all true artists, I don't expect to be understood during my lifetime." (The MOMA exhibit runs through Sept. 3. Admission is $8, excluding a one-time write down of deferred stock compensation and other costs associated with the carrying value of inventory.)

TIMING IS EVERYTHING in humor, but the jokes told by a few former Enron executives on a recently surfaced videotape border on bad taste in light of the events of the past year.
Home Video Uncovered by the Houston Chronicle, December 19, 2002
Skits for Enron ex-executive funny then, but full of irony now --- 
(The above link includes a "See it Now" link to download the video itself which played well for me.)
Question:  How does former Enron CEO Jeff Skilling define HFV?

The tape, made for the January 1997 going-away party for former Enron President Rich Kinder, features nearly 30 minutes of absurd skits, songs and testimonials by company executives and prominent Houstonians. The collection is all meant in good fun, but some of the comments are ironic in the current climate of corporate scandal.

In one skit, former administrative executive Peggy Menchaca plays the part of Kinder as he receives a budget report from then-President Jeff Skilling, who plays himself, and financial planning executive Tod Lindholm. When the pretend Kinder expresses doubt that Skilling can pull off 600 percent revenue growth for the coming year, Skilling reveals how it will be done.

"We're going to move from mark-to-market accounting to something I call HFV, or hypothetical future value accounting," Skilling jokes as he reads from a script. "If we do that, we can add a kazillion dollars to the bottom line."

Richard Causey, the former chief accounting officer who was embroiled in many of the business deals named in the indictments of other Enron executives, makes an unfortunate joke later on the tape.

"I've been on the job for a week managing earnings, and it's easier than I thought it would be," Causey says, referring to a practice that is frowned upon by securities regulators. "I can't even count fast enough with the earnings rolling in."

Texas' political elite also take part in the tribute, with then-Gov. George W. Bush pleading with Kinder: "Don't leave Texas. You're too good a man."

Former President George Bush also offers a send-off to Kinder, thanking him for helping his son reach the Governor's Mansion.

"You have been fantastic to the Bush family," he says. "I don't think anybody did more than you did to support George."

Note:  Jim Borden showed me that it is possible to download and save this video using Camtasia.  Thank you Jim.  It is not a perfect capture, but it gets the job done.

UPSKILLING: To develop new skills, generally technical ones -- often by reskilling (retraining). 
To see the full Buzzword Compliant Dictionary.  Click here.
According to Ed Scribner, former Enron employees have a different definition for "upskilling."

Humor forwarded on December 21, 2002 by Miklos A. Vasarhelyi []

The corporate scandals are getting bigger and bigger. In a speech on Wall Street, President Bush spoke out on corporate responsibility, and he warned executives not to cook the books. Afterwards, Martha Stewart said the correct term was to saute the books.
Conan O'Brien

Martha Stewart denied allegations that she had been given inside information to sell 4,000 shares of a stock in a biotech firm about to go under. Stewart then showed her audience how to make a festive, quick-burning yule log out of freshly-shredded financial documents.
Dennis Miller

In New York the other day, there was a pro-Martha Stewart rally. Only four people showed up ... and three of them were made out of crepe paper!
Conan O'Brien

When reached for comment on the charges, Martha didn't say much, (only) that a subpoena should be served with a nice appetizer.
Conan O'Brien

NBC is making a movie about Martha Stewart that will cover the recent stock scandal. They are thinking of calling it 'The Road To Extradition."
Conan O'Brien

Things are not looking good for Martha Stewart. Her stock was down 23 percent yesterday. Wow, that dropped quicker than Dick Cheney after a double-cheeseburger.
Jay Leno

Tom Ridge announced a new color-coded alarm system. ... Green means everything's okay. Red means we're in extreme danger. And champagne-fuschia means we're being attacked by Martha Stewart.
Conan O'Brien

The August, 2002 issue of PLAYBOY has a pictorial entitled "The Women of Enron" --- 

Now we are anxiously awaiting "The Women of Andersen" and "The Women of WorldCom."  

However, I doubt that there will be a pictorial event for "The Women of the Baptist Foundation" or "The Women of Waste Management."

A musical tribute to "The Day Worldcom Died" --- 

From the Financial Times, 28th June 02

EBITDA Earnings Before I Tricked the Dumb Auditor 
EBIT Earnings Before Irregularities and Tampering 
CEO Chief Embezzlement Officer 
CFO Corporate Fraud Officer 
NAV Nominal Andersen's Valuation 
FRS Fantasy Reporting Standards 
P/E Parole Entitlement 
EPS Eventual Prison Sentence

Paul Zielbauer in The New York Times reports on the new Enron lexicon developing: 

  • To "enronize" means "to hide fiscal shortcomings through slick financial legerdemain and bald-faced lies." 
  • It is "enronic" when a seemingly invincible person goes down in flames. 
  • "Enronica" refers to cheap souvenirs like Enron stock certificates. 
  • "Enrontia" is the burning desire to shred things. 
  • "Enronomania" is the mania for reform sweeping the nation – the first good kind of mania the market has seen in a very long time.

Note the 1995 Year Below
The accountants at Arthur Andersen knew Enron was a high-risk client who pushed them to do things they weren’t comfortable doing. Testifying in court in May, partner James Hecker said he wrote a parody to that effect in 1995. The Financial Times of London reported: "To the tune of the Eagles hit song ‘Hotel California,’ Mr. Hecker wrote lines such as: ‘They livin’ it up at the Hotel Cram-It-Down-Ya, When the [law]suits arrive, Bring your alibis.’"
Business Ethics [] on May 15, 2002

I don't know who wrote the following, but it was forwarded by a former student who is at the local office of Arthur Andersen.

A take-off from the movies "A Few Good Men"  (Some phrases are in the original script and some are altered.)

Tom Cruise: "Did you order the shredding?"

Jack Nicholson: "You want answers?"

Tom Cruise: "I think I'm entitled."

Jack Nicholson: "You want answers!!"

Tom Cruise: "I want the truth!"

Jack Nicholson: "You can't handle the truth!"

Jack Nicholson: "Son, we live in a world that has financial statements. And those financial statements have to be audited by men with calculators. Who's gonna do it? You? You, Dept. of Justice? I have a greater responsibility than you can possibly fathom. You weep for Enron and you curse Andersen. You have that luxury. You have the luxury of not knowing what I know: that Enron's death, while tragic, probably saved investors. And my existence, while grotesque and incomprehensible to you, saves investors. You don't want the truth. Because deep down, in places you don't talk about at parties, you want me on that audit. You need me on that audit! We use words like materiality, risk-based, special purpose entity...we use these words as the backbone to a life spent auditing something. You use 'em as a punchline. I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very assurance I provide, then questions the manner in which I provide it. I'd prefer you just said thank you and went on your way. Otherwise, I suggest you pick up a pencil and start ticking. Either way, I don't give a damn what you think you're entitled to!!"

Tom Cruise: "Did you order the shredding???"

Jack Nicholson: "You're damn right I did!"

Remember how the consulting divisions called Andersen Consulting split off of Aurther Andersen and became a company known as Accenture.  Now you can also read about Indenture --- 

A November 2001 message from Ken Lay, CEO of Enron

Happy Thanksgiving!

This past weekend, I was rushing around in Houston, Texas trying to do some holiday season shopping done. I was stressed out and not thinking very fondly of the weather right then. It was dark, cold, and wet in the parking lot as I was loading my car up. I noticed that I was missing a receipt that I might need later. So mumbling under my breath, I retraced my steps to the mall entrance. As I was searching the wet pavement for the lost receipt, I heard a quiet sobbing. The crying was coming from a poorly dressed boy of about 12 years old. He was short and thin. He had no coat. He was just wearing a ragged flannel shirt to protect him from the cold night's chill. Oddly enough, he was holding a hundred dollar bill in his hand. Thinking that he had gotten lost from his parents, I asked him what was wrong. He told me his sad story. He said that he came from a large family. He had three brothers and four sisters. His father had died when he was nine years old. His Mother was poorly educated and worked two full time jobs. She made very little to support her large family. Nevertheless, she had managed to skimp and save two hundred dollars to buy her children some holiday presents (since she didn't manage to get them anything during the previous holiday season).

The young boy had been dropped off, by his mother, on the way to her second job. He was to use the money to buy presents for all his siblings and save just enough to take the bus home. He had not even entered the mall, when an older boy grabbed one of the hundred dollar bills and disappeared into the night. "Why didn't you scream for help?" I asked. The boy said, "I did." "And nobody came to help you?" I queried. The boy stared at the sidewalk and sadly shook his head. "How loud did you scream?" I inquired.

The soft-spoken boy looked up and meekly whispered, "Help me!"

I realized! that absolutely no one could have heard that poor boy cry for help. So I grabbed his other hundred and ran to my car.

Happy Thanksgiving everyone!


Kenneth Lay Enron CEO

A potential investor came to seek investment advice from a financial analyst (F.A.). The F.A. told the investor, " I have the experience, you have the money."

Several weeks later, after the investor has lost all the money from following the advice of the F.A., the investor came to see the F.A. and the F.A. said to the investor:

"You have the experience, I have the money!"

I liked the one below about Teaching Accounting in the 1970s.  It is so True!

Also forwarded by Dick Haar

Teaching Accounting in 1950:

A logger sells a truckload of lumber for $100.

His cost of production is 4/5 of the price.

What is his profit?


Teaching Accounting in 1960:

A logger sells a truckload of lumber for $100.

His cost of production is 4/5 of the price, or $80.

What is his profit?


Teaching Accounting in 1970:

A logger exchanges a set "L" of lumber for a set "M" of money.

The cardinality of set "M" is 100. Each element is worth one dollar.

Make 100 dots representing the elements of the set "M."

The set "C", the cost of production contains 20 fewer points than set "M."

Represent the set "C" as a subset of set "M" and answer the following

question: What is the cardinality of the set "P" of profits?


Teaching Accounting in 1980:

A logger sells a truckload of lumber for $100.

His cost of production is $80 and his profit is $20.

Your assignment: Underline the number 20.


Teaching Accounting in 1990:

By cutting down beautiful forest trees, the logger makes $20.

What do you think of this way of making a living?

Topic for class participation after answering the question:

How did the forest birds and squirrels feel as the logger cut down the trees?

There are no wrong answers.


Teaching Match in 2000:

A logger sells a truckload of lumber for $100.

His cost of production is $120.

How does Arthur Andersen determine that his profit margin is $60?


In an Enron tort litigation trial, the defense attorney was cross-examining a pathologist.

Attorney: Before you signed the death certificate, had you taken the pulse?

Coroner: No.

Attorney: Did you listen to the heart?

Coroner: No.

Attorney: Did you check for breathing?

Coroner: No.

Attorney: So, when you signed the death certificate, you weren't sure the man was dead, were you?

Coroner: Well, let me put it this way. The man's brain was sitting in a jar on my desk. But I guess he still managed to audit Enron.

Forwarded by George Lan

1. Enronitis : A company suffering from accounting concerns 

2. To do an "enron" : To do an end-run

One of my colleages keeps referring to "getting 'Layed.'"

Forwarded by Glen Gray

A company is interviewing candidates for a new position. 

The first candidate is an engineer. The interviewer says, "I only have one question, what is 2 plus 2?" The engineer pulls out his calculator and punches in the numbers and says, "4.000000." 

The next candidate is a lawyer. She says 4, but wraps her answer in legalize. 

The third candidate is a CPA. When asked what is 2 plus 2, he looks around and looks at the interviewer and says, "Whatever you want it to be."


A message from William Brent Carper [

You have two cows. Your lord takes some of the milk. 

You have two cows. The government takes both, hires you to take care of them, and sells you the milk.

You have two cows. Your neighbors help take care of them and you share the milk.

You have two cows. The government takes them both and denies they ever existed and drafts you into the army. Milk is banned. 

You have two cows. You sell one and buy a bull. Your herd multiplies, and the economy grows. You sell them and retire on the income. 

Enron Venture Capitalism 
You have two cows. You sell three of them to your publicly listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows. The milk rights of the six cows are transferred via an intermediary to a Cayman Island company secretly owned by the majority shareholder who sells the rights to all seven cows back to your listed company. The annual report says the company owns eight cows, with an option on one more.

You have two cows. You borrow 80% of the forward value of the two cows from your bank, then buy another cow with 5% down and the rest financed by the seller on a note callable if your market cap goes below $20B at a rate 2 times prime. You now sell three cows to your publicly listed company, using letters of credit opened by your brother-in-law at a 2nd bank, then execute a debt/equity swap with an associated general offer so that you get four cows back, with a tax exemption for five cows. The milk rights of six cows are transferred via an intermediary to a Cayman Island company secretly owned by the majority shareholder who sells the rights to seven cows back to your listed company. The annual report says the company owns eight cows, with an option on one more and this transaction process is upheld by your independent auditor and no Balance Sheet is provided with the press release that announces that Enron as a major owner of cows will begin trading cows via the Internet site COW (cows on web).

A Message from Hossein Nouri [hnouri@TCNJ.EDU

In case you were wondering how Enron came into so much trouble, here is an explanation reputedly given by an Ag Eco professor at Texas A&M, to explain it in terms his students could understand.


You have two cows.

You sell one and buy a bull.

Your herd multiplies and you hire cowhands to help out on the ranch. You sell cattle.

The economy grows and eventually you can pass the business on and your cowhands can retire on the profits.


You have two cows. You sell three of them to your publicly listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows.

The milk rights of the six cows are transferred via an intermediary to a Cayman Island company secretly owned by the majority shareholder who sells the rights to all seven cows back to your listed company.

The annual report says the company owns eight cows, with an option on one more.

Now do you see why a company with $62 billion in assets is declaring bankruptcy?

"President Bush didn't help the company's image, joking over the weekend that Saddam Hussein has now agreed to weapons inspections. "The bad news is he wants Arthur Andersen to do it," Bush said."

(from:  )

The founder-namesake of the Enron-racked accounting megafirm (Arthur Andersen) was born in 1885, the stalwart son of new Norwegian immigrants, and to his dying day in 1947 at age 61, he maintained a passion for preserving Norwegian history. He even held an honorary degree from St. Olaf College. And would you believe he straightened out the finances of a pioneering energy empire and won his reputation for honesty by keeping it from bankruptcy? Is that a cosmic joke, or what? Not if you bought Enron stock at $80 a share, it's not.
Ken Ringle Washington Post Staff Writer --- 
(There are some humorous and some sobering parts of this article by Ken Ringle that Don Ramsey pointed out to me.)

Fraud Follies from

Fraud Follies

The business of fraud isn't always serious. Below are some of our favorite funny stories. If you would like to share one with us, please send it to

We are neither hunters nor gatherers.  We are accountants..
New Yorker

It's up to you now Miller.  The only thing that can save us is an accounting breakthrough.
New Yorker

Money is life's report card.
New Yorker

Millions is craft.  Billions is art.
New Yorker

My strength is the strength of ten, because I'm rich.
New Yorker Cartoon

Picture a Pig Ready for Market
Basic economics --- sometimes the parts are worth more than the whole.
New Yorker

You drive yourself too hard.  You really must learn to take time to stop and sniff the profits.
New Yorker

I was on the cutting edge.  I pushed the envelope.  I did the heavy lifting.  I was the rain maker.  Then suddenly it all crashed when I ran out of metaphors.
New Yorker

Try as we might, sir, our team of management consultants has been unable to find a single fault in the manner in which you conduct your business.  Everything you do is a hundred per cent right.  Keep it up!  That will be eleven thousand dollars.
New Yorker Cartoon

It's kinda fun to play on words. I'm always inspired by an Anne Murray song entitled "Little Good News" --- 

I rolled out this morning...ACEMers had email systems on 
AccountingWeb tells of an audit failure long after old Enron 
SmartPros shows us how accounting careers have grown dicey 
It's gonna get worse you see, we need a change in policy

There's a Wall Street Journal rolled up in a rubber band 
One more sad story's one more than I can stand 
Just once, how I'd like to see the headline say 
Not much to print about, can't find any frauds today


Nobody cheated on taxes owed 
No lawsuits filed, no investors got POed 
No new FASB rules, no unaccounted stock options in our pay 
We sure could use a little good news today

I'll come home this evening...I'll bet that the news will be the same 
Ernst & Young's fired a partner, PwC's been found to blame 
How I wanna hear the anchor man talk about a county fair 
And how we cleaned up the everybody's playing fair

Whoa, tell me...

Nobody was cheated by their brokers 
And the mutual funds all played square 
And everybody loves everybody in the good old USA 
We sure could use a little good news today

Nobody embezzled a widow on the lower side of town 
Nobody OD'd, only the courthouses got burned down 
Nobody failed an exam...nobody cussed out FAS 133 
Now that would surely be good news for me

Sorry folks!

Bob Jensen

-----Original Message----- 
From: Richard C. Sansing [mailto:Richard.C.Sansing@DARTMOUTH.EDU]  
Sent: Wednesday, October 22, 2003 10:28 AM 
Subject: Re: An accounting parody

--- You wrote:

I am looking for an "accounting" song. I would like to be able to have a popular song and change some of the lyrics to include basic accounting principles but my creative juices do not flow in that way. Does anyone know of such a parody?

--- end of quote ---

Possibilities include "Enron-Ron-Ron" (on the Capital Steps CD, "When Bush comes to shove") and "When IRS Guys are Smilin'" (Capital Steps, "Unzippin' My Doodah"). Also, the first part of "I want to be a producer" (The Producers) deals with accounting.

Richard C. Sansing Associate Professor of Business Administration Tuck School of Business at Dartmouth 100 Tuck Hall Hanover, NH 03755

Office: Tuck 203A Phone: (603) 646-0392 Fax: (603) 646-0995 email:  URL:  
Luck is the residue of design--Branch Rickey

KEVIN WOODWARD Free Folksongs (audio clips) --- 
Includes part of the song "Henry the Accountant"
October 24, 2003 message from Dave Albrecht [albrecht@PROFALBRECHT.COM

A sound clip of Henry the Accountant can be found at ---

Other songs about an accountant:

The Ballad of Kenny-Boy ---

My Cat Accountant ---

Somehow, Says My Accountant ---




In a $2.1 billion action against accounting firm Grant Thornton, a Baltimore Circuit Court is investigating a possible violation involving the withholding and willful destruction of audit records in a manner likened to the contemporary but more- publicized Enron case. A court action also alleges that a former director of risk management and senior partner of the firm, "willfully, knowingly, and intentionally destroyed (client) documents with the full understanding that litigation was imminent." 

Big Five firm Ernst & Young has been hit with a lawsuit by Bull Run Corp., a company that provides, among other things, marketing and event management services to universities, athletic conferences, associations, and corporations. The lawsuit alleges that E&Y failed to discover material errors in its audit of a company that Bull Run acquired in late 1999. 

Credit Suisse First Boston -- the investment bank that managed some of the most hyped stock offerings of the Internet boom era -- agrees to pay a $100 million fine for improperly pumping up share prices ---,1367,49930,00.html 

See also:

New IPO Rallying Cry: This is War
Bankrupt? So What? Lawyers Ask

Forwarded by Patrick Charles

Arthur Andersen: The Enron Scandal's Other Big Donor

By Holly Bailey

During the record-breaking 1999-2000 fund-raising cycle, very few companies outpaced Enron's prolific giving to George W. Bush. In fact, only 11 companies gave more money to the Bush-Cheney ticket, and one of them was Arthur Andersen, the embattled energy giant's now equally troubled auditor.

Andersen was the fifth biggest donor to Bush's White House run, contributing nearly $146,000 via its employees and PAC. Furthermore, Andersen fielded one of Bush's biggest individual fund-raisers that year. D. Stephen Goddard, who until yesterday was the managing partner of Andersen's Houston office, was one of the "Pioneers," individuals who raised at least $100,000 for the Bush campaign during 1999-2000. (Goddard was among the employees "relieved of their duties" Tuesday by Andersen.)

But that's only the tip of the iceberg when it comes to Andersen's political ties to Washington. As Congress prepares to launch hearings into the Enron collapse, lawmakers will be examining two companies whose political giving has affected the bottom line of nearly every campaign on Capitol Hill. Since 1989, Andersen has contributed nearly $5 million in soft money, PAC and individual contributions to federal candidates and parties, more than two-thirds to Republicans.

While Enron's giving was concentrated mainly in big soft money gifts to the national political parties, Andersen's generosity often was targeted directly at members of Congress. For instance, more than half the current members of the House of Representatives were recipients of Andersen cash over the last decade. In the Senate, 94 of the chamber's 100 members reported Andersen contributions since 1989.

Among the biggest recipients, members of Congress now in charge of investigating Andersen's role in the Enron debacle-a list that includes House Energy and Commerce Committee chairman Billy Tauzin (D-La.), who, with $47,000 in contributions, is the top recipient of Andersen contributions in the House.

In the fall of 2000, Tauzin helped broker a deal between the Securities and Exchange Commission and the Big Five accounting firms, including Andersen, which essentially dropped the SEC's push to restrict auditors from selling consulting services to their clients. The provision had been aimed at ending what the SEC had deemed a major conflict of interest between accountant's duties as an auditor and the money they earn to consult on behalf of that same client.

Before the SEC could act, however, the accounting industry unleashed a massive lobbying campaign to block the proposed rule. In Andersen's case, it nearly doubled its campaign contributions-going from $825,000 in overall spending during the 1997-98 election cycle to more than $1.4 million in 1999-2000. In lobbying expenditures alone, Andersen spent $1.6 million between July and December 2000-compared to $860,000 for the first six months of that year.

It's unclear what kind of impact, if any, the proposed rule might have had on the Enron collapse. Andersen, according to press reports, collected $25 million in auditing fees and $27 million in consulting fees from Enron during 2001.

Click here for a breakdown of Andersen contributions, including contributions to members of Congress and presidential candidates, as well as information on the company's lobbying expenditures and other money in politics stats: 


Corporate America's accounting problems raise the question: Can the public depend on the auditors?

Washington Post Article:  Part 1
"THE NUMBERS CRUNCH After Enron, New Doubts About Auditors," Part 1 of 2 Articles, by David S. Hilzenrath, The Washington Post,  December 5, 2001 ---

This article is much too long to do justice to in a few quotes.  I did, however, extact the quotes connected with Andersen, the firm that audited and certified the Enron financial statements prior to Enron's meltdown.

The collapse came swiftly for Enron Corp. when investors and customers learned they could not trust its numbers. On Sunday, six weeks after Enron disclosed that federal regulators were examining its finances, the global energy-trading powerhouse became the biggest bankruptcy in U.S. history.

Like all publicly traded companies in the United States, Enron had an outside auditor scrutinize its annual financial results. In this case, blue-chip accounting firm Arthur Andersen had vouched for the numbers. But Enron, citing accounting errors, had to correct its financial statements, cutting profits for the past three years by 20 percent -- about $586 million. Andersen declined comment and said it is cooperating in the investigation.

The number of corporations retracting and correcting earnings reports has doubled in the past three years, to 233, an Andersen study found. Major accounting firms have failed to detect or have disregarded glaring bookkeeping problems at companies as varied as Rite Aid Corp., Xerox Corp., Sunbeam Corp., Waste Management Inc. and MicroStrategy Inc.

Corporate America's accounting problems raise the question: Can the public depend on the auditors?

"Financial fraud and the accompanying restatement of financial statements have cost investors over $100 billion in the last half-dozen or so years," said Lynn E. Turner, who stepped down last summer as the Securities and Exchange Commission's chief accountant.

The shareholder losses resulting from accounting fraud or error could rival the cost to taxpayers of the savings-and-loan bailout of the early 1990s, he said. Enron investors, including employees who held the company's stock in their retirement accounts, lost billions.

Accounting industry leaders deny they are to blame. They say that the number of failed audits is tiny in relation to the many thousands performed successfully, and that it's often impossible for auditors to see through a sophisticated fraud.

Quotations Relating to the Andersen Accounting Firm

Quote 01
Accounting firms cite a number of reasons for the rise in corrections. It's tough to apply standards that are nearly 70 years old to the modern economy, they say. And the SEC has made matters worse by issuing new interpretations of complex standards. "The question is not how does this reflect on the auditors," Arthur Andersen said in a written statement. Instead, the firm asked: "How is it that auditors are able to do so well in today's environment?"

Quote 02
A case study posted on Arthur Andersen's Web site under "Success Stories" shows how the firm sees itself. As auditor for Inc., a financial news service, Arthur Andersen said, it helped its client prepare for an initial public offering of stock, develop a global expansion strategy and secure a weekly television show through another client, News Corp.

One of Arthur Andersen's "greatest strengths . . . is developing full-service relationships with emerging companies and then using all of our capabilities to find inventive ways to help them continue to grow," auditor Tom Duffy is quoted as saying.

Quote 03
Last year, Gene Logic Inc., a Gaithersburg biotechnology firm, fired Arthur Andersen, saying it was disappointed with the outside auditor's level of service and cost. Andersen said in a letter included in an SEC filing that, before Andersen was fired, the accounting firm had told the company it thought it was trying to book $1.5 million of revenue from new contracts prematurely. Gene Logic spokesman Robert Burrows said the revenue disagreement had nothing to do with the auditor's dismissal.

Arthur Andersen said it quickly resigned or refused to accept more than 60 auditing jobs last year after its background checks turned up questions about the integrity of the clients' management.

Quote 04
Some industry veterans say audits have become loss leaders -- a way for firms to get their foot in a client's door and win consulting contracts.

Arthur Andersen disagreed, telling The Post that audits are among the more profitable services the firm provides, adding that "lower pricing in some years" is "made up over time."

Indeed, accounting firms say that if the audit becomes more complicated than initially expected, their contracts generally allow them to go back to their clients and adjust the fee.

In a long-running lawsuit, Calpers, the giant pension fund for California public employees accused Arthur Andersen of doing such a superficial job auditing a finance company that the "purported audits were nothing more than 'pretended audits.' "

Andersen assigned a young, inexperienced auditor "who has candidly testified he did not even know what a Contract Receivable was, then or now," consultants for Calpers wrote in a September 2000 report prepared in support of the lawsuit.

Andersen didn't test any of those accounts while the unpaid balances soared, and it failed to recognize that a substantial amount was uncollectible, the report said.

Andersen declined to comment on the case, which was settled confidentially

Quote 05
Few cases illustrate the potential conflicts in the accounting business as vividly as the one involving Arthur Andersen and Waste Management.

Many investors may not realize they were victims because they held Waste Management stock indirectly, through mutual funds and retirement plans. Lolita Walters, an 80-year-old retired New York City government employee who suffers from diabetes and a heart condition, can count what she lost -- more than $2,800, enough money to pay for almost a year of prescription drugs.

"I think it's unconscionable," Walters said of Andersen's role.

According to the SEC, Andersen lent its credibility to Waste Management's annual reports even though it had documented that they were deeply flawed.

Waste Management eventually admitted that, over several years, it had overstated its pretax profits by $1.4 billion.

In a civil suit filed in June, the SEC accused Arthur Andersen of fraud for signing off on Waste Management's false financial statements from 1993 through 1996. For example, during the 1993 audit, the SEC said, the auditors noted $128 million of cumulative "misstatements" that would have reduced the company's earnings, before including special items, by 12 percent. But Andersen partners decided the misstatements were not significant enough to require correction, the SEC said.

An Andersen memorandum showed the accounting firm disagreed with the approach Waste Management used "to bury charges" and warned Waste Management that the practice represented "an area of SEC exposure," but Andersen did not stop it, the SEC said.

An SEC order noted that, from 1971 until 1997, all of Waste Management's chief financial officers and chief accounting officers were former Andersen auditors. The Andersen partner assigned to lead the disputed audits coordinated marketing of non-audit services, and his compensation was influenced by the volume of non-audit fees Andersen billed to Waste Management, the SEC said.

Over a period of years, Andersen and an affiliated consulting firm billed Waste Management about $18 million for non-audit work, more than double the $7.5 million it was paid in audit fees, which were capped, the SEC said. Andersen said some of the non-audit work was related to auditing.

Andersen, which continues to serve as Waste Management's auditor, agreed to pay a $7 million fine to the SEC, and joined with Waste Management to settle a class-action lawsuit on behalf of shareholdersfor a combined $220 million. Andersen did not admit wrongdoing in either settlement.

"There are important lessons to be learned from this settlement by all involved in the financial reporting process," Terry E. Hatchett, Andersen's managing partner for North America, said in a statement after the SEC action. "Investors can continue to rely on our signature with confidence."

Washington Post Article:  Part 2
"THE NUMBERS CRUNCH Auditors Face Scant Discipline Review Process Lacks Resources, Coordination, Will," Part 2 of 2 Articles, by David S. Hilzenrath, The Washington Post,  December 6, 2001 ---

Starting in the mid-1980s, he oversaw the outside audits of JWP Inc., an obscure New York company that bought a string of businesses and transformed itself into a multibillion-dollar conglomerate. The job required LaBarca, a partner at the big accounting firm Ernst & Young LLP, to scrutinize the work of JWP's chief financial officer, Ernest W. Grendi, a running buddy and former colleague.

In 1992, a new president at JWP discovered rampant accounting manipulations, and the company's stock sank. When the numbers were corrected, the 1991 earnings were slashed from more than $60 million to less than $30 million.

After hearing extensive evidence in a bondholders' lawsuit, a federal judge criticized "the seeming spinelessness" of LaBarca.

"Time and again, Ernst & Young found the fraudulent accounting at JWP, but managed to 'get comfortable' with it," Judge William C. Conner wrote in a 1997 opinion. "The 'watchdog' behaved more like a lap dog."

Today, LaBarca is senior vice president of financial operations and acting controller at the media conglomerate AOL Time Warner Inc., where his duties include overseeing internal audits.

The Securities and Exchange Commission filed and settled fraud charges against Grendi but took no action against LaBarca. Neither did the American Institute of Certified Public Accountants (AICPA), a 340,000-member professional organization charged with disciplining its own, or the state of New York, which licensed LaBarca.

LaBarca declined to discuss the JWP case but maintainedduring thetrial that the accounting was "perfectly within the guidelines."

An Ernst & Young spokesman said the firm was confident it upheld a tradition "of integrity, objectivity and trust." Grendi declined comment.

A Washington Post analysis of hundreds of disciplinary cases since 1990 found that, when things go wrong, accountants face little public accountability.

"The deterrent effect that's necessary is just not there," said Douglas R. Carmichael, a professor of accountancy at the City University of New York's Baruch College. That "makes investing like Russian roulette," he added.

In theory, the system has several complementary layers of review. In practice, it is undermined by a lack of resources, coordination and will.

The SEC can bar accountants from auditing publicly traded companies for unprofessional conduct. The agency, however, has the personnel to investigate only the most egregious examples of auditing abuse, officials say. It typically settles its cases without an admission of wrongdoing, often years after the trouble surfaced.

Between 1990 and the end of last year, the SEC sanctioned about 280 accountants, evenly divided between outside auditors and corporate financial officers, The Post's review found.

The AICPA can expel an accountant from its ranks, whichcan prompt the accountant's firm to reassign or fire him. The trade grouptook disciplinary action in fewer than a fifth of the cases in which the SEC imposed sanctions, The Post found. About one-third of the accountants the SEC sanctioned weren't AICPA members and thus were beyond its reach.

Even when the AICPA determined that accountants sanctioned by the SEC had committed violations, it closed the vast majority of ethics cases without disciplinary action or public disclosure.

President Bill Clinton's SEC chairman, Arthur Levitt Jr., a frequent critic of the industry, said the AICPA "seems unable to discipline its own members for violations of its own standards of professional conduct."

The membership group works as a lobbying force for accountants and often battles SEC regulatory efforts.

State regulators have the ultimate authority. They can take away an accountant's license. But some state authorities acknowledge that their efforts are hit-or-miss.

"We only find out about violations on the part of regulants [licensees] in two ways: One, somebody complains, or two, we get lucky," said David E. Dick,assistant director of Virginia's Department of Professional and Occupational Regulation, which until recently administered discipline for the state's accountants.

When the SEC settles without a court judgment or an admission of culpability, state authorities must build their case from scratch, said regulators in New York, where many corporate accountants are licensed.

"You could probably fault both state boards and the SEC for not having worked cooperatively enough with one another over the years," said Lynn E. Turner, who stepped down this summer as the SEC's chief accountant. He added that the agency has tried harder over the past year and a half to share investigative records with state regulators.

As of June, the state of New York had taken disciplinary action against about a third of the New York accountants The Post culled from 11 years of SEC professional-misconduct cases.

While prosecutors occasionally file criminal charges against corporate officials in financial fraud case, they hardly ever bring criminal cases against independent auditors, in part because the accounting rules are so complex. The AICPA's general counsel could recall only a handful of prosecutions.

"From my perspective, this was very hard stuff," said a federal prosecutor who investigated a major accounting fraud. "The prospect of litigating a case against people who actually do this stuff for a living and at least in theory are the world's experts . . . is a daunting prospect."

Investor lawsuits sometimes lead to multimillion-dollar settlements. But they rarely shed light on the performance of individual auditors because accounting firms generally get court records sealed and settle before trial, limiting public scrutiny.

The accounting firms say they discipline those who violate professional standards, including removing them from audits or terminating their employment.

Barry Melancon, president of the AICPA, said "you cannot look at discipline alone" when assessing accountability in the accounting profession.

The profession's emphasis is on preventing rather than punishing mistakes, he added. Thus, it invests heavily in quality-control efforts, such as periodic "peer reviews" of the paperwork accounting firms generate during audits.

In disciplinary cases, the AICPA's goal is to rehabilitate accountants, not to expel them, officials said. "While it may feel good and it may give somebody something to write about when somebody is disciplined, the most important thing is whether or not this profession does a good job doing audits or not," Melancon said.

Continued at  

"Watchdogs and Lapdogs," by Burton Malkiel, Editorial in The Wall Street Journal, January 16, 2002 ---
Dr. Malkiel, professor of economics at Princeton, is author of "A Random Walk Down Wall Street," 7th ed. (W.W. Norton, 2000).

The bankruptcy of Enron -- at one time the seventh-largest company in the U.S. -- has underscored the need to reassess not only the adequacy of our financial reporting systems but also the public watchdog mission of the accounting industry, Wall Street security analysts, and corporate boards of directors. While the full story of what caused Enron to collapse has yet to be revealed, what is clear is that its accounting statements failed to give investors a complete picture of the firm's operations as well as a fair assessment of the risks involved in Enron's business model and financing structure.

Enron is not unique. Incidents of accounting irregularities at large companies such as Sunbeam and Cendant have proliferated. As Joe Berardino, CEO of Arthur Andersen, said on these pages, "Our financial reporting model is broken. It is out of date and unresponsive to today's new business models, complex financial structures, and associated business risks."

Blind Faith

It is important to recognize that losses suffered by Enron's shareholders took place in the context of an enormous bubble in the "new economy" part of the stock market during 1999 and early 2000. Stocks of Internet-related companies were doubling, then doubling again. Past standards of valuation like "buy stocks priced at reasonable multiples of earnings" had given way to blind faith that any company associated with the Internet was bound to go up. Enron was seen as the perfect "new economy" stock that could dominate the market for energy, communications, and electronic trading and commerce.

I have sympathy for the Enron workers who came before Congress to tell of how their retirement savings were wiped out as Enron's stock collapsed and how they were constrained from selling. I have long argued for broad diversification in retirement portfolios. But many of those who suffered were more than happy to concentrate their portfolios in Enron stock when it appeared that the sky was the ceiling.

Moreover, for all their problems, our financial reporting systems are still the world's gold standard, and our financial markets are the fairest and most transparent. But the dramatic collapse of Enron and the rapid destruction of $60 billion of market value has shaken public trust in the safeguards that exist to protect the interests of individual investors. Restoring that confidence, which our capital markets rely on, is an urgent priority.

In my view, the root systemic problem is a series of conflicts of interest that have spread through our financial system. If there is one reliable principle of economics, it is that individual behavior is strongly influenced by incentives. Unfortunately, often the incentives facing accounting firms, security analysts, and even in some circumstances boards of directors militate against their functioning as effective guardians of shareholders' interests.

While I will concentrate on the conflicts facing the accounting profession, perverse incentives also compromise the integrity of much of the research product of Wall Street security analysts. Many of the most successful research analysts are compensated largely on their ability to attract investment banking clients. In turn, corporations select underwriters partly on their ability to present positive analyst coverage of their businesses. Security analysts can get fired if they write unambiguously negative reports that might damage an existing investment banking relationship or discourage a prospective one.

Small wonder that only about 1% of all stocks covered by street analysts have "sell" recommendations. Even in October 2001, 16 out of 17 securities analysts covering Enron had "buy" or "strong buy" ratings on the stock. As long as the incentives of analysts are misaligned with the needs of investors, Wall Street cannot perform an effective watchdog function.

In some cases, boards of directors have their own conflicts. Too often, board members have personal, business, or consulting relationships with the corporations on whose boards they sit. For some "professional directors," large fees and other perks may militate against performing their proper function as a sometime thorn in management's side. Our watchdogs often behave like lapdogs.

But it is on the independent accounting profession that we most rely for assurance that a corporation's financial statements accurately reflect the firm's condition. While we cannot expect independent auditors to detect all fraud, we should expect we can rely on them for integrity of financial reporting. While public accounting firms do have reputations to maintain and legal liability to avoid, the incentives of these firms and general auditing practices can sometimes combine to cloud the transparency of financial statements.

In my own experience on several audit committees of public companies, the audit fee was only part of the total compensation paid to the public accounting firm hired to examine the financial statements. Even after the divestiture of their consulting units, revenues from tax and management advisory services comprise a large share of the revenues of the "Big Five" accounting firms. In some cases auditing services may be priced as a "loss leader" to allow the accounting firm to gain access to more lucrative non-audit business.

In such a situation, the audit partner may be loath to make too much of a fuss about some gray area of accounting if the intransigence is likely to jeopardize a profitable relationship for the accounting firm. Indeed, audit partners are often compensated by how much non-audit business they can capture. They may be incentivized, then, to overlook some particularly aggressive accounting treatment suggested by their clients.

Outside auditors also frequently perform and review the inside audit function within the corporation, as was the case with Andersen and Enron. Such a situation may weaken the safeguards that exist when two independent organizations examine complicated transactions. It's as if a professor let students grade their own papers and then had the responsibility to hear any appeals. Auditors may also be influenced by the prospect of future employment with their clients.

Unfortunately, our existing self-regulatory and standard-setting organizations fall short. The American Institute of Certified Public Accountants has neither the resources nor the power to be fully effective. The institute may even have contributed to the problem by encouraging auditors to "leverage the audit" into advising and consulting services.

The Financial Accounting Standards Board has often emphasized the correct form by which individual transactions should be reported rather than the substantive way in which the true risk of the firm may be obscured. Take "Special Purpose Entities," for example, the financing vehicles that permit companies such as Enron to access capital and increase leverage without adding debt to the balance sheet. Even if all of Enron's SPEs had met the narrow test for balance sheet exclusion (which, in fact, they did not), our accounting standard would not have illuminated the effective leverage Enron had undertaken and the true risks of the enterprise.

Given the complexity of modern business and the way it is financed, we need to develop a new set of accounting standards that can give an accurate picture of the business as a whole. FASB may have helped us measure the individual trees but it has not developed a way to give us a clear picture of the forest. The continued integrity of the financial reporting system and our capital markets must be insured. We need to modernize our accounting system so financial statements give a clearer picture of what assets and liabilities on the balance sheet are at risk. And we must find ways to lessen the conflicts facing auditors, security analysts, and even boards of directors that undermine checks and balances our capital markets rely on.

Change Auditors

One possibility is to require that auditing firms be changed periodically the way audit partners within each firm are rotated. This would incentivize auditors to be particularly careful in approving accounting transactions for fear that leniency would be exposed by later auditors.

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

"SEC seeks accounting reform:  Chairman Harvey Pitt says restoring public confidence is goal No. 1," CNN Money, January 17, 2002 --- 

Securities & Exchange Commission Chairman Harvey Pitt called Thursday for reform of the way accounting firms are monitored and regulated in the United States in an effort to restore public confidence in the profession in the wake of scandals involving Enron Corp. and other companies.

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

Pitt proposed the creation of a new body, composed mostly of representatives from the public sector, to oversee and discipline accounting firms, and he called for a reform of the triennial peer review process, which has been criticized "with some merit," Pitt said.

His suggestions were prompted mostly by the recent collapse of energy trader Enron and the revelations of accounting irregularities that led to it. Its auditor, Arthur Andersen, has come under intense scrutiny for failing to discover or disclose problems with Enron's books that hid massive debt and helped the company avoid paying taxes.

Enron's shares lost almost all their value as the disclosures came to light, the company filed for bankruptcy and investor confidence in the accuracy of companies' financial disclosures was shaken.

"I place restoring the public's confidence in the auditing profession to be immediate goal number one," Pitt said

Pitt said he and others in the SEC were still trying to work out the details of the new oversight group, which would have the power to compel testimony and the production of documents, and were investigating the circumstances of Enron's collapse.

Despite Pitt's proposals, Sen. Jon Corzine, D - New Jersey, told CNNfn's The Money Gang that the SEC should be policing the accounting firms. (WAV 597KB) (AIFF 597KB).

Pitt did say he thought the SEC should have oversight of the new body's decisions and actions.

Of particular interest to the SEC may be the actions of Andersen, which admitted to intentionally destroying Enron documents -- excepting the important "work papers" associated with an audit -- and recently fired the partner heading up its work on Enron.

Andersen's actions were only the latest in a series of stumbles by accounting firms. Andersen was recently fined $7 million by the SEC, the largest penalty ever, for irregularities connected with its work on Waste Management Inc. Other venerable firms like PricewaterhouseCoopers and Ernst & Young have also had their share of trouble.

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

In a surprise response to last week's SEC announcement, the Public Oversight Board, the independent body that oversees the self-regulatory function for auditors of companies registered with the Securities & Exchange Commission, passed a resolution stating its intent to close its doors no later than March 31, 2002. 

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.  

Warren Buffett 
Three years ago the Berkshire Hathaway CEO proposed three questions any audit committee should ask auditors: 

(1) If the auditor were solely responsible for preparation of the company's financial statements, would they have been done differently, in either material or nonmaterial ways? If differently, the auditor should explain both management's argument and his own. 


(2) If the auditor were an investor, would he have received the information essential to understanding the company's financial performance during the reporting period? 


(3) Is the company following the same internal audit procedure the auditor would if he were CEO? If not, what are the differences and why? Damn good questions.

Andersen Was Not Forthcoming to the Audit and Compliance Committee

"Web of Details Did Enron In as Warnings Went Unheeded," by Kurt Eichenwald and Diana Henriques, The New York Times, February 10, 2002 --- 

The opportunity to cross to-do's off the list came just one week later, on Feb. 12. That day, the Enron board's audit and compliance committee held a meeting, and both Mr. Duncan and Mr. Bauer from Andersen attended. At one point, all Enron executives were excused from the room, and the two Andersen accountants were asked by directors if they had any concerns they wished to express, documents show.

Subsequent testimony by board members suggests the accountants raised nothing from their to-do list. "There is no evidence of any discussion by either Andersen representative about the problems or concerns they apparently had discussed internally just one week earlier," said the special committee report released last weekend.

Tone at the Top

AUDIT COMMITTEE MEMBERS AND BOARDS of directors are taking a fresh look at potential risks within their organizations following the Enron debacle. What financial reporting red flags and key risk factors should your organization know? Read more in Tone at the Top, The IIA’s corporate governance newsletter for executive management, boards of directors, and audit committees. 

Note especially the February 2002 edition at 

In response to the Enron situation, The Institute of Internal Auditors (IIA) is conducting Internet-based “flash surveys” of directors and chief audit executives (CAEs). The purpose of these surveys is gaining information — and sharing it in an upcoming Tone at the Top — on how audit committees and other governance entities monitor complex financial transactions. We encourage you to participate by typing in  


Also see 

You might enjoy "The AICPA's Prosecution of Dr. Abraham Briloff: Some Observations," by Dwight M. Owsen ---  
I think Briloff was trying to save the profession from what it is now going through in the wake of the Enron scandal.


Bob Jensen's other threads are at 

Bob Jensen's homepage is at

Updates following the Accounting Scandals

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

Bob Jensen's Commentary on the Above Messages From the CEO of Andersen
     (The Most Difficult Message That I Have Perhaps Ever Written!) 


My paper on "Damages" at


Suggested Reforms
Suggested Reforms (Including those of Warren Buffet and the Andersen Accounting Firm)


Bottom-Line Commentary of Bob Jensen:  Systemic Problems That Won't Go Away
Bottom-Line Commentary of Bob Jensen:  Systemic Problems That Won't Go Away



Bob Jensen's homepage is at



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


An Enron Timeline Featuring Events Surrounding the Purported Suicide of Enron Executive J. Clifford Baxter ---



The Professions of Investment Banking and Security Analysis are Rotten to the Core  
This module was moved to 

A Bit of Accountancy Humor Inspired by Enron and the Scandals That Follow and Follow and . . .

The Wall Street Journal's full text of what happened at Enron as of January 15, 2002 --- 


Frank Partnoy's Testimony on Enron's Derivative Financial Instruments Frauds ---

Corporate America's accounting problems raise the question: Can the public depend on the auditors?

Washington Post Article:  Part 1 ---
"THE NUMBERS CRUNCH After Enron, New Doubts About Auditors," Part 1 of 2 Articles, by David S. Hilzenrath, The Washington Post,  December 5, 2001 ---

Washington Post Article:  Part 2 ---
"THE NUMBERS CRUNCH Auditors Face Scant Discipline Review Process Lacks Resources, Coordination, Will," Part 2 of 2 Articles, by David S. Hilzenrath, The Washington Post,  December 6, 2001 ---

"Watchdogs and Lapdogs," by Burton Malkiel, Editorial in The Wall Street Journal, January 16, 2002 ---
Dr. Malkiel, professor of economics at Princeton, is author of "A Random Walk Down Wall Street," 7th ed. (W.W. Norton, 2000) ---,

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

Updates following the Enron Scandal

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

Bob Jensen's Commentary on the Above Messages From the CEO of Andersen
     (The Most Difficult Message That I Have Perhaps Ever Written!) 

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

My paper on "Damages" at


Suggested Reforms
Suggested Reforms (Including those of Warren Buffet and the Andersen Accounting Firm)


Bottom-Line Commentary of Bob Jensen:  Systemic Problems That Won't Go Away
Bottom-Line Commentary of Bob Jensen:  Systemic Problems That Won't Go Away



Bob Jensen's homepage is at



Other Links

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

Bob Jensen's threads on professionalism and independence are at

Bob Jensen's threads on pro forma frauds are at 

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

The Saga of Auditor Professionalism and Independence ---

Incompetent and Corrupt Audits are Routine ---

Bob Jensen's threads on accounting theory are at 

Future of Auditing ---

Bob Jensen's threads on accounting theory are at 

Future of Auditing ---




The Consumer Fraud Portion of this Document Was Moved to