Accounting Scandal Updates on February 28, 2003
Bob Jensen at Trinity University

Bob Jensen's main document on the Enron scandal and other accounting frauds is at http://www.trinity.edu/rjensen/fraud.htm 

Bob Jensen's SPE threads are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm  

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

Bob Jensen's Summary of Suggested Reforms --- http://www.trinity.edu/rjensen/FraudProposedReforms.htm 

Bob Jensen's Bottom Line Commentary --- http://www.trinity.edu/rjensen/FraudConclusion.htm 

The Virginia Tech Overview:  What Can We Learn From Enron? --- http://www.trinity.edu/rjensen/fraudVirginia.htm 

Fraud Facts and Prevention Tips from SmartPros --- http://www.smartpros.com/x36701.xml 
Bob Jensen's tips are at http://www.trinity.edu/rjensen/fraud.htm#ThingsToKnow 

Many of the scandals are documented at http://www.trinity.edu/rjensen/fraud.htm 

Domenic Martino, CEO of the Australian arm of Deloitte Touche Tohmatsu, resigned last week in the wake of publicity surrounding his role as director of failed telco company New Tel. http://www.accountingweb.com/item/97080 

Former EDS Executive Accuses Company of Inflating Results
The Wall Street Journal, January 31, 2003 --- 
http://online.wsj.com/article/0,,SB1044055325641025584,00.html?mod=technology_main_whats_news 

It is claimed that in the 1870s the whole boom town of Palisade, Nevada, known as one of the most violent towns west of Chicago, was in on a huge spoof. To build up its Wild West image, when a train pulled in, the townspeople usually staged public shoot-outs or bank robberies. (Beef blood from the local slaughterhouse added to the effect.) Everyone in town played a role at one time or another, and no one let out the truth. As a result, Palisade became famous; but after the iron-ore raid to Eureka was abandoned in 1876, the town faded away. As long as the hoax lasted, however, there was not one real-life crime recorded in Palisade.
Source: Fakes, Frauds, and Other Malarkey, by Kathryn Lindskoog, Hope Publishing House, 1993. (Forwarded by Kate Head)

The 8th Ernst & Young Global Fraud Survey, "Fraud: The Unmanaged Risk," based on a survey of 400 CEOs in more than 30 countries, reveals that, despite attempts to improve corporate governance in the wake of recent financial scandals, more than half of the companies interviewed had suffered a significant fraud in the last two years. Moreover, some 85% of the worst frauds were by insiders on the payroll. When asked what keeps them up at night, participants were significantly more concerned about asset misappropriation than any other kind of fraud. --- http://www.ey.com/global/download.nsf/South_Africa/Jan03_8th_Global_Fraud_Survey/$file/8th%20Global%20Survey.pdf 

Ernst & Young breathed a sigh of relief this week as a judge threw out two out of three of the claims made against it in a negligence case brought against the Big Four firm by Equitable Life. Had it been successful, the suit could have cost the accounting firm $4.5 billion in damages. http://www.accountingweb.com/item/97126 

A lawsuit initiated in 1994 ended this week with Big Four auditor Deloitte & Touche agreeing to pay $23 million to the State of Kentucky's Department of Insurance on behalf of Kentucky Central Life Insurance Company. http://www.accountingweb.com/item/97178 

Two former Kmart Corp. vice presidents were indicted on securities fraud and other charges. The executives, whose names weren't immediately released, also were charged with conspiracy and making false statements to the Securities and Exchange Commission. The retailer has been under investigation for executive dealings before it filed for bankruptcy protection 13 months ago.  http://www.business2.com/articles/mag/0,1640,47023,00.html 

FOR MORE INFORMATION, see: http://online.wsj.com/article/0,,SB1046278928738020503,00.html

Most of Wall Street's payments of $1.5 billion to settle alleged stock-research abuses will be tax-deductible for the companies.
Gregory Zuckerman, The Wall Street Journal, February 13, 2003 --- http://online.wsj.com/article/0,,SB1045105237868602943,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs 

The SEC is considering making two rivals of Merck's Medco unit use a Medco accounting technique that some critics say is aggressive.
The Wall Street Journal, February 20, 2003 --- http://online.wsj.com/article/0,,SB1045704096963121463,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs 
Read about earlier revenue accounting scandals at Merck --- http://www.trinity.edu/rjensen/ecommerce/eitf01.htm#Merck 

Stock analysts will now have to certify the truthfulness of their research reports, under a recent unanimous ruling by federal regulators. http://www.accountingweb.com/item/97116 

Demand for Public Accountants Is Rising, Experts Say --- http://www.smartpros.com/x37056.xml 

STARTING SALARIES FOR ACCOUNTING GRADS UP ON LAST YEAR --- http://accountingeducation.com/news/news3788.html 

Updated IRS listing of tax scams and consumer alerts --- http://www.irs.gov/newsroom/article/0,,id=98269,00.html 

Tax Scams/Consumer Alerts

Tax Scams The IRS urges you not to fall victim to tax scams. Remember that if it sounds too good to be true, it probably is. If you suspect a tax scam, you can report suspected tax fraud activity by calling 1-800-829-0433. Some of the common scams the IRS sees include: The "Dirty Dozen" -- 12 Common Scams (IR-2003-18) Schemes Promoting Use of Disabled Access Credit (IR-2002-17) Home-Based Business Tax Avoidance Schemes (IR-2002-13) Slavery Reparation Scams (IR-2002-08) For more details on other scams, visit the IRS Criminal Investigation's Tax Fraud Alerts.   Identity and Financial Theft Scam Be on the alert for a scam that uses phony bank correspondence and IRS forms to trick unwary bank customers into disclosing their personal and financial information to the scam promoters. The information is used to steal the customer's identity and bank account deposits, run up charges on credit cards, apply for loans, services or benefits in the customer's name, file fraudulent tax returns and more. The phony IRS forms used in this scam may be labeled W-9095, W-8BEN or W-8888. News release IR-2002-55 has more details. Report instances of this fraud to the Treasury Inspector General for Tax Administration at 1-800-366-4484. The Comptroller of the Currency issued Alerts 2002-3 and 2002-6, warning of this identity theft scam and including copies of phony bank correspondence and the phony W-9095. These are on the 2002 Alerts page of the Comptroller's Web site.

Bob Jensen's main site for fraud detection and prevention (including tax fraud and identity theft) is at http://www.trinity.edu/rjensen/fraud.htm 

The U.S. Government's Central Website for Identity Theft Information --- http://www.consumer.gov/idtheft/ 

Coming Up on Dateline from NBC

Also, how do you know if your water is safe to drink? In a hidden camera investigation, ”Dateline NBC” found that some salesmen will scare you into believing you need an expensive filter. You could spend thousands of dollars on a water filter, but do you really need to? Lea Thompson investigates.

One thing that bothered me recently was a television solicitation to send money to purchase slaves in Africa.  There are indeed modern day slaves.  However, doesn't buying slaves from evil owners merely make business better for dealing in slaves?  There must be a better way to help without making it a growing business.

Independence Rules

Corporate Reform: The New SEC Auditor Independence Rules (from Ernst & Young) --- 

http://www.ey.com/global/download.nsf/US/Corporate_Reform_SEC_Auditor_Independence_Rules/$file/CorporateReformSECAuditorIndependenceRules.pdf 

Enron Update - Tax Schemes Even The IRS Doesn't Understand
Last week, the U.S. Senate's Joint Committee on Taxation published a three-volume, 2,700 page report describing what the committee had learned of the tax shelters used by Enron Corporation to reduce and in some cases avoid paying U.S. corporate income tax. http://www.accountingweb.com/item/97152 

The SEC leadership is often on the side of the crooks!
SEC Staff Wants to End 'Short Seller Wars' --- http://www.smartpros.com/x37167.xml 

Feb. 21, 2003 (FinancialWire) — The Financial Times is reporting that the SEC staff had wanted to propose "sweeping changes" to rules governing "short selling," but was rebuffed by Chairman Harvey Pitt. Naming three NYSE companies that have claimed manipulation -- Allied Capital, MBIA and mortgage lender Federal Agricultural Mortgage Corp. "Farmer Mac" -- FT says the staff plans to take its case before new SEC Chief William Donaldson as early as next week.

Also, Wednesday's entry of InternetStudios, Inc. into the fray now brings the number of companies associated with short selling, mostly of the naked variety, to a whopping 57 varieties.

FT's reporter John Labate said that "regulators around the world are under pressure to tighten rules on short-selling, in which traders bet a stock price will fall, amid concern that it is used by professional traders to manipulate share prices, particularly of smaller companies."

Among the proposals could be "rules forcing traders to borrow stock to cover their short positions. Under current rules, traders can take out 'naked' short positions over an unlimited number of shares, putting huge downward pressure on an illiquid stock.

FT said regulators are less concerned about short-selling in the most liquid stocks and may even consider loosening the rules for large companies; and that officials want a consistent set of rules across all US markets. For example, it said, traders are forbidden from shorting a stock quoted on the New York Stock Exchange when the price is falling but Nasdaq stocks operate under a separate rule that does not apply to small stocks in the over-the-counter market.

The staff said it has been lobbied by politicians who complain that small companies and shareholders in their constituencies are being hurt -- perhaps unlawfully. A rule proposal by Georgetown University Associate Professor James J. Angell, presented to the CEO Council last fall, is at http://www.investrend.com/default.asp?level=137 

Continued in the article.

February 19, 2003 message from Tom Hood

-----Original Message----- 
From: Tom Hood [mailto:Tom@macpa.org]  
Sent: Wednesday, February 19, 2003 4:30 PM 
To: Jensen, Robert 
Subject: Content for your website : Summary of Suggested Reforms Importance: High

Bob,

I have attached a copy of our whitepaper entitled The Road to Reform: Protecting the Public Interest, Strengthening the Profession, which was released by us in September, 2002. It was produced by a "blue ribbon" panel of experts from our membership and included Big Four firms, national, regional and local firms; two public company CFOs, two private company CFOs, the Maryland Chamber of Commerce, educators, and a government accounting expert. Our task force also had a member of the Auditing Standards Executive Committee of the AICPA, member of the PCPS Executive Committee of the AICPA, and GASB expert. We reviewed thousands of pages of proposals in crafting our response. We were the first State CPA Society to approach this issue from a comprehensive reform perspective. In fact, our membership demanded that we (the MACPA) do something about the deteriorating situation and show some leadership and this was our response.

I have also included a pdf file of our PowerPoint which was used to expose this to our membership via a Webcast townhall meeting. It ultimately has received significant acceptance. You are free to post on your website and distribute. I would love to hear you comments as well.

I only wish more educators kept up with the massive issues facing this Profession like you do - keep up the great work!!!

<<Road to Reform.pdf>> <<MACPA Webcast.pdf>> Here is a link to our "reform" website that we are using to inform Maryland CPAs

http://www.macpa.org/headlines/2002/Reform/ 

Thanks,

Tom Hood, CPA 
Executive Director 
Maryland Association of CPAs (800) 782-2036

Note that the link to the white paper mentioned below is http://www.macpa.org/headlines/2002/Reform/white_paper.pdf 

The link to the slides is at http://www.macpa.org/headlines/2002/Reform/slides.pdf 

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

"Tax-Shelter Sellers Lie Low For Now, Wait Out a Storm," by Cassel Bryan-Low and John D. McKinnon, The Wall Street Journal, February 14, 2003, Page C1 --- http://online.wsj.com/article/0,,SB1045188334874902183,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs 

With the Internal Revenue Service, Congress and even their own clients on their case, tax-shelter promoters are changing their act to survive.

Using names that evoke an aggressive Arnold Schwarzenegger movie is undesirable right now. Which may be why accounting firm Deloitte & Touche LLP's corporate tax-shelter group has ditched its informal name, Predator, and morphed into a new group with a safer, if duller, name: "Comprehensive Tax Solutions."

KPMG LLP has taken a similar tack. Last year, it disbanded some teams that pitched aggressive strategies -- including some named after the Shakespearean plays "The Tempest" and "Othello" -- to large corporate clients and their top executives. The firm also created a separate chain of command for partners dealing with technical tax issues; those partners handling ethical and regulatory issues report to different bosses.

Shelter promoters also have largely abandoned their strategy of selling one-size-fits-all tax-avoidance plans to hundreds or even thousands of corporate and individual clients. IRS investigators targeted these plans, especially in the past two years, as the government began requiring firms to disclose lists of their clients for abusive tax shelters. Other shelter firms are going down-market, pitching tax-avoidance plans to real-estate agents and car dealers, rather than the super-rich. Demand for tax-avoidance schemes of all kinds is bound to rebound sharply, promoters figure, especially when the stock market rebounds.

For now, though, some traditional corporate clients and wealthy individuals are getting nervous about using aggressive tax-avoidance plans. The IRS cracked down last year to try to force several big accounting firms -- KPMG, BDO Seidman LLP and Arthur Andersen LLP, among others -- to hand over documents about the tax shelters their corporate clients were using. The travails of Sprint Corp.'s two top executives, who are being forced out for using a complicated tax-avoidance scheme, is the latest big blow to tax shelters.

This week, about 100 financial executives gathered for cocktails at a hotel in Sprint's hometown of Kansas City, Kan. Milling outside the dining room, the discussion quickly turned to tax shelters. The debate: Should executives turn to their company's outside auditors for personal tax strategies, given that executives are pitted against the auditor if the tax strategies turn out to be faulty? The risk for executives lies not only in getting stuck with back taxes and penalties, but, as the Sprint case demonstrates, a severely damaged personal reputation.

Some large accounting firms once earned as much as $100 million or more in revenue annually from their shelter-consulting business at the market's peak around 2000. Now, the revenues are in sharp decline, partners at Big Four firms say. In some cases, business from wealthy individuals has dropped about 75% from a few years ago. Business from corporate clients has suffered less, because accounting firms have been able to persuade customers to buy customized, more costly, advice.

Ernst & Young LLP says a group there that had sold tax strategies for wealthy individuals has been shut. E&Y does continue to sell tax strategies to corporate clients, but, a spokesman says: "We don't offer off-the-shelf strategies that don't have a business purpose."

Among the downsides of tax-shelter work: litigation risk. Law firm Brown & Wood LLP, which is now a part of Sidley Austin Brown & Wood LLP, is a defendant in two lawsuits filed in December by disgruntled clients, who allege the law firm helped accountants sell bogus tax strategies by providing legal opinions that the transactions were proper. The suits, one filed in federal court in Manhattan and one in state court in North Carolina, contend that the law firm knew or should have known the tax strategies weren't legitimate.

Continued at http://online.wsj.com/article/0,,SB1045188334874902183,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs 

Bob Jensen's threads on stock compensation controversies are at  http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

Jensen Note:  Accounting educators might ask their students why performance looked better.  
Hint:  See the article and see one of Bob Jensen's former examinations at 
http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/Exam02VersionA.htm 

It's Still The Pitts (Obviously)
Reactions to the new auditor independence rules vary widely. Large accounting firms seem generally pleased. But consumer activists are openly scolding the SEC for watering down the rules. http://www.accountingweb.com/item/97078 

Also see http://www.consumerfed.org/auditreformeval.pdf 

Last week Ernst & Young weighed in on the issue of expensing stock options and in the process upset its high-technology clients. The Big Four accounting firm reversed its previous opinion, notifying the Fed

The Financial Accounting Standards Board (FASB) that it now believes employee stock options should be expensed. http://www.accountingweb.com/item/97167 

Some E&Y Clients Are Not Happy About This Reversal
Last week Ernst & Young weighed in on the issue of expensing stock options and in the process upset its high-technology clients. The Big Four accounting firm reversed its previous opinion, notifying the Federal Accounting Standards Board (FASB) that it now believes employee stock options should be expensed. http://www.accountingweb.com/item/97167 

I think the tax shelter marketing of the large CPA firms is probably the most depressing auditing scandal since the fall of Enron.  The article below by Jeremy Kahn makes me want to see my doctor about a prescription for Prozac.  What is worse is that on the way out, the large CPA firms biggest friend ever at the SEC, Harvey Pitt, decided to continue to officially allow this type of consulting bias to continue as his one last act of favoritism on his way out of town.  See http://www.consumerfed.org/auditreformeval.pdf 

To date, only PwC has promised to stop mass-marketing these aggressive tax shelters.  But the horse is out of the barn for all the big firms in terms of billions of dollars of litigation coming down the pike.  This is an illustration of how the entire culture of auditing changed in the large firms just as Paul Volker complained about following his doomed effort to save Andersen --- http://www.fei.org/download/Volker_Kellogg_Speech_6-25-02.pdf 
I think that dealing in tax shelters is not wrong per se.  But it’s a conflict of interest when the auditors deal in them for audit clients.  Where is Abe Briloff when we need him the most to focus auditors back on investors --- http://accounting.rutgers.edu/raw/aaa/pi/newsletr/spring99/item07.htm 

The last thing the Big Four needed was yet another scandal. But they've got one--this time over tax shelters. 
"Do Accountants Have a Future?" by Jeremy Kahn, Fortune, March 3, 2003, pp. 115-116 --- http://www.fortune.com/fortune/articles/0,15114,423588,00.html 

On a snowy Friday in February, dozens of men and women shuffled through Arthur Andersen's spacious Midtown Manhattan office. The place hadn't seen this much activity in months. But it wasn't a sign that the once-proud accounting firm decimated by the Enron scandal was suddenly springing back to life. The visitors hadn't come for help in setting up off-balance-sheet partnerships. No, the firm was selling its furniture and artwork--and the people roaming the halls were hunting for bargains.

A year ago Andersen was still a thriving business, with 28,000 workers in the U.S. and $9 billion in annual revenues. Today it exists--barely--employing fewer than 500 people. Scores of them spend their time traveling from office to office, auctioning stuff off. Meanwhile, with the accounting industry leaping from one crisis to another--the latest one concerns the marketing of suspect tax shelters--investors wonder whether the same fate awaits the remaining Big Four firms.

Accounting firms lobbied successfully last year to block proposals that would have severely limited the type of work they can perform for public companies. There was no conflict of interest between auditing and tax advice, they argued. The latest debacle suggests otherwise. And with each new scandal, the profession hurtles closer to a future it wants desperately to avoid, one in which public accounting firms perform audits and nothing else. To escape that outcome, the Big Four will have to convince regulators that they are serious about changing the way they do business.

Nor is that their only problem. Shocked by Enron's abuse of corporate tax shelters, Congress is taking steps to outlaw such structures. In addition, all the firms face a wave of litigation from wealthy clients who bought into complex individual tax shelters marketed in the 1990s. The IRS is cracking down and pressing investors who used shelters to pay back taxes, interest, and penalties. The clients in turn are suing their accountants for fraud and malpractice. Some have filed civil racketeering claims, which will allow them to collect triple damages if they win. The issue burst on to front pages earlier this month when the board of Sprint ousted CEO William Esrey and president Ronald LeMay over tax shelters they had bought from the firm's auditor, Ernst & Young. (E&Y says it stands by the tax advice it provided the deposed executives.)

Although the extent of the industry's potential liability from failed tax schemes isn't yet known, it is likely to run into the billions. The Justice Department is also suing--on behalf of the IRS--KPMG and another firm, BDO Seidman, for withholding documents related to their promotion of tax shelters. PricewaterhouseCoopers has already paid $1 million to settle an IRS examination of its tax shelter business.

As if all that weren't enough, the Big Four are still fighting lawsuits from shareholders angry about earnings restatements at companies they audited. One firm, KPMG, is especially vulnerable. On Jan. 29 the SEC filed a civil fraud complaint against the firm for allowing Xerox to inflate its revenues by $3 billion between 1997 and 2000. (KPMG says it "did the right thing" at Xerox and calls the SEC complaint an "injustice.")

As usual, the accountants have only themselves to blame. Their lax attitudes toward aggressive corporate accounting and their decision to market risky tax strategies have the same root cause: greed, coupled with a peculiar inferiority complex. Accountants have always wanted to be more than mere bean counters. In the 1990s they invested heavily in consulting, investment banking, and even legal services. The big firms seemed almost embarrassed by their "legacy role" as guardians of the public's trust in financial reporting. There was more sex appeal--and money--elsewhere.

To increase revenues, accounting firms began using their audits as loss leaders for selling more lucrative consulting work. They also discovered a gold mine in tax shelters. In 1991 the American Institute of Certified Public Accountants changed its code of professional conduct to allow accountants to charge performance-based contingency fees, as opposed to traditional hourly rates. The change set off a race to invent and market tax strategies, for which accountants would ask clients to pay 10% to 40% of the amount they saved in taxes. Tax experts say many of the schemes the accounting firms were selling crossed the line. "They were based on a literal interpretation of the law, but what was being accomplished was clearly violating the spirit of the law," says Robert Willens, a Lehman Brothers accounting expert who has reviewed dozens of tax shelters.

Throughout much of the 1990s the IRS lacked the resources to combat proliferating tax-shelter sales. The schemes were too complex for the IRS to understand--unless someone tipped it off--and the accounting firms made prospective clients sign nondisclosure agreements. By the end of the Clinton administration, however, the Treasury started cracking down. The IRS forced accounting firms to turn over information about how they marketed shelters--including client lists. The agency offered amnesty programs to encourage individuals using suspect structures to come forward. And when it uncovered an abusive tax strategy, it issued notices banning it and recommended penalties. "At one point they were issuing notices almost weekly," Willens says.

Now accounting firms are in hot water with both the IRS and their former clients. "It's not like they screwed people who can't come after them," says Blair Fensterstock, a lawyer who is suing E&Y for $1 billion on behalf of four executives who bought a shelter idea now being challenged by the IRS. Several suits have been filed against the other firms as well.

The industry also faces the prospect of further regulation. New moves are afoot to shutter the shelter business. For example, in regulations issued in late January the SEC told corporate audit committees to "strictly scrutinize" tax services their auditors were providing. Several Congressional Democrats have written the SEC asking it to go even further and ban the auditors from performing tax work.

A host of corporate-governance experts criticize accounting firms for using their position as auditors to sell tax advice to individual executives. Sometimes firms have made more money selling such advice than they did auditing an entire company. That was true at Sprint, where in 2000 Esrey and LeMay paid E&Y $5.8 million--3% of their investment in tax shelters the accounting firm recommended--while Sprint paid E&Y just $2.5 million for the audit and another $2.6 million for services related to it. "Should the accounting firm advising the company also advise the executives? Probably not," says shareholder activist Nell Minow. The new Public Company Accounting Oversight Board will probably examine the subject when it starts work in April.

Another issue is contingent fees. In 2000 the SEC prohibited accounting firms from taking a cut of clients' tax savings when selling advice to companies they audit. But many think the government should ban their use in all cases. To preempt the regulators, the AICPA may urge the IRS to bolster disclosure of any tax strategy sold under a confidentiality agreement or a contingency arrangement.

Some individual accounting firms are doing more--getting out of the shelter game altogether. Even before its legal settlement with the IRS, PwC had stopped mass-marketing tax shelters. Others may follow its lead. Ironically, the scandals during the past year present accountants with an opportunity. Corporations are now willing to pay for high-quality audits. That may enable the Big Four to shed their more dubious practices and regain public trust. Eliminating abusive tax shelters would be a good place to start. Otherwise, they too may one day find themselves selling off furniture.

The following is an important article in accounting. It shows how something students may think is a minor deal can have an enormous impact on reported performances of corporations.

It also illustrates the enormous ramifications of controversial and complex tax shelters invented by tax advisors from the same firm (in this case E&Y) that also audits the financial statements. It appears that one of the legacies of the not-so-lame-duck Harvey Pitt who's still at the SEC is to continue to allow accounting firms to both conduct audits and do consulting on complex tax shelters for the client. Is this an example of consulting that should continue to be allowed?

SPRINT RECEIVED big tax benefits in 1999 and 2000 from the exercise of stock options by its executives. The exercises also made the telecom concern's performance look better. Sprint President Ronald LeMay is negotiating for a larger severance package.
Ken Brown and Rebecca Blumenstein, The Wall Street Journal, February 13, 2002 --- http://online.wsj.com/article/0,,SB104510738662209143,00.html?mod=technology_main_whats_news 

NEW YORK -- While Sprint Corp.'s two top executives have lost their jobs and face financial ruin over the use of tax shelters on their stock-option gains, the company itself received big tax benefits from the options these and other Sprint executives exercised.

Regulatory filings show that Sprint had a tax benefit of $424 million in 2000 and $254 million in 1999 stemming from its employees' taxable gains of about $1.9 billion from the exercise of options in those two years. Sprint, which was burning through cash at the time as the telecommunications market bubble burst, had virtually no tax bill in 1999 and 2000, because of sizable business losses. But the Overland Park, Kan., company was able to carry the tax savings forward to offset taxes in future years.

Under the complicated accounting and tax rules that govern stock options, the exercises also made Sprint's performance look better by boosting the company's net asset value, an important measure of a company's financial health.

The dilemma facing Sprint and its two top executives over whether to reverse the options shows how the executives' personal financial situation had become inextricably intertwined with the company's interests. In Sprint's case, the financial interests of the company and its top two executives had diverged. Both were using the same tax adviser, Ernst & Young LLP. The matter has renewed debate about whether such dual use of an auditing firm creates auditor-independence issues that can hurt shareholders.

Stock-option exercises brought windfalls to Sprint employees as the company's shares rose in anticipation of a 1999 planned merger with WorldCom Inc., which later was blocked by regulators.

Sprint Chairman and Chief Executive William T. Esrey and President Ronald LeMay sought to shield their gains from taxes using a sophisticated tax strategy offered by Ernst & Young. That tax shelter now is under scrutiny by the Internal Revenue Service. If it's disallowed, the executives would owe tens of millions of dollars in back taxes and interest.

Sprint recently dismissed the two men and intends to name Gary Forsee, vice chairman of BellSouth Corp., to succeed Mr. Esrey. Messrs. Esrey and LeMay are now trying to negotiate larger severance packages with the company because of their unexpected dismissals. (See related article.)

Sprint, like other companies, was allowed to take as a federal income-tax deduction the value of gains reaped from all those stock options that employees exercised during the year. Between 1999 and 2000, Mr. LeMay exercised options with a taxable gain of $149 million, while Mr. Esrey exercised options with a taxable gain of $138 million. Assuming the standard 35% corporate tax rate on the $287 million in options gains, the executives would have helped the company realize $100 million of tax savings in those two years.

If the company had agreed to unwind the transactions -- by buying back the shares and issuing new options -- the $100 million in savings would have been wiped out and the company would have had to record a $100 million compensation expense, which would have cut earnings.

"They would have had a large compensation expense immediately at the moment of recision equal to the tax benefit they would have foregone," says Robert Willens, Lehman Brothers tax-and-accounting analyst. "So there was no way they were going to do that."

The tax savings to Sprint revealed in the filings shed light on why the company opted not to unwind the now-controversial options exercises of Messrs. Esrey and LeMay. The executives wanted to unwind the options at the end of 2000 after learning that the IRS was frowning on the tax shelters they had used and the value of Sprint's stock had fallen markedly. However, the conditions the SEC put on such a move would have been expensive for the company. The subject wasn't discussed by the board of directors, according to people familiar with the situation. It isn't clear what role Messrs. Esrey and LeMay played in making the decision not to unwind the options.

Many tax-law specialists believe the IRS will rule against the complicated shelters, which the two executives have said could spell their financial ruin. Because Sprint's stock price collapsed after Sprint's planned merger with WorldCom was rejected by regulators in June 2000, the executives were left holding shares worth far less than the tax bill they could potentially face if their shelters are disallowed by the IRS.

If the telecommunications company had unwound the transactions, Sprint would have had to restate and lower its 1999 profits. The company could have seen its earnings pushed lower for years to come and might have been forced to refile its back taxes at a time when Sprint's cash was limited, according to tax experts.

The large companywide burst of options activity demonstrates just what a frenzy was taking place within Sprint in the wake of its proposed $129 billion merger with WorldCom. In 1998, Sprint deducted only $49 million on its federal taxes from employees exercising their stock options. That swelled to $424 million in 2000.

The push to exercise options in 2000 was intensified by Sprint's controversial decision to accelerate the timing of when millions of options vested to the date of shareholder approval of the WorldCom deal -- not when the deal was approved by regulators. The deal ultimately was approved by shareholders and rejected by regulators. In the meanwhile, many executives took advantage of their options windfalls, while common shareholders got saddled with the falling stock price.

Continued in the article.

 

Jensen Note:  Accounting educators might ask their students why performance looked better.  
Hint:  See the article and see one of Bob Jensen's former examinations at 
http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/Exam02VersionA.htm 

Also note http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

February 13, 2003 reply from Ed Scribner

Paragraph on p. A17 of Wall Street Journal, Tuesday, February 11, 2003, about E&Y's advice to Sprint executives William Esrey and Ronald LeMay:

Along with selling the executives on the tax shelters, Ernst & Young advised them against putting Sprint shares aside to pay for potential taxes and to claim thousands of exemptions so they would owe virtually no taxes. The accountant advised Mr. LeMay to claim more than 578,000 [sic] exemptions on his 2000 federal tax W4 form, for example. 

Can this be for real? 

Ed Scribner 
Department of Accounting & Business Computer Systems 
Box 30001/MSC 3DH New Mexico State University 
Las Cruces, NM, USA 88003-8001

February 13, 2003 reply from Todd Boyle [tboyle@ROSEHILL.NET] 

Of course, they aren't binding and don't persuade the IRS or anybody else, very much. The main effect of "Comfort Letters" has been that they reduce the likelihood of penalties on the taxpayer. As such, the accounting profession has a printing press, for printing money. The "audit lottery" already exhibits much lower taxes, statistically. Together with "Comfort Letters" the whole arrangement makes the CPA a key enabler of financial crime, an unacceptable moral hazard.

Legislation is needed (A) Whenever a "Comfort Letter exists, if penalties otherwise applicable on the taxpayer are abated, those penalties shall be born by the author of the "Comfort Letter"

and (B) Whenever such determination is made that a "Comfort Letter" defense was successfully raised by a taxpayer, the author of the "Comfort Letter" shall be required to provide IRS with a list of all clients and TINs, to whom that position in the "Comfort Letter" was explained or communicated."

Todd Boyle CPA - Kirkland WA

Bob Jensen's threads on stock compensation controversies are at  http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

William T. Esrey, who recently resigned as CEO of Sprint Corporation, fears for his financial future as he places his fate in the hands of the Internal Revenue Service. Although the former executive expects Sprint to pay him $1 million per year for the next three years, that sum won't go far if he is charged a projected $63 million in taxes as well as interest and penalties. http://www.accountingweb.com/item/97120 

Big Four firms Ernst & Young and KPMG are being sued by clients for selling tax shelters that have been found by the Internal Revenue Service to be illegal tax evasion strategies. Meanwhile shelter participants are relying on law firms to free them from the burden of paying penalties should the shelters be found to be illegal. http://www.accountingweb.com/item/97121 

Stage Is Set for Auditors, Management to Clash --- http://www.smartpros.com/x37165.xml 

Feb. 24, 2003 (USA TODAY) — The Sarbanes-Oxley Act and stringent new oversight of the accounting profession are causing friction in the once-smooth relationship between management and outside auditors. Those rifts are likely to become evident in coming weeks as companies file their annual financial statements to the Securities and Exchange Commission.

Take Qwest. Wednesday, the struggling telecom company reported fourth-quarter and 2002 results that had not been signed off on by outside auditor KPMG. Qwest reported fourth-quarter net income of $2.7 billion, vs. a loss of $645 million a year earlier.

People familiar with the discussions say that KPMG is fighting with top management at Qwest over the company's attempts to restate its earnings for 2000 and 2001.

Qwest has made several announcements regarding the size of the write-down it plans to take for those years. KPMG has told the company that it would be better to issue one audited restatement all at once.

Other auditor-management disputes:

Universal Health Services fired its longtime chief financial officer, Kirk Gorman, last week because of a dispute between him and auditor KPMG. In a conference call Friday, several analysts -- noting that the stock was down 20% that day -- demanded to know why Universal didn't dump KPMG. CEO Alan Miller said that firing the auditor on the eve of reporting year-end results would have caused far more damage.

When Sprint's board was concerned last month that an IRS investigation into unusual tax shelters could hurt the company's image, it ousted CEO William Esrey and his top lieutenant instead of the outside auditor that set up the questionable tax shelters. Auditor Ernst & Young remains on the job. "It's going to be a brutal battle for auditors," says Lynn Turner, former chief accountant of the Securities and Exchange Commission. "Things they would have passed on a year ago they're not going to pass on now."

Some observers say the collapse of Arthur Andersen last year after Enron's meltdown has helped foster a ''zero tolerance'' policy among auditors.

Continued in the article.

From The Wall Street Journal Accounting Educators' Review on February 14, 2003 

TITLE: More Sprint Officials Used Questionable Tax Shelters 
REPORTER: Rebecca Blumenstein 
DATE: Feb 06, 2003 
PAGE: A3 
LINK: http://online.wsj.com/article/0,,SB1044446466337280013,00.html  
TOPICS: Auditing Services, Auditor Independence

SUMMARY: Two Sprint officers, William Esrey and Ronald LeMay, have been forced to resign because they used tax shelters, developed by Ernst & Young, to reduce and defer income taxes on stock options they exercised. The officers exercised options while Sprint was in discussions with WorldCom for what was, at the time, the world's biggest proposed merger.

QUESTIONS: 
1.) Why do companies issue the types of executive stock options held and exercised by Messrs. Esrey and LeMay, officers of Sprint Corp.?

2.) Describe the possible accounting treatments for the types of stock options. What accounting standards establish these reporting requirements?

3.) Do you think the stock options being discussed were qualified or non-qualified stock option plans for tax purposes? What are the features of such plans which define tax treatment of these items? What is the amount of income which is taxed to the stock option holder under each of these plans? How must the company which issues the options report these transactions on its corporate tax return?

4.) Describe the strategies that were used to both defer taxable income and to reduce the amount of tax on that income to these Sprint Corp. officers. How did deferring the taxable income to the option holder result in significant reductions of tax liability?

5.) Based on the description in the article, why do you think the Sprint Corp. officers exercised their options when they did? Do you think the availabilty of this tax strategy might have influenced their decisions in this matter?

6.) What events left these officers with potential tax liabilities far exceeding the value of the Sprint stock they now hold? Could these men have avoided this perilous situation?

7.) What is the concern with having a company's auditor also provide tax consulting services to the firm's officers? In your answer, specifically describe the professional attitude which must be maintained by accountants in each of these roles.

8.) What do you think about the tone of the articles with respect to the accounting profession? Does the fact that the IRS now is questioning these tax strategies indicate any improper action on the part of E&Y tax professionals?

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

--- RELATED ARTICLES --- 
TITLE: IRS Later Opposed Tax Strategies Sold by Auditor 
REPORTER: Ken Brown and John D. McKinnon 
PAGE: A3
 ISSUE: Feb 06, 2003 LINK: http://online.wsj.com/article/0,,SB1044486181347757413,00.html 

TITLE: How the Sprint Tax Shelter Worked 
REPORTER: Rebecca Blumenstein and Ken Brown 
PAGE: A3 
ISSUE: Feb 07, 2003 
LINK: http://online.wsj.com/article/0,,SB1044592317993269173,00.html 

It just gets deeper and deeper for KPMG.

KPMG to Be the First Int'l Auditor Taken to Court in China
SmartPros, February 18, 2003 --- http://www.smartpros.com/x37092.xml 

Beijing, Feb 13, 2003 — KPMG will be the first international accounting firm to be taken to court in China after a Chinese investor filed a lawsuit against Jinzhou Port Co Ltd., its auditor KPMG, and its underwriter GF Securities.

The Shenyang Intermediate People's Court accepted the case last Sunday.

The case means Chinese investors are gradually learning to protect their interests via laws and also signals an 'international' case as it involves the B-share markets, industry experts said.

"There have been no lawsuits against the big four international accounting companies in China, although some have been under scrutiny elsewhere after a slew of corporate scandals in the US involving the big four," a CPA at a Beijing-based accounting company told XFN.

"But I don't think the investor will win the case as there are too many of these kinds of cases," the CPA said, adding if the investor wins, many other investors will sue listed firms and related companies.

The spokespersons in both KPMG's Beijing and Hong Kong subsidiaries, which were sued by the investor, were not available at the moment for comment.

"I think the result of the case is uncertain but the action is very significant to the legal system and the stock market development in China," Huang Weimin, a partner of Grandall Legal Group, told XFN.

Huang said investors should not lose their confidence in China's legal system, and although there have been scandals in China's securities markets in the past, many regulations and laws are improving.

Jinzhou Port was fined 100,000 yuan by the finance ministry last September for the fraudulent booking of a combined 367.17 million yuan in income between 1996 and 2000.

The Wall Street Journal on June 28, 2002

A new Xerox audit found that the company improperly accelerated far more revenue during the past five years than the SEC estimated in an April settlement, according to people familiar with the matter. The total amount of improperly recorded revenue from 1997 through 2001 could be more than $6 billion... In an indication of how seriously the SEC views the Xerox case, the agency earlier this year notified a number of former executives of Xerox and KPMG that it was considering filing civil charges against them in connection with the accounting abuses. Among those receiving the so-called Wells notices -- which give potential defendants an opportunity to make a case against being charged -- were former Xerox Chairman Paul A. Allaire, Former Chief Executive G. Richard Thoman and former Chief Financial Officer Barry Romeril. Two senior KPMG partners who had been in charge of the Xerox account, Michael Conway and Ronald Safran, also received the notices.

The Right Hand 
On January 23, 2003 I opened my mail and found the excellent Year 2002 Annual Report of the KPMG Foundation outlining the many truly wonderful things KPMG is doing for minority students, education, and accounting research --- http://kpmgfoundation.org/faculty.html 

The Left Hand 
On January 23, 2003 I linked to the electronic version of  The Wall Street Journal 

SEC Set to File Civil Action Against KPMG Over Xerox The Securities and Exchange Commission is set to file civil-fraud charges against KPMG LLP as early as next week for its role auditing Xerox Corp., which last year settled SEC accusations of accounting fraud, people close to the situation said. The expected action by the SEC would represent the second time in recent years that the SEC has charged a major accounting firm with fraud. It comes at a crucial juncture for the accounting industry, which is attempting to rebuild its credibility and make changes following more than a year of accounting scandals at major corporations. It also indicates that, while the political furor over corporate fraud has died down, the fallout may linger for some time. 
The Wall Street Journal, January 23, 2003 --- http://online.wsj.com/article/0,,SB1043272871733131344,00.html?mod=technology_main_whats_news 
Also see http://www.nytimes.com/2003/01/23/business/23KPMG.html 

If the S.E.C. files a complaint, KPMG would become only the second major accounting firm to face such charges in recent decades. The first was Arthur Andersen, which settled fraud charges in connection with its audit of Waste Management in 2001, the year before it was driven out of business as a result of the Enron scandal.

The S.E.C. settled a complaint against Xerox in April, when the company said it would pay a $10 million fine and restate its financial results as far back as 1997. The company later reported that the total amount of the restatement was $6.4 billion, with the effect of lowering revenues and profits in 1997, 1998 and 1999 but raising them in 2000 and 2001.

The Right Hand 
On January 23, 2003 I opened my mail and found the excellent Year 2002 Annual Report of the KPMG Foundation outlining the many truly wonderful things KPMG is doing for minority students, education, and accounting research --- http://kpmgfoundation.org/faculty.html 

The Left Hand 
On January 23, 2003 I linked to the electronic version of  The Wall Street Journal 

SEC Set to File Civil Action Against KPMG Over Xerox The Securities and Exchange Commission is set to file civil-fraud charges against KPMG LLP as early as next week for its role auditing Xerox Corp., which last year settled SEC accusations of accounting fraud, people close to the situation said. The expected action by the SEC would represent the second time in recent years that the SEC has charged a major accounting firm with fraud. It comes at a crucial juncture for the accounting industry, which is attempting to rebuild its credibility and make changes following more than a year of accounting scandals at major corporations. It also indicates that, while the political furor over corporate fraud has died down, the fallout may linger for some time. 
The Wall Street Journal, January 23, 2003 --- http://online.wsj.com/article/0,,SB1043272871733131344,00.html?mod=technology_main_whats_news 
Also see http://www.nytimes.com/2003/01/23/business/23KPMG.html 

If the S.E.C. files a complaint, KPMG would become only the second major accounting firm to face such charges in recent decades. The first was Arthur Andersen, which settled fraud charges in connection with its audit of Waste Management in 2001, the year before it was driven out of business as a result of the Enron scandal.

The S.E.C. settled a complaint against Xerox in April, when the company said it would pay a $10 million fine and restate its financial results as far back as 1997. The company later reported that the total amount of the restatement was $6.4 billion, with the effect of lowering revenues and profits in 1997, 1998 and 1999 but raising them in 2000 and 2001.

It's Now Official at the SEC Website --- http://www.sec.gov/litigation/litreleases/lr17954.htm 

Securities and Exchange Commission
Washington, D.C.

Litigation Release No. 17954 / January 29, 2003
Accounting and Auditing Enforcement Release No. 1709 / January 29, 2003

Securities and Exchange Commission v. KPMG LLP, Joseph T. Boyle, Michael A. Conway, Anthony P. Dolanski and Ronald A. Safran, Civil Action No. 03 CV 0671 (DLC) (S.D.N.Y.) (January 29, 2003)

SEC Charges KPMG and Four KPMG Partners with Fraud in Connection with Audits of Xerox

SEC Seeks Injunction, Disgorgement and Penalties

On January 29, 2003, the Securities and Exchange Commission filed a civil fraud injunctive action in the United States District Court for the Southern District of New York against KPMG LLP and four KPMG partners - including the head of the firm's department of professional practice - in connection with KPMG's audits of Xerox Corporation from 1997 through 2000. The complaint charges the firm and four partners with fraud, and seeks injunctions, disgorgement of all fees and civil money penalties.

The complaint alleges that KPMG and its partners permitted Xerox to manipulate its accounting practices to close a $3 billion "gap" between actual operating results and results reported to the investing public. Year after year, the defendants falsely represented to the public that their audits were conducted in accordance with generally accepted auditing standards (GAAS) and that Xerox's financial reports fairly represented the company's financial condition and were prepared in accordance with generally accepted accounting principles (GAAP).

The four partners named as defendants, all of whom are certified public accountants, are:

• Michael A. Conway, 59, a resident of Westport, CT, has been KPMG's Senior Professional Practice Partner and the National Managing Partner of KPMG's Department of Professional Practice since 1990. He was the senior engagement partner on the Xerox account from 1983 to 1985. He again became the lead worldwide Xerox engagement partner for the 2000 audit. Conway also is a member of the KPMG board and is chairman of the KPMG Audit and Finance Committee.
   
• Joseph T. Boyle, 59, a resident of New York City, was the "relationship partner" on the Xerox engagement in 1999 and 2000 and is a managing partner of the New York office of KPMG and of the Northeast Area Assurance (Audit) Practice. As the relationship partner, Boyle's chief duty was serving as liaison between KPMG and the Xerox Board of Directors, including its Audit Committee.
   
• Anthony P. Dolanski, 56, a resident of Malvern, PA, was the lead engagement partner overseeing Xerox's audits from 1995 through 1997. He left KPMG in 1998. He is currently the chief financial officer of the Internet Capital Group, a public company.
   
• Ronald A. Safran, 49, a resident of Darien, CT, was the lead engagement partner on the 1998 and 1999 Xerox audits. He was removed as engagement partner at Xerox's request after completing the 1999 audit and was replaced by Conway. KPMG or its predecessor has employed Safran since his graduation from college in 1976.

The Commission's complaint alleges that beginning at least as early as 1997, Xerox initiated or increased reliance on various accounting devices to manipulate its equipment revenues and earnings. Most of these "topside accounting devices" violated GAAP and most improperly increased the amount of equipment revenue from leased office equipment products which Xerox recognized in its quarterly and annual financial statements filed with the Commission and distributed to investors and the public. This improper revenue recognition had the effect of inflating equipment revenues and earnings beyond what actual operating results warranted. In addition, the complaint alleges that the defendants fraudulently permitted Xerox to manipulate reserves to boost the company's earnings.

Continued at http://www.sec.gov/litigation/litreleases/lr17954.htm  

Accounting firm KPMG has been reprimanded and fined by the Institute of Chartered Accountants in Ireland for what the Institute described as an audit that "in terms of efficiency and competence fell below the standards to be expected." http://www.accountingweb.com/item/87371 

KPMG-U.S. (August 28, 2002) has been caught in the net of shareholder lawsuits that will relate to accounting work performed for voice recognition software company Lernout & Hauspie. The company's auditor, KPMG-Belgium, will share defendant status with its U.S. counterpart as the shareholder suits alleging fraud go to trial. http://www.accountingweb.com/item/89337 

KPMG-U.S. has been caught in the net of shareholder lawsuits that will relate to accounting work performed for voice recognition software company Lernout & Hauspie. The company's auditor, KPMG-Belgium, will share defendant status with its U.S. counterpart as the shareholder suits alleging fraud go to trial. It is anticipated that shareholders will band together to file a class action lawsuit alleging that KPMG auditors should have been aware of problems with the software company's accounts.

U.S. District Court Judge Patti Saris, who ruled that KPMG-U.S. was eligible to be included in the legal action, stated that "an escalating pageant of red flags" in the software company's financial statements "strongly support the inference that KPMG-U.S. acted with recklessness or actual knowledge" in helping prepare the 1999 Form 10-K for Lernout & Hauspie. The form was subsequently found to be fraudulent.

Learnout & Hauspie filed for Chapter 11 bankruptcy protection in November, 2000 after restating financial reports for 1998, 1999, and the first half of 2000. Originally, KPMG issued a clean opinion of the 1998 and 1999 financials, later stating that the opinions "could no longer be relied upon."

KPMG has said that the lawsuit is "completely without me

Big Four firms Ernst & Young and KPMG are being sued by clients for selling tax shelters that have been found by the Internal Revenue Service to be illegal tax evasion strategies. Meanwhile shelter participants are relying on law firms to free them from the burden of paying penalties should the shelters be found to be illegal. http://www.accountingweb.com/item/97121 

December 2002
Big Four firm KPMG has been named as the defendant in a lawsuit filed by the Missouri Department of Insurance. The suit, filed in Jackson County Circuit Court in Kansas City, Missouri, alleges that KPMG contributed to the 1999 downfall of General American Holding Company. http://www.accountingweb.com/item/96883 

SEC News Digest, Issue 2002-9 January 14, 2002 --- http://www.sec.gov/news/digest/01-14.txt 

The Commission today censured KPMG LLP, a big-five accounting firm based in New York City, for engaging in improper professional conduct because it purported to serve as an independent accounting firm for an audit client at the same time that it had made substantial financial investments in the client. The SEC found that KPMG violated the auditor independence rules by engaging in such conduct. KPMG consented to the SEC's order without admitting or denying the SEC's findings.

"The SEC's decision to censure KPMG reflects the seriousness with which the SEC treats violations of the auditor independence rules, even in the absence of demonstrated investor harm or deliberate misconduct," said Stephen M. Cutler, the SEC's Director of Enforcement

In addition to censuring the firm, the SEC ordered KPMG to undertake certain remedies designed to prevent and detect future independence violations caused by financial relationships with, and investments in, the firm's audit clients.

"This case illustrates the dangers that flow from a failure to implement adequate policies and procedures designed to detect and prevent auditor independence violations," said Paul R. Berger, Associate Director of Enforcement.

The SEC found that, from May through December 2000, KPMG held a substantial investment in the Short-Term Investments Trust (STIT), a money market fund within the AIM family of funds. According to the SEC's order, KPMG opened the money market account with an initial deposit of $25 million on May 5, 2000, and at one point the account balance constituted approximately 15% of the fund's net assets. In the order, the SEC found that KPMG audited the financial statements of STIT at a time when the firm's independence was impaired, and that STIT included KPMG's audit report in 16 separate filings it made with the SEC on November 9, 2000. The SEC further found that KPMG repeatedly confirmed its putative independence from the AIM funds it audited, including STIT, during the period in which KPMG was invested in STIT.

Rule 102(e) of the SEC's Rules of Practice provided the basis for the SEC's finding in its administrative order that KPMG engaged in improper professional practice. According to the SEC, KPMG's independence violation occurred primarily because the firm lacked adequate policies or procedures to prevent or detect such violations, and because the steps which KPMG personnel usually took before initiating investments of the firm's surplus cash were not taken in this instance.

The SEC also found that KPMG:

* had no procedures directing its treasury department personnel to check the firm's "restricted entity list" to confirm that a proposed investment was not restricted;

* had no specific policies or procedures requiring any participation by a KPMG partner in the investigation and selection of money market investments; and

* had no policies or procedures designed to put KPMG audit professionals on notice of where the firm's cash was invested, or requiring them to check a listing of the firm's investments, prior to accepting new audit engagements or confirming the firm's independence from audit clients.

As a result, the SEC found that there was no system KPMG audit engagement partners could have used to confirm the firm's independence from its audit clients.

The SEC concluded that KPMG's lack of adequate policies and procedures constituted an extreme departure from the standards of ordinary care, and resulted in violation of the auditor independence requirements imposed by the SEC's rules and by Generally Accepted Auditing Standards. (Rels. 34-45272; IC-25360; AAE Rel. 1491; File No. 3-10676; Press Rel. 2002-4)

Allegations that Big Five firm KPMG helped the nation's largest for-profit hospital chain cheat Medicare and Medicaid will be resolved by a $9 million settlement by the firm http://www.accountingweb.com/cgi-bin/item.cgi?id=61513 

Allegations that Big Five firm KPMG helped the nation's largest for-profit hospital chain cheat Medicare and Medicaid will be resolved by a $9 million settlement by the firm. KPMG this week agreed to settle out of court in a case that last year slapped their client the Columbia Hospital Corporation with over $840 million in criminal fines for defrauding government health care programs.

The case alleged that KPMG filed false claims on behalf of Basic American Medical Inc. and later Columbia Hospital Corp. that allowed them to collect on costs they knew were not allowed. The case revolved around false claims made from 1990 to 1992, and involved four hospitals in Florida and two in Kentucky.

"We vigorously deny that we engaged in any wrongdoing," KPMG spokesman George Ledwith said. He added that the accounting firm agreed to settle only to avoid costly litigation and put a 10-year-old dispute behind it.

Accounting firm KPMG has been reprimanded and fined by the Institute of Chartered Accountants in Ireland for what the Institute described as an audit that "in terms of efficiency and competence fell below the standards to be expected." http://www.accountingweb.com/item/87371 

The Wall Street Journal on June 28, 2002

A new Xerox audit found that the company improperly accelerated far more revenue during the past five years than the SEC estimated in an April settlement, according to people familiar with the matter. The total amount of improperly recorded revenue from 1997 through 2001 could be more than $6 billion... In an indication of how seriously the SEC views the Xerox case, the agency earlier this year notified a number of former executives of Xerox and KPMG that it was considering filing civil charges against them in connection with the accounting abuses. Among those receiving the so-called Wells notices -- which give potential defendants an opportunity to make a case against being charged -- were former Xerox Chairman Paul A. Allaire, Former Chief Executive G. Richard Thoman and former Chief Financial Officer Barry Romeril. Two senior KPMG partners who had been in charge of the Xerox account, Michael Conway and Ronald Safran, also received the notices.

KPMG-U.S. (August 28, 2002) has been caught in the net of shareholder lawsuits that will relate to accounting work performed for voice recognition software company Lernout & Hauspie. The company's auditor, KPMG-Belgium, will share defendant status with its U.S. counterpart as the shareholder suits alleging fraud go to trial. http://www.accountingweb.com/item/89337 

KPMG-U.S. has been caught in the net of shareholder lawsuits that will relate to accounting work performed for voice recognition software company Lernout & Hauspie. The company's auditor, KPMG-Belgium, will share defendant status with its U.S. counterpart as the shareholder suits alleging fraud go to trial. It is anticipated that shareholders will band together to file a class action lawsuit alleging that KPMG auditors should have been aware of problems with the software company's accounts.

U.S. District Court Judge Patti Saris, who ruled that KPMG-U.S. was eligible to be included in the legal action, stated that "an escalating pageant of red flags" in the software company's financial statements "strongly support the inference that KPMG-U.S. acted with recklessness or actual knowledge" in helping prepare the 1999 Form 10-K for Lernout & Hauspie. The form was subsequently found to be fraudulent.

Learnout & Hauspie filed for Chapter 11 bankruptcy protection in November, 2000 after restating financial reports for 1998, 1999, and the first half of 2000. Originally, KPMG issued a clean opinion of the 1998 and 1999 financials, later stating that the opinions "could no longer be relied upon."

KPMG has said that the lawsuit is "completely without me

And if the auditors are not truly changing their ways, things are even worse on CEO side of things. 

See "Can We Trust Them Now?" Fortune, March 3, 2003, pp. 97-100 --- http://www.fortune.com/fortune/investing/articles/0,15114,423586,00.html 

The best explanation for corporate America's continuing ability to meet or beat consensus earnings estimates, it turns out, has less to do with the earnings than with the estimates. Company executives nowadays put a lot of time and effort into making sure that the earnings forecasts that analysts come up with are ones they can meet or beat. And the question is, Is that really such a bad thing?

The bottom line is that the CEOs are still pulling the puppet analysts by the strings

CEO Robert Gannon allowed himself to be seduced by investment bankers from Goldman Sachs to sell off all the solid assets (e.g., a hydro power dam) for pie in the sky so Goldman Sachs could earn $20 million in sales commissions and Gannon could become a multi zillionaire.  The February 9, 2003 airing of Sixty Minutes of this scandal is one of the most sickening things I've learned about in this saga of recent corporate scandals.  http://www.cbsnews.com/stories/2003/02/06/60minutes/main539719.shtml 

Bob Jensen's threads on Goldman Sachs-type frauds and Partnoy's insider book (Fiasco) are discussed at http://www.trinity.edu/rjensen/fraud.htm#DerivativesFraud 

The Montana Power fraud should just be another chapter in Partnoy's book.

From The Wall Street Journal Accounting Educators' Review on February 21, 2003

TITLE: Hot Issues Await Donaldson 
REPORTER: Deborah Solomon 
DATE: Feb 18, 2003 
PAGE: A4 
LINK: http://online.wsj.com/article/0,,SB1045256562165382863,00.html  
TOPICS: Investment Banking, Accounting, Audit Quality, Sarbanes-Oxley Act, Securities and Exchange Commission, Standard Setting

SUMMARY: William Donaldson, the new chairman of the Securities and Exchange Commission (SEC), faces a number of controversial issues in his new position. Questions focus on the importance of the SEC in financial reporting and the impact of changes that will be implemented by the SEC.

QUESTIONS: 
1.) Who is William Donaldson? Why was he chosen to be the chairman of the SEC? Describe the primary roles of the SEC. Does the SEC have powers that it has historically chosen not to exercise? Support your answer.

2.) Why is it important to restore investor confidence in financial reporting? Of the issues discussed in the article, which do you think is most important in restoring investor confidence in financial reporting? Support your answer.

3.) What is an accounting industry watchdog? Should the SEC play this role? Are there any other organizations that could better serve as the accounting industry watchdog? Support your answers.

4.) What is investment research? What is investment banking? Why is the SEC considering separating the two functions?

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

LANDMARK GOVERNMENT REPORTING MODEL ISSUED IN CANADA 
The Canadian Institute of Chartered Accountants' (CICA) Public Sector Accounting Board (PSAB) has released a new Government Reporting Model that will see federal, provincial and territorial governments move to a full accrual system of accounting and a more comprehensive set of financial statements that places less emphasis on the annual surplus or deficit number ---  http://accountingeducation.com/news/news3755.html 

The Massachusetts Society of CPAs has launched its newest student recruitment initiative, CPATrack.com. This comprehensive Web site targeting both high school and college students is designed as a place for students to explore accounting education and career opportunities. http://www.accountingweb.com/item/97127 

The CPA Track Website is at http://www.cpatrack.com/ 
Note that students may post resumes at this site and join a student forum.

Bob Jensen's bookmarks on accountancy careers can be found at http://www.trinity.edu/rjensen/bookbob1.htm#careers 

CCH Outlines SEC Rules and Outstanding Reform Issues --- http://www.smartpros.com/x36916.xml 

Stock analysts will now have to certify the truthfulness of their research reports, under a recent unanimous ruling by federal regulators. The rule requiring analysts to certify their reports is similar to recent SEC regulations for senior-level corporate executives and mutual fund officers. http://www.accountingweb.com/item/97116 

What's new in accounting standards? --- http://www.smartpros.com/x36926.xml 

From the FEI on February 13, 2003
CCR Survey of Critical Accounting Estimates Disclosures --- http://www.fei.org/download/CCR_Survey_Result.pdf 

"SEC's Top Cop Again Says Audit Firms May Face Suits," by Judith Burns, The Wall Street Journal, January 31, 2003 --- http://online.wsj.com/article/0,,SB1044063159310521504,00.html?mod=technology%5Fmain%5Fwhats%5Fnews 

Accounting fraud remains a top priority for regulators and could spur lawsuits against accounting firms as well as accountants, the Securities and Exchange Commission's top cop said Friday.

Underscoring that push, the SEC sued KPMG LLP and four partners this week in connection with work they did for Xerox Corp., the Stamford, Conn., maker of copiers and printers that allegedly inflated revenue by $6 billion over three years. Xerox previously settled with the SEC without admitting or denying the claims. KPMG and its partners plan to litigate.

SEC enforcement division director Stephen Cutler said the case involves more than "an honest disagreement" about the method Xerox used to account for revenue on equipment it leased. He made his remarks at a Northwestern University Law School conference and gave the usual disclaimer that his remarks reflect his own views, not those of the SEC.

Mr. Cutler said he is "very comfortable" that KPMG was reckless in using the accounting method in question, saying others in the firm "had raised a red flag," about it. He said, "the facts will come out in the litigation."

Continued in the article.

FAS 123: New Guidance for Stock Option Accounting 
Overview from Watson Wyatt --- http://www.watsonwyatt.com/us/pubs/hrfinance/showarticle.asp?ArticleID=10908

In response to a growing number of companies announcing plans to record expenses for the fair value of stock options, Statement 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement 148 amends the disclosure requirements of Statement 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation.

Under the provisions of Statement 123, companies that adopted the preferable, fair value based method were required to apply that method prospectively for new stock option awards. This contributed to a "ramp-up" effect on stock-based compensation expense in the first few years following adoption, which caused concern for companies and investors because of the lack of consistency in reported results. To address that concern, Statement 148 provides two additional methods of transition that reflect an entity's full complement of stock-based compensation expense immediately upon adoption, thereby eliminating the ramp-up effect.

Statement 148 also improves the clarity and prominence of disclosures about the pro forma effects of using the fair value based method of accounting for stock-based compensation for all companies--regardless of the accounting method used--by requiring that the data be presented more prominently and in a more user-friendly format in the footnotes to the financial statements. In addition, the Statement improves the timeliness of those disclosures by requiring that this information be included in interim as well as annual financial statements. In the past, companies were required to make pro forma disclosures only in annual financial statements.

The transition guidance and annual disclosure provisions of Statement 148 are effective for fiscal years ending after December 15, 2002, with earlier application permitted in certain circumstances. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002.

As previously reported, the FASB has solicited comments from its constituents relating to the accounting for stock-based compensation, including valuation of stock options, as part of its recently issued Invitation to Comment, Accounting for Stock-Based Compensation: A Comparison of FASB Statement No. 123, Accounting for Stock-Based Compensation, and Its Related Interpretations, and IASB Proposed IFRS, Share-based Payment. That Invitation to Comment explains the similarities of and differences between the proposed guidance on accounting for stock-based compensation included in the International Accounting Standards Board's (IASB's) recently issued exposure draft and the FASB's guidance under Statement 123.

After considering the responses to the Invitation to Comment, the Board plans to make a decision in the latter part of the first quarter of 2003 about whether it should undertake a more comprehensive reconsideration of the accounting for stock options. As part of that process, the Board may revisit its 1995 decision permitting companies to disclose the pro forma effects of the fair value based method rather than requiring all companies to recognize the fair value of employee stock options as an expense in the income statement. Under the provisions of Statement 123 that remain unaffected by Statement 148, companies may either recognize expenses on a fair value based method in the income statement or disclose the pro forma effects of that method in the footnotes to the financial statements.

Copies of Statement 148 may be obtained by contacting the FASB's Order Department at 800-748-0659 or by placing an order at the FASB's website at www.fasb.org 

FEI Response --- http://www.fei.org/download/FEI_IMA_FAS123.pdf 

Bob Jensen's threads are at http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

From The Wall Street Journal Accounting Educators' Reviews on January 31, 2003

TITLE: Accounting's Paper Maze 
REPORTER: Baruch Lev 
DATE: Jan 28, 2003 
PAGE: B2 
LINK: http://online.wsj.com/article/0,,SB1043696329392896624,00.html  
TOPICS: Accounting Law, Audit Quality, Audit Report, Accounting, Auditing, Sarbanes-Oxley Act, Securities and Exchange Commission, Standard Setting

SUMMARY: Baruch Lev offers his views on restoring investor confidence in the financial reporting process. Questions encourage students to consider the advantages and disadvantages of Lev's proposals.

QUESTIONS: 
1.) Lev's first suggestion encourages the Public Company Accounting Oversight Board (PCAOB) to "resist the temptation to adopt wholesale the standards developed by the accounting industry." What appears to be the rationale behind this suggestion? Do you agree with this suggestion? If the PCAOB does not adopt existing accounting standards, what major issues should be considered in developing a new set of accounting standards? How would this alter the current standard setting process?

2.) Lev suggests that the PCAOB should first consider the "audit certificate and the focus of auditors' examinations." Currently, what is the purpose of an audit? What changes does Lev suggest?

3.) What is the difference between financial statements that are consistent with GAAP and financial statements that properly reflect economic reality? Should the auditor be expected to express an opinion on the degree of economic reality represented in the financial statements? How is economic reality measured?

4.) What responsibility does the auditor have for detecting fraud? How would this responsibility change under Lev's proposals? Discuss the advantages and disadvantages of increasing the auditors' responsibility for detecting fraud.

5.) What proposals does Lev offer for oversight of the audit industry? Discuss the advantages and disadvantages of his proposals.

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

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

"An Analysis of Restatement Matters: Rules, Errors, Ethics, For the Five Years Ended December 31, 2002," free from the Huron Consulting Group --- http://www.huronconsultinggroup.com//files/tbl_s6News/PDF134/112/HuronRestatementStudy2002.pdf 

Objective:
Analyze issues relating to public companies that filed restated financial statements (10-K/ A's and 10-Q/A's) during the five-year period from January 1, 1998, through December 31, 2002.

Purpose:
The purpose of our analysis was to identify common attributes within these restatements including the size of the companies, their industry, and ultimately the underlying accounting error that necessitated the restatement. Procedures:

• Performed a search of all 10K/A and 10Q/A filings in the Edgar database from 1998 through 2002 using the keywords "restate," "restated," "restatement," "revise," and "revised."

• Refined search to include only "restatements" defined as a restatement of financial statements that was the result of an error, as defined in APB 20. Our report excludes restatements due to changes in accounting principles and non-financial related restatements.

• Prepared a database and input relevant information for each restatement identified, including the following fields: Company Name; SIC Code; Annual Revenues (from most recent filing); Footnote Disclosure Describing the Restatement Issue; Classification of Restatement Issue; Restating 10K or 10Q; Auditor of Record (limited to amended annual financial statements).

Filed restatements went from 158 in 1998 to 330 in Year 2002.  Major accounting issues in all years seem to be Revenue Recognition, Resrves/Accruals/Contingencies, Equity, Acquisition Accounting, and Captalization/Expense of Assets. 

"Judge Dismisses Claims Filed Against Ex-Andersen Lawyer," The Wall Street Journal, January 29, 2003 --- http://online.wsj.com/article/0,,SB1043805673973679024,00.html?mod=DAT 

A federal district judge handed Nancy Temple a victory in dismissing fraud and liability claims against the former Arthur Andersen LLP lawyer in a civil class-action suit representing Enron Corp. shareholders.

The once-thriving accounting firm was indicted in March in connection with its audit of the Houston energy trader. An e-mail Ms. Temple sent to the Andersen partner responsible for Enron's audits had been at the center of the criminal case against Andersen, which was convicted on a criminal obstruction-of-justice charge in June. In post-trial interviews, several jurors pointed to the e-mail, in which Ms. Temple had at least attempted to get another Andersen employee to edit an Enron-related memo at a crucial point in October 2001.

No criminal charges have been brought against Ms. Temple, who remains the subject of the Justice Department's criminal investigation. Ms. Temple's attorney declined to comment.

U.S. District Court Judge Melinda Harmon in Houston also dismissed fraud claims against 17 other Andersen executives named as defendants in the Enron-related class-action suit, including former Andersen chief executive Joseph Berardino.

Plaintiffs will, however, be able to pursue other claims seeking to hold Mr. Berardino and 12 other Andersen executives liable for damages in connection with Enron's collapse. Ms. Temple isn't one of them. Mr. Berardino couldn't be reached to comment.

"We have not yet had time to study today's order in depth. But it doesn't appear that it will ultimately have much impact on the ability of the class to achieve meaningful recovery," said Trey Davis, director of special projects for the Regents of the University of California, lead plaintiff in the Enron class action.

Conference Board: More Companies Striving to Be Good Corporate Citizens --- http://www.smartpros.com/x36887.xml

There is a growing consensus among prosecutors that crimes would be easier to prevent by going after gatekeepers of capital markets, especially auditors, rather than just prosecuting corporate executives. http://www.accountingweb.com/item/97064 

It's Now Official at the SEC Website --- http://www.sec.gov/litigation/litreleases/lr17954.htm 

Securities and Exchange Commission
Washington, D.C.

Litigation Release No. 17954 / January 29, 2003
Accounting and Auditing Enforcement Release No. 1709 / January 29, 2003

Securities and Exchange Commission v. KPMG LLP, Joseph T. Boyle, Michael A. Conway, Anthony P. Dolanski and Ronald A. Safran, Civil Action No. 03 CV 0671 (DLC) (S.D.N.Y.) (January 29, 2003)

SEC Charges KPMG and Four KPMG Partners with Fraud in Connection with Audits of Xerox

SEC Seeks Injunction, Disgorgement and Penalties

On January 29, 2003, the Securities and Exchange Commission filed a civil fraud injunctive action in the United States District Court for the Southern District of New York against KPMG LLP and four KPMG partners - including the head of the firm's department of professional practice - in connection with KPMG's audits of Xerox Corporation from 1997 through 2000. The complaint charges the firm and four partners with fraud, and seeks injunctions, disgorgement of all fees and civil money penalties.

The complaint alleges that KPMG and its partners permitted Xerox to manipulate its accounting practices to close a $3 billion "gap" between actual operating results and results reported to the investing public. Year after year, the defendants falsely represented to the public that their audits were conducted in accordance with generally accepted auditing standards (GAAS) and that Xerox's financial reports fairly represented the company's financial condition and were prepared in accordance with generally accepted accounting principles (GAAP).

The four partners named as defendants, all of whom are certified public accountants, are:

• Michael A. Conway, 59, a resident of Westport, CT, has been KPMG's Senior Professional Practice Partner and the National Managing Partner of KPMG's Department of Professional Practice since 1990. He was the senior engagement partner on the Xerox account from 1983 to 1985. He again became the lead worldwide Xerox engagement partner for the 2000 audit. Conway also is a member of the KPMG board and is chairman of the KPMG Audit and Finance Committee.
   
• Joseph T. Boyle, 59, a resident of New York City, was the "relationship partner" on the Xerox engagement in 1999 and 2000 and is a managing partner of the New York office of KPMG and of the Northeast Area Assurance (Audit) Practice. As the relationship partner, Boyle's chief duty was serving as liaison between KPMG and the Xerox Board of Directors, including its Audit Committee.
   
• Anthony P. Dolanski, 56, a resident of Malvern, PA, was the lead engagement partner overseeing Xerox's audits from 1995 through 1997. He left KPMG in 1998. He is currently the chief financial officer of the Internet Capital Group, a public company.
   
• Ronald A. Safran, 49, a resident of Darien, CT, was the lead engagement partner on the 1998 and 1999 Xerox audits. He was removed as engagement partner at Xerox's request after completing the 1999 audit and was replaced by Conway. KPMG or its predecessor has employed Safran since his graduation from college in 1976.

The Commission's complaint alleges that beginning at least as early as 1997, Xerox initiated or increased reliance on various accounting devices to manipulate its equipment revenues and earnings. Most of these "topside accounting devices" violated GAAP and most improperly increased the amount of equipment revenue from leased office equipment products which Xerox recognized in its quarterly and annual financial statements filed with the Commission and distributed to investors and the public. This improper revenue recognition had the effect of inflating equipment revenues and earnings beyond what actual operating results warranted. In addition, the complaint alleges that the defendants fraudulently permitted Xerox to manipulate reserves to boost the company's earnings.

Continued at http://www.sec.gov/litigation/litreleases/lr17954.htm  

KPMG and EIU Release Corporate Governance White Paper --- http://www.kpmg.com/news/index.asp?cid=650 

Nearly a year after the Enron revelations first surfaced, corporate governance dominates the political and business agenda. A new white paper, written by the Economist Intelligence Unit (EIU) and sponsored by KPMG International, reveals the views and concerns of executives regarding corporate governance and transparency.

As part of the research for the white paper, Corporate Governance: the New Strategic Imperative, the EIU surveyed 115 senior executives worldwide on their attitudes to corporate governance. Further, a series of indepth interviews were held with executives at over 30 different institutions from a diverse range of countries and industries.

Read Corporate Governance: the New Strategic Imperative attached below in Acrobat.pdf format.

View Corporate Governance: the New Strategic Imperative in Acrobat.pdf format --- www.us.kpmg.com/microsite/Attachments/corp_govern_newstrat.pdf 

"Europe not free of corporate greed -U.S. watchdog,"  by Mark Bendeich, Reuters, February 6, 2003 --- http://www.reuters.com/financeNewsArticle.jhtml?type=governmentFilingsNews&storyID=2183343 

A top U.S. securities regulator questioned on Thursday suggestions that European firms were better behaved than their tarnished U.S. counterparts, saying European regulators had no better defence against fraud.

Steve Cutler, head of enforcement at the Securities and Exchange Commission (SEC), also said his team of about 1,000 officials were still on the lookout for wrongdoing by foreign firms, despite a bigger workload of domestic investigations.

"The one thing I am quite sure of, which is common across the globe, is greed and human weakness," he told Reuters in an interview on the sidelines of a conference in London.

"I don't think that it is particularly fair to say that somehow the system is responsible for greed. The one thing you can say about the system in the U.S. is that we are bringing prosecutions, and the people responsible for some of the weaknesses that we have seen are being brought to justice.

"In that way, the (U.S.) system is working.

"No matter whether you have a principles-based system or a rules-based system, if you have someone intent on committing fraud it will be done in either system."

European regulators have resisted attempts by the SEC to include European firms in a regulatory crackdown designed to prevent companies, both domestic and foreign, from misleading U.S. investors.

Chafing at some of the SEC's tough new reforms and powers, European authorities have pointed out that the region has so far been free of the huge accounting scandals that impoverished many investors in U.S. energy trading group Enron ENRNQ.PK and telecoms firm WorldCom Inc WCOEQ.PK .

NO SPECIAL RELATIONSHIP IN ACCOUNTING

In Britain in particular, regulators, brokers, accountants and bankers have made unfavourable comparisons between Washington's rules-based approach to regulating companies and auditors, and London's principles-based approach.

Under UK law, auditors must give an opinion as to whether accounts give a true and fair picture of a company's affairs.

The SEC has responded to intense lobbying from the European Commission on the regulatory crackdown. In January, it decided to grant non-U.S. firms some exemptions from its new anti-fraud regime, such as allowing labour representatives to sit on audit committees, a custom in countries like Germany.

But an EU source has said that there are still concerns about whether U.S. authorities should get access to confidential audit working papers of non-U.S. audit firms.

The SEC's Cutler said that as far as he was aware the SEC or the newly created Public Company Accounting Oversight Board could demand confidential working papers from non-U.S. auditors that vetted accounts prepared for U.S. investors.

"I think I would have the right to get them," he said, adding that auditors, domestic or foreign, risked being barred from auditing accounts filed in the United States if they refused to hand over documents.

Cutler gave several examples where the SEC had taken action against non-U.S. companies, individuals and auditors. He stressed that the extra burden of stepping up investigations into U.S. cases would not distract them from foreign firms.

"It's fair to say that the number of big investigations that we have had, and the profile of them, over the last year has not blurred our focus in any way on our responsibility to protect U.S. investors, even when that protection involves foreign companies," Cutler said.

From the FEI Treasurers Newsletter on January 30, 2003
The SEC Responds to Sarbanes-Oxley with Final Rules

Under the final rules, a public company would be required to provide disclosures, in a separate section of MD&A, about off-balance sheet arrangements that are "reasonably likely" to have a material current or future effect on the company's financial condition or results of operations. The SEC had originally proposed a lower disclosure threshold of "more than remote."

The scope of the new rules will require MD&A disclosures about the following categories of contractual off-balance sheet arrangements:

* Certain guarantee contracts (see Financial Accounting Standards Board (FASB) Interpretation No. 45); 

* Retained or contingent interests in assets transferred to an unconsolidated entity (see FASB Statement No. 140); * Derivative instruments classified as equity (see Emerging Issues Task Force (EITF) No. 00-19); and 

* Material variable interests in certain unconsolidated entities (see FASB Interpretation No. 46).

The required MD&A disclosures about such an off-balance sheet arrangement that meets the MD&A disclosure threshold would be:

* Nature and business purpose of the arrangement; 

* Importance to the company for liquidity, capital resources, market risk or credit risk support, or other benefits; 

* Financial impact and exposure to risk; 

* Known events, demands, commitments, trends or uncertainties affecting the company's ability to benefit from the arrangement; and * Any other information necessary to understand the arrangement and its material effects.

Conditions for Use of Non-GAAP Financial Measures (Section 401b) On Wednesday, January 15, 2003, the Commission voted to adopt final rules related to the conditions for public disclosures of non-GAAP (for generally accepted accounting principles) financial measures. The final rules become effective on March 28, 2003.

Once the rules become effective, U.S. companies will be required to furnish (as opposed to file) earnings press releases, using new Item 12 of Form 8-K, regardless of whether that release presents a non-GAAP financial measure. As a result, press releases provided in a Form 8-K will not be subject to incorporation by reference into other securities filings, with the associated liabilities. Also, non-GAAP financial measures included in earnings releases would be subject to the disclosure requirements (but not the new restrictions) of amended Item 10 of Regulations S-K and S-B.

The final rules include the adoption of a new disclosure regulation, Regulation G. Consistent with the SEC's original proposal, Regulation G will require a quantitative reconciliation of each non-GAAP financial measure to the most directly comparable GAAP measure. The disclosure requirements of Regulation G would apply to any public disclosure or release that includes a non-GAAP financial measure.

Recent CCR Surveys on Pension Assumptions and Stock Option Use
CCR has been actively surveying its members this month on 2002 Pension Assumptions and Use of Employee Stock Options and the accounting for them. You can access the anonymous results of these surveys on the FEI website at:

• Stock Option Accounting
  
• Pension Assumptions

Vendor Financing Controversies

"Report: SEC widens accounting investigation," by ITworld.com, May 15, 2002 --- http://www.itworld.com/Man/2698/020516sec/ 

A U.S. Securities and Exchange Commission (SEC) investigation into revenue accounting among telecommunication service providers has regulators questioning the business practices of a broader array of companies, The Wall Street Journal reported Thursday.

The SEC is peering into the vendor financing agreements made by telecommunication equipment maker Lucent Technologies Inc., according to the Journal report. Vendor financing, the practice of selling equipment to customers on credit, cost Lucent hundreds of millions of dollars as financially unstable phone service startups failed over the course of the last two years. Lucent reduced its vendor financing commitments from about US$8.4 billion in February 2000 to the current level of $2.2 billion, according to SEC filings.

Lucent disclosed an accounting error of about $125 million to the SEC in November of 2000 for its third fiscal quarter of that year, then changed the downward revision to $679 million in December 2000. Reports of an SEC investigation over the Murray Hill, New Jersey, telecom equipment maker's accounting in that matter surfaced in February 2000, although the SEC customarily declines to confirm if an investigation is ongoing.

"We brought some issues to their attention back in November of 2000, and we've been cooperating with them ever since," said Michelle Davidson, a Lucent spokeswoman. "We have no reason to believe that their inquiry now includes vendor financing."

The SEC began an accounting practices sweep through the telecommunications industry this January, when international carrier Global Crossing Holdings Ltd. filed for bankruptcy. A former financial executive at the carrier alleged that Global Crossing improperly inflated its revenue by swapping fiber-optic capacity with other carriers, booking the exchange as a financial transaction.

The allegations compounded general concerns about corporate accounting raised in the aftermath of the Enron Corp. accounting scandal. Several other carriers and equipment companies have fallen under the scrutiny of government regulators and investors, including Qwest Communications International Inc., WorldCom Inc., and network equipment maker Enterasys Networks Inc.

"Accounting Abuses and Proposed Countermeasures," by Scott Sprinzen, Standard & Poors, July 2, 2002 --- http://www.fma.org/FMAOnline/accounting%202.pdf 

Accounting Abuses The greatest concentration of abuses has been in revenue reporting. Such improprieties have accounted for the dominant share of the restatements mandated by the SEC in the past few years. Notable recent examples include the following: 

• Some energy marketers have admitted to engaging in phantom, or "round trip," trades in electricity contracts. These are essentially back-to- back swaps with no business purpose except to artificially bolster apparent trading volume and revenue. 
• Similarly, in the telecom sector, Global Crossing Ltd. and Qwest Communications International Inc. are reportedly being investigated by the SEC for back-to-back swaps of fiber-optic capacity. 
• In the pharmaceuticals sector, Allergan Inc. and Elan Corp. PLC have entered into transactions in which they formed joint ventures (JV) with third parties, made cash investments into the JV entity, but then got back some or all of the cash in the form of fees for performing R&D, these fees having been reported as revenue. 
• Manufacturers of telecom equipment such as Lucent Technologies Inc. have made highly aggressive use of vendor financing in which, on sales to financially shaky buyers, profits are reported up front, with the financing being provided by the seller. Lucent's vendor notes receivables reached $8.4 billion at year-end 1999. Among its biggest vendor-financing deals was a $2 billion, five-year pact signed in 1998 with Winstar Communications Inc.: Winstar filed for bankruptcy in 2001. 

Also, companies have increasingly made use of large, one-time, "big bath" restructuring charges or have regularly booked smaller restructuring charges-- hoping these would be disregarded by analysts and investors--to accelerate the recognition of operating expenses with the objective of bolstering subsequent reported earnings. Among the many companies that Forbes magazine has termed "serial chargers" are Allied Waste Industries Inc., Cisco Systems Inc., Compaq Computer Corp., E.I. DuPont de Nemours & Co., Fortune Brands Inc., Tenet Healthcare Corp., and Waste Management Inc. 

Moreover, notwithstanding the generally poor pension investment portfolio returns of the past two years, most companies have clung to seemingly aggressive long-range–return assumptions (i.e., 9.5% to 10.0% per year), enabling some of them to continue reporting material non-cash pension credits. For certain companies, including Ethyl Corp., United States Steel Corp., Weirton Steel Corp., Verizon Communications Inc., GenCorp Inc., Northrop Grumman Corp., and Allegheny Technologies Inc., pension credits represent a substantial portion of their total reported earnings. 

Although the statement of cash flows is much less susceptible to accounting manipulations than the income statement, recent developments have shown that it is far from sacrosanct. Thus, WorldCom Inc. has just admitted that it improperly reported $3.8 billion of expenses as capital expenditures within the past five quarters, thereby bolstering reported net cash flow from operating activities.

Continued in the article.

"Cisco, Lucent and Nortel: Prime Lenders for the Network Buildout," by Scott Moritz, TheStreet.com, November 8, 2000 --- http://www.thestreet.com/tech/telecom/1163145.html 

When the capital markets say "no," Nortel (NT:NYSE - news) says "yes."

That sounds good to Peter Geddis, who is building a fiber-optic network to dwarf all fiber-optic networks. After raising $100 million in initial investments this summer, the chief executive of closely held Aerie Networks found venture capitalists were increasingly skittish about providing more funding, as telecom stocks and bonds tumbled. That left Aerie surveying a $40 million shortfall on its $150 million capital goal, the executive says.

Would the nascent networker need to scale back its plans? No. Instead, in a scene that is playing out more and more frequently across the hypercompetitive telecommunications equipment sector, Nortel rode to the young network builder's rescue. Last month, the equipment maker provided Aerie with a much-needed windfall in the form of $500 million worth of equipment financing as well as an undisclosed amount of capital for Aerie's operations, says Geddis.

Aerie is just one of the 45 vendor financing deals Nortel has on its books. As such, it offers a glimpse into a battle the big telecommunications equipment makers -- notably Nortel, Lucent (LU:NYSE - news) and Cisco (CSCO:Nasdaq - news) -- are rushing to join: picking up more of the financing slack for the very companies that buy their equipment.

Islands in the Stream

While Nortel is certainly knee-deep in the lending business, rival Lucent is the true champion of vendor financing. Lucent has been saying "yes" ever since it hit the ground four years ago, to the tune of $7 billion in financing commitments, more than double Nortel's $3.1 billion. (Nortel has $1.4 billion in actual loans outstanding to buyers of its equipment; Lucent, $1.6 billion.)

Cisco, in order to compete with the incumbent telecom equipment makers, says it has been increasing its vendor financing activities through its banking arm, Cisco Capital. Cisco has so far promised $2.4 billion in loans to its customers. (Cisco's loans outstanding amount to $600 million.)

Equipment makers derive several advantages from so-called vendor financing arrangements, the terms of which often remain under wraps. Namely, they gain relationships with potentially lucrative customers and revenue that will look good on the next financial statement.

 

The Commitments Lucent, Nortel, Cisco finance deals
Company	Financing ($millions)
	Commitment	Drawn down
Lucent (LU:NYSE)	$7,000	$1,600
Nortel (NT:NYSE)	3,100	1,400
Cisco (CSCO:Nasdaq)	2,400	600
Source: SEC filings.

But as spending on telecommunications equipment slows and traditional financing options shrivel or become prohibitively expensive, equipment makers are racing into risky territory with their funding efforts, analysts say.

The game plays out this way, observers say: Cash-hungry start-ups with big-bandwidth dreams slither up to growth-obsessed equipment sellers. In a strong telecom-stock market like the one that prevailed this spring, these deals make everyone look good, the network companies by permitting speedy buildouts and the equipment companies by adding to already record growth rates.

But when the froth leaves the stock market, funding grows scarce. Network-building start-ups begin to fail, leaving equipment builders on the hook for bad loans and drying up anticipated revenue streams from repeat equipment sales. Worse still, the abundance of early financing for network builders feeds a glut of bandwidth providers, which further depresses prospects for network companies.

Shady Glade

Even in good times, vendor financing smacks of buying your own business. It can be even more insidious in down times: For instance, analysts and industry insiders say it can influence purchasing decisions, shifting decision-making away from the equipment's merits to who's offering cash incentives. And some on Wall Street suspect the practice in some companies' sky-high growth numbers.

 

The Leader Selected Lucent financing deals
Company	Business	Financing ($millions)
		Commitment	Drawn down
Winstar (WCII:Nasdaq)	Broadband access	$2,000	$1,000
Leap Wireless (LWIN:Nasdaq)	Wireless communications	1,350	111
GT Group (GTTLB:Nasdaq)	Bandwidth wholesaler	315	N/A
Diveo*	Latin American ISP	100	26
KMC Telecom*	Broadband access	50	N/A
Source: SEC filings. *Private.

"It's a real shady, backwater practice," says a Wall Street debt analyst who asked not to be identified. "Over the past year, you could make the argument that a lot of equipment companies started stuffing their revenue line by getting into vendor financing."

Lucent, Nortel and Cisco officials say vendor financing is an age-old practice. Each company says it is more cautious than its competitors about who it climbs in bed with. Yet all three have accelerated the practice in recent months, just as venture capitalists have backed away from new network projects and the stock and debt markets have fled nearly all things telecom.

Aggression

For its part, Lucent told analysts during its recent earnings conference call last month that it plans to be more "like a bank" and get even more aggressive in vendor financing. Lucent upped its outstanding loans last quarter by $300 million, or 23%. Nortel has boosted its loans to customers by nearly $300 million, or 27%, since the beginning of the year.

 

In the Mix Selected Nortel financing deals
Company	Business	Financing ($millions)
		Commitment	Drawn down
Universal Broadband (UBNT:Nasdaq)	ISP	$37	$7.6
Impsat (IMPT:Nasdaq)	Latin American satellite	297	N/A
Leap Wireless (LWIN:Nasdaq)	Wireless communications	525	N/A
Savvis (SVVS:Nasdaq)	ISP	38	N/A
Eschelon Telecom*	Local access	45	2
Nettel*	Local access**	140	N/A
TriVergent*	Local access	45	N/A
Illinois PCS*	Wireless communications	48	N/A
Telergy*	Bandwidth wholesaler	25	N/A
Source: SEC filings. *Private. **In Chapter 7 bankruptcy proceedings.

The vendors say that, in many cases, they can quickly sell the loans to banks or third parties, so they aren't exposed to the risk. But selling the loans, especially on the high-yield market, has proven difficult lately. Both markets have been rocked by bankruptcies, such as the one at GST Telecom (GSTXQ:OTC BB - news), and by looming troubles with telcos such as ICG (ICGX:Nasdaq - news), RSL Communications (RSLC:Nasdaq - news), Globalstar (GSTRF:Nasdaq - news) and PSINet (PSIX:Nasdaq - news). Some debt analysts predict there will be between 50 and 75 defaults in the telecom sector by the end of the year. That is more than double the defaults in telecom last year.

Continued in the article.

Bob Jensen's threads on revenue accounting theory are at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm 

February 5, 2003 message from FERF [mailmanager@feiexpress.fei.org] 

January 28 in a speech to the New York State Society of Certified Public Accountants http://www.sec.gov/news/speech/spch012803jmd.htm, Jackson Day, Acting Chief Accountant of the SEC, touched on Sarbanes-Oxley rulemaking activities and focused on three of the SEC initiatives:

* The establishment of the Public Company Accounting Oversight Board (PCAOB),

* The adoption of new independence standards for public company auditors, and

* The efforts underway to improve the accounting standard-setting process and bring about international convergence of accounting standards."

Day reviewed the PCAOB statutory responsibilities, which include:

* Registering CPAs and public accounting firms that prepare audit reports for public companies-which is required within 180 days of the Commission's determination that the Oversight Board is operational;

* Establishing auditing, quality control, ethics, and independence standards for auditors and audit firms; and

* Conducting inspections, investigations, and disciplinary proceedings of public accounting firms and their associated persons that work on public companies; and otherwise

* Enforcing compliance with the rules of the Oversight Board and professional standards.

Day also said that the PCAOB is studying the past activities and effectiveness of all aspects of the current self-regulatory system including the functions of the AICPA SEC Practice Section including the peer review, discipline, and quality control functions; Auditing Standards Board; and the Transition Oversight Staff.

The speech also summarized the measures regarding independence standards for public company auditors, which will:

* revise the rules related to the non-audit services that, if provided to an audit client, would impair an accounting firm's independence;

* require that certain partners on the audit engagement team rotate after no more than five or seven consecutive years, depending on the partner's involvement in the audit, except that certain small accounting firms may be exempt from this requirement;

* establish rules that an accounting firm would not be independent if certain members of management of that issuer had been members of the accounting firm's audit engagement team within the one-year period preceding the commencement of audit procedures;

* establish rules that an accountant would not be independent from an audit client if any "audit partner" received compensation based on the partner procuring engagements with that client for services other than audit, review and attest services;

* require the auditor to report certain matters to the issuer's audit committee, including "critical" accounting policies used by the issuer;

* require the issuer's audit committee to pre-approve all audit and non-audit services provided to the issuer by the auditor; and

* require disclosures to investors of information related to audit and non-audit services provided by, and fees paid to, the auditor.

In a new study from Financial Executives Research Foundation (FERF), "Best Practices for Sarbanes-Oxley Implementation" http://www.fei.org/rfbookstore/PubDetail.cfm?Pub=14, FERF researchers summarize practices used in the following areas: Financial Statement Certification, Disclosure Committees, Internal and Disclosure Controls, Audit Committees, External Auditors, Code of Ethics and Whistleblower Provisions.

FEI Research Foundation Publications --- http://www.fei.org/rfbookstore/ 

A new bill passed by Colorado state legislators stiffens the penalties for practitioners who violate the state's accountancy practice act. The bill makes accounting fraud a felony, punishable by up to 12 years in jail. http://www.accountingweb.com/item/97083 

Hi Linda,

Although the 1933/34 Securities Acts gratefully preceded Denny and me, it should be stressed that legislation and legislative process is never independent of the circumstances and crisis atmosphere of the times in question.

Recall that before these Securities Acts, the CPA Profession had no audit monopoly and very little government interference and regulation. Auditing was truly a value added service in the pure context of agency theory. Auditors either added net value to financial reporting or firms did not have to engage auditors. And auditors had only their professional traditions to follow and their reputations to sell.

The 1933 & 1934 Securities Acts were passed in the context of the crisis of 1929 Crash and the ensuing Great Depression. Investors lost all confidence in their banks and corporate investing of any kind. The only way to lure savings back into banks and corporations was to bring government into the picture and to do so in a big rush. I'm not so sure that the committees really took all that much time considering the massive legislation that brought government into an almost-dead Wall Street in such a monumental way. These Securities Acts embraced far more government intervention than the Sarbanes-Oxley Act.

The Sarbanes-Oxley Act was also conceived in an atmosphere of crisis of confidence in investing (due to the Wall Street and CEO enormous scandals) and the reality that the Big Five CPA firms in many large audits had sold their souls and their professionalism to corporate management. Andersen was not unique, but Andersen was the most visible big firm charged with fraud by the SEC (e.g., the Waste Management fraud) and highly publicized unprofessional and uncaring audits.

The atmosphere leading up to Sarbanes-Oxley was one of urgency before investors pulled all their money out of corporate stocks and bonds. The Crash of Year 2002 most likely would have been as bad or worse than the 1929 Crash if it were not for the large pension funds and other savings plans that removed buy and sell discretion from individual investors and buffered the panic.

The sad truth, in my opinion, is that relying upon government agencies to regulate industry behavior rarely works. And when it does work, it is almost after some scandalous media expose. The airline industry owns the FAA; the large food and drug companies own the FDA; Agribusiness owns the Department of Agriculture; and Wall Street owns the SEC. Each agency rears up and roars like a mouse once in a while for the media, and the public is impressed with fines reaching as much as 10 million dollars. However, the public just fails to appreciate that $10 million comes out of the petty cash drawers of these outfits. Even fines reaching $1 billion may not be all that painful to Wall Street. Recall the billions Wall Street coughed up to keep the Long-Term Capital derivatives instrument fiasco from caving in the dikes. Coming up with a spare billion on Wall Street is a shoulder-shrugging misfortune while the crooks are moving on to the next big $10 billion dollar deal.

What big crooks on Wall Street have you seen really headed for jail? Poor Martha may get a few months, but she's a small fish that the media loves to play up. Do you know the names of recent CEOs of CitiBank, Merrill Lynch, Goldman Sachs, Lehman Brothers, etc.? Are any of them going to do jail time?

You can bet the biggest crooks are like the biggest fish --- they're always the ones that get away! Legislation ain't going to net the biggest fish. The only thing netting those fish are DC political campaigns.

Bob

-----Original Message----- 
From: Dennis Beresford [mailto:dberesfo@TERRY.UGA.EDU]  
Sent: Thursday, February 06, 2003 
Subject: Re: Audit disclaimer being tested in UK

Linda,

Actually, Senator Sarbanes had a whole series of hearings before proposing legislation (I'm sure you can find the full record at the Senate Banking Committee's web site). I testified at one hearing and he had numerous other thoughtful individuals from a wide variety of backgrounds appear before him, such as the last three SEC Chief Accountants who appeared on the same day that I did. Also, several former SEC Chairmen testified. I agree that the final legislation was put together rather quickly but the earlier process was actually quite thoughtful. That doesn't mean that I or anyone else agrees with all aspects of the bill, but at least the Senate's version (which constitutes the vast majority of the final legislation) was pretty well considered.

I can't contrast that with the process that led to the securities acts in 19933 and 1934 because that legislation was even before Bob Jensen and my time.

Denny Beresford

Linda Kidwell wrote:

I have to agree wholeheartedly about congressional committees. I have  talked with my students about the Securities Acts and the Sarbanes-Oxley in  this regard. Although the Securities Acts were not without flaws, the  committees took the time necessary to think things through and to get the  advice of truly knowledgable people (I recognize that not all will agree  with me on this). By contrast, under the glare of modern media, congress  quickly threw together S-O without sufficient time to gather and analyze  expert advice, and the unforeseen problems have taken little time to  emerge. Of course it didn't help that the experts in this area were  themselves not credible at that point in time, but if time had been more  generously allowed, perhaps those untainted by current scandals could have  played a larger role in shaping the legislation.   As to the independent review committee for the Columbia, you remind me that  I need to read up a bit more on who comprises the committee. 

Linda

February 7, 2003 message from Bill Mister [William.Mister@BUSINESS.COLOSTATE.EDU] 
I asked Lynn Turner to respond to questions raised by Jim McKinney. Here is his response. It is lengthy, however, I believe informative about the process that occurred in passing Sarbanes-Oxley. Enjoy, with Lynn's permission.

I am not sure what question I am suppose to answer but here are some comments.

Denny is right on point with his comments. I presented a paper at the SEC Major Issues conference held in DC on 11/14/01. Sarbanes spoke at the conference and afterwards I was asked by some of the congressional staff if I would assist them with legislation if the Enron matter heated up. The 8-k announcing restatements was not filed until a few days later. And then Enron filed for bankruptcy the first week of December. Around that time the House started to rush forward with hearings, with Oxley trying to be the first on TV. Sarbanes staff called and we started to plan a series of hearings based on what were expected to be the likely systemic issues arising. In the end, 10 days of hearings were held by Sarbanes commencing on February 14th, 2002 with the testimony of five former SEC chairman appointed by Ford, Carter, Reagan, Bush, and Clinton. The hearings also included the people Denny mentioned, the leading corporate governance attorney in the country and former co-chair of the Blue Ribbon Panel on Audit Committees, Ira Millstein, the former co-chairman of Goldman Sachs and former undersecretary of state and also co-chair of the Blue Ribbon Panel on Audit Committees, John Whitehead, the well known and widely respected Prudential Banking analyst Paul Mayo, former comptroller of the US and head of the GAO and former chair of the Public Oversight Board Charles Bowsher and two of his fellow members on the POB, Aulana Peters, also a former SEC commissioner and defense counsel for years for Big Five accounting firms and John Biggs, the chairman of the largest institutional investor, TIAA-Cref, James Copeland From DT as well as Jim Gerson from PWC and chairman of the Auditing Standards Board, as well as other representatives of the profession, the comptroller of the US and head of the GAO, DAvid Walker, and others including Harvey Pitt who testified at the last hearing at the end of March, 2002.

While this was all going on, efforts were being made to draft legislation. I took a piece of legislation we had drafted while I was at the SEC. We had drafted it when we were meeting throughout 1999 with Phil Laskaway, CEO of E&Y, to discuss a structure for the disposal of E&Y's consulting business. Those discussions between Phil, his general counsel and Harvey Goldschmid, SEC general counsel and myself, also covered the topic of how the profession should be regulated in light of the changing environment. This lead to the development of legislation for a new oversight body, that drew in part from similar legislation that had been introduced in Congress in the 1970's as well as a draft of a bill done by members of congress in 1995.

In December, 2001, I took that draft bill, revised it and circulated it to six people including Charles Bowsher, Mike Sutton the former Chief accountant, harvey Goldschmid who was at Columbia law school at the time, Bevis Longstreth, who is a member of various boards, a former Reagan appointee to the SEC and excellent securities attorney, David Martin who ran the Division of Corp fin at the SEC and is now the lead securities attorney at Convington and Burling. I January we got a request to provide the legislation to Senator Dick Durbin of Illinois who then turned it into a Senate Bill. Dick is on the Senate Governmental Affairs committee which is the first committee in the Senate to have held hearings on Janaury 26th, 2002. Within a few days we would get a request form Senator's Corzine and Dodd for a copy of it and we provided it to them. They were key as they served on the Senate Banking committee where the Bill had to first be introduced. These senators with a few modifications, introduced the bill. The key changes they made were to call for a study on auditor rotation rather than mandate it and in lieu of that, we inserted word for word the original prohibitions on nonaudit services the SEC had proposed the last week of June in 2000. This was a change that stuck all the way thru to the final signed legislation. The Dodd and Corzine bill, was introduced in February, but really had been substantially drafted by the middle of January, and again, was for the most part, what had been drafted in 2000. As a result, this was far from a rush to judgement and actually received a fair amount of outside scrutiny and review.

At the February 14th hearings, Levitt provided a copy of the legislation we had drafted to Sarbanes staff. They would use it as the basic foundation for the bill. However, thru the ten days of hearings, they would make substantial and very good changes after hearing testimony on analysts, corporate governance, ethics, the profession and others on oversight. Sections would be added to the bill on analysts which came from Paul Mayo, a section on internal controls that Bowsher and I pushed along, the section on ethics and a code of conduct which came from Phil Livingston and the FEI, a section on corporate governance and audit committees speared on by the testimony of a number of people including Whitehead and Millstein, etc. A draft of the bill was circulated among members of the senate committee and many outside it by around the middle to end of April. But by memorial day, two democrats, Zell Miller and Evan Bayh were still not willing to vote for it. People worked on language over the memorial day recess and within a few days thereafter, we crafted language acceptable to Bayh o the independence prohibitions and Miller then came on Board. Within a few days, Sarbanes announced he was going to do a "mark-up" in the committee. He worked hard to get a bi-partisan bill, and made a number of "watering down" changes during the next week to get some Republican votes. Enzi led the Republicans in the negotiations with the Dems. Enzi was also constantly meeting with the lobbyists from the Big Four and AICPA during this time period. Finally, around the middle of June the Committee voted on the Bill and six republicans joined the 11 democrats to approve the bill in committee. four republicans led by Phil Gramm of Texas continued to oppose the legislation. In fact, it was expected the full Senate would approve the bill, but absolutely no one thought the bill would survive a house/senate conference and everyone expected it would die. But within days of when the bill came out of the committee, WordCom hit. That changed everything. Daschle had not expected to bring the bill to a vote until September. Instead, he agreed to bring it to the floor as soon as the Senate returned after the July 4th break. By that time the polls clearly showed the public was going to "punish" any politician who opposed major reforms. As a result, debate began on the bill on the full senate floor on around July 8th.

The sections of the bill establishing criminal penalties for violating the stattutes (Titles 8-11) were all added as admendments to the committee bill from the senate floor. Senators Leahy and McCain added as an amendment, the penalties for fraud and document destruction, Senator Edwards of north Carolina added the amendment calling for attorneys to report to the board, senator Carnahan added an amendment on trading during a blackout period, Senator schumer and Gramm added the prohibition on loans to executives. The section of the bill on the penalties and criminal code had all been passed as a separate bill in April in the Senate Judiciary Committee.

The bill was passed by a 97-3 vote in the senate, and went back to the house on July 17th (where by the way, the House leadership initially tried to kill it by doing what is known as a "blue slip" but the White House told them the President would support Sarbanes publicly if they tried that). that following friday, the senate house conference committee met and Phil Gramm provided it with 52 pages of amendments or suggested changes. However, the Dems opposed ( and so did some of the

Repubs) almost all of these and they were not made. The following Wednesday the conference committee agreed to the final bill and it was approved that friday and signed by the president the last week of July.

In the end, the Bill was far from being an "overnight" piece of drafting. Our markets, which are the most regulated markets in the workd, with no one a close second, have also proven to be the most successful, attracting over half of the total capital to just this one country and the NYSE and Nasdaq. We also have the lowest cost of capital. As a result, we have demonstrated very clearly our regulatory system, while not perfect, is still in the lead. It will remain that way until other markets, such as London, Frankfurt, Tokyo, Hong Kong, Sydney, etc. can demonstrate to investors they can do as well in those markets as they can here. While we often criticize organizations such as the SEC and FASB, they have under some severe constraints, done a very good job in the face of sometimes fersome opposition and a lack of support. (how many academics have you EVER seen write a letter of comment to the FASB or SEC???). That is not to say things do not need improving because without a question they do, and in some situations a lot of improving, but I am hopeful we are making some progress - just not enough for my liking and not fast enough either, yet.

By the way, it was in the 1890's due to corporate scandals that the NYSE first began pushing for audited financial statements. (There was a market crash in 1892 and a depression in '93). By the time of the crash, something like 70% of the companies were having audits, albeit they were not stopping some of the shabby accounting any better than those of recent years.

The 1933 and 34 Acts came out of a series of hearings in the Senate Banking committee in 1932 called the Pecora hearings. Pecora was the chief of staff for the Committee and they held indepth hearings of the problems with the markets. Interestly, these acts were also "watered down" from the initial drafts which had prohibited a number of practices including "short selling." Some things never change. It was at these hearings that the CEo of Haskins and Sells at the time, Colonel Carter testified in support of private sector auditors. Originally, the Senate was going to have governmental auditors as they used in banking regulation put in place in 1913 when the Federal Reserve was created. Ultimately Carter carried the day.

Lynn Turner

Public Accounting Report has published its annual ranking of America's Top 100 Accounting Firms, and it's no surprise that Andersen, last year's number five ranked firm, is no longer on the list. http://www.accountingweb.com/item/95611

1. PricewaterhouseCoopers: $8,056.5 million
2. Deloitte & Touche: $6,130 million
3. Ernst & Young: $4,485 million
4. KPMG: $3,171 million
5. Grant Thornton: $432.5 million
6. BDO Seidman: $353 million
7. BKD: $210.9 million
8. Crowe, Chizek & Co.: $204.7 million
9. McGladrey & Pullen: $203 million
10. Moss Adams: $163 million

"Second Six: Ready to Step Up?" CFO.com --- http://www.cfo.com/specialreport/0,5487,564||A,00.html 

As contributing editor Ed Zwirn reveals in his article ''The Second Six: Ready to Step Up?'', the demise of Andersen and the advent of Sarbanes-Oxley have not been an unqualified blessing for those firms that remain. And in ''Same Straw, Smaller Back,'' Zwirn notes how new regulatory burdens that fall heavily on smaller companies (the usual Group B clients) may persuade many of them to go private.

From The Wall Street Journal Accounting Educators' Review on February 21, 2003

TITLE: Manager's Journal: Corporate Boards: A Director's Cut 
REPORTER: Stanley Gold 
DATE: Feb 18, 2003 
PAGE: B2 
LINK: http://online.wsj.com/article/0,,SB1045539673283618623,00.html  
TOPICS: Corporate Governance

SUMMARY: Gold explains the role of the corporation's board of directors, how and why they have failed in the past, and how they can improve on their oversight responsibility in the future.

QUESTIONS: 

1.) Explain what is meant by corporate governance and why it has been so prominent in the news of late. How do/can directors exercise oversight of senior executives? What role should directors play in the development of a firm's strategic direction?

2.) Why is experience in the industry of the firm so important for directors to have? Why are directors unwilling to challenge senior management?

3.) Explain who the "owners" of the firm are and how the directors are their agents. Have the directors fulfilled their roles as agents? What are fiduciary responsibilities?

4.) What does the author mean by the term "professional directors," and can they effectively serve as independent agents of the shareholders? What does the author mean when he talked of a financial alignment between director goals and firm goals?

5.) How are directors "managed" by management? What historical role did labor and capital play in these relationships and why are they less important today compared to the firm's products?

6.) What does the author mean by active participation by directors, asking constructive questions of management, and familiarizing them with the management process?

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

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

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

Bob Jensen's SPE threads are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm  

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

Bob Jensen's Summary of Suggested Reforms --- http://www.trinity.edu/rjensen/FraudProposedReforms.htm 

Bob Jensen's Bottom Line Commentary --- http://www.trinity.edu/rjensen/FraudConclusion.htm 

The Virginia Tech Overview:  What Can We Learn From Enron? --- http://www.trinity.edu/rjensen/fraudVirginia.htm 

Professor Robert E. Jensen (Bob) http://www.trinity.edu/rjensen
Jesse H. Jones Distinguished Professor of Business Administration
Trinity University, San Antonio, TX 78212-7200
Voice: 210-999-7347 Fax: 210-999-8134  Email:  rjensen@trinity.edu