Accounting Scandal Updates on April 30, 2003
Bob Jensen at Trinity University


Updates and issues in the accounting, finance, and business scandals --- 

Many of the scandals are documented at 

The Whitewing SPE is only one of the thousands of Special Purpose Entities set up by Enron CFO Andy Fastow with the assistance of its auditor, Andersen, and its law firm.  The SPE appears to be almost hopelessly complex to hide risk as well as hide the trail of the millions of dollars Andy Fastow was making in double dealing at Enron. 

As an educator, I find the following chart interesting because it illustrates the hopelessness of applying the new 2003 FASB Interpretation 46 that requires tracing out the ultimate risks in deciding whether to consolidate SPEs (that are now called VIEs by the FASB).

The chart below appears as Appendix D beginning on Page 372 of the infamous Enron whistleblower's book.

Power Failure: The Inside Story of the Collapse of Enron, by Mimi Swartz, Sherron Watkins, Page 373.

For more details, see 

"Tough rules have been replaced by free marketeers," he says, alluding to the moves such as the 1999 repeal of the Glass-Steagall Act, which had separated banks, securities firms and insurers since 1933.  "I think we've shown that a free-market system left to its own devices will destroy itself."
Jack Willoughby quoting former tough SEC Director of Enforcement Stanley Sporkin in "Strictly Accountable," Barron's, April 7, 2003, Page 20.

Corporate governance is one of the key components of investor protection," William H. Donaldson, the new SEC chairman, said before the unanimous vote at a public meeting. "The audit committee ... is the bedrock upon which corporate governance has to be built."
As reported in "SEC Adopts Auditing Rules for Companies," by: SmartPros Editorial Staff, SmartPros, April 4, 2003

The San Jose newspaper contained an interesting story on internal auditors in last Sunday's edition. They are in great demand given Sarbanes-Oxley and other recent developments. The article is at:
Denny Beresford

The only statistics you can trust are those you falsified yourself.
Winston Churchill

The day Arthur Andersen loses the public's trust is the day we are out of business.  
Steve Samek, Country Managing Partner, United States, on Andersen's Independence and Ethical Standards CD-Rom, 1999.

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

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

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

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

Summary of Raptor oddities: 

1.  The accounting treatment looks questionable. 

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

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

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

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

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

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

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

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

From SmartPros on April 17, 2003 ---

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

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

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

The $1.4 billion settlement sounds like a big number, but the crooks are only giving back a small fraction of the take.


"Wall Street Firms Settle Charges Over Research in $1.4 Billion Pact," by Randall Smith, Susanne Craig, and Deborah Solomon, The Wall Street Journal, April 29, 2003, Page C1

In a pact that could change the face of Wall Street, 10 of the nation's largest securities firms agreed to pay a record $1.4 billion to settle government charges involving abuse of investors during the stock-market bubble of the late 1990s.

The long-awaited settlement, which followed an intense investigation that brought together three national regulatory bodies and a dozen state securities authorities, centers on civil charges that the Wall Street firms routinely issued overly optimistic stock research to investors in order to curry favor with corporate clients and win their lucrative investment-banking business. The pact also settles charges that at least two big firms, Citigroup Inc.'s Citigroup Global Markets unit, formerly Salomon Smith Barney, and Credit Suisse Group's Credit Suisse First Boston, improperly doled out coveted shares in initial public offerings to corporate executives in a bid to win banking business from their companies.

Regulators unveiled dozens of previously undisclosed examples of financial analysts tailoring their research reports and stock ratings to win investment-banking business. They added up to a scathing critique that scorched all the firms involved. The boss of one star analyst, Internet expert Mary Meeker of Morgan Stanley, praised her for being "highly involved" in the firm's investment-banking business. An analyst at the UBS Warburg unit of UBS AG explained she soft-pedaled concerns about a drug because its developer was "a very important client."

"I am profoundly saddened -- and angry -- about the conduct that's alleged in our complaints," said William Donaldson, chairman of the Securities and Exchange Commission. "There is absolutely no place for it in our marketplace and it cannot be tolerated."

The penalties included lifetime bans from the securities business for two former star analysts, Jack Grubman of Salomon and Henry Blodget of Merrill Lynch & Co., who were charged with issuing fraudulent research reports and agreed to pay penalties of $15 million and $4 million, respectively. Both the firms and the individuals consented to the charges without admitting or denying wrongdoing. But the regulators vowed to pursue cases against analysts and their supervisors as far up the chain of command as possible.

Bowing to political pressure from Congress, the regulators, which also included the National Association of Securities Dealers, the New York Stock Exchange and state regulators led by New York's Eliot Spitzer, also won a promise by the firms not to seek insurance repayment or tax deductions for $487.5 million of the settlement payments.

The agreement sets new rules that will force brokerage companies to make structural changes in the way they handle research. Analysts, for instance, will no longer be allowed to accompany investment bankers during sales pitches to clients. The pact also requires securities firms to have separate reporting and supervisory structures for their research and banking operations, and to tie analysts' compensation to the quality and accuracy of their research, rather than how much investment-banking fees they help generate.

Moreover, stock research will be required to carry the equivalent of a "buyer beware" notice. Securities firms, regulators said, must include on the first page of research reports a note making clear that the reports are produced by firms that do investment-banking business with the companies they cover. This, the firms must acknowledge, may affect the objectivity of the firms' research.

Continued in the article.

The main points of the settlement:

 A clear separation of stock research from investment banking
 "Independent" research for investors at no cost
 Better disclosure of stock rankings
 Ban of IPO "spinning"
 $1.4 billion payout, including a $387.5 million investor fund
 Penalties aren't tax deductible for the firms
Issued fraudulent research reports
Merrill Lynch
Salomon Smith Barney
Issued unfair research, or research not in good faith
Bear Stearns
Goldman Sachs
Lehman Brothers
Merrill Lynch
Piper Jaffray
Salomon Smith Barney
Received or made undisclosed payments for research
Piper Jaffray
Bear Stearns
Morgan Stanley
J.P. Morgan
Engaged in spinning of IPOs
Salomon Smith Barney
Source: Securities and Exchange Commission --- 

Additional Reading

Regulators Unveil Research Settlement
 Settlement Creates Restitution Fund
 Spitzer Views Salomon Notes as Key
 More Lawsuits Could Follow Deal
 How You Come Out in Settlement

 See excerpts of firms' internal e-mails released by regulators.
 See who's paying what and where it's going.
 See a gallery of key players.
 Listen to the SEC's press conference.
 See other resources available online.

Bob Jensen's threads on "Rotten to the Core" are available at 

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

"IPO 'Spinning' Is Under Fire; Securities Firms Are Charged:  Regulators Say Exchanges Of Business May Be Bribes," by Randall Smith, The Wall Street Journal, April 29, 2003 ---,,SB105157294734000800,00.html?mod=article-outset-box 

WASHINGTON -- Regulators took special aim at IPO "spinning" Monday, warning that corporate executives who received hot initial public offerings of stock in exchange for investment-banking business may have accepted "virtual commercial bribery" from Wall Street and could be forced to disgorge IPO profits.

Securities regulators Monday, as part of a broader $1.4 billion global-research pact, brought formal spinning charges against two of the securities firms in the settlement, the Credit Suisse First Boston unit of Credit Suisse Group and the former Salomon Smith Barney unit of Citigroup Inc.

Spinning occurs when securities firms allocate initial public stock offerings to the personal brokerage accounts of corporate or venture-capital executives -- so the shares can then be sold, or "spun," for quick profits -- in a potential bid to get future business from the executives' companies.

CSFB declined to comment. But Charles Prince, chairman and chief executive of Citigroup's global corporate and investment bank, said in an unusual public apology accompanying the settlement: "We deeply regret that our past research, IPO and distribution practices raised concerns about the integrity of our company and we want to take this opportunity to publicly apologize to our clients, shareholders and employees."

New York Attorney General Eliot Spitzer, who has filed suit against five telecommunications executives who received hot IPOs, warned executives who received IPO profits that should have gone to their companies may be forced to return those profits to the companies.

Under a legal doctrine known as "corporate opportunity," executives are barred from taking personal advantage of financial opportunities that come to them by virtue of their position at the company. Rather, executives are supposed to offer the opportunity to their companies.

And Robert Glauber, chairman and CEO of the National Association of Securities Dealers, said the cases sent Wall Street "an unmistakeable signal ... that hot IPOs cannot be doled out to corporate insiders as virtual commercial bribes." The spinning charges Monday were brought by the Securities and Exchange Commission and the NASD.

Monday's charges included new details about how Salomon Smith Barney, now named Citigroup Global Markets, directed the IPO shares to corporate executives through a special team of two brokers that functioned as a separate branch.

Between June 1996 and August 2000, Bernard Ebbers, the former WorldCom Inc. CEO, received a total of $11.5 million in profits on 21 IPOs from Salomon; in the same period, WorldCom, now named MCI, paid Salomon $76 million in investment-banking fees, according to the settlement papers filed Monday. Both firms neither admitted or denied wrongdoing.

The executives named in Mr. Spitzer's suit were Mr. Ebbers, Philip Anschutz, the former chairman and founder of Qwest Communications International Inc.; Joseph Nacchio, former Qwest CEO; Stephen Garofalo, founder of Metromedia Fiber Network Inc.; and Clark E. McLeod, founder of McLeod Telecommunications. The executives have denied wrongdoing.

Continued in the article.

The AICPA Issues Business Fraud Case Studies --- 

List of Cases

Bummer of the Week:  They Still Don't Get It
Protection of Employees That Need it the Least

"Top Executives’ Pensions Protected in Bankruptcy Filings," by the Editors of The Accounting Web, April 14, 2003 --- 

AccountingWEB US - Apr-14-2003 - Even in the wake of significant layoffs, some companies are reportedly making use of trusts and other creative arrangements to protect their top executives’ huge pensions, which are not usually covered by pension insurance when a company declares bankruptcy.

Airlines such as Delta and United have taken steps to protect their top executives’ pensions as the airline industry struggles to regain its footing after the Sept. 11 terrorist attacks.

Delta, which is working hard to stay afloat, disclosed recently that it had formed retirement trusts that will guarantee pension payments to its top 33 executives, a move that infuriated rank and file employees who may see their pensions cut as the airline strives to reduce costs.

UAL Corp., the parent company of United Airlines, used a similar arrangement to attract its Chairman and Chief Executive Glenn F. Tilton last September. UAL put $4.5 million in three trusts in Tilton’s name to compensate him for the pension benefits he gave up by leaving ChevronTexaco Corp. The agreement was designed to protect Tilton if the company ended up filing for bankruptcy court protection, which did in fact occur in December. Tilton will keep the money if he puts in three years with UAL or if the company emerges from bankruptcy.

While these arrangements clearly afford top executives even more security than regular employees enjoy, industry defends the practice by noting that when tough times are coming, it is better for the company to ensure its top people will stay put to ride out the storm.

LTV Corp., Conseco, Altria Group Inc. (formerly Philip Morris) and Abbott Laboratories are just a few of the companies that have disclosed similar arrangements in the last year.

They Still Don't Get It

CEO performance stank last year, yet most CEOs got paid more than ever. Here's how they're getting away with it.

But the pigs were so clever that they could think of a way round every difficulty.
--George Orwell, Animal Farm

Who says CEOs don't suffer along with the rest of us? As his company's stock slid 71% last year, one corporate chief saw his compensation fall 12%. Sure, he still earned $82 million, making him the second-highest-paid executive at an S&P 500 company in 2002, according to the 360 proxy statements that had rolled in as of April 9. And yeah, he's under indictment for the wholesale looting of his company, Tyco. But at least Dennis Kozlowski set a better example than the top-paid executive, who pulled in a whopping $136 million. That was Mark Swartz, his former CFO.

Unusual, you might say, for one company to produce the two top earners in a given year. But three of the top six? Now that's truly striking--especially since the other person isn't part of Kozlowski's gang at all. It's Ed Breen, the guy hired to clean up the mess.

You'd think that in the aftermath of a scandal that made Tyco a symbol of cartoonish greed, its board might want to make a point of frugality. Yet even as it was pressuring its former officers to "disgorge" their ill-gotten gains, it was letting its new man, who became CEO last July, gorge himself on $62 million worth of cash, stock, and other prizes. By all accounts Breen is doing a fine job so far (see Exorcism at Tyco), but still. And the gravy train didn't stop there. Tyco's board of directors dished out another $25 million for a new CFO, plus $25 million to a division head, putting them both on a par with the CEOs of Wal-Mart and General Electric. At least the company, now with a new board of directors, seems to recognize the need for some limits: Its bonus scheme "now caps out at 200% of base salary," notes Breen, "whereas before it was more like 600% or 700%."

That, in a nutshell, is what a year of unprecedented uproar and outrage can do. Before, CEOs had a shot at becoming very, very, very rich. Now they're likely to get only very, very rich. More likely, in fact. FORTUNE asked Equilar, an independent provider of compensation data, to analyze CEO compensation at 100 of the largest companies that had filed proxy statements for 2002. Their findings? Average CEO compensation dropped 23% in 2002, to $15.7 million, but that's mostly because the pay of a few mega-earners fell significantly. A more telling number--median compensation, or what the middle-of-the-road CEO earned--actually rose 14%, to $13.2 million. This in a year when the total return of the S&P 500 was down 22.1%.

"The acid test for reform," wrote Warren Buffett in his most recent letter to shareholders, "will be CEO compensation." With most of the results now in, the acid strip is bright red: Corporate reform has failed. Not only does executive pay seem more decoupled from performance than ever, but boards are conveniently changing their definition of "performance." "From a compensation point of view," says Matt Ward, an independent pay consultant, "it's a whole new bag of tricks."

What did fall last year were monster grants of stock options, like the 20 million awarded to Apple's Steve Jobs in 2000. The declining use of options (which even Kozlowski once called a "free ride--a way to earn megabucks in a bull market") would seem cause for reformers to rejoice. But delve more closely into the data for those 100 big companies and what do you find? That every other form of compensation--including some burgeoning forms of stealth wealth--has grown.

Continued in the article.

Also see Enron's Cast of Characters at

Book Recommendation from The AccountingWeb on April 25, 2003

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

Bob Jensen's references to other books on accounting and corporate fraud are at 

April 22, 2003 message from 

Our latest book by Don Silver, Cookin' the Book$: Say Pasta La Vista to Corporate Accounting Tricks and Fraud, is a parable about accounting fraud.

Author Don Silver is also an educational consultant for The Wall Street Journal Classroom Edition Teacher Guide.


Sue Ann Bacon 
Marketing Director 
Adams-Hall Publishing 800/888-4452

At a time when interest rates are low and personal bankruptcies are high, credit card companies have come up with new ways to boost revenues. Increasingly, customers are seeing new income- generating tactics, such as increased late fees and surcharges for overseas purchases. 

Beware Mystery Fees for Web Services ---,aid,110349,00.asp 
Web firms face investigations of 'cramming'--charging via telcos for unordered services.

CyberStalking Is Increasing --- 

Management perceives major threats from viruses and teenage hackers. But bigger threats come from organised crime involving fraud and commercial espionage, argues David Love, former head of security at NATO and current Head of Security Strategy for Europe, the Middle East and Africa at Computer Associates --- 

Experience is the best teacher, especially for con artists.
Online Fraud Complaints Triple Internet auction fraud continues to lead the list at IFCC, but the Nigerian oil minister scam actually rips off the most money on a per-complaint basis.,,10375_2179261,00.html 
Complaints about fraud perpetrated online tripled in 2002, and auction fraud continues to be the most frequently reported offense, according to figures from the Internet Fraud Complaint Center 

FBI report that Internet Fraud is up sharply ---,1284,58409,00.html 

Bob Jensen's threads on Internet Fraud are at 
The above link contains things to know before buying on eBay.

Forwarded on April 16, 2003 by MABDOLMOHAMM@BENTLEY.EDU 

U.S. accounting board votes to set auditing rules

April 16, 2003 11:14am ET (Reuters)

WASHINGTON, April 16 (Reuters) - The new U.S. board set up to regulate accountants on Wednesday voted to take over responsibility for setting auditing rules, marking the end of an era in which the accounting industry set its own standards.

Under the Sarbanes-Oxley Act -- a sweeping corporate reform bill passed last year -- the Public Company Accounting Oversight Board had the option to leave the auditing standard-setting process to another group, but decided against that.

So far, the accounting profession has been governed by auditing rules developed and issued by the Auditing Standards Board, an arm of the industry's main trade and lobby group -- the American Institute of Certified Public Accountants.

The recently formed accounting board, which named departing New York Federal Reserve President William McDonough as its new head on Tuesday, also agreed to set auditing rules with help from an advisory group to be set up comprising of accounting, investing and other experts.

Apart from setting auditing rules, the board's other crucial task will be to regularly inspect major accounting firms. It can also revoke an auditing firm's registration and set fines up to $15 million.

"Deloitte 'Sends Wrong Message' By Not Spinning Off Consultancy Arm," by: SmartPros Editorial Staff, SmartPros, April 4, 2003

Apr. 4, 2003 (AFX News Limited) — PwC chief executive Samuel DiPiazza said rival Deloitte Touche Tohmatsu's decision not to split off its consultancy arm could undermind efforts to restore the profession's integrity.

In an interview with the Financial Times, the head of the world's largest accountancy firm said Deloitte's decision not to follow the rest of the Big Four in selling or breaking from their main consultancy practices could "send the wrong message".

The spinoffs were implemented in response to widespread criticism over conflicts of interest within the industry.

"I'm surprised (Deloitte) reached that conclusion. We felt that the market was sending a clear message," DiPiazza said.

Deloitte said it would not offer banned consultancy services to its existing audit clients, and is committed to compliance with all new regulations, the newpaper added.

Also see 

Deloitte's decision last week not to separate its consulting arm is beginning to show its affects in the marketplace. "We are in the process of absorbing change; and change is a challenge," said James Quigley, who is set to take over the Big Four firm in June. 

Also see 

From The Wall Street Journal Accounting Educators' Review on April 11, 2003

TITLE: GM Will End Consulting Projects With Deloitte Touche Tohmatsu 
REPORTER: Cassell Bryan-Low 
DATE: Apr 07, 2003 
TOPICS: Accounting, Audit Quality, Auditing, Auditing Services, Auditor Independence, Consulting

SUMMARY: Amid concerns of lack of independence, General Motors Corp. will no longer accept consulting services from its independent auditor. Questions focus on the importance of independence and changes in the profession.

1.) What is independence in fact? What is independence in appearance? Does providing consulting services to audit clients compromise independence in fact and/or independence in appearance? Support your answer.

2.) Why is independence in fact important to the audit profession? Why is independence in appearance important to the audit profession? Is it possible to achieve either independence in fact or independence in appearance without achieving the other? Support your answer.

3.) Why did General Motors Corp opt to eliminate consulting services provided by its independent auditor? Was General Motors Corp more concerned about independence in fact or independence in appearance or both? Support your answer.

4.) When did consulting become a significant part of the services provided by large accounting firms? Why did the accounting firms begin providing these services? Why have most large accounting firms disposed of their consulting divisions?

5.) Discuss the advantages and disadvantages of accounting firms providing both independent auditing and consulting services.

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

Stock Analysts:  They Still Don't Get It

"Wall Street Analysts Still Give Banking Clients High Ratings," by Randall Smith, The Wall Street Journal, April 7, 2003, Page C1 ---

Some investors, heartened by regulatory scrutiny of stock-research conflicts, expect big changes in the way securities firms rate stocks of their corporate clients.

They shouldn't.

Despite a raft of new rules enacted to curtail the influence of investment banking on Wall Street research, the nation's top securities firms still consistently give higher ratings to stocks of their own banking clients, according to a review of the firms' research disclosures. The statistics, which recently began appearing at the back of all Wall Street research reports under regulatory reform measures enacted last summer, quantify for the first time a pattern that lies near the heart of the uproar over alleged stock-research bias, and one that has persisted on Wall Street for decades.

The upshot: Individual investors still must take Wall Street research with a chunk of salt, some specialists say.

"There's still a hesitancy to put a sell on a banking client," says Chuck Hill, director of research at Thomson First Call, which tracks analysts' stock ratings and earnings estimates. "There's still a good possibility that some firms are still biasing things in favor of their clients -- not to the extent they had been, but there's still some of that in there."

Historically, Wall Street firms have tended to pick up coverage of companies for which they underwrite securities sales, including initial public offerings, and analysts have played a key role in evaluating the companies before agreeing to manage those sales. So securities firms argue that they wouldn't underwrite, say, an IPO if they didn't believe their analysts would issue a positive stock recommendation.

Conversely, if analysts wouldn't be comfortable recommending the stock at that level, a Wall Street executive says, "we won't do the deal." In addition, he says, it's only natural for top securities firms to "want to do investment-banking business with the better-quality companies," which would also lead the firm to rate clients higher than average.

That said, take a look at the numbers. At Goldman Sachs Group Inc., 79% of all stocks with the highest "outperform" rating were investment-banking clients, based on the firm's most recent tally. But 61% of the stocks with the lowest "underperform" rating were clients. At Morgan Stanley, 40% of all stocks rated "overweight" were investment-banking clients, while 27% of stocks rated "underweight" were clients.

At Merrill Lynch & Co., 35% of the stocks rated "buy" were clients, but clients accounted for 21% of those rated "sell." At Citigroup Inc.'s recently rechristened Smith Barney brokerage network, 47% of all stocks rated "outperform/buy" were clients, while 37% of the stocks rated "underperform/sell" were clients. And at Credit Suisse Group's Credit Suisse First Boston, 49% of stocks rated "outperform" were clients, but 33% of those rated "underperform" were clients.

"We would try to underwrite better-quality companies, with strong fundamentals," says William Genco, chairman of Merrill's research-recommendation committee. As a former analyst who covered environmental-services companies for more than 30 years, Mr. Genco says he wouldn't allow the firm to underwrite securities sales for companies he didn't consider "suitable," and has vetoed as many as a dozen deals on that basis.

As a result, Mr. Genco says, "If you're underwriting companies that have positive fundamentals, you're more likely to have a positive recommendation on their stock."

At Goldman, Kim Ritrievi, co-director of investment research for the Americas, says "the determination of ratings has nothing to do with whether someone is a client or not." Ms. Ritrievi wouldn't address why the highest rating category contained more clients on a percentage basis, saying she didn't want to speculate on the reasons.

Continued in the article.

Bob Jensen's threads on "Rotten to the Core" are at 

A US Push on Accounting Fraud, by Alex Berenson, The New York Times, April 9, 2003


Anew emphasis at the Justice Department on accounting and securities fraud cases is already producing indictments and will almost certainly lead over the next several months to a wave of additional cases, according to prosecutors, defense lawyers and independent legal experts.

Nine months after President Bush ordered the formation of a federal task force to prosecute corporate fraud, the former chief executives of Enron and WorldCom, who have come to symbolize corporate corruption, have not been charged, and may never be.

But in other cases, federal prosecutors are moving aggressively to bring criminal charges for accounting gimmickry or securities fraud that in the past might not have been pursued.


Prosecutors and regulators were not willing to speculate about which companies might face criminal charges, or how many new cases might be brought. And they cautioned that securities cases, especially those where companies appear to have manipulated accounting rules to inflate their earnings, can be complicated and difficult to prove.

But they broadly agree — and criminal defense lawyers concur — that the Justice Department's commitment to pursuing fraud is serious, not just a public relations effort.


"These have become the hot, sexy cases," said Christine A. Bruenn, president of the North American Securities Administrators Association, a group of state and Canadian stock regulators that works with the Securities and Exchange Commission and with prosecutors. "I think a lot of people have changed their focus in terms of how seriously they're taking these cases."

Investigations that would once have been conducted solely by the S.E.C. now involve federal prosecutors and F.B.I. agents from the start, officials said.


The commission — which in the 1990's had a difficult time persuading prosecutors outside Manhattan, Brooklyn and San Francisco to follow up on its referrals of potential fraud cases — is now working with prosecutors in offices across the country. When there are accusations of serious fraud at companies based in states where prosecutors lack experience in accounting investigations, the Justice Department is dispatching specialists from Washington to help them.


All this is producing faster results. When prosecutors are convinced that they have clear evidence of fraud — as at HealthSouth, the operator of rehabilitation hospitals and clinics, or Symbol Technologies, a Long Island manufacturer of bar-code scanners — they quickly pursue indictments of midlevel and senior managers to prod them to turn in top executives.

Continued in the article.

"U.C. Sues Ernst & Young Over AOL-Time Warner Actions< by the Editors of The Accounting Web on April 17, 2003 --- 

AccountingWEB US - Apr-17-2003 - The University of California (UC) filed suit on April 14 against Big Four accounting firm Ernst & Young LLP and 32 other defendants, claiming it misrepresented the financial situation of America Online and Time Warner around the time of the firms’ 2001 merger.

AOL stock plummeted soon after the merger with Time-Warner and UC lost $450 million.

In the suit, the university claims that E&Y, concerned with holding on to a fat contract, helped falsify financial facts and continued to offer an unqualified audit opinion of the company long after it was clear that the company was in trouble.

An EY spokesman denied the charges. "We continue to strongly stand behind our work," E&Y spokesman Ken Kerrigan said.

Despite the lawsuit, another branch of E&Y will continue its wide-scale review of the University of California's Los Alamos National Laboratory’s financial operations. The university manages the laboratory, which is the subject of congressional charges of theft, fraud and mismanagement.

"It's like you being indicted because your brother stole something," UC spokesman Trey Davis said. "It's really quite separate."

Only a few firms are qualified to do the kind of work E&Y is doing at Los Alamos and more than 30 consultants from E&Y’s government contract services group are involved in a top-to-bottom review of the lab’s operations.

Bob Jensen's threads on Ernst & Young lawsuits are at 

Two E&Y Partners Suspended by SEC For Failure to Catch Fraud --- 

AccountingWEB US - May-1-2003 - Two Ernst & Young partners settled a civil lawsuit filed by the Securities and Exchange Commission (SEC) by agreeing to a suspension from auditing public companies for at least four years. The suit alleged that Kenneth Wilchort and Marc Rabinowitz, who both work in E&Y’s Stamford, CT office, failed to detect accounting fraud at Cendant Corporation and its predecessor, CUC International.

In 1977 CUC International merged with HFS Inc. to form Cendant, a travel and real estate provider that is also the franchiser of Jackson Hewitt, the second-largest tax service in the United States. Mr. Wilchort served as audit engagement partner for Cendant from 1990 until 1996. He was succeeded by Mr. Rabinowitz, who held the position until 1998.

In its complaint letter, the SEC claims that between 1995 and 1998, Cendant managers devised a scheme that inflated operating income by more than $500 million. The SEC alleges that Mr. Wilchort and Mr. Rabinowitz aided and abetted these violations by approving financial statements that did not conform to generally accepted accounting principles. The SEC further alleges that the two men excessively relied on management’s representations and failed to perform independent testing even when there were "multiple, conflicting and sometimes contradictory" financial documents.

Continued in the article.

Other selected lawsuits aimed at Ernst & Young are mentioned at 

Amerco Inc., the parent company of U-Haul International, itself hauled Big Four accounting firm PricewaterhouseCoopers into federal court in Arizona last week charging that the Big Four accounting firm was to blame for Amerco's dire financial situation. 

Bob Jensen's threads on PwC lawsuits can be found at 

SPEs and Off Balance Sheet Financing Advice from PwC
"U Haul's Parent Citing Faulty Advice Sues Its Old Auditor," Reuters, REUTERS April 22, 2003

Amerco Inc., the parent of U-Haul International, said yesterday that it had sued its former auditor PricewaterhouseCoopers for more than $2.5 billion in damages.

In the suit, Amerco accused PricewaterhouseCoopers of providing financial advice that it said was flawed and led it to the brink of bankruptcy.

The suit, filed on Friday in the Federal District Court for Arizona , contends PricewaterhouseCoopers's advice, coupled with delays in disclosing an error once it was discovered, caused events that put Amerco in "serious jeopardy."

Amerco said the delay forced it to postpone filing financial statements with regulators and put it in danger of being delisted from the Nasdaq stock market. Amerco, which named a new finance chief last week, avoided bankruptcy by reaching an agreement with lenders last month.

"They gave us bad advice for seven straight years," Amerco's general counsel, Gary Klinefelter, said in an interview yesterday. "We're in the business of renting out trucks and trailers, and they're in the business of giving out accounting advice."

A spokesman for PricewaterhouseCoopers, David Nestor, said the lawsuit appeared to be an effort by Amerco's management to shift blame away from itself.

"The primary responsibility for the accuracy of financial statements lies with the company," Mr. Nestor said. "Once it became apparent that there was an error in Amerco's, we worked with them to get their financial statements correct, which is, of course, the important thing."

The dispute centers on financing arrangements known as special purpose entities that Amerco set up in the mid-1990's. These were created to help expand the company's self-storage business without weighing down its balance sheet with debt.

Mr. Klinefelter said the idea for the special purpose entities, a term that has gained notoriety since they played a crucial role in Enron's collapse, came from PricewaterhouseCoopers, which guided the deals.

Amerco said in the lawsuit that it had been assured by PricewaterhouseCoopers that the special purpose entities could be excluded from its financial statements under federal accounting rules. But last year, after the Enron debacle put the spotlight on these arrangements, PricewaterhouseCoopers re-examined the accounting and realized that Amerco's financial statements had to be restated to include those entities, Amerco said.

Bob Jensen's SPE/VIE threads are at 

"Strictly Accountable," Barron's, April 7, 2003, Page 20.

For Stanley Sporkin, a former director of enforcement for the Securities and Exchange Commission, it's deja vu all over again. A policy he championed in the 'Seventies--cracking down on entire accounting firms rather than individual accountants--is suddenly back in vogue. When the agency lowered the boom on accounting giant KPMG in January, charging the firm with civil fraud in connection with its audits of Xerox, Sporkin saw that his old "Access" program had, in effect, been pulled from the mothballs. 

Under the program, the tough, fiercely independent Sporkin had gone after accounting concerns, law firms and brokerage houses--any outfit providing access to the capital markets for corporate America. In the years since, the agency has generally restricted its action in those fields to individuals. 

Sporkin, now 71 and a private lawyer in Washington, D.C., naturally applauds the renewed emphasis on entire firms. He urges the agency to follow through with vigor, holding accounting concerns "strictly accountable" for upholding rules. The SEC, he adds, can't give in to the inevitable industry pressure. "Believe me, when I last used Access, I got a lot of resistance from the old-boy network," he says. 

But even if the policy proves successful, Sporkin adds, it won't be enough to restore confidence in the markets. What's needed, he tells Barron's, is for the SEC and Congress to launch a broad investigation into the causes of the market meltdown of the past few years. Although Congress and regulators have attacked pieces of the problem--probing the Enron scandal, for instance, and clamping down on conflicts involving brokerage-house analysts--Sporkin wants to see much more. 

"What we need is a large study to draw the threads together," he says. "We've done a great job of getting things out into the open, but lately we've sort of let things slip." 

The study, he suggests, could shed light on the roles of everyone from day traders to mutual funds, hedge funds and venture-capital shops. Eventually, he says, the study might lead to some much-needed re-regulation of the financial scene. 

"Tough rules have been replaced by free marketeers," he says, alluding to moves such as the 1999 repeal of the Glass-Steagall Act, which had separated banks, securities firms and insurers since 1933. "I think we've shown that a free-market system left to its own devices will destroy itself."

Continued in the article.

"Sarbanes-Oxley "A Well-Meaning Attempt" That Will Impose Unnecessary Costs, Say CEOs." by: SmartPros Editorial Staff, SmartPros, April 4, 2003

The initial costs of complying with Sarbanes-Oxley were perceived as modest: only three percent say it has been very costly to implement, and 29 percent somewhat costly. In contrast, 46 percent say implementation has not been particularly costly, and 15 percent not at all costly. But 71 percent of surveyed executives believe that costs will increase over the long term -- including 12 percent expecting much higher future costs, and 59 percent somewhat higher. Sixty-five percent of executives said the Sarbanes-Oxley Act presents increased risk for their CEO, CFO, and other key executives who are required to certify the company's financial reports. Seventeen percent said those executives face much higher risk, and 48 percent generally higher risk. Only two percent expect lower risk, while 32 percent perceive no real change.

From The Wall Street Journal Accounting Educators' Review on April 11, 2003

TITLE: Megadamages Against Industry May Be History 
REPORTER: Kathryn Kranhold 
DATE: Apr 09, 2003 
PAGE: B1,4 
TOPICS: Financial Accounting Standards Board, Legal Liability, Pharmaceutical Industry, Disclosure Requirements

SUMMARY: Kranhold reports on the potential impact of the Supreme Court ruling that may limit the scope of allowable punitive damages in liability cases against large firms. The ruling is said to offer "guideposts" for determining the level of punitive damages.

1.) What is the difference between compensatory damages and punitive damages?

2.) The article says that the tobacco, automobile, pharmaceutical and insurance industries "cheered" this ruling from the highest court. Why would these industries be seen as reacting this way? Why are these firms more concerned with punitive rather than compensatory damages? How would you guess trial lawyers feel about this ruling?

3.) How do these firms estimate their potential liability from an expected suit or a pending suit filed against them? What guidance do they receive from standard-setting bodies? What is "reasonably estimable?" What impact, if any, would this ruling have on the estimation of potential liability in the GE case in the related article?

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

TITLE: GE Suit Charges Superfund Process Is Unconstitutional 
REPORTER: Matt Murray 
ISSUE: Jan 29, 2000 

In an 85-page brief submitted to the U.S. 5th Circuit Court of Appeals, lawyers for former Big Five accounting firm Arthur Andersen LLP presented reasons why they believe the appeals court should overturn Judge Melinda Harmon's guilty verdict on the obstruction of justice charge issued last year. 

PwC Chief Criticizes Deloitte's Decision to Keep Consulting 

April 28, 2003 message from Robert B Walker [walkerrb@ACTRIX.CO.NZ]

The web link below is to a report of potentially enormous significance to the accounting profession. It concerns an insurance company specialising in workers compensation insurance which collapsed in Australia about 2 years ago, leaving a deficiency of about $A5 billion.

The report analyses a number of accounting and auditing issues, including: provisioning for complex liabilities; accounting for assets such as goodwill, future income tax benefits, deferred costs such as IT and marketing related; the nature of going concern.

There are several matters of interest.

The first may be that Andersen's audit approach is analysed in great detail. HIH was one of Andersen's biggest clients in Australia. The judge who presided over the Commission does not directly conclude that Andersen was conflicted. However, he does draw out the following features of the auditors' relationship with HIH's management: Audit staff were assessed against 'conerstone' measures, important amongst which were on-selling of new business. Some internal memoranda make interesting reading in this regard. (Again, as with Enron, the British branch of Andersens comes out with their reputation intact.) The engagement partner held a meeting with members of the audit committee because he was unhappy with some of the accounting. The meeting was held without management. The partner was taken off the assignment. Also of interest is the consideration of audit evidence obtained by Andersen's to support carrying values of assets. In the case of what is referred to as Deferred Acquisition Cost (the deferral of marketing costs against the future recognition of premium revenue), Andersens claimed that the financial controller did an impairment review. In evidence to the Commission, the financial controller said he was completely unaware of the requirement until after he had left HIH!

Of most significance is the damning criticism of the Australian standard setting process. The judge singles out the Australian insurance standard and its standard on goodwill. In the first case he said that the standard setting process was not independent of the industry for whom the standard was set. He then compared the resulting standard unfavourably with solvency requirements laid down by a government regulator, the regulator requiring completely different accounting based more on the conceptual framework than the 'matching' concept underlying the standard. (It is the foolish adherence to 'matching' that has given rise to the carrying of marketing cost as an asset.)

In the case of goodwill the judge concludes the standard to be deeply ambiguous. He then concludes that the standard setting process is deficient because it lacks input from proper legal draughtsmen. In saying this it needs to be borne in mind that Australia and New Zealand are unique in conferring on standards the express force of law. In view of the criticism of FASB and its propensity for legalism in the wake of the Enron matter, the judge's criticism is particularly ironic.

Royal Commission Report:

Mark Morze has the dubious distinction of having perpetrated one of the biggest and most brazen financial frauds in American history, serving as "president" of ZZZZ Best's insurance restoration business. Mr. Morze, who is now helping auditors discover fraud, shares over 30 questions that the auditors should have asked that would have stopped him dead in his tracks. 

From FEI Express on April 23, 2003

FASB To Require Fair Value Expensing of Stock Options
At its April 22 public Board Meeting, the FASB decided to require all companies to expense the fair value of employee stock options. The decision was reached during deliberations on the FASB's recently-added agenda project on stock-based compensation. The FASB also reached tentative decisions to measure "employee equity-based awards" at grant date. The FASB will strive to work with the IASB on its similar project to achieve maximum convergence on final U.S. GAAP and IAS Standards on Accounting for Employee Stock Options. For additional details on the FASB decisions read KPMG's Defining Issues on the topic.

Congress is reacting to the FASB's move. Reps. David Drieir (R-CA) and Anna Eshoo (D-CA) have introduced the "Broad-Based Stock Option Plan Transparency Act of 2003," directing the SEC to require enhanced reporting disclosures of stock options, and preventing the SEC from recognizing any new accounting standard related to stock options until they have submitted a report to Congress on the effectiveness of the new disclosures, following a three year period of study. The bill would also require that the Secretary of Commerce spend a year studying the economic impact of stock option plans. Click here to view H.R. 1372. Also Sen. Barbara Boxer (D-CA) will introduce a bill sending the whole matter to the SEC for review before proposed rules are adopted.

Bob Jensen's threads on stock options are at 

From the SEC on April 1, 2003 --- 

SEC Requires Exchange Listing Standards for Audit Committees

The Securities and Exchange Commission today voted to adopt rules directing the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with the audit committee requirements established by the Sarbanes-Oxley Act of 2002. The new rules and amendments implement the requirements of Section 10A(m)(1) of the Securities Exchange Act of 1934, as added by Section 301 of the Sarbanes-Oxley Act of 2002.

Under the new rules, national securities exchanges and national securities associations will be prohibited from listing any security of an issuer that is not in compliance with the following requirements.

The new rules will establish Section 10A(m)'s two criteria for audit committee member independence.

The new rules will apply to both domestic and foreign listed issuers. It is important to note that, based on significant input from and dialogue with foreign regulators and foreign issuers and their advisers, several provisions, applicable only to foreign private issuers, have been included that seek to address the special circumstances of particular foreign jurisdictions. These provisions include

The new rules also will make several updates to the Commission's disclosure requirements regarding audit committees, including updates to the audit committee financial expert disclosure requirements for foreign private issuers.

The Commission voted to establish two sets of implementation dates for listed issuers. Generally, listed issuers will be required to comply with the new listing rules by the date of their first annual shareholders meetings after Jan. 15, 2004, but in any event no later than Oct. 31, 2004. Foreign private issuers and small business issuers will be required to comply by July 31, 2005.

"Sara Lee Investigates Rebate Data," by Sherri Day, The New York Times, April 8, 2003 --- 

The Sara Lee Corporation said yesterday that three of its sales representatives had signed off on inaccurate rebate amounts for U.S. Foodservice, whose accounting is under investigation by federal regulators and prosecutors.

The sales representatives remain employees at Sara Lee but are not allowed to work on any customer- or sales-related business, the company said.

"Their focus is the investigation," Julie Ketay, a spokeswoman at Sara Lee, said of the employees. "Once the investigation is complete, we'll make a further decision."

In examining the promotional and rebate payments, officials at Sara Lee say they discovered a discrepancy between company records and the documents that its sales representatives confirmed last week with Deloitte & Touche, the auditors for U.S. Foodservice. Sara Lee is conducting an internal inquiry and is cooperating with the investigations into U.S. Foodservice and its parent, Royal Ahold of the Netherlands.

Royal Ahold said in February that it had overstated earnings by $500 million for the last two years because of accounting problems connected to payments made to U.S. Foodservice. The problems involved the inflation of promotional payments from suppliers, falsely increasing the unit's profit.

Continued in the article.

Just because a company inflates its earnings by a couple hundred million doesn't mean it won't pay the taxes on those bogus earnings. At least that's what three university researchers discovered when they conducted a study on the tax consequences of allegedly fraudulent earnings. 

Bob Jensen's documents on accounting for derivative financial instruments and hedging activities are linked at

From The Wall Street Journal Accounting Educators' Review on April 3, 2003

TITLE: Lending Less, "Protecting" More: Desperate for Better Returns, Banks Turn to Credit-Default Swaps 
REPORTER: Henny Sender and Marcus Walker 
DATE: Apr 02, 2003 
PAGE: C13 
TOPICS: Advanced Financial Accounting, Banking, Fair Value Accounting, Financial Analysis, Insurance Industry

SUMMARY: This article describes the implications of banks selling credit-default swap derivatives. Firtch Ratings has concluded in a recent report that banks are adding to their own risk as they use these derivatives to sell insurance agains default by their borrower clients.

QUESTIONS: 1.) Define the term "derivative security" and describe the particular derivative, credit-default swaps, that are discussed in this article.

2.) Why are banks entering into derivatives known as credit-default swaps? Who is buying these derivatives that the bank is selling?

3.) In general, how should these derivative securities be accounted for in the banks' financial statements? What finanicial statement disclosures are required? How have these disclosures provided evidence about the general trends in the banking industry that are discussed in this article?

4.) Explain the following quote from Frank Accetta, an executive director at Morgan Stanley: "Banks are realizing that you can take on the same risk [as the risk associated with making a loan] at more attractive prices by selling protection."

5.) Why do you think the article equates the sale of credit-default swaps with the business of selling insurance? What do you think are the likely pitfalls of a bank undertaking such a transaction as opposed to an insurance company doing so?

6.) What impact have these derivatives had on loan pricing at Deutsche Bank AG? What is a term that is used to describe the types of costs Deutsche Bank is now considering when it decides on a lending rate for a particular borrower?

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

"Banks' Increasing Use of Swaps May Boost Credit-Risk Exposure, by Henny Sender and Marcus Walker, The Wall Street Journal, April 1, 2003 ---,,SB104924410648100900,00.html 

When companies default on their debt, banks in the U.S. and Europe increasingly will have to pick up the tab.

That is the conclusion of Fitch Ratings, the credit-rating concern. Desperate for better returns, more banks are turning to the "credit default" markets, a sphere once dominated by insurers. In a recent report, Fitch says the banks -- as they use these derivatives to sell insurance against default by their borrowers -- are adding to their credit risk.

The trend toward selling protection, rather than lending, could well raise borrowing costs for many companies. It also may mean greater risk for banks that increasingly are attracted to the business of selling protection, potentially weakening the financial system as a whole if credit quality remains troubled. One Canadian bank, for example, lent a large sum to WorldCom Inc., which filed for Chapter 11 bankruptcy protection last year. Rather than hedging its loan to the distressed telecom company by buying protection, it increased its exposure by selling protection. The premium it earned by selling insurance, though, fell far short of what it both lost on the loan and had to pay out to the bank on the other side of the credit default swap.

"The whole DNA of banks is changing. The act of lending used to be part of the organic face of the bank," says Frank Accetta, an executive director at Morgan Stanley who works in the loan-portfolio management department. "Nobody used to sit down and calculate the cost of lending. Now banks are realizing that you can take on the same risk at more attractive prices by selling protection."

Despite its youth, the unregulated, informal credit-default swap market has grown sharply to total almost $2 trillion in face value of outstanding contracts, according to estimates from the British Bankers Association, which does the most comprehensive global study of the market. That is up from less than $900 billion just two years ago. (The BBA says the estimate contains a good amount of double counting, but it uses the same method over time and thus its estimates are considered a good measuring stick of relative change in the credit-default swap market.) Usually, banks have primarily bought protection to hedge their lending exposure, while insurers have sold protection. But Fitch's study, as well as banks' own financial statements and anecdotal evidence, shows that banks are becoming more active sellers of protection, thereby altering their risk profiles.

The shift toward selling more protection comes as European and American banks trumpet their reduced credit risk. And it is true that such banks have cut the size of their loan exposures, either by taking smaller slices of loans or selling such loans to other banks. They also have diversified their sources of profit by trying to snare more lucrative investment-banking business and other fee-based activity.

Whether banks lend money or sell insurance protection, the downside is generally similar: The bank takes a hit if a company defaults, cushioned by whatever amount can eventually be recovered. (Though lenders are first in line in bankruptcy court; sellers of such protection are further back in the queue.)

But the upside differs substantially between lenders and sellers of protection. Banks don't generally charge their corporate borrowers much when they make a loan because they hope to get other, more lucrative assignments from the relationship. So if a bank extends $100 million to an industrial client, the bank may pocket $100,000 annually over the life of the loan. By contrast, the credit-default swap market prices corporate risk far more systematically, devoid of relationship issues. So if banks sell $100 million of insurance to protect another party against a default by that same company, the bank can receive, say, $3 million annually in the equivalent of insurance premiums (depending on the company's creditworthiness).

All this comes as the traditional lending business is becoming less lucrative. The credit-derivatives market highlights the degree to which bankers underprice corporate loans, and, as a result, bankers expect the price of such loans to rise.

"We see a change over time in the way loans are priced and structured," says Michael Pohly, head of credit derivatives at Morgan Stanley. "The lending market is becoming more aligned with the rest of the capital markets." In one possible sign of the trend away from traditional lending, the average bank syndicate has dropped from 30 lenders in 1995 to about 17 now, according to data from Loan Pricing Corp.

Some of the biggest players in the market, such as J.P. Morgan Chase & Co., are net sellers of such insurance, according to J.P. Morgan's financial statements. In its annual report, J.P. Morgan notes that the mismatch between its bought and sold positions can be explained by the fact that, while it doesn't always hedge, "the risk positions are largely matched." A spokesman declined to comment.

But smaller German banks, some of them backed by regional governments, are also active sellers, according to Fitch. "Low margins in the domestic market have compelled many German state-guaranteed banks to search for alternative sources of higher yielding assets, such as credit derivatives," the report notes. These include the regional banks Westdeutsche Landesbank, Bayerische Landesbank, Bankgesellschaft Berlin and Landesbank Hessen-Thueringen, according to market participants. The state-owned Landesbanken in particular have been searching for ways to improve their meager profits in time for 2005, when they are due to lose their government support under pressure from the European Union.

Deutsche Bank AG is one of biggest players in the market. It is also among the furthest along in introducing more-rational pricing to reflect the implicit subsidy in making loans. At Deutsche Bank, "loan approvals now are scrutinized for economic shortfall" between what the bank could earn selling protection and what it makes on the loan, says Rajeev Misra, the London-based head of global credit trading.

Bookland of Maine, a defunct bookstore chain, has won a $6.6 million judgment against its Portland, Maine-based accounting firm, Baker Newman & Noyes. 

AccountingWEB US - Apr-9-2003 - Bookland of Maine, a defunct bookstore chain, has won a $6.6 million judgment against its Portland, Maine-based accounting firm, Baker Newman & Noyes. In a unanimous verdict, a federal jury found that Baker Newman had failed to notify the bookseller of discrepancies in its financial statements and as a result, caused the bookstore to go out of business. The jury found the accounting firm guilty of breach of contract, negligent misrepresentation, and negligence

Bookland of Maine hired Baker Newman & Noyes in 1995 to review the company’s financial statements. The accounting firm agreed to notify Bookland’s owner, David Turitz, of any errors, illegalities, or other discrepancies. The bookseller showed a profit for 1997 and 1998 and relying on those numbers, Mr. Turitz expanded his company. However, during that time the controller had made a number of errors and the company was actually losing money. Turitz claimed that even when Baker Newman discovered the accounting errors, it didn’t notify him of the problem.

Continued in the article.

From The Wall Street Journal Accounting Educators' Review on April 3, 2003

TITLE: Pension-Plan Accounting Rules Led to Overvalued Stock, Fed Says 
REPORTER: Jonathan Weil 
DATE: Mar 28, 2003 
TOPICS: Advanced Financial Accounting, Pension Accounting

SUMMARY: Pension accounting standards which allow for slow amortization of certain items resulted in companies reporting income from pension plans even as plan asset values fell sharply in 2001. The Fed conducted a study which concluded that "investors tend to apply the same price-to-earnings mutilples to pension earnings that they do to earnings from core operations." These results occur partly because "fuzzy disclosures make it hard for investors to carve out pension earnings from corporate income statements."

1.) Define the terms "defined-benefit pension plan" and "defined-contribution pension plan." For each of these types of plans, list the general components of pension expense and describe, in general, required disclosures for pension plans.

2.) The Federal Reserve Board research study that is the subject of this article analyzes companies reporting earnings from pension plans. How can it be possible for companies to show earnings, rather than expenses, for pension plans? Did the companies included in the study provide defined-benefit or defined-contribution pension plans?

3.) Describe the items that are part of pension expense which are accounted for using "smoothing" mechanisms. How could these items have allowed companies to continue favorable reporting about pension plans when plan asset values were in a free-fall?

4.) What is the implication of the statement that "investors tend to apply the same price-to-earnings multiples to pension earnings that they do to earnings from core operations"? When would an investor make such a step? How could an investor instead use pension disclosures about plan asset values for this purpose?

5.) Make several general recommendations for improvements to current pension plan accounting and reporting requirements to alleviate the problems described in this article.

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

April 4, 2003 message received from KPMG

We are delighted to introduce you to KPMG's Audit Committee Institute (ACI). We hope our complimentary information and guidance will greatly assist you in the classroom as well as provide a resource for you and those faculty interested in conducting research on corporate governance. 

Recognizing the challenge that audit committees face in meeting their demanding responsibilities, KPMG created the Audit Committee Institute in 1999 to serve as a resource for audit committee members and senior management. Our primary mission is to communicate with audit committee members and enhance their awareness, commitment, and ability to implement effective audit committee processes.

The purpose of ACI is to provide information and knowledge-sharing forums to help audit committee members learn about audit committee processes and technical issues relevant to their oversight and monitoring responsibilities. Wholly sponsored by KPMG International, ACI provides free-of-charge guidance and increases awareness for corporate audit committee members. Board members can turn to the Institute at any time for help and advice or to share knowledge.

ACI serves as a highly useful, informative resource in key areas such as audit committee governance, technical, and regulatory issues; sounding board for enhancing audit committees' process and policies; and surveys of trends and concerns. In addition, ACI participates in initiatives sponsored by a number of prestigious governance associations and academic institutions focused on serving board members. ACI has conducted active outreach to audit committee members and we have sponsored hundreds of workshops, presentations, and issue-oriented meetings.

ACI takes a proactive approach that emphasizes frequent communication - we communicate directly with audit committee members and also support KPMG engagement teams. Since our formation, our dedicated team of professionals has been in direct contact with thousands of board members. In addition, we monitor corporate governance issues on a worldwide basis.

We are pleased to introduce you to a range of tools created to assist audit committee members in meeting their financial reporting oversight role that may be useful to you. These tools include:

· ACI Web site, -- Please bookmark this site and forward this address to other members of your faculty. Our Web site provides detailed information including analysis, articles, governance regulations including the Sarbanes-Oxley Act of 2002, presentations, international corporate governance, a new "Quick Poll" survey question, roundtables, evolving issues, and much more.

·  Focused presentations - ACI has delivered presentations at numerous national conferences.

ACI also issues a number of publications designed to enhance the timeliness of knowledge sharing with audit committee members that we also recommend to you. The Audit Committee Quarterly (ACQ) is a summary of current issues, ideas, and analysis to assist audit committees and members of management. Please send an e-mail request to with your name, address, phone, and fax numbers if you would like to receive the ACQ electronically.  This and other resources, including Shaping the Audit Committee Agenda and a variety of international resources is also available on the ACI Web site.

ACI has also collaborated with academics, audit committee members, and others on a number of research projects and articles, and are interested in your ideas about future research.  Please contact Mark C. Terrell, Executive Director, at 201-505-2681 or Scott A. Reed, Partner, at 201-505-2112 if you have any questions, research ideas, or suggestions for future publications - or visit or e-mail

 Very truly yours,


Martin Salinas, Jr.
Tel:  210-270-1608


What is COSO?

Answer --- 

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

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

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

Bob Jensen's accounting bookmarks are at 

Proving Once Again That White Collar Crime Pays

Bob Jensen at Trinity University

Why hold up a gas station for $150 when you can work a deal for stock options, cheat on the accounting to run up the price of the stock, exercise the options, and resign before the price plunges?  Particularly depressing to me are the stock sales of Robert Jaedicke.  He was once my major professor at Stanford University.  In the years preceding the collapse of Enron, he was head of Enron's Audit Committee and a member of the Board of Directors.  Don't stock options create moral hazards for members of audit committees?  I do not know that Dr. Jaedicke cheated anybody intentionally.  However, his stock sales proceeds have a tainted smell.  As for Lou Pai and the rest, I highly recommend that you read Pipe Dreams:  Greed, Ego, and the Death of Enron by Robert Bryce (PublicAffairs, 2002).



J. Clifford Baxter Vice-Chairman 619,898 $34,734,854
Robert Belfer Member of Board of Directors 2,065,137 $111,941,200
Norman Blake Member of Board of Directors 21,200 $1,705,328
Rick Buy Chief Risk Officer 140,234 $10,656,595
Rick Causey Chief Accounting Officer 208,940 $13,386,896
Ronnie Chan Member of Board of Directors 8,000 $337,200
James Derrick General Counsel 230,660 $12,563,928
John Duncan Member of Board of Directors 35,000 $2,009,700
Andy Fastow Chief Financial Officer 687,445 $33,675,004
Joe Foy Member of Board of Directors 38,160 $1,639,590
Mark Frevert Chief Executive Office, Enron Europe 986,898 $54,831,220
Wendy Gramm Member of Board of Directors 10,328 $278,892
Kevin Hannon President, Enron Broadband Services Unknown Unknown
Ken Harrison Member of Board of Directors 1,011,436 $75,416,636
Joe Hirko CEO, Enron Communications 473,837 $35,168,721
Stan Horton CEO, Enron Transportation 830,444 $47,371,361
Robert Jaedicke Member of Board of Directors 13,360 $841,438
Steve Kean Executive Vice President, Chief of Staff 64,932 $5,166,414
Mark Koenig Executive Vice President 129,153 $9,110,466
Ken Lay Chairman, Enron Corp. 4,002,259 $184,494.426
Charles LeMaistre Member of Board of Directors 17,344 $841,768
Rebecca Mark Chief Executive Officer, Azurix 1,895,631 $82,536,737
Michael McConnell Executive Vice President 32,960 $2,506,311
Jeff McMahon Treasurer 39,630 $2,739,226
Cindy Olson Executive Vice President 83,183 $6,505,870
Lou Pai CEO, Enron Energy Services 3,912,205 $270,276,065
Ken Rice CEO, Enron Broadband Services 1,234,009 $76,825,145
Jeffrey Skilling Chief Executive Officer, Enron Corp. 1,307,678 $70,687,199
Joe Sutton Vice-Chairman 688,996 $42,231,283
Greg Whalley Chief Operating Officer, Enron Corp. Unknown Unknown
TOTALS 20,788,957 $1,190,479,472
*All listed sales occurred between October 19, 1998 and November 27, 2001. The number shown under
gross proceeds indicates the number of shares times the price of Enron stock on the day the shares were
sold. It does not reflect any costs the Enron officials incurred in exercising the sale of the stock. Therefore,
the net proceeds to the listed individuals is likely less than the amount shown.

SOURCES: Mark Newby, et al. vs. Enron Corp., et al., Securities and Exchange Commission filings,
Congressional testimony, Enron Corp. press releases.

Question 1
Who owns 77,000 acres in Colorado and is the only person to own a 14,000 foot mountain?  I wish he'd take a flying leap from it!
Who at Enron refused to commute from Sugarland on the outskirts of Houston to catch flights on Enron's corporate jets departing out of Houston's International Airport?  Instead that former Enron executive required that a corporate jet be dispatched for him to commute from Sugarland.  Mostly the longer flights out of Houston for this executive were to his vacation home.

See Page 264 of Pipe Dreams by Robert Bryce cited above.

Question 2
Relative to the executive mentioned above, what woman was an even worse abuser of Enron's corporate jets?

See Page 262 of Pipe Dreams by Robert Bryce cited above.


Click here to go to Bob Jensen's main document on accounting for stock options --- 

Click here to go to Bob Jensen's main document on fraud ---


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  
Bob Jensen's SPE threads are at  
Bob Jensen's threads on accounting theory are at  

Bob Jensen's Summary of Suggested Reforms --- 

Bob Jensen's Bottom Line Commentary --- 

The Virginia Tech Overview:  What Can We Learn From Enron? --- 



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