Accounting Scandal Updates and Other Fraud Between April 30 and June 30 in the Year 2009
 Bob Jensen at Trinity University

Bob Jensen's Main Fraud Document --- http://www.trinity.edu/rjensen/fraud.htm 

Bob Jensen's Enron Quiz (and answers) --- http://www.trinity.edu/rjensen/FraudEnronQuiz.htm

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

Other Documents

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

Resources to prevent and discover fraud from the Association of Fraud Examiners --- http://www.cfenet.com/resources/resources.asp 

Self-study training for a career in fraud examination --- http://marketplace.cfenet.com/products/products.asp 

Source for United Kingdom reporting on financial scandals and other news --- http://www.financialdirector.co.uk 

Updates on the leading books on the business and accounting scandals --- http://www.trinity.edu/rjensen/Fraud.htm#Quotations 

I love Infectious Greed by Frank Partnoy ---  http://www.trinity.edu/rjensen/Fraud.htm#Quotations 

Bob Jensen's American History of Fraud ---  http://www.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm

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

"What’s Your Fraud IQ?  Think you know enough about corruption to spot it in any of its myriad forms? Then rev up your fraud detection radar and take this (deceptively) simple test." by Joseph T. Wells, Journal of Accountancy, July 2006 --- http://www.aicpa.org/pubs/jofa/jul2006/wells.htm

What Accountants Need to Know --- http://www.trinity.edu/rjensen/FraudReporting.htm#AccountantsNeedToKnow

Global Corruption (in legal systems) Report 2007 --- http://www.transparency.org/content/download/19093/263155

Tax Fraud Alerts from the IRS --- http://www.irs.gov/compliance/enforcement/article/0,,id=121259,00.html

White Collar Fraud Site --- http://www.whitecollarfraud.com/
Note the column of links on the left.

Bob Jensen's essay on the financial crisis bailout's aftermath and an alphabet soup of appendices can be found at
http://www.trinity.edu/rjensen/2008Bailout.htm

The Heroes of Financial Fraud, The Atlantic, April 2009 --- http://meganmcardle.theatlantic.com/archives/2009/04/the_heroes_of_financial_fraud.php

History of Fraud in America ---  http://www.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm

Rotten to the Core --- http://www.trinity.edu/rjensen/FraudRotten.htm

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

"A Timeline of the Madoff Fraud," The New York Times, June 29, 2009 --- http://www.nytimes.com/interactive/2009/06/29/business/madoff-timeline.html?ref=business

New Hints at Why the SEC Failed to Seriously Investigate Madoff's Hedge Fund
After being repeatedly warned for six years that this was a criminal scam
It's beginning to look like a family "affair"

(The SEC's) Swanson later married Madoff's niece, and their relationship is now under review by the SEC inspector general, who is examining the agency's handling of the Madoff case, the Post reported. Swanson, no longer with the agency, declined to comment, the Post said.
"SEC lawyer raised alarm about Madoff: report," Reuters, July 2, 2009 --- http://news.yahoo.com/s/nm/20090702/bs_nm/us_madoff_sec
The Washington Post account is at --- Click Here

A U.S. Securities and Exchange Commission lawyer warned about irregularities at Bernard Madoff's financial management firm as far back as 2004, The Washington Post reported on Thursday, citing agency documents and sources familiar with the investigation.

Genevievette Walker-Lightfoot, a lawyer in the SEC's Office of Compliance Inspections and Examinations, sent emails to a supervisor saying information provided by Madoff during her review didn't add up and suggesting a set of questions to ask his firm, the report said.

Several of the questions directly challenged Madoff activities that turned out to be elements of his massive fraud, the newspaper said.

Madoff, 71, was sentenced to a prison term of 150 years on Monday after he pleaded guilty in March to a decades-long fraud that U.S. prosecutors said drew in as much as $65 billion.

The Washington Post reported that when Walker-Lightfoot reviewed the paper documents and electronic data supplied to the SEC by Madoff, she found it full of inconsistencies, according to documents, a former SEC official and another person knowledgeable about the 2004 investigation.

The newspaper said the SEC staffer raised concerns about Madoff but, at the time, the SEC was under pressure to look for wrongdoing in the mutual fund industry. Walker-Lightfoot was told to focus on a separate probe into mutual funds, the report said.

One of Walker-Lightfoot's supervisors on the case was Eric Swanson, an assistant director of her department, the Post reported, citing two people familiar with the investigation.

Swanson later married Madoff's niece, and their relationship is now under review by the SEC inspector general, who is examining the agency's handling of the Madoff case, the Post reported.

Swanson, no longer with the agency, declined to comment, the Post said.

SEC spokesman John Nester also declined to comment, citing the ongoing investigation by the agency's inspector general, the newspaper said.

Our Main Financial Regulating Agency:  The SEC Screw Everybody Commission
One of the biggest regulation failures in history is the way the SEC failed to seriously investigate Bernie Madoff's fund even after being warned by Wall Street experts across six years before Bernie himself disclosed that he was running a $65 billion Ponzi fund.

CBS Sixty Minutes on June 14, 2009 ran a rerun that is devastatingly critical of the SEC. If you’ve not seen it, it may still be available for free (for a short time only) at http://www.cbsnews.com/video/watch/?id=5088137n&tag=contentMain;cbsCarousel
The title of the video is “The Man Who Would Be King.”
Also see http://www.fraud-magazine.com/FeatureArticle.aspx

Between 2002 and 2008 Harry Markopolos repeatedly told (with indisputable proof) the Securities and Exchange Commission that Bernie Madoff's investment fund was a fraud. Markopolos was ignored and, as a result, investors lost more and more billions of dollars. Steve Kroft reports.

Markoplos makes the SEC look truly incompetent or outright conspiratorial in fraud.

I'm really surprised that the SEC survived after Chris Cox messed it up so many things so badly.

As Far as Regulations Go

An annual report issued by the Competitive Enterprise Institute (CEI) shows that the U.S. government imposed $1.17 trillion in new regulatory costs in 2008. That almost equals the $1.2 trillion generated by individual income taxes, and amounts to $3,849 for every American citizen. According the 2009 edition of Ten Thousand Commandments: An Annual Snapshot of the Federal Regulatory State, the government issued 3,830 new rules last year, and The Federal Register, where such rules are listed, ballooned to a record 79,435 pages. “The costs of federal regulations too often exceed the benefits, yet these regulations receive little official scrutiny from Congress,” said CEI Vice President Clyde Wayne Crews, Jr., who wrote the report. “The U.S. economy lost value in 2008 for the first time since 1990,” Crews said. “Meanwhile, our federal government imposed a $1.17 trillion ‘hidden tax’ on Americans beyond the $3 trillion officially budgeted” through the regulations.
 Adam Brickley, "Government Implemented Thousands of New Regulations Costing $1.17 Trillion in 2008," CNS News, June 12, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487

Jensen Comment
I’m a long-time believer that industries being regulated end up controlling the regulating agencies. The records of Alan Greenspan (FED) and the SEC from Arthur Levitt to Chris Cox do absolutely nothing to change my belief ---
http://www.trinity.edu/rjensen/FraudRotten.htm

How do industries leverage the regulatory agencies?
The primary control mechanism is to have high paying jobs waiting in industry for regulators who play ball while they are still employed by the government. It happens time and time again in the FPC, EPA, FDA, FAA, FTC, SEC, etc. Because so many people work for the FBI and IRS, it's a little harder for industry to manage those bureaucrats. Also the FBI and the IRS tend to focus on the worst of the worst offenders whereas other agencies often deal with top management of the largest companies in America.

Bob Jensen's fraud updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm

In Troy, New York, where a quarter of the children live below the poverty level and the average household makes less than $30,000 a year, the 29th richest man in the world is being given more than 300,000 taxpayer dollars to open a restaurant. They call it economic development. What it is is a sin. What it is is welfare for the wealthy, proof positive that raping the taxpayer is what the government does best. Meet George Soros. He owns Dinosaur Bar-B-Que. Specifically, his company – Soros Strategic Partners – owns 70 percent of Dinosaur Bar-B-Que.
Bob Ionsberry, July 2, 2009 --- http://www.boblonsberry.com/writings.cfm?go=4

Another Liberal Victory for GE/NBC
General Electric, the world's largest industrial company, has quietly become the biggest beneficiary of one of the government's key rescue programs for banks. At the same time, GE has avoided many of the restrictions facing other financial giants getting help from the government. The company did not initially qualify for the program, under which the government sought to unfreeze credit markets by guaranteeing debt sold by banking firms. But regulators soon loosened the eligibility requirements, in part because of behind-the-scenes appeals from GE. As a result, GE has joined major banks collectively saving billions of dollars by raising money for...
Jeff Gerth and Brady Dennis, "How a Loophole Benefits GE in Bank Rescue Industrial Giant Becomes Top Recipient in Debt-Guarantee Program," The Washington Post, June 29, 2009 ---
http://www.washingtonpost.com/wp-dyn/content/article/2009/06/28/AR2009062802955.html?hpid=topnews
Jensen Comment
GE thus becomes the biggest winner under both the TARP and the Cap-and-Trade give away legislation. It is a major producer of wind turbines and other machinery for generating electricity under alternative forms of energy. The government will pay GE billions for this equipment. GE Capital is also "Top Recipient in Debt-Guarantee Program." Sort of makes you wonder why GE's NBC network never criticizes liberal spending in Congress.
Jensen's threads on the bank rescue swindle are at http://www.trinity.edu/rjensen/2008Bailout.htm z
Bob Jensen's fraud updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm

The Greatest Swindle in the History of the World
"The Greatest Swindle Ever Sold," by Andy Kroll, The Nation, May 26, 2009 ---
http://www.thenation.com/doc/20090608/kroll/print

The legislation's guidelines for crafting the rescue plan were clear: the TARP should protect home values and consumer savings, help citizens keep their homes and create jobs. Above all, with the government poised to invest hundreds of billions of taxpayer dollars in various financial institutions, the legislation urged the bailout's architects to maximize returns to the American people.

That $700 billion bailout has since grown into a more than $12 trillion commitment by the US government and the Federal Reserve. About $1.1 trillion of that is taxpayer money--the TARP money and an additional $400 billion rescue of mortgage companies Fannie Mae and Freddie Mac. The TARP now includes twelve separate programs, and recipients range from megabanks like Citigroup and JPMorgan Chase to automakers Chrysler and General Motors.

Seven months in, the bailout's impact is unclear. The Treasury Department has used the recent "stress test" results it applied to nineteen of the nation's largest banks to suggest that the worst might be over; yet the International Monetary Fund, as well as economists like New York University professor and economist Nouriel Roubini and New York Times columnist Paul Krugman predict greater losses in US markets, rising unemployment and generally tougher economic times ahead.

What cannot be disputed, however, is the financial bailout's biggest loser: the American taxpayer. The US government, led by the Treasury Department, has done little, if anything, to maximize returns on its trillion-dollar, taxpayer-funded investment. So far, the bailout has favored rescued financial institutions by subsidizing their losses to the tune of $356 billion, shying away from much-needed management changes and--with the exception of the automakers--letting companies take taxpayer money without a coherent plan for how they might return to viability.

The bailout's perks have been no less favorable for private investors who are now picking over the economy's still-smoking rubble at the taxpayers' expense. The newer bailout programs rolled out by Treasury Secretary Timothy Geithner give private equity firms, hedge funds and other private investors significant leverage to buy "toxic" or distressed assets, while leaving taxpayers stuck with the lion's share of the risk and potential losses.

Given the lack of transparency and accountability, don't expect taxpayers to be able to object too much. After all, remarkably little is known about how TARP recipients have used the government aid received. Nonetheless, recent government reports, Congressional testimony and commentaries offer those patient enough to pore over hundreds of pages of material glimpses of just how Wall Street friendly the bailout actually is. Here, then, based on the most definitive data and analyses available, are six of the most blatant and alarming ways taxpayers have been scammed by the government's $1.1-trillion, publicly funded bailout.

1. By overpaying for its TARP investments, the Treasury Department provided bailout recipients with generous subsidies at the taxpayer's expense.

When the Treasury Department ditched its initial plan to buy up "toxic" assets and instead invest directly in financial institutions, then-Treasury Secretary Henry Paulson Jr. assured Americans that they'd get a fair deal. "This is an investment, not an expenditure, and there is no reason to expect this program will cost taxpayers anything," he said in October 2008.

Yet the Congressional Oversight Panel (COP), a five-person group tasked with ensuring that the Treasury Department acts in the public's best interest, concluded in its monthly report for February that the department had significantly overpaid by tens of billions of dollars for its investments. For the ten largest TARP investments made in 2008, totaling $184.2 billion, Treasury received on average only $66 worth of assets for every $100 invested. Based on that shortfall, the panel calculated that Treasury had received only $176 billion in assets for its $254 billion investment, leaving a $78 billion hole in taxpayer pockets.

Not all investors subsidized the struggling banks so heavily while investing in them. The COP report notes that private investors received much closer to fair market value in investments made at the time of the early TARP transactions. When, for instance, Berkshire Hathaway invested $5 billion in Goldman Sachs in September, the Omaha-based company received securities worth $110 for each $100 invested. And when Mitsubishi invested in Morgan Stanley that same month, it received securities worth $91 for every $100 invested.

As of May 15, according to the Ethisphere TARP Index, which tracks the government's bailout investments, its various investments had depreciated in value by almost $147.7 billion. In other words, TARP's losses come out to almost $1,300 per American taxpaying household.

2. As the government has no real oversight over bailout funds, taxpayers remain in the dark about how their money has been used and if it has made any difference.

While the Treasury Department can make TARP recipients report on just how they spend their government bailout funds, it has chosen not to do so. As a result, it's unclear whether institutions receiving such funds are using that money to increase lending--which would, in turn, boost the economy--or merely to fill in holes in their balance sheets.

Neil M. Barofsky, the special inspector general for TARP, summed the situation up this way in his office's April quarterly report to Congress: "The American people have a right to know how their tax dollars are being used, particularly as billions of dollars are going to institutions for which banking is certainly not part of the institution's core business and may be little more than a way to gain access to the low-cost capital provided under TARP."

This lack of transparency makes the bailout process highly susceptible to fraud and corruption. Barofsky's report stated that twenty separate criminal investigations were already underway involving corporate fraud, insider trading and public corruption. He also told the Financial Times that his office was investigating whether banks manipulated their books to secure bailout funds. "I hope we don't find a single bank that's cooked its books to try to get money, but I don't think that's going to be the case."

Economist Dean Baker, co-director of the Center for Economic and Policy Research in Washington, suggested to TomDispatch in an interview that the opaque and complicated nature of the bailout may not be entirely unintentional, given the difficulties it raises for anyone wanting to follow the trail of taxpayer dollars from the government to the banks. "[Government officials] see this all as a Three Card Monte, moving everything around really quickly so the public won't understand that this really is an elaborate way to subsidize the banks," Baker says, adding that the public "won't realize we gave money away to some of the richest people."

3. The bailout's newer programs heavily favor the private sector, giving investors an opportunity to earn lucrative profits and leaving taxpayers with most of the risk.

Under Treasury Secretary Geithner, the Treasury Department has greatly expanded the financial bailout to troubling new programs like the Public-Private Investment Program (PPIP) and the Term Asset-Backed-Securities Loan Facility (TALF). The PPIP, for example, encourages private investors to buy "toxic" or risky assets on the books of struggling banks. Doing so, we're told, will get banks lending again because the burdensome assets won't weigh them down. Unfortunately, the incentives the Treasury Department is offering to get private investors to participate are so generous that the government--and, by extension, American taxpayers--are left with all the downside.

Joseph Stiglitz, the Nobel-prize winning economist, described the PPIP program in a New York Times op-ed this way:

Consider an asset that has a 50-50 chance of being worth either zero or $200 in a year's time. The average "value" of the asset is $100. Ignoring interest, this is what the asset would sell for in a competitive market. It is what the asset is 'worth.' Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership!

Assume that one of the public-private partnerships the Treasury has promised to create is willing to pay $150 for the asset. That's 50 percent more than its true value, and the bank is more than happy to sell. So the private partner puts up $12, and the government supplies the rest--$12 in "equity" plus $126 in the form of a guaranteed loan.

If, in a year's time, it turns out that the true value of the asset is zero, the private partner loses the $12, and the government loses $138. If the true value is $200, the government and the private partner split the $74 that's left over after paying back the $126 loan. In that rosy scenario, the private partner more than triples his $12 investment. But the taxpayer, having risked $138, gains a mere $37."

Worse still, the PPIP can be easily manipulated for private gain. As economist Jeffrey Sachs has described it, a bank with worthless toxic assets on its books could actually set up its own public-private fund to bid on those assets. Since no true bidder would pay for a worthless asset, the bank's public-private fund would win the bid, essentially using government money for the purchase. All the public-private fund would then have to do is quietly declare bankruptcy and disappear, leaving the bank to make off with the government money it received. With the PPIP deals set to begin in the coming months, time will tell whether private investors actually take advantage of the program's flaws in this fashion.

The Treasury Department's TALF program offers equally enticing possibilities for potential bailout profiteers, providing investors with a chance to double, triple or even quadruple their investments. And like the PPIP, if the deal goes bad, taxpayers absorb most of the losses. "It beats any financing that the private sector could ever come up with," a Wall Street trader commented in a recent Fortune magazine story. "I almost want to say it is irresponsible."

4. The government has no coherent plan for returning failing financial institutions to profitability and maximizing returns on taxpayers' investments.

Compare the treatment of the auto industry and the financial sector, and a troubling double standard emerges. As a condition for taking bailout aid, the government required Chrysler and General Motors to present detailed plans on how the companies would return to profitability. Yet the Treasury Department attached minimal conditions to the billions injected into the largest bailed-out financial institutions. Moreover, neither Geithner nor Lawrence Summers, one of President Barack Obama's top economic advisors, nor the president himself has articulated any substantive plan or vision for how the bailout will help these institutions recover and, hopefully, maximize taxpayers' investment returns.

The Congressional Oversight Panel highlighted the absence of such a comprehensive plan in its January report. Three months into the bailout, the Treasury Department "has not yet explained its strategy," the report stated. "Treasury has identified its goals and announced its programs, but it has not yet explained how the programs chosen constitute a coherent plan to achieve those goals."

Today, the department's endgame for the bailout still remains vague. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, wrote in the Financial Times in May that the government's response to the financial meltdown has been "ad hoc, resulting in inequitable outcomes among firms, creditors, and investors." Rather than perpetually prop up banks with endless taxpayer funds, Hoenig suggests, the government should allow banks to fail. Only then, he believes, can crippled financial institutions and systems be fixed. "Because we still have far to go in this crisis, there remains time to define a clear process for resolving large institutional failure. Without one, the consequences will involve a series of short-term events and far more uncertainty for the global economy in the long run."

The healthier and more profitable bailout recipients are once financial markets rebound, the more taxpayers will earn on their investments. Without a plan, however, banks may limp back to viability while taxpayers lose their investments or even absorb further losses.

5. The bailout's focus on Wall Street mega-banks ignores smaller banks serving millions of American taxpayers that face an equally uncertain future.

The government may not have a long-term strategy for its trillion-dollar bailout, but its guiding principle, however misguided, is clear: what's good for Wall Street will be best for the rest of the country.

On the day the mega-bank stress tests were officially released, another set of stress-test results came out to much less fanfare. In its quarterly report on the health of individual banks and the banking industry as a whole, Institutional Risk Analytics (IRA), a respected financial services organization, found that the stress levels among more than 7,500 FDIC-reporting banks nationwide had risen dramatically. For 1,575 of the banks, net incomes had turned negative due to decreased lending and less risk-taking.

The conclusion IRA drew was telling: "Our overall observation is that US policy makers may very well have been distracted by focusing on 19 large stress test banks designed to save Wall Street and the world's central bank bondholders, this while a trend is emerging of a going concern viability crash taking shape under the radar." The report concluded with a question: "Has the time come to shift the policy focus away from the things that we love, namely big zombie banks, to tackle things that are truly hurting us?"

6. The bailout encourages the very behaviors that created the economic crisis in the first place instead of overhauling our broken financial system and helping the individuals most affected by the crisis.

As Joseph Stiglitz explained in the New York Times, one major cause of the economic crisis was bank overleveraging. "Using relatively little capital of their own," he wrote, banks "borrowed heavily to buy extremely risky real estate assets. In the process, they used overly complex instruments like collateralized debt obligations." Financial institutions engaged in overleveraging in pursuit of the lucrative profits such deals promised--even if those profits came with staggering levels of risk.

Sound familiar? It should, because in the PPIP and TALF bailout programs the Treasury Department has essentially replicated the very over-leveraged, risky, complex system that got us into this mess in the first place: in other words, the government hopes to repair our financial system by using the flawed practices that caused this crisis.

Then there are the institutions deemed "too big to fail." These financial giants--among them AIG, Citigroup and Bank of America-- have been kept afloat by billions of dollars in bottomless bailout aid. Yet reinforcing the notion that any institution is "too big to fail" is dangerous to the economy. When a company like AIG grows so large that it becomes "too big to fail," the risk it carries is systemic, meaning failure could drag down the entire economy. The government should force "too big to fail" institutions to slim down to a safer, more modest size; instead, the Treasury Department continues to subsidize these financial giants, reinforcing their place in our economy.

Of even greater concern is the message the bailout sends to banks and lenders--namely, that the risky investments that crippled the economy are fair game in the future. After all, if banks fail and teeter at the edge of collapse, the government promises to be there with a taxpayer-funded, potentially profitable safety net.

The handling of the bailout makes at least one thing clear, however. It's not your health that the government is focused on, it's theirs-- the very banks and lenders whose convoluted financial systems provided the underpinnings for staggering salaries and bonuses, while bringing our economy to the brink of another Great Depression.

Bob Jensen's threads on why the infamous "Bailout" won't work --- http://www.trinity.edu/rjensen/2008Bailout.htm#BailoutStupidity

"IT'S THE HOUSE THAT RUTH LOST MRS. MADOFF SUFFERS $UITE REVENGE," by Bruce Golding, The New York Post, June 27, 2009 ---
http://www.nypost.com/seven/06272009/news/regionalnews/its_the_house_that_ruth_lost_176389.htm

Ruth Madoff agreed yesterday to give up her deluxe apartment on the Upper East Side as part of a massive surrender of more than $80 million in cash and property to cover a bit of the billions looted by her Ponzi-scheming hubby, Bernie.

Under terms of the deal, the former jet-setters will have to cough up a treasure trove of loot, including more than $46 million in securities and $13 million in cash that Ruth formerly claimed wasn't tainted by her husband's crimes.

The Madoffs will also have to fork over the couple's $7 million beachfront home in Montauk, LI, a $7.5 million property in Palm Beach, Fla., tens of millions in loans to family members and a 55-foot yacht named "Bull."

Federal prosecutors are letting the Ponzi king's wife hold on to only $2.5 million they couldn't tie directly to his $65 billion mega-fraud.

But the agreement -- inked just three days before Madoff faces sentencing of up to 150 years in prison -- offers his wife no protection from collection efforts by other government agencies or other parties, including the bankruptcy trustees seeking funds for his many wiped-out investors.

Court papers don't indicate how soon Ruth will have to scoot from her $7.5 million penthouse, but the feds say they plan "to distribute, as soon as practicable, the net proceeds from the sale . . . to victims of the offenses of which [Bernard] Madoff was convicted."

The US Marshals Service, which will handle the sale of the East 64th Street duplex, will also "facilitate the expeditious disposition of the personal property" inside.

Those goodies include a $65,000 set of silverware and a $39,000 Steinway piano, court papers say.

Ruth initially balked at surrendering her pricey pad after the feds began the forfeiture proceedings following Bernard's guilty plea in March.

The massive transfer of booty as part of the judgment is only a drop in the bucket of the $171 billion judgment entered against Bernie, covering every nickel that passed through his crooked investment-advisory business.

In other court papers filed yesterday, prosecutors urged Judge Denny Chin to sentence Bernie Monday to the maximum 150 years in prison.

"The scope, duration and nature of Madoff's crimes render him exceptionally deserving of the maximum punishment allowed by law," prosecutors Marc Litt and Lisa Baroni said.

As an alternative, they suggested "a term of years that . . . would assure that Madoff will remain in prison for life."

The feds also attacked arguments made earlier this week by defense lawyer Ira Lee Sorkin, who said Madoff, 71, should get a 12-year term based on his life expectancy of only 13 more years.

Such a short sentence, the prosecutors said, "would not distinguish this case from the mine run of securities-fraud cases that in this district regularly result in sentences of 10 to 15 years."

By comparison, they noted that his scheme -- which caused at least $13 billion in actual losses -- greatly exceeded the crimes of other white-collar crooks, including WorldCom's Bernard Ebbers, who got 25 years, and hedge-fund scammer Samuel Israel III, who got 20.

Jensen Comment
Meanwhile Bernie himself is pleading for 12 years or less in prison, which averages out to one year or less for every $5 billion that he stole. He probably has a billion or two hidden away for those "massages" he can sneak in when Ruth's back is turned.

Bob Jensen's threads on securities fraud are at http://www.trinity.edu/rjensen/FraudRotten.htm

Admissions Scandal at the University of Illinois
Newly released e-mail messages may mark a new low in the admissions scandal that just keeps growing at the University of Illinois. The Chicago Tribune reported that the e-mails show that the chancellor of the university's Urbana-Champaign campus, Richard Herman, pressured the law school to let in an applicant favored by the then-governor, Rod Blagojevich, in return for having the governor get jobs for five law graduates with less than stellar academic records. An e-mail from Herman to the then-dean of the law school, Heidi Hurd, who was apparently balking at admitting the applicant, said that the request came "straight from the G. My apologies. Larry has promised to work on jobs (5). What counts?" Hurd's response, which suggested why the university might need to take special steps to get these students jobs: "Only very high-paying jobs in law firms that are absolutely indifferent to whether the five have passed their law school classes or the Bar." The Tribune noted that law school rankings are based in part on job placement success, so a law school would have reason to worry if even poor academic performers couldn't get jobs. University officials declined to respond to the e-mails, telling the Tribune that their first response should be to a special state panel investigating admissions at the university.
Inside Higher Ed, June 26, 2009 --- http://www.insidehighered.com/news/2009/06/26/qt#202107

How to blow a whistle!

June 14, 2009 message from XXXXX

Mr. Jensen:

  I know you are retired so I hope this email is not an imposition.

 I have been dealing with an accounting fraud for years. Can’t get SEC or PCAOB to act.  Do you have any suggestions?  I do have a Civil RICO filed but it like fighting city hall.  The defendants have all the money.

 Regards,

XXXXX

June 18, 2009 reply from Bob Jensen

Hi XXXXX

This is a tough question that comes to me quite often. Much depends upon the nature of the crime or other fraud when you are trying to whistleblow a fraud.

A white collar crime blog edited by some law professors --- http://lawprofessors.typepad.com/whitecollarcrime_blog/ 

How to report cybercrime (including Internet crime) --- http://www.usdoj.gov/criminal/cybercrime/

One link is to a listing of where you can file Internet complaints ---
http://www.consumerwebwatch.org/consumer-center.cfm

Organizations and government agencies featured in this section are listed alphabetically.

Better Business Bureau Online
The Better Business Bureau Online, the electronic arm of the Better Business Bureau, offers consumers the opportunity to file a complaint against e-commerce sites as well as offline businesses. The Better Business Bureau was founded in 1912 and seeks to create a more fair marketplace through consumer education and voluntary self-regulation on the part of companies.
http://www.bbbonline.org/consumer/complaint.asp

Consumer Sentinel
Consumer Sentinel is a complaint database designed to provide law enforcement agencies with information on Internet cons, telemarketing scams and other consumer fraud-related complaints. The database, which is maintained by the Federal Trade Commission, is available to 40 federal law enforcement organizations, more than 200 state and local fraud-fighting agencies, and every state attorney general in the United States. You may register a complaint here.
http://www.consumer.gov/sentinel/index.html

econsumer.gov
This international site, launched by a coalition of 13 nations, registers cross-border e-commerce complaints and offers tips for safe shopping online. It utilizes the Consumer Sentinel's network of Internet fraud complaint data and shares it in several languages with consumer protection law enforcers in countries that belong to the International Marketing Supervision Network.
http://www.econsumer.gov

Internet Fraud Complaint Center
The Internet Fraud Complaint Center enables consumers to log online fraud complaints. The center is the result of a partnership between the FBI and the National White Collar Crime Center (NW3C), a nationwide support network for enforcement agencies involved in the prevention, investigation, and prosecution of economic and high-tech crime. NW3C is funded through a grant from the Bureau of Justice Assistance, Office of Justice Programs, and the U.S. Department of Justice.
http://www1.ifccfbi.gov/index.asp

National Fraud Information Center
The National Fraud Information Center (NFIC) was established in 1992 by the National Consumers League and continues to be funded by the organization. NFIC offers an online form for consumers who are interested in registering an Internet fraud complaint.
http://www.fraud.org/

State Attorneys General
Contact your state attorney general if you feel you have been a victim of consumer fraud on the Web. Consult individual state sites for telephone or electronic contact information for filing complaints. U.S. Securities and Exchange Commission The U.S. Securities and Exchange Commission offers tips on avoiding Internet fraud when investing, and a mechanism to register Internet fraud or spam complaints for investigation.
http://www.naag.org/ag/full_ag_table.php

U.S. Securities and Exchange Commission
The U.S. Securities and Exchange Commission offers tips on avoiding Internet fraud when investing, and a mechanism to register Internet fraud or spam complaints for investigation.
http://www.sec.gov/complaint.shtml

Corporate Fraud Reporting

§  Bob Jensen's Links http://www.trinity.edu/rjensen/FraudReporting.htm 

§  FBI Corporate Fraud Hotline (Toll Free) 888-622-0177
FBI  http://www.fbi.gov/

§  Commodity Futures Trading Commission   http://www.sec.gov/answers/cftc.htm

§  Defense Criminal Investigative Service  http://www.dodig.osd.mil/INV/DCIS/

§  Department of Labor  http://www.dol.gov/

§  Federal Energy Regulatory Commission  http://www.ferc.gov/

§  Internal Revenue Service  http://www.irs.gov/

§  National Association of Securities Dealers  http://www.nasd.com/

§  Postal Inspection Service  http://www.usps.com/postalinspectors/

§  Securities and Exchange Commission  http://www.sec.gov/

If the SEC ignored the Bernie Madoff $65 billion Ponzi fraud for six years, you probably cannot expect much from the SEC.

My threads on crime and fraud reporting are at
http://www.trinity.edu/rjensen/FraudReporting.htm#ThingsToKnow

Russian Credit Card Fraud:  800,000 Preauthorization Checks Per Month

"An Odyssey of Fraud," by Brian Krebs, The Washington Post, June 18, 2009 --- http://voices.washingtonpost.com/securityfix/2009/06/an_odyssey_of_fraud.html?wprss=securityfix

Andy Kordopatis is the proprietor of Odyssey Bar, a modest watering hole in Pocatello, Idaho, a few blocks away from Idaho State University. Most of his customers pay for their drinks with cash, but about three times a day he receives a phone call from someone he's never served -- in most cases someone who's never even been to Idaho -- asking why their credit or debit card has been charged a small amount by his establishment.

Kordopatis says he can usually tell what's coming next when the caller immediately asks to speak with the manager or owner.

"That's when I start telling them that I know why they're calling, and about the Russian hackers who are using my business," Kordopatis said.

The Odyssey Bar is but one of dozens of small establishments throughout the United States seemingly picked at random by organized cyber criminals to serve as unwitting pawns in a high-stakes game of chess against the U.S. financial system. This daily pattern of phone calls and complaints has been going on for more than a year now. Kordopatis said he has talked to the company that processes his bar's credit card payments about fixing the problem, but says they can't do anything because he hasn't actually lost any money from the scam.

The Odyssey Bar's merchant account is being abused by online services that cyber thieves built to help other crooks check the balances and limits on stolen credit and debit card account numbers. In April, I wrote about a pet store in Buffalo, N.Y., whose merchant account was being similarly abused by another card-checking service. In that story, I cited research on this trend by Lawrence Baldwin, a security consultant in Alpharetta, Ga., who has been working with several financial institutions to help infiltrate illegal card-checking services:

The services are advertised on Internet forums that facilitate identity theft, and cater to criminals who wish to buy large numbers of stolen credit and debit cards. Using such services, the would-be buyers can quickly verify whether a random sampling of the cards is still active, and -- for an additional fee -- the available balance on each card. In most cases, the only barrier to new customers signing up at these services is the ability to speak and read Russian, and the ability to pay with one of several virtual currencies, such as Webmoney.

Baldwin estimates that at least 25,000 credit and debit cards are checked each day at three separate illegal card-checking Web sites he is monitoring. That translates to about 800,000 cards per month or nearly 10 million cards each year.

Baldwin said the checker sites take advantage of authentication weaknesses in the card processing system that allow merchants to conduct so-called "pre-authorization requests," which merchants use to place a temporary charge on the account to make sure that the cardholder has sufficient funds to pay for the promised goods or services.

Pre-authorization requests are quite common. When a waiter at a restaurant swipes a customer's card and brings the receipt to the table so the customer can add a tip, for example, that initial charge is essentially a pre-authorization.

With these card-checking services, however, in most cases the charge initiated by the pre-authorization check is never consummated. As a result, unless a consumer is monitoring their accounts online in real-time, they may never notice a pre-authorization initiated by a card-checking site against their card number, because that query won't show up as a charge on the customer's monthly statement.

In fact, in most cases when banks are alerted to the card-checking activity, it is because a credit card customer is regularly checking their online statement or has signed up with their bank to receive e-mail alerts each time a charge is initiated against their account.

The crooks have designed their card-checking sites so that each check is submitted into the card processing network using a legitimate, hijacked merchant account number combined with a completely unrelated merchant name, Baldwin discovered.

On June 11, Kordopatis heard from Keri Tetlow, a mother of three from the suburbs of Houston. Tetlow, who watches her family's debit account balance like a hawk from their home computer, said she called Odyssey Bar because she noticed a $2.77 charge from the establishment. Tetlow said that after checking with her husband to make sure he hadn't made the charge, she decided to wait and see if the pending charge would clear. It never did.

But a few days later, Tetlow spotted $300 missing from her checking account, which she noticed was due to two unauthorized charges at a Office Depot on Broadway in New York City. So she called her bank. After confirming neither she nor her husband had lost their debit card, she told the bank to cancel the card.

Continued in article

Bob Jensen's threads on identity theft are at
http://www.trinity.edu/rjensen/FraudReporting.htm#IdentityTheft

PBS Video on Multinational Illegal Payments
FRONTLINE: Black Money --- http://www.pbs.org/wgbh/pages/frontline/blackmoney/

Old geezer gang (all in walkers) 'tortures adviser' who lost their $4 million
A group of wealthy pensioners has been accused of kidnapping and torturing a financial adviser who lost about $4 million of their savings. The pensioners, nicknamed the "Geritol Gang" by German police after an arthritis drug, face up to 15 years in jail if found guilty of subjecting German-American James Amburn to the alleged four-day ordeal.
Sydney Morning Herald, June 24, 2009 --- Click Here

The Worldcom fraud accompanied by one of the largest bankruptcies is characterized by what, in my viewpoint, was the worst audit in the history of the world that contributed, along with Enron, to the implosion of the historic Arthur Andersen accounting firm.

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

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

June 15, 2009 message from Dennis Beresford [dberesfo@TERRY.UGA.EDU]

I apologize if this is something that has already been mentioned but I just became aware of a very interesting video of former WorldCom Controller David Meyers at Baylor University last March - http://www.baylortv.com/streaming/001496/300kbps_str.asx 

The first 20 minutes is his presentation, which is pretty good - but the last 45 minutes or so of Q&A is the best part. It is something that would be very worthwhile to show to almost any auditing or similar class as a warning to those about to enter the accounting profession.

Denny Beresford

Jensen Comment on Some Things You Can Learn from the Video
David Meyers became a convicted felon largely because he did not say no when his supervisor (Scott Sullivan, CFO)  asked him to commit illegal and fraudulent accounting entries that he, Meyers, knew were wrong. Interestingly, Andersen actually lost the audit midstream to KPMG, but KPMG hired the same same audit team that had been working on the audit while employed by Andersen. David Myers still feels great guilt over how much he hurt investors. The implication is that these auditors were careless in a very sloppy audit but were duped by Worldcom executives rather than be an actual part of the fraud. In my opinion, however, that the carelessness was beyond the pale --- this was really, really, really bad auditing and accounting.

At the time he did wrong, he rationalized that he was doing good by shielding Worldcom from bankruptcy and protecting employees, shareholders, and creditors. However, what he and other criminals at Worldcom did was eventually make matters worse. He did not anticipate this, however, when he was covering up the accounting fraud. He could've spent 65 years in prison, but eventually only served ten months in prison because he cooperated in convicting his bosses. In fact, all he did after the fact is tell the truth to prosecutors. His CEO, Bernard Ebbers, got 25 years and is still in prison.

The audit team while with Andersen and KPMG relied too much on analytical review and too little on substantive testing and did not detect basic accounting errors from Auditing 101 (largely regarding capitalization of over $1 billion expenses that under any reasonable test should have been expensed).

Meyers feels that if Sarbanes-Oxley had been in place it may have deterred the fraud. It also would've greatly increased the audit revenues so that Andersen/KPMG could've done a better job.

To Meyers' credit, he did not exercise his $17 million in stock options because he felt that he should not personally benefit from the fraud that he was a part of while it was taking place. However, he did participate in the fraud to keep his job (and salary). He also felt compelled to follow orders the CFO that he knew was wrong.

The hero is detecting the fraud was Worldcom's internal auditor Cynthia Cooper who subsequently wrote the book:
Extraordinary Circumstances: The Journey of a Corporate Whistleblower (Hoboken, New Jersey: John Wiley & Sons, Inc.. ISBN 978-0-470-12429) http://www.amazon.com/gp/reader/0470124296/ref=sib_dp_pt#

Meyers does note that the whistleblower, Cooper, is now a hero to the world, but when she blew the whistle she was despised by virtually everybody at Worldcom. This is a price often paid by whistleblowers --- http://www.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

Bob Jensen's threads on the Worldcom fraud are at http://www.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud

"Kmart officials as purposely violating accounting principles with the knowledge of the company's auditors, PricewaterhouseCoopers."

"Jury in Michigan Sides with SEC in Kmart Case," SmartPros, June 1, 2009 ---
http://accounting.smartpros.com/x66692.xml

The former head of Kmart Corp., who told jurors he was hired to save the venerable retailer, was found liable Monday for misleading investors about company finances before a bankruptcy filing in 2002.

The verdict in the civil fraud trial followed 10 days of testimony in federal court in Ann Arbor. The case was a fresh look at Charles Conaway's brief tenure and the desperate scramble to keep Kmart afloat before one of the largest bankruptcies in retail history.

The Securities and Exchange Commission accused him of failing to disclose that the retailer was delaying payments to suppliers to save cash. The trial centered on a conference call with analysts and Kmart's quarterly report to regulators, both in November 2001.

"It was a clean sweep," SEC trial lawyer Alan Lieberman said of the verdict.

"It is never enough for the numbers to be right. For the average investor, the numbers being right do not tell the whole story," he said. "They need to know the material information that management knows. The foundation of the markets is full and honest disclosure."

The SEC blamed Conaway for not sharing details in the report's management-analysis section. He testified that he didn't write it, didn't read it and relied on his chief financial officer and others.

During a call with Wall Street analysts, Conaway said sales were poor - and the stock took a 15 percent hit - but he didn't talk about the vendor strategy or an ill-timed purchase of $800 million in merchandise.

He testified that Kmart had $1 billion in cash and credit when the call was made and the quarterly report was filed. Conaway said it "never" crossed his mind that he was withholding critical news.

The jury, however, found that he acted "with intent to defraud or with reckless disregard for the truth."

Despite Conaway's testimony, the jury found that delaying payments to vendors was a "material liquidity deficiency" affecting Kmart's finances and should have been publicly reported.

Conaway's lawyer, Scott Lassar, said they were disappointed with the verdict and would pursue an appeal.

U.S. Magistrate Judge Steven Pepe will handle the penalty phase. Conaway, 48, could be fined and banned from serving as an executive or director at a public company.

He had a successful career in the drugstore industry when he agreed in 2000 to try to turn around Kmart, which was no match for discount rivals Wal-Mart Stores Inc. and Target Corp. Conaway was gone less than two years later.

Kmart emerged from Chapter 11 bankruptcy as a smaller company and now is part of Sears Holdings Corp., based in Hoffman Estates, Ill.

The lawsuit against Conaway and his former CFO, John McDonald Jr., was filed in 2005, three years after the bankruptcy.

Ronald Kiima, formerly an assistant chief accountant at the SEC, said when a company fails "there's a lot of `What did you know and when did you know it?'"

"If you don't give the sausage-making of what happened during a quarter, that could be an issue," Kiima said in an interview. "For a CEO to say he didn't lay eyes on the report is pretty damning."

Continued in article

Jensen Comment
Discount retailer Kmart came under investigation for irregular accounting practices in 2002. In January an anonymous letter initiated an internal probe of the company's accounting practices. The Detroit News obtained a copy of the letter that contains allegations pointing to senior Kmart officials as purposely violating accounting principles with the knowledge of the company's auditors, PricewaterhouseCoopers. http://www.accountingweb.com/item/82286 

Bankrupt retailer Kmart explained the impact of accounting irregularities and said employees involved in questionable accounting practices are no longer with the company. http://www.accountingweb.com/item/90935 

Kmart's CFO Steps up to Accounting Questions

 
AccountingWEB US - Sep-19-2002 -  Bankrupt retailer Kmart explained the impact of accounting irregularities in a Form 10-Q filed with the U.S. Securities and Exchange Commission (SEC) this week. Chief Financial Officer Al Koch said several employees involved in questionable accounting practices are no longer with the company.

Speaking to the concerns about vendor allowances recently raised in anonymous letters from in-house accountants, Mr. Koch said, "It was not hugely widespread, but neither was it one or two people."

The Kmart whistleblowers who wrote the letters said they were being asked to record transactions in obvious violation of generally accepted accounting principles. They also said "resident auditors from PricewaterhouseCoopers are hesitant to pursue these issues or even question obvious changes in revenue and expense patterns."

In response to the letters, the company admitted it had erroneously accounted for certain vendor transactions as up-front consideration, instead of deferring appropriate amounts and recognizing them over the life of the contract. It also said it decided to change its accounting method. Starting with fourth quarter 2001, Kmart's policy is to recognize a cost recovery from vendors only when a formal agreement has been obtained and the underlying activity has been performed.

According to this week's Form 10-Q, early recognition of vendor allowances resulted in understatement of the company's fiscal year 2000 net loss by approximately $26 million and overstatement of its fiscal year 2001 net loss by approximately $78 million, both net of taxes. The 10-Q also said the company has been looking at historical patterns of markdowns and markdown reserves and their relation to earnings.

Kmart is under investigation by the SEC and the Justice Department. The Federal Bureau of Investigation, which is handling the investigation for the U.S. Attorney, said its investigation could result in criminal charges. In the months before Kmart's bankruptcy filing, top executives took home approximately $29 million in retention loans and severance packages. A spokesperson for PwC said the firm is cooperating with the investigations.
 

Bob Jensen's threads on the KMart auditing firm, PwC, are at http://www.trinity.edu/rjensen/fraud001.htm#PwC

BDO Seidman:  Good News and the Bad News

Y PATRICK DANNER
pdanner@MiamiHerald.com
640 words
17 June 2009
The Miami Herald
A1
3
English
(c) Copyright 2009, The Miami Herald. All Rights Reserved.

BDO International is not liable for $351 million in punitive damages that a Miami jury awarded a Portuguese bank in 2007, a Miami-Dade Circuit judge has ruled.

Banco Espirito Santo was awarded $170 million for its losses and $351 million in punitive damages for the negligence of accounting firm BDO Seidman. The reason: BDO failed to uncover fraud at a now-defunct financial services firm in which the bank held a stake. Still left to be decided is whether BDO International is on the hook for the $170 million award, too.

TRIAL UNDER WAY

In a trial now under way in Miami-Dade Circuit, Banco Espirito Santo had wanted a new jury to hold BDO International responsible for the 2007 award, as well. The bank alleged BDO International was grossly negligent in failing to ensure Chicago-based BDO Seidman performed proper audits of factoring firm E.S. Bankest.

Belgium-based BDO International was part of the earlier trial, but was dismissed from the case after a judge found the bank presented no evidence establishing its claim against BDO International. An appeals court disagreed and ordered that a jury must decide whether BDO International was responsible for ensuring the quality of BDO Seidman's audits.

 

Article continues

QUESTION FOR JURY

Still left for the jury to decide is whether BDO International should be responsible for the $170 million in losses sustained by the bank because of the fraud. The bank alleges BDO International is liable for the verdict because BDO Seidman is an agent of BDO International. BDO Seidman has appealed the verdict.

On Tuesday, BDO International completed the presentation of its case. Closing arguments in the trial, which started two weeks ago, may happen on Wednesday.

Document MHLD000020090617e56h0000o

From The Wall Street Journal Accounting Weekly Review on June 18, 2009

In BDO Case, 7 Charged with Fraud
by Chad Bray
The Wall Street Journal
Jun 10, 2009
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB124458292771699471.html?mod=djem_jiewr_AC

TOPICS: Ethics, Public Accounting, Public Accounting Firms, Tax Evasion, Tax Shelters, Taxation

SUMMARY: "Seven people including the former chief executive and chairman of accounting firm BDO Seidman LLP have been charged criminally in an allegedly fraudulent tax-shelter scheme that generated billions of dollars in false tax losses for clients." The remaining six include three former Jenkens & Gilchrist PC lawyers--one of which is Paul Daugerdas, former head of the law firm's Chicago office who joined the firm bringing in the revenue from these tax-structured transactions--and two former investment-bank employees. The investment bank wasn't named in the indictment but "a person familiar with the matter" said it was Deutsche Bank AG.

CLASSROOM APPLICATION: Ethics, including the need to stand up against others' unethical actions, can be discussed with this article.

QUESTIONS: 
1. (Introductory) What is tax evasion? Differentiate it from tax avoidance.

2. (Advanced) What types of firms have been charged in this "27-count federal indictment, which includes charges of conspiracy and tax evasion"? How must these types of firms work together to structure tax-beneficial transactions?

3. (Introductory) Refer to the related articles. Summarize the description of the types of transactions questioned by the IRS and leading to the indictment.

4. (Advanced) Are there ways in which structured transactions can be legitimate tax shelters? What are some general requirements that must be met for a transaction to be considered legitimate?

5. (Introductory) Refer again to the related articles. What were the Jenkens & Gilchrist partners' concerns about the risk of the transactions and services structured and sold by the Chicago office partner Mr. Daugerdas? What factors did they allow to override their concerns?

6. (Introductory) Place yourself in the position of partner in the law firm of Jenkens & Gilchrist. Consider the issues discussed at the board meetings in offering a position to Mr. Daugerdas and in dealing with the beginning lawsuits from clients facing IRS scrutiny. How would you react in each of these meetings?

7. (Advanced) What is the affiliation of the accounting firm BDO Seidman in these transactions? How could the accounting firm and its partner be held responsible for a transaction designed by another firm--a law firm, not an accounting firm, at that?

Reviewed By: Judy Beckman, University of Rhode Island

RELATED ARTICLES: 
How A Bid to Boost Profits Led to a Law Firm's Demise
by Nathan Koppel
May 17, 2007
Online Exclusive

Gone But Not Forgotten: Jenkens Gilchrist Trio Indicted for Tax Fraud
by Ashby Jones
Jun 09, 2009
Online Exclusive

"Former BDO Seidman vice chair pleads guilty to tax fraud," AccountingWeb, March 20, 2009 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=107235 

Adrian Dicker, a United Kingdom chartered accountant and former vice chairman and board member at a major international accounting firm, has pleaded guilty to conspiring with certain tax shelter promoters to defraud the United States in connection with tax shelter transactions involving clients of the accounting firm and the law firm Jenkens & Gilchrist (J&G), the Justice Department and Internal Revenue Service (IRS) announced. In the hearing before U.S. Magistrate Judge Theodore H. Katz in the Southern District of New York, Dicker, who is a resident of Princeton Junction, NJ, also pleaded guilty to tax evasion in connection with a multi-million dollar tax shelter that Dicker helped sell to a client of the accounting firm.

According to the information and the guilty plea, between 1995 and 2000, Dicker was a partner in the New York office of the accounting firm which he identified during his guilty plea as BDO Seidman. From early 1999 through October 2000, Dicker was on the firm's Board of Directors, and through October 2003 he served as a retired partner director. From 1998 until 2000, Dicker was one of the leaders of the firm's "Tax Solutions Group" (TSG), a group led by the firm's chief executive officer, Dicker, and another New York-based tax partner. The activities of the TSG were devoted to designing, marketing, and implementing high-fee tax strategies for wealthy clients, including tax shelter transactions.

According to the information and the guilty plea, Dicker and the other two TSG managers used a bonus structure that handsomely rewarded the accounting firm personnel involved in the design, marketing, and implementation of the TSG's transactions, including: the individual who referred the client to TSG personnel; the TSG member who pitched and closed the sale; other TSG members; and TSG management. From July 1999, Dicker, the CEO, and the other TSG manager earned and shared equally 30 percent of the net profits of the TSG. Dicker earned approximately $6.7 million in net TSG profits, as well as salary and bonuses between 1998 and 2000. In addition, the CEO of the firm doled out additional bonuses from the profits earned as a result of the sale of the tax shelter products. Moreover, the firm made the sale of the tax shelter products a focal point of its aggressive "value added" product promotion activities, using a "Tax $ells" logo and other marketing hype to induce employees to generate additional tax shelter sales.

According to the information and the guilty plea, while serving as a manager of the TSG, Dicker, along with other TSG partners, engaged in the design, marketing, and implementation of two different tax shelter transactions with the Chicago office of the law firm of Jenkens & Gilchrist, as well as an international bank with its U.S. headquarters in New York. As a member of TSG and the accounting firm's tax opinion committee - which reviewed the tax opinions issued in connection with tax shelter transactions sold by the accounting firm and J&G - Dicker knew that the tax shelter transactions he helped vet and sell would be respected and allowed by the IRS only if the client had a substantial non-tax business purpose for entering the transaction, and the client had a reasonable possibility of making a profit through the transaction. Dicker and his co-conspirators knew and understood that the clients entering into the tax shelter transactions being marketed and sold with J&G had neither a substantial non-tax business purpose nor a reasonable possibility of earning a profit, given the large amount of fees being charged by the accounting firm and J&G to enter the transaction. Those fees were set by the co-conspirators as a percentage of the tax loss being sought by the tax shelter clients. Dicker also knew that the clients who purchased the tax shelter had no non-tax business reasons for entering into the transactions and their pre-planned steps.

According to the information and the guilty plea, in order to make it appear that the tax shelter clients of Dicker, other TSG members, and J&G had the requisite business purpose and possibility of profit, Dicker and his co-conspirators reviewed and approved the use of a legal opinion letter issued by J&G that contained false and fraudulent representations purportedly made by the clients about their motivations for entering into the transactions. In addition, Dicker and his co-conspirators created and used, or approved of the creation and use of, other documents in the transactions that were false, fraudulent, and misleading in order to paint a picture for the IRS that was patently untrue - that is, that the clients had a legitimate non-tax business purpose for entering the transaction and executing the preplanned steps of the transaction. Dicker also admitted during his plea that TSG members created and placed into client files certain paperwork that falsely conveyed fabricated business purposes and rationales for clients entering into the shelters. The false paperwork was created to mislead and defraud the IRS.

Continued in article

Bob Jensen's threads on accounting firms are at
http://www.trinity.edu/rjensen/Fraud001.htm

 

When Private Equity Owners Screw Their Bankers
The sad part is that Wachovia did not require independent audits
Now there are no deep pocket auditors to sue

Wachovia, for instance, provided tens of millions of dollars in loans and lines of credit backed by assets to Archway despite the fact the company had not had a formal independent audit of its financial statements in three years. A spokeswoman for Wells Fargo, which acquired Wachovia last year, declined comment.
"Oh, No! What Happened to Archway?" by Julie Creswell, The New York Times, May 30, 2009 --- http://www.nytimes.com/2009/05/31/business/31archway.html?_r=1

SITTING in his office late one evening in April last year, Keith Roberts, the director of finance for the Archway & Mother’s Cookie Company, stared in shocked silence at the numbers on his desk.

He knew things had been bad — daily reports he had been monitoring for six months showed that cookie sales at the company had been dismal. But the financial data he was looking at showed much more robust sales.

“Where on earth had all of these sales come from?” Mr. Roberts recalls thinking to himself.

Tired, but intrigued, he began digging through orders and shipping and inventory records until, well after midnight, he reached the conclusion that Archway, based in Battle Creek, Mich., was booking nonexistent sales.

He reasoned that sham transactions allowed Archway, which was owned by a private-equity firm, Catterton Partners, to maintain access to badly needed money from its lender, Wachovia. Mr. Roberts’s investigation eventually caused Wachovia to pull its financing lines, helping to push Archway into bankruptcy last fall. Two other food companies picked off much of its assets earlier this year for $42 million and are churning out the brands’ cookies again.

As accounting scandals go, Archway is no Enron. Not in the size of the possible accounting fraud itself — sales were probably overstated by a few million dollars — or in its sophistication or ingenuity. Yet what court documents filed in Delaware describe as a fairly simplistic fraud went on for months, seemingly missed by the company’s lenders as well as its savvy, private-equity stewards.

And Archway’s collapse is a reminder of the apparent lengths to which some of the nation’s biggest banks went to do deals with private-equity firms during the recent buyout boom.

Wachovia, for instance, provided tens of millions of dollars in loans and lines of credit backed by assets to Archway despite the fact the company had not had a formal independent audit of its financial statements in three years. A spokeswoman for Wells Fargo, which acquired Wachovia last year, declined comment.

Archway’s failure also raises questions about how some private-equity shops operate. When they acquire broken companies, the firms pledge to use their financial, strategic and operational expertise to fix them. The firms receive management fees from their portfolio companies while also charging investors — large institutions and pension funds — fees for managing their money.

Although Catterton placed three of its partners on Archway’s board, naming one as vice chairman, it hired a management company, Insight Holdings, to handle day-to-day operations at Archway. Several former executives and employees who worked at Archway’s headquarters say Insight conducted most of its oversight of the company via telephone and videoconferences.

The Catterton partners, these former employees say, were never seen at Archway. Catterton and Insight nonetheless collected about $6 million in management fees and compensation during their nearly four-year tenure running Archway, court documents assert.

In an e-mailed statement, a spokeswoman for Catterton said the firm did make on-site visits to Archway and stopped receiving fees in October 2007. In total, she said, Catterton received only $2.75 million in fees, half of which was distributed to its investors.

A multitude of lawsuits have been filed in connection with Archway’s collapse, including suits brought by former employees as well as independent distributors. In one suit filed earlier this year in Delaware bankruptcy court, a committee of unsecured creditors contends that the alleged accounting fraud continued for as long as it did because of the “control, participation and acquiescence” of Catterton.

Continued in article

Bob Jensen's threads on the credit crisis are at http://www.trinity.edu/rjensen/2008Bailout.htm

"PCAOB Rips E&Y on Revenue Recognition:  Two of Ernst & Young's clients had to restate financial results after the accounting-firm overseer found departures from GAAP," by Sarah Johnson, CFO.com, May 27, 2009 --- http://www.cfo.com/article.cfm/13725058/c_13725042 

Ernst & Young failed to note when two clients strayed from revenue-recognition rules, according to the latest inspection report on the Big Four firm by the Public Company Accounting Oversight Board. Consequently, the regulator's sixth annual inspection of E&Y resulted in those clients having to restate their previously issued financial statements to make up for the departure from U.S. generally accepted accounting principles.

These companies — whose identity the PCAOB keeps confidential — had "failed" to fully follow FAS 48, Revenue Recognition When Right of Return Exists. The rule calls on companies to, at the time of sale, make reasonable estimates of how many products that customers will return as a factor in deciding when revenue can be recorded.

Further criticizing the audit firm for its work on a third client, the PCAOB claims E&Y didn't test the issuer's VSOE, or vendor-specific objective evidence, which is used to figure out whether the amount of revenue recognized for individual parts of a technology contract was reasonable.

The PCAOB noted the revenue recognition audit deficiencies mentioned here, as well as several others at eight of E&Y's clients after reviewing the firm's work between April and December of last year. The deficiencies were linked to the firm's national office in New York and 22 of its 85 U.S. offices. These errors were significant enough for the oversight board to conclude the firm "had not obtained sufficient competent evidential matter to support its opinion on the issuer's financial statements or internal control over financial reporting."

The PCAOB also criticized E&Y for not fully exploring a client's revenue contracts to see how their terms could affect the issuer's revenue recognition, for not doing enough work to assess the valuation of another issuer's securities, and for relying on information an issuer had deemed unreliable for estimating an income-tax valuation allowance.

To be sure, eight clients may not be many in terms of the number of audits looked at by the oversight board, or when taking into account that E&Y audits more than 2,300 publicly traded companies. The PCAOB, however, doesn't specify how many audits it reviewed and discourages readers of its inspection reports from drawing conclusion on a firm's performance based solely on the number of the reported deficiencies mentioned. "Board inspection reports are not intended to serve as balanced report cards or overall rating tools," the PCAOB notes.

For its part, E&Y, in all but two of the deficiencies cited, revisited its work and made changes. "Although we do not always agree with the characterization in the report ... in some instances we did agree to perform certain additional procedures or improve aspects of our audit documentation," E&Y wrote in a letter dated May 4, that was included in the PCAOB report.

Read the PCAOB report at http://www.pcaobus.org/Inspections/Public_Reports/2009/Ernst_Young.pdf
Part 1 of the report is partially quoted below:

Firm (Ernst & Young)  failed to identify a material weakness in the issuer's internal controls over the accounting for sales returns.

Issuer B
In this audit, the Firm failed to identify a departure from GAAP that it should have identified and addressed before issuing its audit report. The issuer failed to appropriately account for estimated future product returns at the time of sale in accordance with SFAS No. 48.

Issuer C
 In this audit, there was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had identified certain terms and conditions contained in the issuer's revenue contracts and evaluated their effect on the issuer's ability to report revenue on a gross basis. Further, there was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had identified and evaluated certain other terms and conditions included in these contracts, such as multiple products and deliverables, acceptance clauses, guarantees of cost savings, and volume rebates, that may have affected the issuer's revenue recognition.

Issuer D
During the fourth quarter, the issuer recorded three individually significant adjustments to correct misstatements in its income tax balances. Two of these misstatements related to prior years. The third related to the issuer's first quarter adoption of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"). The issuer corrected all three misstatements, which netted to an insignificant amount, by adjusting the current year's income tax expense. The Firm concluded that two of the adjustments should have been recorded as corrections of prior years' errors and the third adjustment should have been recorded as a charge to retained earnings as of the beginning of the year under audit. The Firm also concluded that the net effect of the misstatements was not material to either the current year's or the prior year's financial statements.

In evaluating the net effect of the misstatements, the Firm failed to sufficiently quantify and evaluate one of the misstatements, which related to the income tax valuation allowance. The Firm's analysis both excluded a significant tax asset and relied on information that the issuer had deemed to be unreliable for the purpose of estimating the income tax valuation allowance because the use of the information by the issuer in the past had produced results that were not accurate. Further, the Firm did not evaluate the effect of this misstatement on prior years because it assumed that all amounts related solely to the preceding year, despite evidence to the contrary. Finally, concerning one of the other misstatements, the Firm failed to evaluate the materiality of the FIN 48 adjustment, which represented almost 75 percent of the initial FIN 48 liability recorded in the first quarter, against the cumulative effect of the accounting change.

Issuer E
In this audit, the Firm failed in the following respects to obtain sufficient competent evidential matter to support its audit opinion –

  • • The Firm failed to perform sufficient procedures to assess the valuation of certain securities. Specifically, there was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had sufficiently evaluated whether certain of the assumptions underlying the issuer's valuation of the securities were reasonable, and not inconsistent with information that would be used by other market participants to value these types of securities. While the Firm obtained certain historical information, the Firm did not analyze how this historical information provided evidence on the reasonableness of the issuer's assumptions.
     
  • The Firm failed to perform sufficient procedures to assess the valuation of certain of the issuer's loans in the following respects – o To determine the values of certain loans, the issuer used prices from certain recent transactions. There was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had evaluated whether the loans being valued were of comparable quality to the loans included in the transactions.
     
    • For other loans, the Firm developed an independent estimate of the value. The Firm's independent estimate was not appropriately supported, as it was based on the incorrect premise that the transactions to which the Firm looked for certain of the inputs were comparable to transactions that would involve the loans being valued

Issuer F
With respect to a significant portion of the issuer's revenue, the Firm failed to test the issuer's vendor-specific objective evidence of the value of deliverables offered in multiple-element arrangements in order to determine whether the amount of revenue that was recognized for individual elements was reasonable. Further, regarding revenue cut-off, the Firm noted that, in the year under audit and the preceding year, revenue significantly increased during the final month of each quarter and at year end. Nonetheless, other than obtaining a list of all contracts, including any changes made to existing contracts, the Firm's substantive procedures to test sales cut-off were limited to analytical procedures that failed to provide the necessary level of assurance because the Firm did not establish expectations for the procedures. Issuer G In this audit, in evaluating the issuer's reserve analysis for two impaired loans, the Firm failed to perform procedures, beyond management inquiries, to evaluate the appropriateness of the methods and the reasonableness of the assumptions that the issuer and certain specialists engaged by the issuer used in estimating the fair value of certain assets that collateralized the loans. Issuer H The issuer amortized certain of its intangible assets on a straight-line basis over the estimated useful lives of the assets. The Firm failed to evaluate whether the issuer's use of the straight-line basis was appropriate given evidence that the economic benefit of the intangible assets was expected not to be consumed at the same rate throughout the assets' lives.

In addition to evaluating the quality of the audit work performed on specific audits, the inspection included review of certain of the Firm's practices, policies, and processes related to audit quality. This review addressed practices, policies, and procedures concerning audit performance and the following five areas (1) management structure and processes, including the tone at the top; (2) practices for partner management, including allocation of partner resources and partner evaluation, compensation, admission, and disciplinary actions; (3) policies and procedures for considering and addressing the risks involved in accepting and retaining clients, including the application of the Firm's risk-rating system; (4) processes related to the Firm's use of audit work that the Firm's foreign affiliates perform on the foreign operations of the Firm's U.S. issuer audit clients; and (5) the Firm's processes for monitoring audit performance, including processes for identifying and assessing indicators of deficiencies in audit performance and processes for responding to weaknesses in quality control. Any defects in, or criticisms of, the Firm's quality control system are discussed in the nonpublic portion of this report and will remain nonpublic unless the Firm fails to address them to the Board's satisfaction within 12 months of the date of this report.

End of Part 1

Bob Jensen's threads on Ernst & Young are at
http://www.trinity.edu/rjensen/fraud001.htm#Ernst

Bob Jensen's threads on independence and professionalism in auditing are at
http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

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

KPMG Should Be Tougher on Testing, PCAOB Finds The Big Four audit firm was cited for not ramping up its tests of some clients' assumptions and internal controls.
KPMG did not show enough skepticism toward clients last year, according to the Public Company Accounting Oversight Board, which cited the Big Four accounting firm for deficiencies related to audits it performed on nine companies. The deficiencies were detailed in an inspection report released this week by the PCAOB that covered KPMG's 2008 audit season. The shortcomings focused mostly on a lack of proper evidence provided by KPMG to support its audit opinions on pension plans and securities valuations. But in some instances, the firm was cited for weak testing of internal controls over financial reporting and the application of generally accepted accounting principles.
Marie Leone, CFO.com, June 19, 2009 ---
http://www.cfo.com/article.cfm/13888653/c_2984368/?f=archives

In one instance, the audit lacked evidence about whether the pension plans contained subprime assets. In another case, the PCAOB noted, the audit firm didn't collect enough supporting material to gain an understanding of how the trustee gauged the fair values of the assets when no quoted market prices were available.

The PCAOB, which inspects the largest public accounting firms on an annual basis, also found that three other KPMG audits were shy an appropriate amount of internal controls testing related to loan-loss allowances, securities valuations, and financing receivables.

In one audit, KPMG accepted its client's data on non-performing loans without determining whether the information was "supportable and appropriate." In another case, KPMG "failed to perform sufficient audit procedures" with regard to the valuation of hard-to-price financial instruments.

In still another case, the PCAOB found that KPMG "failed to identify" that a client's revised accounting of an outsourcing deal was not in compliance with GAAP because some of the deferred costs failed to meet the definition of an asset - and the costs did not represent a probably future economic benefit for the client.

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

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

 

From The Wall Street Journal Accounting Weekly Review on April 23, 2009

Report Faults World Bank's Anti-Fraud Methods
 by Bob Davis
Apr 17, 2009
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB123992586755527389.html?mod=djem_jiewr_AC

TOPICS: Auditing, Auditing Services, Internal Auditing, Internal Controls

SUMMARY: The World Bank's Independent Evaluation Group produced a report in fall 2008, which cited the bank's fraud-detection procedures in its main program providing aid to poor countries as a material weakness. This $40 billion program is called the International Development Association (IDA). "[World] Bank staffers said that the IDA program faces particularly difficult challenges because corruption is often a problem in especially poor countries....Generally, the IDA received good marks and the results 'should overall be considered a quite respectable outcome,' the report said."

CLASSROOM APPLICATION: The application of internal control procedures, and their independent testing, outside of corporations can be an eye-opener for students.

QUESTIONS: 
1. (Introductory) What is the World Bank?

2. (Introductory) Who issued a report on the internal controls in place in World Bank programs? Why was this review of internal controls undertaken?

3. (Advanced) Describe a corporate function similar to the group that undertook the review described in answer to question 2 above.

4. (Advanced) Which World Bank program has been found to have material weaknesses in control systems? What system has been found as a material weakness?

5. (Advanced) Define the terms "material weakness" and "significant deficiency" in relation to audits of corporate internal control systems.

6. (Advanced) Do you think that the meaning of these terms in the report on World Bank programs is the same as the definitions you have provided? Why or why not?

Reviewed By: Judy Beckman, University of Rhode Island

 

"Report Faults World Bank's Anti-Fraud Methods," by Bob Davis, The Wall Street Journal, April 17, 2009 ---
http://online.wsj.com/article/SB123992586755527389.html?mod=djem_jiewr_AC

The World Bank's fraud-detection procedures in its main aid program to poor countries were labeled a "material weakness" in an internal report, adding to the bank's woes in handling corruption issues.

The bank's Independent Evaluation Group gave it the lowest possible rating for fraud-detection procedures in the $40 billion aid program, called the International Development Association. That could hurt contributions to the effort, which gives grants and interest-free loans to the world's 78 poorest countries.

The 690-page report, the first for the program, was completed last fall. Since then it has been the subject of lengthy discussions between World Bank management and the independent evaluation unit over whether the single designation of "material weakness," the lowest of four ratings, was justified. None of the program's other marks were as low; six other areas were labeled "significant deficiencies."

"The bank's traditional control systems weren't designed to address fraud and corruption," one of the report's authors, Ian Hume, said in an interview. "They were designed for efficiency and equity -- the cheapest possible price." That increases the risk that corruption could occur in the use of IDA grants, he said.

The World Bank has been pilloried by critics for years for not taking corruption seriously enough, and some staffers worried that the report's publication was being delayed for political reasons. The U.S., in particular, pushed for its publication, said bank staffers.

"We have had a tough but cordial interaction with [World Bank] management along the way," said Cheryl Gray, director of the evaluation group.

The report was published on the unit's Web site late Wednesday, but not publicized. Its presence was noted by a small icon on the bottom right of the page. Ms. Gray says that the group didn't intend to bury the report and said the unit didn't put out a press release because the report was "technical and jargony." After an inquiry from The Wall Street Journal, it was given greater prominence on the Web site. Ms. Gray said she had planned to make the change anyway.

The report concluded that the World Bank "has until recently had few if any specific tools" to directly address fraud and corruption "at all stages in the lending cycle." An advisory panel that backed the "material weakness" designation wrote that fraud and corruption issues "involve a considerable reputation risk, involving at least a potential loss of confidence by various stakeholders."

The Obama administration recently asked Congress to approve a three-year, $3.7 billion contribution to the bank's IDA program. A Democratic congressional staffer said it was too early to tell whether the report would make passage more difficult. Overall, the World Bank won commitments in December 2007 for $41.6 billion in funding for IDA over three years.

Bank staffers said that the IDA program faces particularly difficult challenges because corruption is often a problem in especially poor countries. "We operate in some of the most difficult and challenging environments in the world," Fayez Choudhury, the World Bank's controller, said in an interview. "We are always looking to up our game."

The bank's management pressed to get the fraud-and-corruption designation improved by a notch to "significant deficiency." It argued that the evaluation group didn't take into account steps it had taken over the past year to improve its controls.

"The bank is firmly committed to mainstreaming governance and anticorruption efforts into its development work," said a management statement. It listed a number of improvements including the creation of an independent advisory board. The bank said it is trying to better integrate fraud prevention and corruption prevention generally into its operations.

The report doesn't examine cases of actual corruption, though it notes there have been several instances that have received publicity, including health-clinic contracts in India. Rather, it looks at the systems and procedures in place to identify and prevent corruption.

The report uses standards similar to those applied to corporate controls. Generally, the IDA received good marks and the results "should overall be considered a quite respectable outcome," the report said.

For decades, the World Bank largely ignored corruption, figuring that some graft was the price of doing business in poor countries. Starting in 1996, however, former World Bank President James Wolfensohn focused more attention on the issue, as did his successor, Paul Wolfowitz, who held up loans to some poor countries because of concerns about corruption. That led to charges that the bank was enforcing corruption rules selectively.

After Mr. Wolfowitz came under fire earlier for showing favoritism to his girlfriend, a bank employee, some developing nations dismissed the bank's efforts as hypocritical. Mr. Wolfowitz resigned in 2007 and the World Bank's current president, Robert Zoellick , has been trying to depoliticize the corruption issue, especially by beefing up the Department of Institutional Integrity, the main antifraud unit at the bank.

Reviews of other institutions have also turned up designations of "material weakness." A U.S. Treasury "accountability report" for the year ended Sept. 30, 2008, for instance, found four such designations, including three involving the Internal Revenue Service's modernization, computer security and accounting, and one involving government-wide financial statements.

Bob Jensen's threads on World Bank Fraud are at http://www.trinity.edu/rjensen/FraudRotten.htm#WorldBank

"Time to count the cost of failure:  Accounting firms are trying to shield themselves from the consequences of the financial crisis despite being partly to blame." by Prem Sikka, The Guardian, May 21, 2009 ---
http://www.guardian.co.uk/commentisfree/2009/may/21/accounting-financial-crisis

Will large auditing firms survive their professional failures and suspected non-independence prior to the bank failures and other corporate bankruptcies? The spate of shareholder and creditor lawsuits have already commenced and some of the claims are enormous ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Auditors

A class-action lawsuit, settled earlier this week, says the audit firm should have considered the homebuilder's "make the numbers" culture to be a red flag as the housing market tanked.

"Deloitte to Pay $1M in Beazer Suit," by Sarah Johnson, CFO.com, May 7, 2009 --- http://www.cfo.com/article.cfm/13612963/c_2984368/?f=archives

Deloitte & Touche has agreed to pay investors of Beazer Homes USA nearly $1 million to settle claims the firm should have noticed the homebuilder was issuing inaccurate financial statements as the housing market began to decline earlier this decade.

The audit firm, Beazer, and former Beazer executives have settled the class-action lawsuit for a total of $30.5 million, pending approval by the U.S. District Court for the Northern District of Georgia. Deloitte is scheduled to pay $950,000.

The investors had accused Beazer of managing earnings, recognizing revenue earlier than allowed under generally accepted accounting principles, improperly accounting for sales/leaseback transactions, creating "cookie jar" reserves, and not recording land and goodwill impairment charges at the proper time.

For example, according to the allegations, Beazer conducted house closings on homes that weren't move-in ready to push up the date the company could record the revenue from the sales and backdated documents of home sales so that they could be recorded in earlier financial reporting periods. Under FAS 66, Accounting for Sales of Real Estate, the seller recognizes its profit only after a sale is completed.

In a complaint filed nearly two years ago, the plaintiffs said that because of Beazer's culture to "make the numbers" during a time when housing sales had significantly slowed, the company's employees were dealing with unrealistic budgets and pressure to hit financial goals or risk losing their jobs — and that Deloitte should have noticed these issues existed and planned its audit accordingly.

The investors accused Deloitte of turning "a blind eye" to the myriad of "red flags" that should have alerted the firm to potential GAAP violations. These warning signs included the "excessive pressure" employees were under to meet their higher-ups' sales goals, tight competition in Beazer's market, and weak internal controls. Accusing the auditor of "severe recklessness," the shareholders alleged, for example, that Deloitte should have noticed that Beazer was likely overdue in recording impairments on their land assets, as the real estate market began to decline, among other the other alleged accounting violations.

"Deloitte either knowingly ignored or recklessly disregarded Beazer's wide-ranging material control deficiencies and material weaknesses during the class period," according to the shareholders' complaint. "For example, Deloitte was specifically aware that financial periods were regularly held open or re-opened because it had access to Beazer's detailed financial and accounting information via, among other means, access to Beazer's JD Edwards software."

In an educational brochure on public-company accounting released yesterday, the Center for Audit Quality, the trade group for audit firms, said auditors consider potential areas of misconduct for a particular company when deciding what areas of a business to review. However, the CAQ cautioned, "because auditors do not examine every transaction and event, there is no guarantee that all ma­terial misstatements, whether caused by error or fraud, will be detected."

In the Beazer settlement, none of the defendants has admitted wrongdoing. "Deloitte denies all liability and settled to avoid the expense and uncertainty of continued litigation," a spokeswoman told CFO.com.

For its part, Beazer says its insurance provider will pay for the settlement, meaning "there will be no financial contribution by the company." By settling, the firm added, "the uncertainties, distractions, burden and further expense associated with this litigation" have been eliminated.

The suit's plaintiffs include institutional investor Glickenhaus & Co., Northern California Carpenters Pension Fund, and other pension funds. Shareholders holding Beazer stock between January 2005 and May 2008 would benefit from the settlement.

Last year, Beazer restated several years' worth of financial statements to fix many of the same issues mentioned in the class-action suit. An internal investigation into its mortgage-origination business also resulted in the firing of its chief accounting officer who was accused of violating the company's ethics policy by trying to destroy company documents.

Beazer settled a related case with the U.S. Securities and Exchange Commission without paying any penalty. It is still under investigation by the U.S. Attorney's Office in North Carolina, according to its most recent 10-K.

Bob Jensen's threads on Deloitte are at http://www.trinity.edu/rjensen/fraud001.htm#Deloitte

Before reading this May 4, 2009 article you may want to read some introductory modules about Overstock.com at
http://en.wikipedia.org/wiki/Overstock.com

"Overstock.com and PricewaterhouseCoopers: Errors in Submissions to SEC Division of Corporation Finance," White Collar Fraud, May 19, 2008 --- http://whitecollarfraud.blogspot.com/2008/05/overstockcom-and-pricewaterhousecoopers.html

"To Grant Thornton, New Auditors for Overstock.com," White Collar Fraud, March 30, 2009 --- http://whitecollarfraud.blogspot.com/2009/03/to-grant-thornton-new-auditors-for.html

"Overstock.com's First Quarter Financial Performance Aided by GAAP Violations,"  White Collar Fraud, May 4, 2009 ---
http://whitecollarfraud.blogspot.com/2009/05/overstockcoms-first-quarter-financial.html

Overstock.com (NASDAQ: OSTK) and its management team led by its CEO and masquerading stock market reformer Patrick Byrne (pictured on right) continued its pattern of false and misleading disclosures and departures from Generally Accepted Accounting Principles (GAAP) in its latest Q1 2009 financial report.

In Q1 2009, Overstock.com reported a net loss of $2.1 million compared to $4.7 million in Q1 2008 and claimed an earnings improvement of $2.6 million. However, the company's reported $2.6 reduction in net losses was aided by a violation of GAAP (described in more detail below) that reduced losses by $1.9 million and buybacks of Senior Notes issued in 2004 under false pretenses that reduced losses by another $1.9 million.

After the issuance of the Senior Notes in November 2004, Overstock.com has twice restated financial reports for Q1 2003 to Q3 2004 (the accounting periods immediately preceding the issuance of such notes) because of reported accounting errors and material weaknesses in internal controls.

While new CFO Steve Chestnut hyped that "It's been a great Q1," the reality is that Overstock.com’s reported losses actually widened by $1.2 million after considering violations of GAAP ($1.9 million) and buying back notes issued under false pretenses ($1.9 million).

How Overstock.com improperly reported of an accounting error and created a “cookie jar reserve” to manage future earnings by improperly deferring recognition of an income

Before we begin, let’s review certain events starting in January 2008.

In January 2008, the Securities and Exchange Commission discovered that Overstock.com's revenue accounting failed to comply with GAAP and SEC disclosure rules, from the company's inception. This blog detailed how the company provided the SEC with a flawed and misleading materiality analysis to convince them that its revenue accounting error was not material. The company wanted to avoid a restatement of prior affected financial reports arising from intentional revenue accounting errors uncovered by the SEC.

Instead, the company used a one-time cumulative adjustment in its Q4 2007 financial report, apparently to hide the material impact of such errors on previous affected individual financial reports. In Q4 2007, Overstock.com reduced revenues by $13.7 million and increased net losses by $2.1 million resulting from the one-time cumulative adjustment to correct its revenue accounting errors.

Q3 2008

On October 24, 2008, Overstock.com's Q3 2008 press release disclosed new customer refund and credit errors and the company warned investors that all previous financial reports issued from 2003 to Q2 2008 “should no longer be relied upon.” This time, Overstock.com restated all financial reports dating back to 2003. In addition, Overstock.com reversed its one-time cumulative adjustment in Q4 2007 used to correct its revenue accounting errors and also restated all financial statements to correct those errors, as I previously recommended.

The company reported that the combined amount of revenue accounting errors and customer refund and credit accounting errors resulted in a cumulative reduction in previously reported revenues of $12.9 million and an increase in accumulated losses of $10.3 million.

Q4 2008

On January 30, 2009, Overstock.com reported a $1 million profit and $.04 earnings per share for Q4 2008, after 15 consecutive quarterly losses and it beat mean analysts’ consensus expectations of negative $0.04 earnings per share. CEO Patrick Byrne gloated, "After a tough three years, returning to GAAP profitability is a relief." However, Overstock.com's press release failed to disclose that its $1 million reported profit resulted from a one-time gain of $1.8 million relating to payments received from fulfillment partners for amounts previously underbilled them.

During the earnings call that followed the press release, CFO Steve Chesnut finally revealed to investors that:

Gross profit dollars were $43.6 million, a 6% decrease. This included a one-time gain of $1.8 million relating to payments from partners who were under-billed earlier in the year.

Before Q3 2008, Overstock.com failed to bill its fulfillment partners for offsetting cost reimbursements and fees resulting from its customer refund and credit errors. After discovering foul up, Overstock.com improperly corrected the billing errors by recognizing income in future periods when such amounts were recovered or on a cash basis (non-GAAP).

In a blog post, I explained why Statement of Financial Accounting Standards No. 154 required Overstock.com to restate affected prior period financial reports to reflect when the underbilled cost reimbursements and fees were actually earned by the company (accrual basis or GAAP). In other words, Overstock.com should have corrected prior financial reports to accurately reflect when the income was earned from fulfillment partners who were previously underbilled for cost reimbursements and fees.

If Overstock.com properly followed accounting rules, it would have reported an $800,000 loss instead of a $1 million profit, it would have reported sixteen consecutive losses instead of 15 consecutive losses, and it would have failed to meet mean analysts’ consensus expectation for earnings per share (anyone of three materiality yardsticks under SEC Staff Accounting Bulletin No. 99 that would have triggered a restatement of prior year’s effected financial reports).

Patrick Byrne responds on a stock market chat board

In my next blog post, I described how CEO Patrick M. Byrne tried to explain away Overstock.com’s treatment of the “one-time gain” in an unsigned post, using an alias, on an internet stock market chat board. Byrne’s chat board post was later removed and re-posted with his name attached to it, after I complained to the SEC. Here is what Patrick Byrne told readers on the chat board:

Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about.

For example: when one discovers that one underpaid some suppliers $1 million and overpaid others $1 million. For those whom one underpaid, one immediately recognizes a $1 million liability, and cleans it up by paying. For those one overpaid, one does not immediately book an asset of a $1 million receivable: instead, one books that as the monies flow in. Simple conservatism demands this (If we went to book the asset the moment we found it, how much should we book? The whole $1 million? An estimate of the portion of it we think we'll be able to collect?) The result is asymmetric treatment. Yet Antar is screaming his head off about this, while never once addressing this simple principle. Of course, if we had booked the found asset the moment we found it, he would have screamed his head off about that. Behind everything this guy writes, there is a gross obfuscation like this. His purpose is just to get as much noise out there as he can.

Note: Bold print and italics added by me.

In other words, Overstock.com improperly used cash basis accounting (non-GAAP) rather than accrual basis accounting (GAAP) to correct its accounting error. I criticized Byrne’s response noting that:

… Overstock.com recognized the "one-time of $1.8 million" using cash-basis accounting when it "received payments from partners who were under-billed earlier in the year" instead of accrual basis accounting, which requires income to be recognized when earned. A public company is not permitted to correct any accounting error using cash-basis accounting.

Overstock.com tries to justify improper cash basis accounting in Q4 2008 to correct an accounting error

Overstock.com needed to justify Patrick Byrne’s stock chat board ramblings. About two weeks later, Overstock.com filed its fiscal year 2008 10-K report with the SEC and the company concocted a new excuse to justify using cash basis accounting to correct its accounting error and avoid restating prior affected financial reports:

In addition, during Q4 2008, we reduced Cost of Goods Sold by $1.8 million for billing recoveries from partners who were underbilled earlier in the year for certain fees and charges that they were contractually obligated to pay. When the underbilling was originally discovered, we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency. Accordingly, we determined that the appropriate accounting treatment for the potential recoveries was to record their benefit only when such amounts became realizable (i.e., an agreement had been reached with the partner and the partner had the wherewithal to pay).

Note: Bold print and italics added by me.

Overstock.com improperly claimed that a "gain contingency" existed by using the rationale that the collection of all "underbilled...fees and charges...was not assured....”

Why Overstock.com's accounting for underbilled "fees and charges" violated GAAP

Overstock.com already earned those "fees and charges" and its fulfillment partners were "contractually obligated to pay" such underbilled amounts. There was no question that Overstock.com was owed money from its fulfillment partners and that such income was earned in prior periods.

If there was any question as to the recovery of any amounts owed the company, management should have made a reasonable estimate of uncollectible amounts (loss contingency) and booked an appropriate reserve against amounts due from fulfillment partners to reduce accrued income (See SFAS No. 5 paragraph 1, 2, 8, 22, and 23). It didn’t. Instead, Overstock.com claimed that the all amounts due the company from underbilling its fulfillment partners was "not assured" and improperly called such potential recoveries a "gain contingency" (SFAS No. 5 paragraph 1, 2, and 17).

The only way that Overstock.com could recognize income from underbilling its fulfillment partners in future accounting periods is if there was a “significant uncertainty as to collection” of all underbilled amounts (See SFAS No. 5 paragraph 23)

As it turns out, a large portion of the underbilled amounts to fulfillment partners was easily recoverable within a brief period of time. In fact, within 68 days of announcing underbilling errors, the company already collected a total of “$1.8 million relating to payments from partners who were underbilled earlier in the year.” Therefore, Overstock.com cannot claim that there was a "significant uncertainty as to collection" or that recovery was "not assured."

No gain contingency existed. Overstock.com already earned "fees and charges" from underbilled fulfillment partners in prior periods. Rather, a loss contingency existed for a reasonably estimated amount of uncollectible "fees and charges." Overstock.com should have restated prior affected financial reports to properly reflect income earned from fulfillment partners instead of reflecting such income when amounts were collected in future quarters. Management should have made a reasonable estimate for unrecoverable amounts and booked an appropriate reserve against "fees and charges" owed to it (See SFAS No. 5 Paragraph 22 and 23).

Therefore, Overstock.com overstated its customer refund and credit accounting error by failing to accrue fees and charges due from its fulfillment partners as income in the appropriate accounting periods, less a reasonable reserve for unrecoverable amounts. By deferring recognition of income until underbilled amounts were collected, the company effectively created a "cookie jar" reserve to increase future earnings.

In addition, Overstock.com failed to disclose any potential “gain contingency” in its Q3 2008 10-Q report, when it disclosed that it underbilled its fulfillment partners (See SFAS No. 5 Paragraph 17b). Apparently, Overstock.com used a backdated rationale for using cash basis accounting to correct its accounting error in response to my blog posts (here and here) detailing its violation of GAAP.

PricewaterhouseCoopers warns against using "conservatism to manage future earnings"

As I detailed above, Patrick Byrne claimed on an internet chat board that “conservatism demands" waiting until "monies flow in" from under-billed fulfillment partners to recognize income, after such an error is discovered by the company. However, a document from PricewaterhouseCoopers (Overstock.com’s auditors thru 2008) web site cautions against using “conservatism” to manage future earnings by deferring gains to future accounting periods:

SFAS No. 5 Technical Notes cautions about using “conservatism” to manage future earnings by deferring gains to future accounting periods:

"Conservatism...should no[t] connote deliberate, consistent understatement of net assets and profits." Emphasis added] CON 5 describes realization in terms of recognition criteria for revenues and gains, as:"Revenue and gains generally are not recognized until realized or realizable... when products (goods or services), merchandise or other assets are exchanged for cash or claims to cash...[and] when related assets received or held are readily convertible to known amounts of cash or claims to cash....Revenues are not recognized until earned ...when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues." Almost invariably, gain contingencies do not meet these revenue recognition criteria.

Note: Bold print and italics added by me.

Overstock.com "substantially accomplished what it must do to be entitled to the benefits represented by the revenues" since the fulfillment partners were "contractually obligated" to pay underbilled amounts. Those underbilled "fees and charges" were "realizable" as evidenced by the fact that the company already collected a total of “$1.8 million relating to payments from partners who were underbilled earlier in the year" within a mere 68 days of announcing its billing errors.

If we follow guidance by Overstock.com's fiscal year 2008 auditors, the amounts due from underbilling fulfillment partners cannot be considered a gain contingency, as claimed by the company. PricewaterhouseCoopers was subsequently terminated as Overstock.com's auditors and replaced by Grant Thornton.

Q1 2009

In Q1 2009, even more amounts from underbilling fulfillment partners were recovered. In addition, the company disclosed a new accounting error by failing to book a “refund due of overbillings by a freight carrier for charges from Q4 2008.” See quote from 10-Q report below:

In the first quarter of 2009, we reduced total cost of goods sold by $1.9 million for billing recoveries from partners who were underbilled in 2008 for certain fees and charges that they were contractually obligated to pay, and a refund due of overbillings by a freight carrier for charges from the fourth quarter of 2008. When the underbilling and overbillings were originally discovered, we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency. Accordingly, we determined that the appropriate accounting treatment for the potential recoveries was to record their benefit only when such amounts became realizable (i.e., an agreement had been reached with the other party and the other party had the wherewithal to pay).

Note: Bold print and italics added by me.

Overstock.com continued to improperly recognize deferred income from previously underbilling fulfillment partners. The new auditors, Grant Thornton, would be wise to review Overstock.com's accounting treatment of billing errors and recommend that its clients restate affected financial reports to comply with GAAP. Otherwise, they should not give the company a clean audit opinion for 2009.

Using accounting errors to previous quarters to boost profits in future quarters

Lee Webb from Stockwatch sums up Overstock.com's accounting latest trickery:

… Overstock.com managed to turn a controversial fourth-quarter profit last year after discovering that it had underbilled its fulfillment partners to the tune of $1.8-million earlier in the year. Rather than backing that amount out into the appropriate periods, Overstock.com reported it as one-time gain and reduced the cost of goods sold for the quarter by $1.8-million. That bit of accounting turned what would have been an $800,000 fourth-quarter loss into a $1-million profit.

As it turns out, Overstock.com managed to find some more money that it used to reduce the cost of goods sold for the first quarter of 2009, too.

"In Q1 2009, we reduced total cost of goods sold by $1.9-million for recoveries from partners who were underbilled in 2008 for certain fees and charges that they were contractually obligated to pay and a refund due of overbillings by a freight carrier for charges from Q4 2008," the company disclosed.

"We just keep squeezing the tube of toothpaste thinner and thinner and finding new stuff to come out," Mr. Byrne remarked during the conference call after chief financial officer Steve Chesnut said that the underbilling and overbilling had been found "as part of good corporate diligence and governance."

In addition, Overstock.com managed to record a $1.9-million gain, reported as part of "other income," by extinguishing $4.9-million worth of its senior convertible notes, which it bought back at rather hefty discount. If not for the fortuitous 2008 underbilling recoveries, fourth-quarter overbillings refund and the paper gain from extinguishing some of its debt, Overstock.com would have tallied a first-quarter loss of $5.9-million or approximately 26 cents per share.

So, while Overstock.com did not manage to conjure up a first-quarter profit by using the same accounting abracadabra employed in the fourth quarter, it did succeed in trimming its net loss to $2.1-million.

Bad corporate diligence and governance

During the Q1 2009 earnings conference call, CFO Steve Chesnut boasted about finding accounting errors:

So just as part of good corporate diligence and governance we've found these items.

Note: Bold print and italics added by me.

Actually, it was bad corporate diligence and governance by CEO Patrick Byrne that caused the accounting errors to happen by focusing on a vicious retaliatory smear campaign against critics, while he runs his company into the ground with $267 million in accumulated losses to date and never reporting a profitable year.

Memo to Grant Thornton (Overstock.com's new auditors)

Overstock.com is a company that has not produced a single financial report prior to Q3 2008 in compliance with Generally Accepted Accounting Principles and Securities and Exchange Commission disclosure rules from its inception, without having to later correct them, unless such reports were too old to correct. Two more financial reports (Q4 2008 and Q1 2009) don't comply with GAAP and need to be restated, too.

To be continued in part 2.

In the mean time, please read:

William K. Wolfrum: "Sam E. Antar: From Crazy Eddie to Patrick Byrne's Worst Nightmare."

Gary Weiss: "The Whisper Campaign Against an Overstock.com Whistleblower"

Written by:

Sam E. Antar (former Crazy Eddie CFO and a convicted felon)

Blog Update:

Investigative journalist and author Gary Weiss commented on Overstock.com's history of GAAP violations in his blog:

There are few certainties in this world: gravity, the speed of light, and, more obviously every quarter, the utter unreliability of Overstock.com financial statements.

Acclaimed forensic accountant and author Tracy Coenen notes in her blog:

Don’t laugh too hard at Patrick Byrne’s explanation of the repeated accounting errors and improper treatment of those errors, as reported by Lee Webb of Stockwatch:

“We just keep squeezing the tube of toothpaste thinner and thinner and finding new stuff to come out,” Mr. Byrne remarked during the conference call after chief financial officer Steve Chesnut said that the underbilling and overbilling had been found “as part of good corporate diligence and governance.”

Good corporate diligence and governance? Is this guy for real? How about having an accounting system that prevents errors from occurring every quarter?

Of course, Overstock.com management has to explain away why Sam Antar is finding all these manipulations and irregularities in their financial reporting. They can stalk and harass him all they want, call him a criminal all they want, but there is no explaining it away. The numbers don’t lie. Overstock.com just always counted on no one being as thorough as Sam.

Bob Jensen's threads on PwC auditors can be found at http://www.trinity.edu/rjensen/fraud001.htm

Questions About Addictions to Consultancy
Will "independent" auditing firms ever overcome addictions to consultancy that compromises "independence"?

"This banking inquiry is purely cosmetic:  The pseudo-investigations into the banking crisis are being run by firms with a history of unsavoury financial arrangements," by Prim Sikka, The Guardian, May 5, 2009 ---
http://www.guardian.co.uk/commentisfree/2009/may/05/banking-inquiry-fsa

Nearly two years after the start of the economic crisis and £1.4bn of bailouts, the Treasury select committee has provided a scathing critique of the failures of the banking industry and its regulators (pdf). To obfuscate the issues, the Financial Services Authority (FSA) has already decided on pseudo-investigations, which is unacceptable. For any investigation to command public confidence it needs to be independent, credible, thorough and on the public record. The FSA initiative fails on all counts.

In the absence of any commitment to publish a report and all the material at its disposal, the investigation will be little more than cosmetic. The FSA's regulatory shortcomings are central to the banking crisis. It presided over the development of a shadow banking system and showed no inclination to regulate it. It allowed banks to publish opaque accounts, indulge in tax avoidance schemes and develop dangerous financial products. It allowed banks to run up excessive leverage (pdf) and paid little attention to the adequacy of their capital base. It allowed bank executives to collect huge bonuses for mediocre performance. Its ideology of light regulation curried favour with banking elites and paid little attention to the need to protect citizens and society.

The FSA is seeking help from the "big four" accounting firms – Deloitte, PricewaterhouseCoopers, KPMG and Ernst & Young – for its investigation. This is a tacit admission that it does not have in-house capacity to understand the accounting practices of banks. It could not have diligently monitored the accounting practices of banks either before or since the crisis. By relying on consultants, the FSA is unlikely to build any institutional expertise and thus will not be in a position to efficiently monitor banks now or in the future.

Major accounting firms must be eyeing multimillion pound contracts but have been involved in too many unsavoury episodes to command public trust. Last year, a court in Ireland designated a VAT avoidance scheme designed by accountancy firm Deloitte & Touche as "an abusive practice''. Last month, two former US executives of KPMG were given a prison sentence for their role in facilitating tax evasion. Previously, the firm had admitted "criminal wrongdoing" and paid a fine of $456m (£304m). A former employee of Ernst & Young has pleaded guilty (pdf) to facilitating tax fraud and there are tax fraud trials ongoing of four current and former partners of its US arm. Three former executives of ChuoAoyama PricewaterhouseCoopers, the Japanese arm of PricewaterhouseCoopers, received suspended prison sentences for helping a major client to falsify accounts. These may be exceptional incidents, but what credibility will these firms lend to the FSA's investigations?

Almost all major banks are audited by one of the "big four" accounting firms. They collected millions of pounds in audit and consultancy fees, but none reported any financial problems before the banking crash. There were plenty of warnings. For example, in September 2007, Northern Rock, was relying on government help (pdf) for its survival. In April 2007, New Century Financial, the second largest subprime mortgage provider in the US, filed for bankruptcy protection.

Continued in article

Bob Jensen's threads on independence issues in auditing ---
http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

Questions about whether the Big Four auditors will survive the banking scandals ---
http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

The saga of lawsuits among the large auditing firms ---
http://www.trinity.edu/rjensen/fraud001.htm

Credit Derivative Swap Fraud
"SEC Charges Pair with Insider Trading in Swaps," SmartPros, May 5, 2009 ---
http://accounting.smartpros.com/x66466.xml

The Securities and Exchange Commission on Tuesday charged a securities salesman and a portfolio manager with insider trading in the first such case involving credit default swaps.

The SEC alleges that Jon-Paul Rorech, a salesman at Deutsche Bank Securities Inc., tipped off Renato Negrin, a former portfolio manager at hedge fund investment adviser Millennium Partners LP, about a possible change in terms of a bond being issued by VNU NV, a Dutch publishing company that owns Nielsen Media and other media businesses, in 2006. Deutsche Bank was acting as the lead underwriter of the VNU bond issuance.

With knowledge of the potential change in bond terms, Negrin purchased credit default swaps on VNU for a Millennium hedge fund, according to the SEC complaint. After news of the bond terms was released, Negrin sold the swaps at a profit of $1.2 million, according to the SEC.

Credit default swaps are an insurance-like contract that protects a buyer from potential losses that might be incurred on an underlying financial investment, such as a corporate bond or mortgage-backed security. Many of those types of underlying investments have lost much of their value or increasingly defaulted amid the credit crisis.

If the underlying financial investment is not repaid, the buyer of the swap is covered in full for the losses through the swap.

Credit default swaps have been widely seen as one of the major factors in the credit crisis. The trading of swaps helped push Lehman Brothers Holdings Inc. into bankruptcy protection and American International Group Inc. the to brink of failure before being bailed out by the government.

Richard Strassberg, a lawyer representing Rorech, said in a statement that his client acted "consistently with the accepted practice in the industry." Strassberg said Rorech did not violate any securities laws tied to the sale of the VNU bonds.

A lawyer for Negrin was not immediately available to comment on the case.

The SEC is asking for the judge to force the two to repay the money gained from the transaction, plus penalties and back interest on the allegedly ill-gotten gains.

The SEC's hedge fund working group handled the investigation. The group has brought more than 100 cases alleging fraud and manipulation by hedge funds over the past five years, including more than 20 in 2009.

From Jim Mahar's Blog on May 15, 2009 --- http://financeprofessorblog.blogspot.com/

From NPR: Financial Time's Gillian Tett on JP Morgan and Derivatives
I listened to this on the radio tonight. It was so good, that the very first chance I had to blog it, I did. Good stuff!

Fresh Air from WHYY : NPR:
"Journalist Gillian Tett warned about the problems in the financial industry long before many of her colleagues. In her new book, Fool's Gold, Tett examines the role J.P. Morgan played in creating and marketing risky and complex financial products"

The author is from FT fame and FT has two extracts from the book.

"The first sign that there might be a structural problem with the innovative bundles of credit derivatives that bankers at JP Morgan had dreamed up emerged in the second half of 1998. In the preceding months, Blythe Masters and Bill Demchak – key members of JP Morgan’s credit derivatives team – had been pestering financial regulators. They believed that by using the new credit derivative products they had helped create, JP Morgan could better manage the risks in its portfolio of loans to companies, and thereby reduce the amount of capital it needed to put aside to cover possible defaults. The question was by how much. (Though these bundles of credit derivatives later went under other names, such as collateralised debt obligations [CDOs], at that time these pioneering structures were known as “Bistro” deals, short for Broad Index Secured Trust Offering). Masters and Demchak had done the first couple of Bistro deals on behalf of their own bank without knowing the answer to their question for sure. But when they were doing these deals for other banks, the question of reserve capital became more important – the others were mainly interested in cutting their reserve requirements."

Bob Jensen's threads on the role credit derivatives played in the financial crisis beginning in 2008 ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

Bob Jensen's threads on bank fraud are at
http://www.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking

Bob Jensen's threads on derivative financial instruments fraud ---
http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

We need honest accounting more than ever, not fantasy teases for investors

This is a pretty good article on how players (banks), umpires (regulators), and fans (like billionnaires Stever Forbes and Warren Buffet) have inappropriately blamed the scorekeepers (accounts) for the demise of the big banks. In fact the December 30, 2008 research report calls this attribution of blame just plain wrong (and self-serving).

The wonderful December 30, 2008 research report of the SEC shows that fair value accounting is neither the cause nor the cure for the banking crisis. The liquidity problem of the holders of the toxic investments is caused by trillions of dollars invested in underperforming (often zero performing) of bad investments mortgages or mortgaged-backed bonds that have to be written down unless auditors agree to simply lie about values. That is not likely to happen, but client pressures on auditors to value on the high side for many properties will be heavy handed.
The wonderful full SEC report that bankers and regulators do not want to read can be freely downloaded at http://www.sec.gov/news/studies/2008/marktomarket123008.pdf

"We Need Honest Accounting:  Relax regulatory capital rules if need be, but don't let banks hide the truth," by James A. Chanos, The Wall Street Journal, March 24, 2009 --- http://online.wsj.com/article/SB123785319919419659.html?mod=djemEditorialPage

Mark-to-market (MTM) accounting is under fierce attack by bank CEOs and others who are pressing Congress to suspend, if not repeal, the rules they blame for the current financial crisis. Yet their pleas to bubble-wrap financial statements run counter to increased calls for greater financial-market transparency and ongoing efforts to restore investor trust.

We have a sorry history of the banking industry driving statutory and regulatory changes. Now banks want accounting fixes to mask their recklessness. Meanwhile, there has been no acknowledgment of culpability in what top management in these financial institutions did -- despite warnings -- to help bring about the crisis. Theirs is a record of lax risk management, flawed models, reckless lending, and excessively leveraged investment strategies. In the worst instances, they acted with moral indifference, knowing that what they were doing was flawed, but still willing to pocket the fees and accompanying bonuses.

MTM accounting isn't perfect, but it does provide a compass for investors to figure out what an asset would be worth in today's market if it were sold in an orderly fashion to a willing buyer. Before MTM took effect, the Financial Accounting Standards Board (FASB) produced much evidence to show that valuing financial instruments and other difficult-to-price assets by "historical" costs, or "mark to management," was folly.

The rules now under attack are neither as significant nor as inflexible as critics charge. MTM is generally limited to investments held for trading purposes, and to certain derivatives. For many financial institutions, these investments represent a minority of their total investment portfolio. A recent study by Bloomberg columnist David Reilly of the 12 largest banks in the KBW Bank Index shows that only 29% of the $8.46 trillion in assets are at MTM prices. In General Electric's case, the portion is just 2%.

Why is that so? Most bank assets are in loans, which are held at their original cost using amortization rules, minus a reserve that banks must set aside as a safety cushion for potential future losses.

MTM rules also give banks a choice. MTM accounting is not required for securities held to maturity, but you need to demonstrate a "positive intent and ability" that you will do so. Further, an SEC 2008 report found that "over 90% of investments marked-to-market are valued based on observable inputs."

Financial institutions had no problem in using MTM to benefit from the drop in prices of their own notes and bonds, since the rule also applies to liabilities. And when the value of the securitized loans they held was soaring, they eagerly embraced MTM. Once committed to that accounting discipline, though, they were obligated to continue doing so for the duration of their holding of securities they've marked to market. And one wonders if they are as equally willing to forego MTM for valuing the same illiquid securities in client accounts for margin loans as they are for their proprietary trading accounts?

But these facts haven't stopped the charge forward on Capitol Hill. At a recent hearing, bankers said that MTM forced them to price securities well below their real valuation, making it difficult to purge toxic assets from their books at anything but fire-sale prices. They also justified their attack with claims that loans, mortgages and other securities are now safe or close to safe, ignoring mounting evidence that losses are growing across a greater swath of credit. This makes the timing of the anti-MTM lobbying appear even more suspect. And not all financial firms are calling for loosening MTM standards; Goldman Sachs and others who are standing firm on this issue should be applauded.

According to J.P. Morgan, approximately $450 billion of collateralized debt obligations (CDOs) of asset-backed securities were issued from late 2005 to mid-2007. Of that amount, roughly $305 billion is now in a formal state of default and $102 billion of this amount has already been liquidated. The latest monthly mortgage reports from investment banks are equally sobering. It is no surprise, then, that the largest underwriters of mortgages and CDOs have been decimated.

Commercial banking regulations generally do not require banks to sell assets to meet capital requirements just because market values decline. But if "impairment" charges under MTM do push banks below regulatory capital requirements and limit their ability to lend when they can't raise more capital, then the solution is to grant temporary regulatory capital "relief," which is itself an arbitrary number.

There is a connection between efforts over the past 12 years to reduce regulatory oversight, weaken capital requirements, and silence the financial detectives who uncovered such scandals as Lehman and Enron. The assault against MTM is just the latest chapter.

Instead of acknowledging mistakes, we are told this is a "once in 100 years" anomaly with the market not functioning correctly. It isn't lost on investors that the MTM criticisms come, too, as private equity firms must now report the value of their investments. The truth is the market is functioning correctly. It's just that MTM critics don't like the prices that investors are willing to pay.

The FASB and Securities and Exchange Commission (SEC) must stand firm in their respective efforts to ensure that investors get a true sense of the losses facing banks and investment firms. To be sure, we should work to make MTM accounting more precise, following, for example, the counsel of the President's Working Group on Financial Markets and the SEC's December 2008 recommendations for achieving greater clarity in valuation approaches.

Unfortunately, the FASB proposal on March 16 represents capitulation. It calls for "significant judgment" by banks in determining if a market or an asset is "inactive" and if a transaction is "distressed." This would give banks more discretion to throw out "quotes" and use valuation alternatives, including cash-flow estimates, to determine value in illiquid markets. In other words, it allows banks to substitute their own wishful-thinking judgments of value for market prices.

The FASB is also changing the criteria used to determine impairment, giving companies more flexibility to not recognize impairments if they don't have "the intent to sell." Banks will only need to state that they are more likely than not to be able to hold onto an underwater asset until its price "recovers." CFOs will also have a choice to divide impairments into "credit losses" and "other losses," which means fewer of these charges will be counted against income. If approved, companies could start this quarter to report net income that ignores sharp declines in securities they own. The FASB is taking comments until April 1, but its vote is a fait accompli.

Obfuscating sound accounting rules by gutting MTM rules will only further reduce investors' trust in the financial statements of all companies, causing private capital -- desperately needed in securities markets -- to become even scarcer. Worse, obfuscation will further erode confidence in the American economy, with dire consequences for the very financial institutions who are calling for MTM changes. If need be, temporarily relax the arbitrary levels of regulatory capital, rather than compromise the integrity of all financial statements.

Audio on Fair Value Accounting (Canada)

May 1, 2009 message from Patricia Walters [patricia@DISCLOSUREANALYTICS.COM]

If any of you are interested in listening to the media conference given by Paul Cherry, Chair of Canadian Accounting Standard Board, you can access an audio file through the link below. The story was picked up by the National Post, the Globe and Mail, Reuters, Bloomberg, Canadian Press and a number of small online news outlets and blogs.

http://www.vvcnetwork.ca/acsb/20090430/audio.html 

Regards
Pat

Bob Jensen's threads on fair value accounting are at http://www.trinity.edu/rjensen/Theory01.htm#FairValue

Professor Ketz Asserts Other Comprehensive Income (OCI from FAS 130)
may be More Important to Study Than Reported Income

"Citigroup Remains in Critical Condition," by: J. Edward Ketz , SmartPros, May 2009 ---
http://accounting.smartpros.com/x66534.xml
Note that all Citigroup dollar amounts are in millions of dollars such that  $(27,684) is really a $27,684,000,000 billion loss.

The stress tests conducted by the Fed are a farce inasmuch as the stress isn't too strenuous. That the Fed ascertained additional capital requirements for several banks merely points out the obvious - the banking sector remains in serious trouble.

That the financial industry was and remains in trouble is not revelatory to those who pay attention to fair value measurements. Take Citigroup for instance. This firm, once a giant among banks, now gasps for its existence.

Citi’s reported net income was $(27,684) for 2008 (all accounting numbers in millions of dollars). While this is a smelly number, the odor grows worse when one adjusts it for various items that bypass the income statement.

Ever since the FASB invented the comprehensive income statement in a political move to get business enterprises to do some accounting for items they didn’t want to disclose, I have advocated that investors use comprehensive income instead of net income. Comprehensive income includes relevant items that have had a real economic impact on the business entity; therefore, investors will find these items informative.

For fiscal 2008, Citi shows unrealized losses on its available-for-sale securities of $(10,118). It also shows a loss on the foreign currency translation adjustment of $(6,972), a loss on its cash flow hedges of $(2,026), and a loss for additional pension liability adjustment of $(1,419). This makes Citi’s comprehensive income $(48,219).

But the bad news doesn’t end there. The pension footnote (footnote 9) shows the expected rate of return is 7.75%. While this is what is required per FAS 87, it is nonsense. Did anybody know the 2008 rate of return in (say) 2005? The FASB should get rid of such fantasyland assumptions and require business enterprises to employ the actual rate of return. If Citi had done so on its pension assets, it would have had an actual return of (5.42)%, so we shall adjust downward the 2008 income by another $1,370.

The most interesting item is Citi’s move with respect to its investments. It reports debt securities in its 2007 held-to-maturity portfolio of only $1. By year end 2008, however, this amount mushroomed to $64,459. Clearly, Citi is shielding these debt instruments from fair value accounting and the reporting of additional losses. Footnote 16 indicates that these losses for 2008 amounted to $(4,082).

Another item concerns the firm’s deferred income tax assets. For 2008, Citi discloses $52,079 in deferred income tax assets and a valuation allowance of zero. Given that Citi paid no federal income taxes in 2007 or 2008 and likely will pay no federal income taxes in the near future, if ever, how can the company justify a valuation allowance of zero? Whatever amount it should be would further reduce the profits of the firm. Since we don’t know how to estimate this valuation allowance correctly, we shall continue to hold its balance at zero, even though this is clearly wrong.

Putting these considerations together, Citigroup has an adjusted income in 2008 of $(53,671). This is still an estimate but clearly it is more nearly accurate than the reported number. And it reveals that Citi lost twice as much as it reported.

Recently, we have been hearing how Citi has turned things around and that the first quarter in 2009 returns Citi to the black column with a profit of $1,593. Don’t believe a word of it!

Items in comprehensive income shows a modest gain in the available-for-sale portfolio of $20, gains on cash flow hedges of $1,483, and a gain because of the pension liability adjustment of $66. Unfortunately, these gains are wiped out by a loss in the foreign currency translation adjustment of $(2,974). Comprehensive remains ugly at $(225).

We don’t have any disclosure in the quarterly report about actual versus expected returns on pension assets, so we cannot adjust them to show the truth.

But, the strategy to move debt securities from available-to-sale to held-to-maturity paid off significantly. First quarter results show a staggering loss on these securities of $(7,772).

So far, the adjusted earnings for Citigroup for the first quarter of 2009 is $(7,584). Don’t tell me that Citi has improved its operations.

Further, these numbers have been improved by an eccentricity in FAS 157. For some silly reason, the board allows entities to show a gain on their liabilities if the firm’s own credit risk has increased. This takes a perfectly good notion of fair value of liabilities to an absurd result. Failing companies might be able to make liabilities disappear by claiming a sufficiently high increase in their own credit ratings! Utter rubbish—and the FASB should amend its statement.

Citi disclosed in a conference call that the first quarter results include a gain of $2,700 because of this increase in its own nonperformance risk. This gain is total nonsense, so I would adjust quarterly income further, giving Citi adjusted earnings of $(10,284).

Citigroup suffered a cardiac arrest in 2008, and it remains in critical condition. Any other conclusion is propaganda or self deception. And forget the stress tests; they are so flawed that Lehman Brothers might pass them. The Fed says that Citi needs another $5,500 in capital to weather any additional economic crises it might face. It isn’t true. Citi needs a lot more capital than that just to weather current conditions. If a real crisis occurs, Citi will become a flat-liner; it might die anyway.

If you want to protect your portfolio, don’t listen to the optimistic forecasts coming from Washington and don’t stop at the reported income number. Look at the fair value disclosures within SEC filings, adjust reported earnings for these fair value gains and losses, and then you will obtain the truth.

Bob Jensen's threads on the banking bailout are at http://www.trinity.edu/rjensen/2008Bailout.htm

"JPMorgan (read that Chase Bank) faces SEC lawsuit," by Aline van Duyn and Francesco Guerrera, Financial Times, May 8, 2009 ---

JPMorgan Chase may be sued by US regulators for violating securities laws and market rules related to the sale of bonds and interest-rate swaps to Jefferson County, Alabama.

The potential Securities and Exchange Commission action is the latest twist in a complex debt financing saga which has already led to charges against Jefferson County officials and which has left the municipality struggling to avoid default on over $3bn of debt, much of it taken on to improve its sewage system.

JPMorgan said in a regulatory filing, made late on Thursday just as the results of bank stress tests were being released, that it had been told about the SEC action on April 21. It said it “has been engaged in discussions with the SEC staff in an attempt to resolve the matter prior to litigation”. The bank had no further comment on Friday.

Jefferson County is one of the most indebted municipalities in the US due to its expensive overhaul of its sewage system. JPMorgan is one of the lenders which has repeatedly extended the deadline on payments due by Jefferson County on its debt and derivatives.

A law is currently being considered that would create a new tax which would provide revenues to pay the sewer debt. If Jefferson County defaults, it would be the biggest by a US municipality, dwarfing the problems faced by California’s Orange County in the 1990s.

The mayor of Birmingham, Alabama, and two of his friends were last year charged by US regulators in connection with an undisclosed payment scheme related to municipal bond and swap deals.

The SEC alleged that Larry Langford, the mayor, received more than $156,000 in cash and benefits from a broker hired to arrange bond offerings and swap agreements on behalf of Jefferson County, where Birmingham is located.

Although the details of the SEC investigation are not known, it is likely to be related to the payment scheme through which banks like JPMorgan paid fees to local brokers at the request of Jefferson County.

The credit crisis has brought to light numerous problems in the municipal bond markets. Many borrowers relied on bond insurance to sell their deals, and the collapse in the credit ratings of bond insurers has made it difficult for many to raise funds or to do so at low interest rates.

Bob Jensen's banking fraud threads are at
http://www.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking

Reports are surfacing that CPA auditors were warned about toxic assets and pending bank failures.
Yet virtually all of the failed banks in 2008 and early 2009 received clean audit opinions not warning of "going concern" weaknesses

Aside from the massive lawsuits that have been or will soon be filed against banks, mortgage finance companies, and their auditors, it the big question will be investigations of the PCAOB into those failed audits. The Federal Government PCAOB's reputation is somewhat at stake here --- http://www.pcaobus.org/

"CPAs MIA," by Ralph Nader , Independent Political Report, April 12, 2009 --- http://www.independentpoliticalreport.com/2009/04/ralph-nader-cpas-mia/

Where were the giant accounting firms, the CPAs, and the rest of the accounting profession while the Wall Street towers of fraud, deception and cover-ups were fracturing our economy, looting and draining trillions of dollars of other peoples’ money?

This is the licensed profession that is paid to exercise independent judgment with independent standards to give investors, pension funds, mutual funds, and the rest of the financial world accurate descriptions of corporate financial realities.

It is now obvious that the accountants collapsed their own skill, integrity and self-respect faster and earlier than the collapse of Wall Street and the corporate barons. The accountants—both external and internal—could have blown the whistle on what Teddy Roosevelt called the “malefactors of great wealth.”

The Big Four auditors knew what was going on with these complex, abstractly structured finance instruments, these collateralized debt obligations (CDOs) and other financial products too abstruse to label. They were on high alert after early warning scandals involving Long Term Capital Management, Enron, and others a decade or so ago. These corporate casino capitalists used the latest tricks to cook the books with many of the on-balance sheet or off-balance sheet structured investment vehicles that metastasized big time in the first decade of this new century. These big firms can’t excuse themselves for relying on conflicted rating companies, like Moody’s or Standard & Poor, that gave triple-A ratings to CDO tranches in return for big fees. Imagine the conflict. After all, “prestigious” outside auditors were supposed to be on the inside incisively examining the books and their footnotes, on which the rating firms excessively relied.

Let’s be specific with names. Carl Olson, chairman of the Fund for Stockowners Rights wrote in the letters column of The New York Times Magazine (January 28, 2009) that “PricewaterhouseCoopers O.K.’d AIG and FreddieMac. Deloitte & Touche certified Merrill Lynch and Bear Stearns. Ernst & Young vouched for Lehman Brothers and IndyMac Bank. KPMG assured over Countrywide and Wachovia. These ‘Big Four’ C.P.A. firms apparently felt they could act with impunity.” “Undoubtedly they knew that the state boards of accountancy,” continued Mr. Olson, “which granted them their licenses to audit, would not consider these transgressions seriously. And they were right…Not one of them has taken up any serious investigation of the misbehaving auditors of the recent debacle companies.”

“Misbehaving” is too kind a word. The “Big Four” destroyed their very reason for being by their involvement in these and other boondoggles that have made headlines and dragooned our federal government into bailing them out with disbursements, loans and guarantees totaling trillions of dollars. “Criminally negligent” is a better phrase for what these big accounting firms got rich doing—which is to look the other way.

Holding accounting firms like these accountable is very difficult. It got more difficult in 1995 when Congress passed a bill shielding them from investor lawsuits charging that they “aided and abetted” fraudulent or deceptive schemes by their corporate clients. Clinton vetoed the legislation, but Senator Chris Dodd (D-CT) led the fight to over-ride the veto.

Moreover, the under-funded and understaffed state boards of accountancy are dominated by accountants and are beyond inaction. What can you expect?

As for the Securities and Exchange Commission (SEC), “asleep at the switch for years” would be a charitable description of that now embarrassed agency whose mission is to supposedly protect savers and shareholders. This agency even missed the massive Madoff Ponzi scheme.

The question of accounting probity will not go away. In the past couple of weeks, the non-profit Financial Accounting Standards Board (FASB)—assigned to be the professional conscience of accountancy—buckled under overt pressure from Congress and the banks. It loosened the mark-to-market requirement to value assets at fair market value or what buyers are willing to pay.

This decision by the FASB is enforceable by the SEC and immediately “cheered Wall Street” and pushed big bank stocks upward. Robert Willens, an accounting analyst, estimated this change could boost earnings at some banks by up to twenty percent. Voilà, just like that. Magic!

Overpricing depressed assets may make bank bosses happy, but not investors or a former SEC Chairman, Arthur Levitt, who was “very disappointed” and called the FASB decision “a step toward the kind of opaqueness that created the economic problems that we’re enduring today.”

To show the deterioration in standards, banks tried to get the FASB and the SEC in the 1980s to water down fair-value accounting during the savings and loan failures. Then-SEC Chairman Richard Breeden refused outright. Not today.

Former SEC chief accountant, Lynn Turner, presently a reformer of his own profession, supports mark-to-market or fair value accounting as part of bringing all assets and liabilities, including credit derivatives, back on the balance sheets of the financial firms. He wants regulation of the credit rating agencies, mortgage originators and the perverse incentives that lead to making bad loans. He even wants the SEC to review these new financial products before they come to market, eliminating “hidden financing.”

Now comes the life insurance industry, buying up some small banks to qualify for their own large federal bailouts for making bad, risky speculations.

The brilliant Joseph M. Belth, writing in his astute newsletter, the Insurance Forum (May 2009), noted that life insurers are lobbying state insurance departments to weaken statutory accounting rules so as to “increase assets and/or decrease liabilities.” Some states have already caved. Again, voilà, suddenly there is an increase in capital. Magic. Here we go again.

Who among the brainy, head up accountants, in practice or in academia, will join with Lynn Turner and rescue this demeaned, chronically rubber-stamping “profession,” especially the “Big Four,” from its pathetic pretension for which tens of millions of people are paying dearly?

Reports are surfacing that CPA auditors were warned about toxic assets and pending bank failures.
Yet virtually all of the failed banks in 2008 and early 2009 received clean audit opinions not warning of "going concern" weaknesses

Aside from the massive lawsuits that have been or will soon be filed against banks, mortgage finance companies, and their auditors, it the big question will be investigations of the PCAOB into those failed audits. The Federal Government PCAOB's reputation is somewhat at stake here --- http://www.pcaobus.org/

"CPAs MIA," by Ralph Nader , Independent Political Report, April 12, 2009 --- http://www.independentpoliticalreport.com/2009/04/ralph-nader-cpas-mia/

Where were the giant accounting firms, the CPAs, and the rest of the accounting profession while the Wall Street towers of fraud, deception and cover-ups were fracturing our economy, looting and draining trillions of dollars of other peoples’ money?

This is the licensed profession that is paid to exercise independent judgment with independent standards to give investors, pension funds, mutual funds, and the rest of the financial world accurate descriptions of corporate financial realities.

It is now obvious that the accountants collapsed their own skill, integrity and self-respect faster and earlier than the collapse of Wall Street and the corporate barons. The accountants—both external and internal—could have blown the whistle on what Teddy Roosevelt called the “malefactors of great wealth.”

The Big Four auditors knew what was going on with these complex, abstractly structured finance instruments, these collateralized debt obligations (CDOs) and other financial products too abstruse to label. They were on high alert after early warning scandals involving Long Term Capital Management, Enron, and others a decade or so ago. These corporate casino capitalists used the latest tricks to cook the books with many of the on-balance sheet or off-balance sheet structured investment vehicles that metastasized big time in the first decade of this new century. These big firms can’t excuse themselves for relying on conflicted rating companies, like Moody’s or Standard & Poor, that gave triple-A ratings to CDO tranches in return for big fees. Imagine the conflict. After all, “prestigious” outside auditors were supposed to be on the inside incisively examining the books and their footnotes, on which the rating firms excessively relied.

Let’s be specific with names. Carl Olson, chairman of the Fund for Stockowners Rights wrote in the letters column of The New York Times Magazine (January 28, 2009) that “PricewaterhouseCoopers O.K.’d AIG and FreddieMac. Deloitte & Touche certified Merrill Lynch and Bear Stearns. Ernst & Young vouched for Lehman Brothers and IndyMac Bank. KPMG assured over Countrywide and Wachovia. These ‘Big Four’ C.P.A. firms apparently felt they could act with impunity.” “Undoubtedly they knew that the state boards of accountancy,” continued Mr. Olson, “which granted them their licenses to audit, would not consider these transgressions seriously. And they were right…Not one of them has taken up any serious investigation of the misbehaving auditors of the recent debacle companies.”

“Misbehaving” is too kind a word. The “Big Four” destroyed their very reason for being by their involvement in these and other boondoggles that have made headlines and dragooned our federal government into bailing them out with disbursements, loans and guarantees totaling trillions of dollars. “Criminally negligent” is a better phrase for what these big accounting firms got rich doing—which is to look the other way.

Holding accounting firms like these accountable is very difficult. It got more difficult in 1995 when Congress passed a bill shielding them from investor lawsuits charging that they “aided and abetted” fraudulent or deceptive schemes by their corporate clients. Clinton vetoed the legislation, but Senator Chris Dodd (D-CT) led the fight to over-ride the veto.

Moreover, the under-funded and understaffed state boards of accountancy are dominated by accountants and are beyond inaction. What can you expect?

As for the Securities and Exchange Commission (SEC), “asleep at the switch for years” would be a charitable description of that now embarrassed agency whose mission is to supposedly protect savers and shareholders. This agency even missed the massive Madoff Ponzi scheme.

The question of accounting probity will not go away. In the past couple of weeks, the non-profit Financial Accounting Standards Board (FASB)—assigned to be the professional conscience of accountancy—buckled under overt pressure from Congress and the banks. It loosened the mark-to-market requirement to value assets at fair market value or what buyers are willing to pay.

This decision by the FASB is enforceable by the SEC and immediately “cheered Wall Street” and pushed big bank stocks upward. Robert Willens, an accounting analyst, estimated this change could boost earnings at some banks by up to twenty percent. Voilà, just like that. Magic!

Overpricing depressed assets may make bank bosses happy, but not investors or a former SEC Chairman, Arthur Levitt, who was “very disappointed” and called the FASB decision “a step toward the kind of opaqueness that created the economic problems that we’re enduring today.”

To show the deterioration in standards, banks tried to get the FASB and the SEC in the 1980s to water down fair-value accounting during the savings and loan failures. Then-SEC Chairman Richard Breeden refused outright. Not today.

Former SEC chief accountant, Lynn Turner, presently a reformer of his own profession, supports mark-to-market or fair value accounting as part of bringing all assets and liabilities, including credit derivatives, back on the balance sheets of the financial firms. He wants regulation of the credit rating agencies, mortgage originators and the perverse incentives that lead to making bad loans. He even wants the SEC to review these new financial products before they come to market, eliminating “hidden financing.”

Now comes the life insurance industry, buying up some small banks to qualify for their own large federal bailouts for making bad, risky speculations.

The brilliant Joseph M. Belth, writing in his astute newsletter, the Insurance Forum (May 2009), noted that life insurers are lobbying state insurance departments to weaken statutory accounting rules so as to “increase assets and/or decrease liabilities.” Some states have already caved. Again, voilà, suddenly there is an increase in capital. Magic. Here we go again.

Who among the brainy, head up accountants, in practice or in academia, will join with Lynn Turner and rescue this demeaned, chronically rubber-stamping “profession,” especially the “Big Four,” from its pathetic pretension for which tens of millions of people are paying dearly?

The Fate of the Large Auditing Firms After the 2008 Banking Meltdown

Questions
Where were the auditors when auditing those risky investments and bad debt reserves of the ailing banks?
Answer:  Not sure.


Where will the auditors be in after the shareholders in the failing banks lose all or almost all in the meltdowns?
Answer: In court, because the shareholders are the fall guys not being bailed out in when banks declare bankruptcy or are bought out cheap just before declaring bankruptcy. Shareholder will understandably turn to the deep pocket auditors.

"Financial Crisis Provides Fertile Ground for Boom in Lawsuits," by Jonathan D. Glater, The New York Times, Octobver 17, 2008 --- http://www.nytimes.com/2008/10/18/business/18suits.html?_r=1&partner=permalink&exprod=permalink&oref=slogin

It seems like just a few months ago — because it was — that trial lawyers, those advocates who take on companies on behalf of investors, customers or even other businesses, had a wretched reputation. Three of the best known of those lawyers, William S. Lerach, Melvyn I. Weiss and Richard F. Scruggs, had all pleaded guilty to crimes. Defense lawyers were gleeful.

But the pendulum has shifted again, much as in the years after the collapse of Enron and WorldCom.

Accusations of executive excess, accounting fraud and lack of disclosure are far more credible now, since bad bets on real estate and securities linked to home loans have caused some of the biggest and most prestigious financial firms in the country — Lehman Brothers, the American International Group, Fannie Mae, Freddie Mac — to collapse, sell parts of themselves at fire-sale prices or suffer outright government takeovers. A legal argument rarely used in investor lawsuits is tempting: res ipsa loquitur, or the thing speaks for itself.

“There’s clearly going to be an erosion in the presumption that these senior-ranking executives should be given the benefit of the doubt,” said John P. Coffey, a partner at Bernstein Litowitz Berger & Grossmann, adding that as a result of regulators’ investigations and angry former employees, there is also more information available to plaintiffs about questionable conduct. “There’s clearly going to be an effect there; judges are human.”

So are investors, who are angry. Individual shareholders as well as big companies want someone else to pay for their losses on investments in everything from basic stocks to exotic swaps. And lawyers are emboldened in their claims by the huge losses and obvious errors in judgment at companies that, until recently, confidently asserted their immunity to market turbulence.

Investors’ lawyers can point at statements and actions by regulators to bolster their claims. In a suit filed in mid-September by Fannie Mae shareholders, the plaintiffs blamed a government plan to buy shares of the company and then take it over for helping to depress the company’s stock price. The lawsuit names Merrill Lynch, Citigroup, Morgan Stanley and others as defendants, accusing them of making false statements about Fannie Mae’s financial condition.

“The more you think about it, there’re so many different ways that so many different people could be responsible for this,” said H. Adam Prussin, a partner at Pomerantz Haudek Block Grossman & Gross, referring to losses suffered in this financial crisis. His firm is representing Fannie Mae investors. “There are the lenders who screwed up in the first place, there are the people who bought these things from the lenders and then didn’t account correctly for them.”

A recent report by the law firm Fulbright & Jaworski found that more than one-third of lawyers working internally for companies expected to see more litigation in 2009. Lawyers at the biggest companies were more likely to expect a boom in lawsuits, according to the study.

One factor contributing to litigation is the rapid availability of information about corporate mistakes and losses, which in the past might have taken longer to circulate among investors, said Michael Young, a partner at Willkie Farr & Gallagher in New York.

“What’s really going on here is a type of accounting that is capturing changes in value and making them public much faster than anything we’ve seen before,” Mr. Young said.

Armed with such data, shareholders have charged the courthouse steps, claiming that companies failed to disclose their vulnerability to declines in the real estate market, often through holdings of securities backed by home loans. Even companies that have suffered huge losses may still be worth pursuing because of their liability insurance.

“You can’t get blood from a stone,” said Joseph A. Grundfest, a former commissioner of the Securities and Exchange Commission who now teaches at Stanford Law School. “But you sure can get money from the insurance company that covered the stone.”

There are other deep pockets, even in the current economic climate. When confronted by bankruptcy filings or government takeovers, the lawsuits name every possible defendant involved in a stock offering — the underwriters, the rating agencies and individual executives — but not the issuing company itself. That way, they avoid the problem of fighting with other creditors in bankruptcy or the question of whether they can sue the government.

In the case brought by Fannie shareholders, for example, Fannie itself is not a defendant. A suit filed last month by investors who bought Freddie Mac shares names only Goldman Sachs, JPMorgan Chase and Citigroup. The suit claims that the investment firms, which underwrote a Freddie Mac stock offering, did not disclose the company’s “massive exposure to mortgage-related losses.” (JPMorgan Chase did not underwrite the offering itself but it acquired Bear Sterns, which did).

Events have moved quickly enough that some lawyers have found that their lawsuits may have been filed too early, before the biggest losses and consequently before the biggest damage claims were possible.

Continued in article

 

"The harder they fall: Will the Big Four survive the credit crunch?" by Rob Lewis, AccountingWeb, October 2008 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=106124

Ever since Arthur Andersen left the market after its scandalous role in the fall of Enron, people have been asking how long it will be before another big firm follows suit. The (UK) Financial Reporting Council (FRC) has been trying ever since to make sure that the Big Four will be protected if found guilty of similar negligence. The introduction of limited liability should help, but given the accelerating meltdown of the global financial system, will it be enough?

As always, and as was the case with Arthur Andersen, it will be events in America that determine the fate of the Big Four. This summer the U.S. Treasury's Advisory Committee of the Auditing Profession met in Washington and heard that between them the six largest firms had 27 outstanding litigation proceedings against them with damage exposure above $1 billion, seven of which exceed $10 billion. It is impossible to buy insurance that will cover such catastrophic liability and any one of them, if successful, could prove a fatal blow.

That U.S. Treasury committee met again last week to discuss the viability of limited liability for auditors in the U.S., but the 21-strong panel decided against it. With that, the hope of some silver bullet solution to the Big Four's problems expired. Committee member Lynn Turner, formerly a chief accountant to the Securities and Exchange Commission (SEC), was plainly baffled such an idea had even been seriously suggested.

"Do you believe that an auditor found to have been aware of financial reporting problems but never reporting them to the public should be the subject of liability caps or some type of litigation reform protecting them?" he asked. Turner summed the situation up nicely when he described the big accounting firms as a "federally mandated and authorized cartel" which was "too big to [be allowed to] fail".

When Arthur Andersen went down six years ago, Turner had never been quite able to believe that the firm's bad behavior had really been all that anomalous. "It's beyond Andersen," he told CBS Frontline that same year, "it's something that's embedded in the system at this time. This notion that everything is fine in the system just because you can't see it is totally off-base."

The credibility of the markets

Looking at recent economic events, Turner's suspicions that the credibility of the markets were at stake has plainly proved prescient. So too may his belief that unethical accounting was not so much a case of a few bad apples, but a bad barrel.

Consider some of the recent and outstanding claims against the biggest six firms. In Miami last August a jury ordered BDO Seidman to pay $521 million in damages for its negligence in a Portuguese bank audit; almost as much as the firm's estimated revenue for that year. In the U.S., banks and the shareholders of banks are perfectly prepared to go after auditors, and when they win they tend to win big. Note than when Her Majesty's Treasury hired the BDO's valuation partner Andrew Caldwell for the controversial Northern Rock valuation, they hired the man and not the firm. The firms are already worried enough about litigation.

KPMG provides a clear example of how the credit crunch might cull the Big Four. The firm was already looking vulnerable before it hit: there was the 2005 'deferred prosecution' agreement with the New York Attorney's Office, the damning German probe into the Siemens bribery scandal, a lawsuit from superconductor company Vitesse for 'audit failures' and a minor fine from the UK's Joint Disciplinary Scheme (JDS) for allowing fraud to occur at Independent Insurance (it may only have been half a million, but it was the JDS' biggest fine to date). But when the subprime problems of U.S. lender New Century enter the picture, the damages involved escalate drastically.

A U.S. Justice Department report has already concluded that KPMG either helped perpetrate the fraud at the mortgager or deliberately ignored it. Class-action lawsuits are already pending. Only weeks before the report was published the U.S. Supreme Court's Stone Ridge ruling immunized third party advisers like accountants and bankers from the disgruntled shareholders of other entities, but that may be not much of a shield. Of course, New Century might not be KPMG's biggest problem. That's probably the Federal National Mortgage Association, or Fannie Mae.

Fannie Mae initiated litigation way back in 2006, and is trying to reclaim more than $2 billion from its old auditors. That's on top of the $400 million KPMG agreed to pay the SEC to settle the regulator's fraud allegations. Its defense so far has been one of complete innocence, asserting that Fannie Mae successfully hid all evidence of anything untoward. Now that the FBI is investigating the mortgage lender, such a position will have to be abandoned if incriminating evidence turns up. Ostensibly, the Federal investigation relates to Fannie Mae's relationship with ratings agencies, but you never know what will fall out of the closet.

So KPMG is in a spot of bother, but it's not alone. Ernst and Young will almost inevitably see itself in court over the demise of its audit client Lehman Brothers. Similarly, PricewaterhouseCoopers is surely going to feel some heat for its auditing of what was once the world's largest insurance company, AIG, assuming the Northern Rock Shareholders Group doesn't take a pop at it first.

Continued in article

 

Bob Jensen's threads on the litigation woes of the large auditing firms are at http://www.trinity.edu/rjensen/Fraud001.htm

The most serious problem in the U.S. audit model is that clients are becoming bigger and bigger due to non-enforcement of anti-trust laws. For example, the merger of Mobile and Exxon created an even larger single client. The merger of Bear Stearns and JP Morgan created a much larger client. The number of potential clients is shrinking while the size of the clients is exploding. According to the CEO of Bank of America, in a CBS Sixty Minutes interview on October 19, 2008, half of all banking customers in the United States now have accounts with Bank of America. That was before Bank of America bought out Merrill Lynch.

As these giants merge to become bigger giants, it gets to a point where their auditors cannot afford to lose a giant client producing upwards of $100 million in audit revenue each year. Real independence of audits breaks down because a giant client can become a bully with its audit firm fearful of losing giant clients.

Enron was an extreme but not necessarily an outlier. It will most likely be alleged in court over the next few years that giant Wall Street banks bullied their auditors into going along with understating financial risk before the 2008 banking meltdown. We certainly witnessed the understating of financial risk in 2007 and 2008.

I think we need an Accounting Court to deal with clients who become bullies --- http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

The Accounting Hall of Fame Citation for Leonard Spacek --- http://fisher.osu.edu/acctmis/hof/spacek.html

It must be kept in mind that the statements certified are not ours but are our clients--and our clients do not care to mix explanations of accounting theory with explanations of their business nor can we pass onto our readers the responsibility for appraisal of differences in accounting theory. Those fields are for you and me to grapple with, not the public. In general, clients are not primarily interested in arguments of accounting theory at the time of preparing their reports. The companies whose accounts are certified are chiefly interested in what is said to their shareholders, and in the hard practical facts of how accounting rules affect them, their competitors and other companies. Usually they are very critical of what we call accounting principles when these called principles are unrealistic, inconsistent, or do not protect or distinguish scrupulous management from the scrupulous.
"The Need for An Accounting Court," by Leonard Spacek, The Accounting Review, 1958, Pages 368-379  --- http://www.trinity.edu/rjensen/FraudSpacek01.htm

Jensen Comment
Fifty years later I'm a strong advocate of an accounting court, but I envision a somewhat different court than envisioned by the great Leonard Spacek in 1958. Since 1958, the failure of anti-trust enforcement has allowed business firms to merge into enormous multi-billion or even trillion dollar clients who've become powerful bullies that put extreme pressures on auditors to bend accounting and auditing principles. For example see the way executives of Fannie Mae pressured KPMG to bend the rules (an act that eventually got KPMG fired from the audit).

In my opinion the time has come where auditors and clients can take their major disputes to an Accounting Court that will use expert independent judges to resolve these disputes much like the Derivatives Implementation Group (DIG)  resolved technical issues for the implementation of FAS 133. The main difference, however, is that an Accounting Court should hear and resolve disputes in private confidence that allows auditors and clients to keep these disputes away from the media. The main advantage of such an Accounting Court is that it might restrain clients from bullying auditors such as became the case when Fannie Mae bullied KPMG.

Who would sit on accounting courts is open to debate, but the "judges" could be formed by the State Boards of Accountancy much like a grand jury is formed by a court of law. Accounting court cases, however, should be confidential since they deal with sensitive client information.

I really don't anticipate a flood o cases in an accounting court. But I do view the threat of taking client-auditor disputes to such courts (in confidence) as a means of curbing the bullying of auditors by their enormous clients.

The problem is that poor anti-trust enforcement coupled with mergers of huge companies have combined to create mega-clients that auditing firms cannot afford to lose after gearing up to handle such large clients. I think we saw this in the "clean opinions" given to all the enormous failing banks (like WaMu) and enormous Wall Street investment banks (like Lehman). The big auditing firms just could not afford to question bad debt estimates, mortgage application lies, and CDO manipulations of such clients.

I find it hard to believe that auditors failed to detect an undercurrent of massive subprime "Sleaze, Bribery, and Lies" that transpired in the Main Street banks and mortgage lending companies --- http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze
The sleaze was so prevalent the auditors must've worn their chest-high waders on these audits

Bob Jensen's threads on the fate of the large auditing firms following the subprime scandals ---
 

Question
When is $7 billion not a material bad debt exposure?

Answer
When the "bad debt" is from an "empty creditor"
Now do you understand?

"'Empty Creditors' and the Crisis How Goldman's $7 billion was 'not material," by Henry T.C. Hu, The Wall Street Journal, April 10, 2009 ---
http://online.wsj.com/article/SB123933166470307811.html

The defining moments of our financial crisis are now familiar. Last September, Lehman collapsed and AIG was teetering. Because an AIG collapse was viewed as posing unacceptable systemic risks, the Federal Reserve provided the company with an emergency $85 billion loan on Sept. 16.

But a curious incident that fateful day raises significant public policy issues. Goldman Sachs reported that its exposure to AIG was "not material." Yet on March 15 of this year, AIG disclosed that it paid $7 billion of its government loan last fall to satisfy obligations to Goldman. A "not material" statement and a $7 billion payout appear to be at odds.

Why didn't Goldman bark that September day? One explanation is that Goldman was, to use a term that I coined a few years ago, largely an "empty creditor" of AIG. More generally, the empty-creditor phenomenon helps explain otherwise-puzzling creditor behavior toward troubled debtors. Addressing the phenomenon can help us cope with its impact on individual debtors and the overall financial system.

What is an empty creditor? Consider that debt ownership conveys a package of economic rights (to receive principal and interest), contractual control rights (to enforce the terms of the agreement), and other legal rights (to participate in bankruptcy proceedings). Traditionally, law and business practice assume these components are bundled together. Another foundational assumption: Creditors generally want to keep solvent firms out of bankruptcy and to maximize their value.

These assumptions can no longer be relied on. Credit default swaps and other products now permit a creditor to avoid any actual exposure to financial risk from a shaky debt -- while still maintaining his formal contractual control rights to enforce the terms of the debt agreement, and his legal rights under bankruptcy and other laws.

Thus the "empty creditor": someone (or institution) who may have the contractual control but, by simultaneously holding credit default swaps, little or no economic exposure if the debt goes bad. Indeed, if a creditor holds enough credit default swaps, he may simultaneously have control rights and incentives to cause the debtor firm's value to fall. And if bankruptcy occurs, the empty creditor may undermine proper reorganization, especially if his interests (or non-interests) are not fully disclosed to the bankruptcy court.

Goldman Sachs was apparently an empty creditor of AIG. On March 20, David Viniar, Goldman's chief financial officer, indicated that the company had bought credit default swaps from "large financial institutions" that would pay off if AIG defaulted on its debt. A Bloomberg News story on that day quotes Mr. Viniar as saying that "[n]et-net I would think we had a gain over time" with respect to the credit default swap contracts.

Goldman asserted its contractual rights to require AIG to provide collateral on transactions between the two, notwithstanding the impact of such collateral calls on AIG. This behavior was understandable: Goldman had responsibilities to its own shareholders and, in Mr. Viniar's words, was "fully protected and didn't have to take a loss."

Nothing in the law prevents any creditor from decoupling his actual economic exposure from his debt. And I do not suggest any inappropriate behavior on the part of Goldman or any other party from such "debt decoupling." But none of the existing regulatory efforts involving credit derivatives are directed at the empty-creditor issue. Empty creditors have weaker incentives to cooperate with troubled corporations to avoid collapse and, if collapse occurs, can cause substantive and disclosure complexities in bankruptcy.

An initial, incremental, and low-cost step lies in the area of a real-time informational clearinghouse for credit default swaps and other over-the-counter (OTC) derivatives transactions and other crucial derivatives-related information. Creditors are not generally required to disclose the "emptiness" of their status, or how they achieved it. More generally, OTC derivatives contracts are individually negotiated and not required to be disclosed to any regulator, much less to the public generally. No one regulator, nor the capital markets generally, know on a real-time basis the entity-specific exposures, the ultimate resting places of the credit, market, and other risks associated with OTC derivatives.

With such a clearinghouse, the interconnectedness of market participants' exposures would have been clearer, governmental decisions about bailing out Lehman and AIG would have been better informed, and the market's disciplining forces could have played larger roles. Most important, a clearinghouse could have helped financial institutions to avoid misunderstanding their own products, and modeling and risk assessment systems -- misunderstandings that contributed to the global economic crisis.

Henry Hu is a professor at the University of Texas Law School.

Bob Jensen's threads on the credit derivatives mess of AIG are at http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

Note the Link to Company Audits

"The corporate kleptomaniacs Companies are boosting their profits through cartels and price-fixing strategies. It is time to jail their executives for picking our pockets," by Prem Sikka, The Guardian, April 19, 2008 --- http://commentisfree.guardian.co.uk/prem_sikka_/2008/04/the_corporate_kleptomaniacs.html

Companies increasingly take people for a ride. They issue glossy brochures and mount PR campaigns to tell us that they believe in "corporate social responsibility". In reality, too many are trying to find new ways of picking our pockets.

Customers are routinely fleeced through price-fixing cartels. Major construction companies are just the latest example. Allegations of price fixing relate to companies selling dairy products, chocolates, gas and electricity, water, travel, video games, glass, rubber products, company audits and almost everything else. Such is the lust for higher profits that there have even been suspected cartels for coffins, literally a last chance for corporate barons to get their hands on our money.

Companies and their advisers sell us the fiction of free markets. Yet their impulse is to build cartels, fix prices, make excessive profits and generally fleece customers. Many continue to announce record profits. The official UK statistics showed that towards the end of 2007 the rate of return for manufacturing firms rose to 9.7% from 8.8%. Service companies' profitability eased to 21.2% from a record high of 21.4%. The rate of return for North Sea oil companies rose to 32.5% from 30.1%. Supermarkets and energy companies have declared record profits. One can only wonder how much of this is derived from cartels and price fixing. The artificially higher prices also contribute to a higher rate of inflation which hits the poorest sections of the community particularly hard.

Cartels cannot be operated without the active involvement of company executives and their advisers. A key economic incentive for cartels is profit-related executive remuneration. Higher profits give them higher remuneration. Capitalism does not provide any moral guidance as to how much profit or remuneration is enough. Markets, stockbrokers and analysts also generate pressures on companies to constantly produce higher profits. Companies respond by lowering wages to labour, reneging on pension obligations, dodging taxes and cooking the books. Markets take a short-term view and ask no questions about the social consequences of executive greed.

The usual UK response to price fixing is to fine companies, and many simply treat this as another cost, which is likely to be passed on to the customer. This will never deter them. Governments talk about being tough on crime and causes of crime, but they don't seem to include corporate barons who are effectively picking peoples' pockets.

Governments need to get tough. In addition to fines on companies, the relevant executives need to be fined. In the first instance, they should also be required to personally compensate the fleeced customers. Executives participating in cartels should automatically receive a lifetime ban on becoming company directors. There should be prison sentences for company directors designing and operating cartels. That already is possible in the US. Australia's new Labour government has recently said that it will impose jail terms on executives involved in cartels or price fixing. The same should happen in the UK too. All correspondence and contracts relating to the cartels should be publicly available so that we can all see how corporations develop strategies to pick our pockets and choose whether to boycott their products and services.

Is there a political party willing to take up the challenge?

Bob Jensen's threads on The Saga of Audit Firm Professionalism and Independence are at http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism 

Bob Jensen's Rotten to the Core threads are at http://www.trinity.edu/rjensen/FraudRotten.htm

Charles Ponzi (1882-1949) --- http://en.wikipedia.org/wiki/Charles_Ponzi
Ponzi Frauds --- http://en.wikipedia.org/wiki/Ponzi_game

Bernard Madoff --- http://en.wikipedia.org/wiki/Madoff

"How Bernie Madoff did it:  Madoff is behind bars and isn't talking. But a Fortune investigation uncovers secrets of his massive swindle," by James Bandler, Nicholas Varchaver and Doris Burke, CNN Money, April 24, 2009 ---
http://money.cnn.com/2009/04/24/news/newsmakers/madoff.brief.fortune/index.htm?cnn=yes

Since Bernard Madoff was arrested in December and confessed to masterminding a multi-billion Ponzi scheme, countless people have wondered: Who else was involved? Who knew about the fraud? After all, Madoff not only engineered an epic swindle, he insisted to the FBI that he did it all by himself. To date, Madoff has not implicated anybody but himself.

But the contours of the case are changing.

Fortune has learned that Frank DiPascali, the chief lieutenant in Madoff's secretive investment business, is trying to negotiate a plea deal with federal prosecutors. In exchange for a reduced sentence, he would divulge his encyclopedic knowledge of Madoff's scheme. And unlike his boss, DiPascali is willing to name names.

According to a person familiar with the matter, DiPascali has no evidence that other Madoff family members were participants in the fraud. However, he is prepared to testify that he manipulated phony returns on behalf of some key Madoff investors, including Frank Avellino, who used to run a so-called feeder fund, Jeffry Picower, whose foundation had to close as a result of Madoff-related losses, and others.

If, for example, one of these special customers had large gains on other investments, he would tell DiPascali, who would fabricate a loss to reduce the tax bill. If true, that would mean these investors knew their returns were fishy.

Explains the source familiar with the matter: "This is a group of inside investors -- all individuals with very, very high net worths who, hypothetically speaking, received a 20% markup or 25% markup or a 15% loss if they needed it." The investors would tell DiPascali, for example, that their other investments had soared and they needed to find some losses to cut their tax bills. DiPascali would adjust their Madoff results accordingly.

(Gary Woodfield, a lawyer for Avellino, and William Zabel, the attorney for Picower, both declined to comment. Marc Mukasey, DiPascali's laywer, says, "We expect and encourage a thorough investigation.")

Inside the Madoff swindle: Read the full story --- http://money.cnn.com/2009/04/24/news/newsmakers/madoff.fortune/index.htm

These special deals for select Madoff investors have become a key focus for federal prosecutors, according to this source and a second one familiar with the investigation. The second source describes the arrangements as "kickbacks" and "bonuses." A spokesperson for the U.S. Attorney declined to comment.

But a little-noticed line in a public filing by the prosecutors in March supports at least part of these sources' account. The document that formally charged Madoff with his crimes asserted that he "promised certain clients annual returns in varying amounts up to at least approximately 46 percent per year." That was quite a boost when most investors were receiving 10% to 15%. It appears to reflect the benefits that accrued to those who helped bring large sums to Madoff.

The emergence of this potential star witness is the best news to surface publicly for the Madoff family since the case began. DiPascali has every incentive to implicate high-profile names to save his skin -- and nobody is more under scrutiny than the Madoffs, many of whom worked for the firm. (Representatives for all of the family members have asserted their innocence.) It should be noted that DiPascali is not in a position to say what the Madoffs knew -- this should not be construed as an exoneration. But the fact that a high-ranking participant in the investment operation is not implicating them is telling.

The DiPascali revelations are part of a special Fortune investigation into the inner workings of Madoff's firm. It chronicles Madoff's rise -- how he started his firm in 1960 with only $200, rose to become a pioneer of electronic trading, and became notorious for his investment operation -- a strange, secretive world supervised by DiPascali.

DiPascali was a 33-year veteran of Madoff's firm. A high school graduate with a Queens accent, he came to work in an incongruously starched version of a slacker's uniform: pressed jeans, a sweatshirt, and pristine white sneakers or boat shoes. He could often be found outside the building, smoking a cigarette.

Nobody was quite sure what he did or what his title was. "He was like a ninja," says a former trader in the legitimate operation upstairs. "Everyone knew he was a big deal, but he was like a shadow."

He may not have looked or acted like a financier, but when customers like the giant feeder fund Fairfield Greenwich came in to talk, DiPascali was usually the only Madoff employee in the room with Bernie. Madoff told the visitors that DiPascali was "primarily responsible" for the investment operation, according to a Fairfield memo.

And now DiPascali may be primarily responsible for taking the ever-surprising Madoff case in yet another unexpected direction

Bernard Madoff, former Nasdaq Stock Market chairman and founder of Bernard L. Madoff Investment Securities LLC, was arrested and charged with securities fraud Thursday in what federal prosecutors called a Ponzi scheme that could involve losses of more than $64 billion.

It is bigger than Enron, bigger than Boesky and bigger than Tyco

"Madoff Scandal: 'Biggest Story of the Year'," Seeking Alpha, December 12, 2008 ---
http://seekingalpha.com/article/110402-madoff-scandal-biggest-story-of-the-year?source=wildcard

According to RealMoney.com columnist Doug Kass, general partner and investment manager of hedge fund Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd., today's late-breaking report of an alleged massive fraud at a well known investment firm could be "the biggest story of the year." In his view,

it is bigger than Enron, bigger than Boesky and bigger than Tyco.
It attacks at the core of investor confidence -- because, if true, and this could happen ... investors might think that almost anything imaginable could happen to the money they have entrusted to their fiduciaries.

Here are some excerpts from the Bloomberg report, entitled "Madoff Charged in $50 Billion Fraud at Advisory Firm":

Bernard Madoff, founder and president of Bernard Madoff Investment Securities, a market-maker for hedge funds and banks, was charged by federal prosecutors in a $50 billion fraud at his advisory business.

Madoff, 70, was arrested today at 8:30 a.m. by the FBI and appeared before U.S. Magistrate Judge Douglas Eaton in Manhattan federal court. Charged in a criminal complaint with a single count of securities fraud, he was granted release on a $10 million bond guaranteed by his wife and secured by his apartment. Madoff’s wife was present in the courtroom.

"It’s all just one big lie," Madoff told his employees on Dec. 10, according to a statement by prosecutors. The firm, Madoff allegedly said, is "basically, a giant Ponzi scheme." He was also sued by the Securities and Exchange Commission.

Madoff’s New York-based firm was the 23rd largest market maker on Nasdaq in October, handling a daily average of about 50 million shares a day, exchange data show. The firm specialized in handling orders from online brokers in some of the largest U.S. companies, including General Electric Co (GE). and Citigroup Inc. (C).

...

SEC Complaint

The SEC in its complaint, also filed today in Manhattan federal court, accused Madoff of a "multi-billion dollar Ponzi scheme that he perpetrated on advisory clients of his firm."

The SEC said it’s seeking emergency relief for investors, including an asset freeze and the appointment of a receiver for the firm. Ira Sorkin, another defense lawyer for Madoff, couldn’t be immediately reached for comment.

...

Madoff, who owned more than 75 percent of his firm, and his brother Peter are the only two individuals listed on regulatory records as "direct owners and executive officers."

Peter Madoff was a board member of the St. Louis brokerage firm A.G. Edwards Inc. from 2001 through last year, when it was sold to Wachovia Corp (WB).

$17.1 Billion

The Madoff firm had about $17.1 billion in assets under management as of Nov. 17, according to NASD records. At least 50 percent of its clients were hedge funds, and others included banks and wealthy individuals, according to the records.

...

Madoff’s Web site advertises the "high ethical standards" of the firm.

"In an era of faceless organizations owned by other equally faceless organizations, Bernard L. Madoff Investment Securities LLC harks back to an earlier era in the financial world: The owner’s name is on the door," according to the Web site. "Clients know that Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm’s hallmark."

...

"These guys were one of the original, if not the original, third market makers," said Joseph Saluzzi, the co-head of equity trading at Themis Trading LLC in Chatham, New Jersey. "They had a great business and they were good with their clients. They were around for a long time. He’s a well-respected guy in the industry."

The case is U.S. v. Madoff, 08-MAG-02735, U.S. District Court for the Southern District of New York (Manhattan)

Continued in article

And here is the SEC press release

Also see http://lawprofessors.typepad.com/securities/

What was the auditing firm of Bernard Madoff Investment Securities, the auditor who gave a clean opinion, that's been insolvent for years?
Apparently, Mr Madoff said the business had been insolvent for years and, from having $17 billion of assets under management at the beginning of 2008, the SEC said: “It appears that virtually all assets of the advisory business are gone”. It has now emerged that Friehling & Horowitz, the auditor that signed off the annual financial statement for the investment advisory business for 2006, is under investigation by the district attorney in New York’s Rockland County, a northern suburb of New York City.
"The $50bn scam: How Bernard Madoff allegedly cheated investors," London Times, December 15, 2008 ---
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article5345751.ece

It was at the Manhattan apartment that Mr Madoff apparently confessed that the business was in fact a “giant Ponzi scheme” and that the firm had been insolvent for years.

To cap it all, Mr Madoff told his sons he was going to give himself up, but only after giving out the $200 - $300 million money he had left to “employees, family and friends”.

All the company’s remaining assets have now been frozen in the hope of repaying some of the companies, individuals and charities that have been unfortunate enough to invest in the business.

However, with the fraud believed to exceed $50 billion, whatever recompense investors could receive will be a drop in the ocean.

Bob Jensen's fraud updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm

Where were the auditors?
What surprised me is the size of this alleged fraud
"This is huge," said David Rosenfeld, associate regional director of the SEC's New York Regional Office.
"This is a truly egregious fraud of immense proportions."

"Carnegie Mellon and Pitt Accuse 2 Investment Managers of $114-Million Fraud," by Scott Carlson, Chronicle of Higher Education, February 26, 2009 --- Click Here

The University of Pittsburgh and Carnegie Mellon University are suing two investment managers who allegedly took $114-million from the institutions and spent it on cars, horses, houses for their wives, and even teddy bears.

The two managers, Paul Greenwood and Stephen Walsh, are said to have taken a total of more than $500-million from the universities and other investors through their company, Westridge Capital Management, and they have also been charged with fraud by the Federal Bureau of Investigation. The universities named several associates of Mr. Greenwood and Mr. Walsh in the lawsuit.

According to the complaint, the universities became alarmed after the National Futures Association, a nonprofit organization that investigates member firms, tried to audit Mr. Greenwood and Mr. Walsh’s company. The association determined that that Mr. Greenwood and Mr. Walsh had taken hundreds of millions in loans from the investment funds. On February 12 the association suspended their membership after repeatedly trying, and failing, to contact them.

That step spurred the universities to try to locate their money. On February 18 they contacted the Securities and Exchange Commission and sought an investigation. According to their lawsuit, Carnegie Mellon had invested $49-million and the University of Pittsburgh had invested $65-million.

Today’s Pittsburgh Post-Gazette listed some of the things that Mr. Greenwood and Mr. Walsh had purchased with their investors’ money: rare books, Steiff teddy bears at up to $80,000 each, a horse farm, cars, and a $3-million residence for Mr. Walsh’s ex-wife.

Mr. Greenwood and Mr. Walsh were also handling money for retirement funds for teachers and public employees in Iowa, North Dakota, and Sacramento County, California. In the Post-Gazette, David Rosenfeld, an associate regional director of the SEC’s New York Regional Office, said the case represented “a truly egregious fraud of immense proportions.”

Mr. Walsh, it appears, had ties to another university as well. He is a member of the foundation board at the State University of New York at Buffalo, from which he graduated in 1966 with a political-science degree. In a written statement, officials at Buffalo said that he had not been an active board member for the past two years and that foundation policy forbade investing university money with any member of the board.

Bernard Madoff's Gangster Family Seems to Have Been Overlooked by Investors

"Pretty v. Ugly at the University," University Diaries Blog, Inside Higher Ed, February 24, 2009 --- http://www.insidehighered.com/blogs/university_diaries

Bernard Madoff is a classic Mafia-style gangster. He comes from gangsters - his mother was a crook. Investigators are looking into his father-in-law. A lot of his friends and investors are crooks. He was born a crook, has always been a crook.

"The FBI believes Madoff may never have properly invested any of the money entrusted to him," writes Stephen Foley in The Independent. That's <em>never</em>. Madoff is in his seventies.

Psychopathically evil, Madoff makes an exception - again, Mafia-style - for his closest family and friends. His last act before turning himself in was writing big checks to the inner circle.

Tomorrow, Harry Markopolos will tell Congress how easy it was, ten years ago, for him to prove that Madoff was a crook, and how difficult it was for him to convince the SEC, or anyone else, of this obvious truth.

An ugly story, isn't it.... Ugh. Let us turn to the verdant paths of Brandeis University, and walk to the door of its art museum, where pretty canvases hang on the walls and rekindle our sense of the beauty of the world and the goodness of mankind.

Yet all of this beauty will soon be shuttered, because that ugly world is all over Brandeis. It's all over a number of other universities, too -- Yeshiva, Bard, NYU, all the schools who loved charitable Bernie Madoff and his charitable friends.

Madoff, after all, was a philanthropist.

Not that he, as the word suggests, loves people. He hates people.

But he (and benefactors like Carl Shapiro, his closest business associate) gave lots of money to pretty places like universities, places that stand for love, not hate, and beauty, not ugliness. Why did he do that?

For the same reason many other crooks do it. To get their names on buildings, and, much more importantly, to launder their images. Madoff's been cleaning himself up for public consumption all his life, and there's nothing like gifts to universities to do oneself up <em>real</em> good.

University Diaries has covered, over the years, many amusing stories of universities using the latest in stone-blasting technology to get the names of crooks off of buildings the crooks endowed. At any given time, some university in this country is using power tools on its walls in a desperate effort to dissociate itself from scum. Here's the latest case. One of the most amusing was Dennis Kozlowski at Seton Hall.

Even if it doesn't call for power tools, the problem of taking crooks' money can be just as troublesome, as with the University of Missouri-Columbia's Kenneth L. Lay Chair in International Economics.

Sometimes things call for quick-action internet prowess. Recall how, deep in the pre-exposure night, Yeshiva University deleted from its webpages the once-sainted names of Bernard Madoff and his partner, Ezra Merkin.

Our wretched economy will continue to reveal the reputation-laundering enterprise some of our universities have been running.

Just as every Madoff associate or victim claims to be a deceived innocent, so these campuses will tell us they never suspected a thing.

The farce would be fun to watch if it weren't so incredibly destructive.

Bob Jensen's Fraud Updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm

Bob Jensen's threads on security frauds are at http://www.trinity.edu/rjensen/FraudRotten.htm

"Pitt, CMU money managers arrested in fraud FBI says they misappropriated $500 million for lavish lifestyles," by Jonathon Silver, Pittsburgh Post-Gazette, February 26, 2009 --- http://www.post-gazette.com/pg/09057/951834-85.stm

Two East Coast investment managers sued for fraud by the University of Pittsburgh and Carnegie Mellon University misappropriated more than $500 million of investors' money to hide losses and fund a lavish lifestyle that included purchases of $80,000 collectible teddy bears, horses and rare books, federal authorities said yesterday.

As Pitt and Carnegie Mellon were busy trying to learn whether they will be able to recover any of their combined $114 million in investments through Westridge Capital Management, the FBI yesterday arrested the corporations' managers.

Paul Greenwood, 61, of North Salem, N.Y., and Stephen Walsh, 64, of Sands Point, N.Y., were charged in Manhattan -- by the same office prosecuting the Bernard L. Madoff fraud case -- with securities fraud, wire fraud and conspiracy.

Both men also were sued in civil court by the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission, which alleged that the partners misappropriated more than $553 million and "fraudulently solicited" $1.3 billion from investors since 1996.

The Accused

Paul Greenwood and Stephen Walsh are accused of misappropriating millions from investors. Here is a look at some of their biggest personal purchases:

• HOME: Mr. Greenwood, a horse breeder, owned a horse farm in North Salem, N.Y., an affluent community that counts David Letterman as a resident.

• BEARS: Mr. Greenwood owns as many as 1,350 Steiff toys, including teddy bears costing as much as $80,000.

• DIVORCE: Mr. Walsh bought his ex-wife a $3 million condominium as part of their divorce settlement.

"This is huge," said David Rosenfeld, associate regional director of the SEC's New York Regional Office. "This is a truly egregious fraud of immense proportions."

Lawyers for the defendants either could not be reached or had no comment.

Mr. Greenwood and Mr. Walsh, longtime associates and former co-owners of the New York Islanders hockey team, ran Westridge Capital Management and a number of affiliated funds and entities.

As late as this month, the partners appeared to be doing well. Mr. Greenwood told Pitt's assistant treasurer Jan. 21 that they had $2.8 billion under management -- though that number is now in question. And on Feb. 2, Pitt sent $5 million to be invested.

But in the course of less than three weeks, Westridge's mammoth portfolio imploded in what federal authorities called an investment scam meant to cover up trading losses and fund extravagant purchases by the partners.

An audit launched Feb. 5 by the National Futures Association proved key to uncovering the alleged deceit and apparently became the linchpin of the case federal prosecutors are building.

That audit came about in an indirect way. The association, a self-policing membership body, had taken action against a New York financier. That led to a man named Jack Reynolds, a manager of the Westridge Capital Management Fund in which CMU invested $49 million; and Mr. Reynolds led to Westridge.

"We just said we better take a look at Jack Reynolds and see what's happening, and that led us to Westridge and WCM, so it was a domino effect," said Larry Dyekman, an association spokesman. "We're just not sure we have the full picture yet."

Mr. Reynolds has not been charged by federal authorities, but he is named as a defendant in the lawsuit that was filed last week by Pitt and CMU.

"Greenwood and Walsh refused to answer any of our questions about where the money was or how much there was," Mr. Dyekman continued.

"This is still an ongoing investigation, and we can't really say at this point with any finality how much has been lost."

The federal criminal complaint traces the alleged illegal activity to at least 1996.

FBI Special Agent James C. Barnacle Jr. said Mr. Greenwood and Mr. Walsh used "manipulative and deceptive devices," lied and withheld information as part of a scheme to defraud investors and enrich themselves.

The complaint refers to a public state-sponsored university called "Investor 1" whose details match those given by Pitt in its lawsuit.

The SEC's Mr. Rosenfeld said the fraud hinged not so much on the partners' investment strategy but on the fact that they are believed to have simply spent other people's money on themselves.

"They took it. They promised the investors it would be invested. And instead of doing that they misappropriated it for their own use," Mr. Rosenfeld said.

Not only do federal authorities believe Mr. Greenwood and Mr. Walsh used new investors' funds to cover up prior losses in a classic Ponzi scheme, they used more than $160 million for personal expenses including:

• Rare books bought at auction;

• Steiff teddy bears purchased for up to $80,000 at auction houses including Sotheby's;

• A horse farm;

• Cars;

• A residence for Mr. Walsh's ex-wife, Janet Walsh, 53, of Florida, for at least $3 million;

• Money for Ms. Walsh and Mr. Greenwood's wife, Robin Greenwood, 57, both of whom are defendants in the SEC suit. More than $2 million was allegedly wired to their personal accounts by an unnamed employee of the partners.

"Defendants treated investor money -- some of which came from a public pension fund -- as their own piggy bank to lavish themselves with expensive gifts," said Stephen J. Obie, the Commodity Futures Trading Commission's acting director of enforcement.

It is not clear how Pitt and CMU got involved with Mr. Greenwood and Mr. Walsh. But there is at least one connection involving academia. The commission suit said Mr. Walsh represented to potential investors that he was a member of the University at Buffalo Foundation board and served on its investment committee.

Mr. Walsh is a 1966 graduate of the State University of New York at Buffalo where he majored in political science.

He was a trustee of the University at Buffalo Foundation, but the foundation did not have any investments in Westridge or related firms.

Universities, charitable organizations, retirement and pension funds are among the investors who have done business with Mr. Greenwood and Mr. Walsh.

Among those investors are the Sacramento County Employees' Retirement System, the Iowa Public Employees' Retirement System and the North Dakota Retirement and Investment Office, which handles $4 billion in investments for teachers and public employees.

The North Dakota fund received about $20 million back from Westridge Capital Management, but has an undetermined amount still out in the market, said Steve Cochrane, executive director.

Mr. Cochrane said Westridge Capital was cooperative in returning what money it could by closing out their position and sending them the money.

"I dealt with them exclusively all these years," Mr. Cochrane said.

"They always seemed to be upfront and honest. I think they're as stunned and as victimized as we are, is my guess."

He said Westridge Capital had done an excellent job over the years.

The November financial statement indicated that the one-year return from Westridge Capital was a negative 11.87 percent, but the five-year annualized rate of return was a positive 8.36 percent.

Bob Jensen's fraud updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm

Bob Jensen's Rotten to the Core threads are at http://www.trinity.edu/rjensen/FraudRotten.htm

"Executives Took, but the Directors Gave," by Heather Landy, The New York Times, April 4, 2009 ---
http://nytimes.com/2009/04/05/business/05board.html?8dpc 

Little of the ire against outsize C.E.O. paychecks has been aimed at the people who signed off on them: corporate directors.

Instead, the anger has been concentrated on the executives themselves, particularly those running companies at the heart of the financial crisis. And boards — thrust into the limelight only rarely, as when the directors of the New York Stock Exchange were in a legal battle over the pay collected by Richard A. Grasso — have managed to stay in the background.

The exchange’s board “really took a lot of heat for that controversy,” says Sarah Anderson, an analyst on executive pay at the Institute for Policy Studies in Washington. “But so far, with this crisis, I don’t feel like boards have been getting as much attention as they should be.”

Last spring, the House Committee on Oversight and Government Reform examined pay practices at Countrywide Financial, Merrill Lynch and Citigroup, but those issues eventually took a back seat to broader concerns about the viability of the country’s financial system. As investors frustrated by the continuing crisis start seeking ways to avoid the next one, advocates of change in corporate governance expect boards to come under renewed scrutiny that could yield big changes.

Emboldened shareholder activists are pressing more companies to hold annual nonbinding votes on executive pay packages. They’re also pursuing, and appear increasingly likely to win, rules to make it easier for investors to nominate or replace board members.

And as more people start connecting the dots between pay incentives that boards laid out for executives and the risk-taking at the heart of the financial crisis, some lawmakers have been eager to step in, and many directors themselves are re-examining their approach to compensation.

“When you look at cases where compensation of senior management was out of line, or where people arguably were overpaid, it’s definitely the fault of the compensation committee of the board,” says Thomas Cooley, dean of the Stern School of Business at New York University and a director of Thornburg Mortgage. “Congress has gotten into the business of dictating executive pay now, and they shouldn’t be in that business. What they should be doing is turning the light on the committees.”

Activist shareholders have been criticizing executive pay practices for well over a decade, accusing directors of being too cozy with C.E.O.’s, too eager to lavish pay on them and too ambiguous about the formulas they use for setting compensation.

Improved standards for determining director independence and disclosing the procedures of board compensation committees were supposed to help solve those problems. And activist shareholders played a major role in spreading the notion of pay-for-performance, by which executives would be compensated based on their ability to meet board-devised financial targets.

But amid all the changes, a crucial piece of the equation — the unintended risks that could arise from these pay-for-performance incentives — went unnoticed, said James P. Hawley, co-director of the Elfenworks Center for the Study of Fiduciary Capitalism at St. Mary’s College of California.

“The problem isn’t just when people in a particular firm are getting rewarded in ways that take away from the shareholder. That’s been well recognized,” Mr. Hawley says. “What’s not been recognized is that the misalignment of incentives has resulted in firm, sector and systemic risks. None of the corporate governance activists ever made the connection.”

It took the disastrous results of 2008 to expose such links, and to make compensation a central issue for politicians and corporate America.

TWO factors contributed to the pay scales that now have C.E.O.’s earning more than 300 times the pay of the average American worker.

First was the advent of giant stock option grants, a form of compensation made all the more attractive by a 1993 change to the tax law that maintained corporate tax deductions for executive pay over $1 million, but only if the pay was tied to performance.

Second was the widespread practice of linking pay to the levels at companies of similar size or scope. Every time a board tries to keep an executive happy by offering above-average pay, the net effect is to raise the average that everyone else will use as a baseline.

In the absence of fraud or self-dealing, it’s hard for shareholders to make a legal argument that boards have failed at their job. State law in Delaware, where most big public entities are incorporated, simply requires companies to have boards that direct or manage their affairs, and it affords broad legal protection to board members so long as they act in good faith and in a manner “believed to be in or not opposed to the best interests of the corporation.”

That was the basis for the recent ruling of a Delaware judge who threw out most of the claims in a shareholder lawsuit seeking to hold Citigroup directors and officers liable for big losses tied to subprime mortgages. But the judge did allow the plaintiffs to pursue one of their claims, which alleged corporate waste stemming from a multimillion-dollar parting pay package that Citigroup’s board awarded Charles O. Prince III, the former C.E.O., in 2007.

Continued in article

Outrageous Executive and Director Compensation Schemes That Reward Failure and Fraud ---
http://www.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation

Corporate Governance is in a Crisis --- http://www.trinity.edu/rjensen/Fraud001.htm#Governance

Rotten to the Core --- http://www.trinity.edu/rjensen/FraudRotten.htm

Are accounting internal controls at universities lax?

"This person was a dean," says Ms. Willihnganz, the provost. "And deans here have a very wide breadth of control. They have a lot of authority. I think, in fact, no one else here at this university could have gotten some of those things through. Because he was a dean, he was trusted."

"Education Dean's Fraud Case Teaches U. of Louisville a Hard Lesson:  The former official now awaits trial. Some colleagues say the university should have caught him earlier," by David Glenn, Chronicle of Higher Education, June 12,. 2009 --- http://chronicle.com/weekly/v55/i39/39a00102.htm?utm_source=at&utm_medium=en

At the end of 2005, Robert D. Felner was riding high. A well-paid dean at the University of Louisville, he had just secured a $694,000 earmarked grant from the U.S. Department of Education to create an elaborate research center to help Kentucky's public schools.

The grant proposal, which Mr. Felner had labored over for months, made some impressive promises. Five Louisville faculty members would devote time to the center, and four other people would be hired. The advisory board would be led by Virginia G. Fox, Kentucky's secretary of education.

On paper this all seemed plausible: From 1996 until 2003, Mr. Felner directed the University of Rhode Island's education school, where he helped create a well-regarded statewide research center.

To put it gently, Mr. Felner did not duplicate that feat at Louisville.

By the spring of 2008, all but $96,000 of the grant had been spent, but none of the tasks listed in Mr. Felner's proposal had been accomplished. Hundreds of thousands of surveys of students, teachers, and parents? School officials in Kentucky say they know of no such studies. Conferences and special issues of education journals? None. An advisory committee led by the state's top education officials? They say they never heard of Mr. Felner's center.

At this point, Mr. Felner was heading for the exit, continuing his climb up the academic ladder. Late in May 2008, he told his colleagues that he had been hired as chancellor of the University of Wisconsin-Parkside, effective August 1.

During his final weeks at Louisville, Mr. Felner pressed his luck one last time. Even though only $96,000 remained in the account, he implored Louisville officials to approve a $200,000 subcontract with a nonprofit organization in Illinois that had already received $450,000 from the grant. Perhaps, he suggested, the university could draw on a special fund that had been established by the daughter of a former trustee.

The Illinois group, Mr. Felner said, had been surveying students and teachers in Kentucky. That survey would "let us give the feds something that should make them very happy about the efficiency and joint commitment of the university to doing a good job with an earmark, as I know we will want more from this agency," he wrote in an e-mail message on June 18.

Two days later, Mr. Felner's offices were raided by federal agents who took away his files and laptops. He was questioned for hours by a U.S. Postal Service inspector and a member of the University of Louisville's police department. That weekend he called Wisconsin officials: Sadly, he wouldn't be coming to Parkside after all.

In October a federal grand jury indicted Mr. Felner on nine counts of mail fraud, money laundering, and tax evasion. According to the indictment, the Illinois nonprofit group, known as the National Center on Public Education and Prevention, was simply a shell that funneled money into the personal bank accounts of Mr. Felner and Thomas Schroeder, a former student of his and the group's "executive director." Prosecutors say the two men siphoned away not only the $694,000 earmarked grant, but also $1.7-million in payments from three urban school districts, money that ought to have gone to the legitimate public-education center that Mr. Felner had created in Rhode Island.

Mr. Felner and Mr. Schroeder now await trial on charges that could send them to prison for decades. No trial date has been set.

None of the accusations have been proved in court, and Mr. Felner's lawyers have signaled in pretrial briefs that they will defend him aggressively. (They declined to comment for this article.)

But two facts seem hard to avoid: All but $96,000 of the earmarked grant has been spent. And there is no evidence that the activities listed in Mr. Felner's grant proposal have been carried out.

A Question of Oversight

When Louisville accepted the earmarked grant, its officials signed the boilerplate language attached to most federal contracts. The university, they promised, had "the institutional, managerial, and financial capability ... to ensure proper planning, management, and completion of the project."

But did it in fact have that capability? For several months in 2007, Mr. Felner charged almost $37,000 of his salary against the grant, but there is no evidence that he ever worked on the project. (In an October 2008 memorandum, Robert N. Ronau, the college of education's associate dean for research, declared that he knew of no reports, articles, or other products that resulted from the grant.). Federal regulations require that universities use "suitable means of verification that the work was performed" when they prepare time-and-effort reports; Louisville officials declined to comment on how Mr. Felner's time-and-effort reports were processed.) And when he sent his first big payment to the Illinois group, Mr. Felner constructed the deal as a personal-services contract instead of a formal subcontract, which would have been subject to more oversight by the university. But no one corrected that error for more than a year.

In the months since Mr. Felner's indictment, Louisville has seen a parade of blue-ribbon committees, auditors, and management consultants. University leaders insist that they have streamlined their research-compliance systems to prevent any more trouble. They also emphasize that it was a university employee who tipped off law enforcement to Mr. Felner's actions. (Who did this and when remains a mystery — but e-mail records obtained by The Chronicle make clear that by May 2008, Louisville's research administrators were becoming more openly skeptical of Mr. Felner's claims.)

"What these reports have affirmed is that we basically have pretty good practices in place," says Shirley C. Willihnganz, Louisville's provost. "I think what we had in this case was a person who abused the system. And so it's not so much that our policies were bad or that our procedures were bad. We had a person who did not follow them and did not respect them."

But some of Mr. Felner's former colleagues insist that he should have been stopped long before the spring of 2008. They say the university coddled Mr. Felner and turned a blind eye to his grant management, in part because the doctoral program in education rose impressively in the annual U.S. News & World Report rankings after his arrival. If the university had paid more attention to the many faculty and student grievances against Mr. Felner — and especially to a 2006 faculty vote of no confidence in his leadership — the grant money might never have gone missing, they say.

"The University of Louisville, like everybody, is aspiring to bring in more grant dollars," says Bryant A. Stamford, a professor of exercise science at Hanover College who left Louisville's faculty in 2005 after a dispute with Mr. Felner. "When you put yourself in that position, it's pretty amazing what you're willing to do. You sacrifice the infrastructure of the university in order to put out a report that says, Look, grants are up by 60 percent this year."

The Louisville affair comes at a time when officials of Emory University, Harvard University, and other institutions have faced Senate investigations revealing that scholars had failed to disclose hundreds of thousands of dollars they had received from pharmaceutical companies. Throughout the country, research administrators are asking themselves if tougher rules could detect miscreants, or whether determined liars will always find a way around the rules.

Throwing a Bone

In 2005, two years after he arrived at Louisville, Mr. Felner won his $694,000 earmarked federal grant, which was billed as "Support and Continuous Improvement of No Child Left Behind in Kentucky."

The earmark was sponsored by U.S. Representative Anne M. Northup, a Republican who then represented Kentucky's third district. It is easy to see what might have attracted Ms. Northup to Mr. Felner's proposal: He claimed to have lined up cooperation from a host of Kentucky school districts and public officials, and he could point to the track record of his Rhode Island center.

In fact, the proposal promised not only to replicate the success of Mr. Felner's Rhode Island center. It promised to bring the Rhode Island center to Louisville. The National Center on Public Education and Social Policy was "formerly located at the University of Rhode Island" and would "now be subsumed under the aegis of" Mr. Felner's Louisville office, the proposal said.

So maybe it should have raised eyebrows among Louisville's research administrators when in March 2006, only a few months after he had won the earmark, Mr. Felner sent $60,000 of the grant money to Rhode Island.

The "work plan" attached to that subcontract was a blizzard of verbiage that said nothing very specific about what the Rhode Island center was supposed to do with the $60,000. "The National Center on Public Education and Social Policy at the University of Rhode Island agrees to provide data analysis and support relating to critical questions and educational research issues focused on No Child Left Behind Initiatives for project work conducted by the University of Louisville," the plan read. "By subcontracting with the University of Rhode Island, the NCLB Center can begin work immediately with data collected by the Center. URI's established level of expertise and technological capabilities are sophisticated enough to assimilate endeavors of this magnitude seamlessly while the Center is in the process of building their systems and personnel."

The $60,000 actually had nothing to do with Mr. Felner's earmark, according to federal prosecutors and officials at Rhode Island. Instead, they say, Mr. Felner was throwing a bone to his former colleagues, whom he and Mr. Schroeder had cheated out of more than $1.7-million in income.

Here we need to make a quick detour into the heart of the prosecutors' allegations. Between 2000 and 2003, the Rhode Island center conducted tens of thousands of surveys in public schools in Atlanta, Buffalo, and Santa Monica. But Mr. Felner and Mr. Schroeder allegedly tricked the three districts into sending their payments to their fraudulent Illinois organization, whose name was very similar to the Rhode Island center's. (In Rhode Island: the National Center on Public Education and Social Policy. In Illinois: the National Center on Public Education and Prevention.) The Illinois money then flowed into the two men's bank accounts, prosecutors say. Mr. Felner owns four houses whose combined value is more than $2-million.

Stephen Brand, a professor of education at Rhode Island who worked on the three survey projects, says that Mr. Felner strung the center along with vague promises and explanations about why the school districts' money had not materialized. But Mr. Brand says he does not know many details. "I haven't seen copies of those three contracts," he says. "I don't think anyone here has ever seen them." (Anne Seitsinger, the Rhode Island center's director, declined repeated requests for an interview.)

In any case, the Rhode Island center managed to survive for several years without the $1.7-million because it had accumulated a substantial surplus from its multiyear, multimillion-dollar survey contract with the state of Rhode Island. But by 2005 it was facing a deficit. That year, according to The Providence Journal, the center's business manager wrote to Mr. Felner in Louisville: "Are you giving out loans? We sure need one right now."

The $60,000 subcontract was apparently just such a "loan." The money was used only to cover the Rhode Island center's operating deficit. Despite its purported power to "assimilate endeavors of this magnitude seamlessly," the Rhode Island center never actually did any work on the earmarked Louisville grant.

Robert A. Weygand, Rhode Island's vice president for administration, concedes that it was wrong for the center to accept the $60,000, and he says the university has tightened the oversight of all its research centers. But he emphasizes that federal prosecutors have not charged anyone at Rhode Island with any crime. "What they've told us is that we're a victim of a million-dollar theft," Mr. Weygand says. "We have a right to compensation from any funds that may be recovered from Mr. Felner. We've been working with the Secret Service."

Budget Details

The $60,000 Rhode Island subcontract was only a prelude. At the end of 2006, Mr. Felner told his colleagues that Louisville needed to sign a $250,000 personal-services contract with the Illinois center. His grant proposal had said nothing about the Illinois center, but Mr. Felner now declared that that center, as the "developer/owner of the High Performance Learning Communities Assessments," was the only entity that could effectively survey students and teachers in Kentucky. At the end of 2007, he sent another $200,000 to Illinois. According to prosecutors, the entire $450,000 eventually ended up in Mr. Felner's and Mr. Schroeder's wallets.

Where the work plan on the Rhode Island subcontract had been flowery and vague, the work plans on the Illinois subcontracts were curt and vague. The first one said only that the Illinois center would "provide for the use" of the survey assessments "and the use of data derived therefrom." The second one said that the Illinois center would provide survey data from 135,000 students, 50,000 parents, and 10,500 teachers — but it did not name any Kentucky school districts where the surveys would be conducted.

E-mail records offer a detailed tracing of how that second Illinois subcontract was constructed. The process suggests how Mr. Felner tended to parry research administrators' efforts — such as they were — to wring accurate information from him.

On November 9, 2007, Jennifer E. Taylor, director of grant support and sponsored programs at the college of education, wrote to Mr. Felner to report that she had spoken with B. Ann LaPerle, an assistant in the university's office of grants management. "I just spoke with Ann about the subcontract with Tom [Schroeder]'s group," Ms. Taylor wrote. "We are going to need a detailed budget, so if you have time today, we can get this out and processed."

Mr. Felner replied with a small tantrum. "I have no idea what that means but will try as we have never done such a thing," he wrote. "We tend to pay them by the number of students and surveys but since we do not have enough to actually pay for it all so they are giving us some for free this could be tricky. And given the delays already if it takes another week or so we simply will not be able to do it this year nor finish the work. Unbelievable!"

Later that day, Ms. Taylor wrote to Ms. LaPerle, instructing that the subcontract's detailed budget should read simply "$1 per survey for 200,000 surveys."

But hours later, Mr. Felner weighed in with a more detailed budget — the one that ultimately appeared on the subcontract. Mr. Felner's version stipulated 135,000 student surveys at a price of $1.25 each, 10,500 teacher surveys at $1.45 each, and so on through several more categories.

Apparently no one questioned the discrepancy between the two versions. And neither Ms. LaPerle nor Ms. Taylor asked for any proof that the Illinois center had done any work on its first subcontract, which had been signed almost a year earlier.

It is that last element that seems most startling. It must have been an open secret in Ms. Taylor's office that the Illinois group had received $250,000 at the beginning of 2007 but that no surveys had been conducted. Ms. Taylor has left the university. Her supervisor, Mr. Ronau, declined requests for an interview.

So why did Louisville officials not catch this apparent fraud for a full two years? The Rhode Island subcontract said the center was supposed to submit a final report by the end of September 2006, but no report was ever submitted. The Illinois contracts likewise specified report dates, and one of them said that its work would require approval by a human-subjects-protection board. None of that ever happened — but there is no evidence that anyone objected before the spring of 2008.

"This person was a dean," says Ms. Willihnganz, the provost. "And deans here have a very wide breadth of control. They have a lot of authority. I think, in fact, no one else here at this university could have gotten some of those things through. Because he was a dean, he was trusted."

Misplaced Trust

But that is exactly what many of Mr. Felner's former colleagues dispute. Louisville's leaders, they say, had plenty of reason to distrust Mr. Felner long before he began to send six-figure checks to Illinois.

Continued in article

Bob Jensen's threads on Financial and Academic Lack of Accountability and Conflicts of Interest ---
http://www.trinity.edu/rjensen/HigherEdControversies.htm#Accountability

Former top executive of American International Group Inc. plundered an AIG retirement program of billions of dollars

"AIG lawyer tells jury that Greenberg plundered retirement program after being forced out," by Madlen Read,  Newser, June 15, 2009 --- Click Here
Also see The Washington Post's account --- Click Here

The former top executive of American International Group Inc. plundered an AIG retirement program of billions of dollars because he was angry at being forced out of the company, a lawyer for AIG told jurors Monday at the start of a civil trial.

Attorney Theodore Wells told the jury in Manhattan that former AIG Chief Executive Officer Maurice "Hank" Greenberg improperly took $4.3 billion in stock from the company in 2005, after he was ousted by the company amid investigations of accounting irregularities.

"Hank Greenberg was mad. He was angry," Wells said in U.S. District Court of the emotional state of the man who, over a 35-year-career, built AIG from a small company into the world's largest insurance company.

Wells said that Greenberg, within weeks of being forced out in mid-2005, gave the go-ahead for tens of millions of shares to be sold from a trust fund. The fund was set up to provide incentive bonuses to a select group of AIG management and highly compensated employees that they would receive upon their retirement.

Greenberg, 84, has contended through his lawyers that he had the right to sell the shares because they were owned by Starr International, a privately held company he controlled.

Starr International was named after Cornelius Vander Starr, who created a worldwide network of insurance companies in the early 1900s.

AIG maintains that Starr and Greenberg, his protege and successor, decided in the late 1960s to organize the various companies under one holding company, AIG.

Starr International remained a private company and its shareholders decided in 1970 that the amount that its shares of AIG were worth above book value of about $110 million should be used to compensate AIG employees, AIG has said.

The embattled insurer is trying to reclaim the money from Starr it says was wrongly pocketed through stock sales by Greenberg.

Bob Jensen's threads on the history of AIG fraud ---
http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

"MIT Tops List of College Copyright Violators," by Erica R. Hendry, Chronicle of Higher Education, June 17, 2009 ---
http://chronicle.com/wiredcampus/article/3833/mit-tops-list-of-college-copyright-violators

The Massachusetts Institute of Technology had the most instances of digital piracy and other copyright infringements among American colleges and universities in 2008 for the second year in a row, according to a report released by Bay-TSP, a California company that offers tracking applications for copyrighted works.

According to the company’s annual report, MIT had 2,593 infringements of media owned by Bay-TSP’s clients. The University of Washington and Boston University ranked second and third, with 1,888 and 1,408 infringements, respectively.

Clients of the company, whose name means “Bay-Area Track, Security, Protect,” include motion-picture studios; software, video-game and publishing companies; and sports and pay-per-view television networks.

The annual report provides an analysis of data collected using piracy-network crawling software. The company does not track all instances of Internet-based piracy, said Jim E. Graham, a Bay-TSP spokesman. It only monitors violations of movies, videos, TV shows, or software that clients ask the company to follow.

Mr. Graham also said not all violations result in a take-down notice. Clients give the company varying instructions for their data, ranging from sending take-down notices to simply tracking how often and by whom the material is infringed.

Although MIT ranks first among domestic colleges and universities, it is not in the top 10 worldwide. The University of Botswana had 9,027 infringements, followed by Sweden’s Uppsala University, which had 8,032 infringements, according to the report.

Jeffrey I. Schiller, the information-services and technology-network manager at MIT, said he has not seen a copy of Bay-TSP’s report, but the institution does not tolerate copyright infringement, nor does it receive an unusual number of take-down notices.

“I haven’t formally counted the number of take-down notices we’ve received, but if we get more than a few, it’s a big day,” he said. “If we represented truly the worst-case scenario, then copyright infringement can’t be a really big problem, because we don’t have that much.”

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

 

Other Links
Main Document on the accounting, finance, and business scandals --- http://www.trinity.edu/rjensen/Fraud.htm 

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

Bob Jensen's threads on professionalism and independence are at  file:///C:/Documents%20and%20Settings/dbowling/Local%20Settings/Temporary%20Internet%20Files/OLK36/FraudUpdates.htm#Professionalism 

Bob Jensen's threads on pro forma frauds are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#ProForma 

Bob Jensen's threads on ethics and accounting education are at 
http://www.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation

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

Incompetent and Corrupt Audits are Routine ---
http://www.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits

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

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

 

 

 

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

 

 

 

Bob Jensen's home page is at http://www.trinity.edu/rjensen/