Accounting Scandal Updates and Other Fraud on September 30, 2003
Bob Jensen at Trinity University


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

Many of the scandals are documented at 

Critics worry that auditors will advise companies on their controls and then end up approving their own work.
Jonathan Glater (See Below with respect to Section 404 of SOX)

WorldCom internal and external auditors testified in U.S. Bankruptcy Court that the company's books remain a tangled mess and that it may be impossible to properly apportion close to $1 trillion in transactions between more than 200 subsidiaries. WorldCom has argued that its books are so confused that it has little choice but to scrap much of the past three years of accounting records and begin anew on a consolidated basis. U.S. Bankruptcy Court Judge Arthur J. Gonzalez is holding a hearing on the company's reorganization plan, one of the last stages in the bankruptcy process. If Gonzalez approves the plan the company could exit bankruptcy later this fall. I have significant doubts the company could ever prepare accurate accounting statements for its various subsidiaries, testified Joseph L. DAmico, senior managing director of FTI Consulting, an Annapolis-based forensic accounting firm. DAmico testified that WorldCom's own accountants failed to keep accurate records of a blizzard of transactions between the company's various entities. Also testifying was WorldCom's interim corporate controller, Robert L. Pierson, who confirmed DAmicos assessment of the companys financial recordkeeping. We have never balanced our internal accounts, Pierson said.
Christopher Stern's Washington Post article below.

New York State Attorney General Eliott Spitzer's charges of improper trading practices by several leading mutual fund families are another blow to public trust in financial institutions. Mutual funds have been the place you would advise the most unsophisticated investors to go: Mutual funds were designed for grandpa and grandma, and repeatedly recommended to them by all kinds of benevolent authorities. Thus scandals in the mutual fund sector are potentially much more damaging to public trust in our financial institutions than are scandals in other sectors -- such as the one playing out in the New York Stock Exchange right now.
See Robert Shiller's article below.

When the Manhattan Institute's researchers added it all up, the result was staggering: Not only have tort costs risen much faster than either inflation or GDP, the estimated $40 billion in revenues our tort warriors took in for 2001 was 50% more than Microsoft or Intel and double that of Coca-Cola.
See below.

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

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

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

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

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

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

September 10, 2003 message from Tracey Sutherland [

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

Tuesday morning featured Presidential Lecturer, Joel S. Demski, immediate past president of the Association. Joel's speech, "Endogenous Expectations," stimulated considerable discussion during the rest of the meeting. So that the conversation can continue, the full text of his comments is available online at 

Soon video and slides will be available on the AAA website for all plenary sessions for the 2004 Annual Meeting, as well as for the outstanding follow-up panel session to Art Wyatt's address.

While many filings in the Texarkana case are under seal, one internal PricewaterhouseCoopers document from October 1999 estimated the firm's annual credits from travel rebates at $45 million, mostly from postflight rebates on airline tickets. As an example, the court record contains a December 1999 contract under which Budget Rent A Car Corp. agreed to pay PricewaterhouseCoopers a rebate equal to 3% of all rental revenue that Budget received from the firm, if annual sales to PricewaterhouseCoopers topped $15 million. The plaintiff in the Texarkana case has alleged that some of the firms' airline rebates topped 40% of the plane tickets' purchase prices.
Jonathon Weil, The Wall Street Journal, September 23, 2003 ---,,SB106452493527358700,00.html?mod=todays%255Fus%255Fmoneyfront%255Fhs 
Note from Bob Jensen: This is a classic problem of ethics. The issue is not so much what the largest accounting firms are/were doing before they got caught (I guess most have stopped doing it now).  It’s more of a matter of keeping it secret from their clients, potential clients, and the public in general.  For example, many (most) of us get frequent flier miles when we bill our airline tickets to universities and other organizations that pay our air fares.  However, it's no big secret that we get those frequent flier miles.  Some of us also get credit card rebates if we pay with credit cards such as Discover Card.  This is a bit more of a gray area, but if the price is the same no matter how we pay the bill, I guess we can hold our head high and declare that we are not ripping off anybody as long a another form of payment would not reduce the bill.  However, what the large accounting firms have been doing around the world for travel billings is a much more controversial matter of ethics.   The above article notes how the Justice Department is investigating this rip off (my words) in more than just one of the large accounting firms.  What gets me about the above revelation of the magnitude of this scheme is the hypocritical aspect in which large accounting firms are now preaching virtue but still show signs of practicing vice after all the scandals.  Sometimes it seems they are not really listening to Art Wyatt's advice quoted above.


"Travel-Billing Probe Has a Bigger Scope," Jonathan Weil, The Wall Street Journal, September 26, 2003 ---,,SB106452493527358700,00.html?mod=todays%255Fus%255Fmoneyfront%255Fhs 

A Justice Department investigation that started two years ago with questions about PricewaterhouseCoopers LLP's travel-related billing practices as a government contractor also is focusing on possible overbillings by the other Big Four accounting firms, as well as several other companies.

Some details of the probe's scope are contained in a previously unreported November 2002 memorandum that the Justice Department filed with a Texarkana, Ark., state circuit court in connection with a separate civil lawsuit into travel-related billing practices. The lawsuit accuses PricewaterhouseCoopers, Ernst & Young LLP and KPMG LLP of fraudulently padding the travel-related expenses they billed to clients by hundreds of millions of dollars over a 10-year period starting in 1991.

In its memo to the court, the Justice Department said it is investigating each of the suit's defendants, "focusing on whether they have submitted false claims to the government, because they have failed to credit government contracts with amounts they have received as rebates from travel providers."

The Texarkana lawsuit originally was filed in October 2001 by closely held shopping-mall operator Warmack-Muskogee LP and had proceeded without publicity until reported last week in The Wall Street Journal. It alleges that the accounting firms systematically billed their clients for the full face amount of certain travel expenses, including airline tickets, hotel rooms and car-rental expenses, while pocketing undisclosed rebates they received under contracts with various travel-service providers.

The defendants have acknowledged retaining rebates on various travel expenses for which they had billed clients at their pre-rebate amounts. However, they deny that their conduct was fraudulent, saying that the proceeds offset amounts that otherwise would have been billed to clients. They say they have discontinued the practice.

Other defendants in the Texarkana lawsuit include the U.S. unit of Cap Gemini Ernst & Young, a French consulting company that purchased Ernst & Young's consulting practice in 2000, and BearingPoint Inc., a former KPMG unit previously known as KPMG Consulting Inc. that now is an independent public company. The Justice Department memo further disclosed that the defendants "are aware of" the investigation, which "concerns the same issues presented in the" Texarkana civil lawsuit, and that the government had obtained documents from each of the defendants in the Texarkana case through subpoenas.

According to a person familiar with the investigation, the Justice Department's overbilling probe also includes the travel-related billing practices of Deloitte & Touche LLP, as well as four other large government contractors. This person declined to identify the other four contractors under investigation, but said they are not professional-services firms. Federal contracts, this person explained, typically state that government contractors will bill the government for actual travel costs -- often referred to as "out-of-pocket" or "incurred" costs -- which the government interprets to mean the amount that a contractor actually paid for, say, an airline ticket, including any rebates.

Continued in the article.

"Audit Firms Overbilled Clients For Travel, Arkansas Suit Alleges," by Jonathan Weil and Cassell Bryan-Low, The Wall Street Journal, September 17, 2003 ---,,SB106376088299612400,00.html?mod=todays%255Fus%255Fpageone%255Fhs 

Three of the nation's four biggest accounting firms have been accused in a lawsuit of fraudulently overbilling clients by hundreds of millions of dollars for travel-related expenses, and the Justice Department has been conducting an investigation of the billing practices of at least one of the firms, PricewaterhouseCoopers LLP.

Documents describing the government's investigation are contained in the previously unpublicized lawsuit filed here in October 2001 that could pose both a public-relations embarrassment and a big legal challenge to the firms. The industry has been under intense scrutiny for its audit work following the 2001 collapse of Enron Corp., which brought down another big accounting firm, Arthur Andersen LLP, and for its perceived lack of oversight at other companies, including Tyco International Ltd., Xerox Corp. and others.

The suit, pending in an Arkansas state circuit court, accuses PricewaterhouseCoopers, KPMG LLP and Ernst & Young LLP of padding the travel-related expenses they billed thousands of clients over a 10-year period dating back to 1991.

The suit alleges that the firms systematically billed their clients for the full face amount of certain travel expenses, including airline tickets, hotel rooms and car-rental expenses, while pocketing undisclosed rebates and volume discounts they received under contracts with various airline, car-rental, lodging and other companies. At times, the rebates retained by the various firms were for up to 40% of the purchase price of travel-related services, the suit has alleged, citing internal firm documents filed with the court.

The lawsuit shines a light on how some professional-services firms, including law firms and medical practices, in recent years have turned reimbursable out-of-pocket expenses, such as bills for travel and meals, into profit centers, which itself isn't illegal or improper. As big accounting, law and other firms have grown over the past decade, they increasingly have used their size in negotiations with travel companies, credit-card companies and others to secure significant rebates of upfront costs. Such rebates don't generate disputes between firms and their clients when fully disclosed. But any that aren't fully disclosed, as alleged in the Texarkana suit, could open firms up to potential liability.

The suit, filed by closely held Warmack-Muskogee Limited Partnership, a shopping-mall operator, also accuses the accounting firms of colluding with each other to secure favorable deals with various travel vendors. It also alleges the firms operated under an agreement not to disclose the existence of the rebates to clients or credit clients fully for the rebates.

The defendants in the suit, all of which deny the lawsuit's allegations, have filed motions seeking to dismiss the case as groundless and to defeat requests that the lawsuit be certified as a class action, the class for which could include a majority of the nation's publicly held corporations. Still, the lawsuit, for which no trial date has been set, already has proved costly to the firms. In an affidavit last month, a PricewaterhouseCoopers partner estimated the firm's partners and staff had spent 125,000 hours, valued at $10.3 million at the firm's billing rates, gathering and analyzing information to be produced for discovery. KPMG in a July court filing estimated that its discovery expenses could approach $26 million.

Continued in the article

"Pricewaterhouse's Records Indicate Some Partners Opposed Keeping Payments," by Johathan Weil, The Wall Street Journal, September 19, 2003 ---,,SB106391830284530300,00.html?mod=mkts_main_news_hs_h 

PricewaterhouseCoopers LLP's practice of retaining undisclosed rebates on client-related travel expenses generated internal dissent within the accounting firm, some of whose partners complained it was improper to keep the payments rather than passing them on to clients, internal records of the firm show.

The records, including internal e-mails and slide-show presentations to top executives of the firm, were filed this year with a Texarkana, Ark., state circuit court as exhibits to a deposition of PricewaterhouseCoopers Chairman Dennis Nally. The deposition of Mr. Nally was conducted in February in connection with a continuing lawsuit against PricewaterhouseCoopers and four other accounting and consulting firms that accuses them of fraudulently overbilling clients for travel-related expenses by hundreds of millions of dollars.

Continued in the article.

"PricewaterhouseCoopers Partners Criticized the Firm's Travel Billing," by Jonathan Weil, The Wall Street Journal, September 30, 2003, Page C1 ---,,SB106487258837700200,00.html?mod=mkts_main_news_hs_h

Attorneys alleging that PricewaterhouseCoopers LLP overbilled its clients for travel expenses have released a flurry of the accounting firm's e-mails, including one from April 2000 in which the head of its ethics department described the firm's practices as "a bit greedy."

The e-mails and other internal records, filed Friday with a state circuit court here, mark the broadest display yet of evidentiary material in the lawsuit by a closely held shopping-mall operator, Warmack-Muskogee LP, against three of the nation's Big Four accounting firms. The records include complaints by more than a dozen PricewaterhouseCoopers partners and other personnel about the firm's billing practices, as well as case logs for three separate internal ethics-department investigations into the practices since 1999. The firm halted the practices in question in October 2001.

PricewaterhouseCoopers has acknowledged that it retained rebates on various travel expenses for which the firm had billed clients at their prerebate prices, including rebates from airlines, hotels, rental-car companies and credit-card issuers. It also has acknowledged that it didn't disclose the rebates to clients and that most of its partners had been unaware of them. The firm, however, has denied Warmack-Muskogee's allegations that the rebate arrangements constituted fraud, saying the proceeds offset amounts it otherwise would have billed to clients through higher hourly rates.

In her April 2000 e-mail, the top partner in PricewaterhouseCoopers's ethics department, Boston-based Barbara Kipp, scolded Albert Thiess, the New York-based partner responsible for overseeing the firm's infrastructure, including its travel department. "Al, in general, while I appreciate the importance of managing as tight a fiscal ship as we can, I somehow feel that we are being a bit greedy here," she wrote. "I think that, in most of our clients' and partners'/staff's minds, when we say [in our engagement letters] that 'we will bill you for our out-of-pocket expenses, including travel ...', they don't contemplate true overhead types of items being included in that cost."

Continued in the article.

Todd Boyle replied with a link to the following article.
"In the race to make money, some American businesses have been lying their pants off--but is success at any cost really worth the price?" by Joshua Kurlantzick,  Entrepreneur Magazine, October 2003 ---,4453,310950,00.html 

A major U.S. company's chief resigns after authorizing large payments to top executives while negotiating a deal to slash average workers' pay. A multinational with significant business in the United States restates its revenue by nearly $1 billion. A leading American firm based in a southern city is charged with massive financial fraud; its CEO, who had lived an extravagant lifestyle, is indicted. Scenes from scandal-ridden 2002? Nope. All these events--the resignation of American Airlines' chief, the restatement of revenues at food-service giant Ahold, and the charges against HealthSouth and Richard Scrushy--happened this year, just one year after the biggest wave of corporate scandals in decades and after the passage of new legislation to combat corporate malfeasance. 

Indeed, businesspeople and ethics specialists say, it's apparent that despite the 2002 scandals and legislation, little has changed in American business culture. Change appears slow in coming because lying and dishonesty simply have become a much more accepted part of business--and of American life. To fight this trend and to inculcate the idea that dishonesty is unacceptable, companies, business schools and corporate leaders will need to undertake massive, systemic reforms.

Selected Scandals in the Largest Remaining Public Accounting Firms --- 

Andersen's David Duncan is not the only Big Four partner arrested for destroying audit work papers.
"Former Partner at Ernst Is Arrested," by Callell Bryan-Low and Johathan Weil, The Wall Street Journal, September 26, 2003 ---,,SB106451287418543900,00.html?mod=mkts_main_news_hs_h 

Federal agents arrested a former Ernst & Young LLP audit partner on criminal charges of obstruction of justice, in one of the first cases of alleged document destruction brought under the 14-month-old Sarbanes-Oxley Act.

The U.S. Attorney's Office for the Northern District of California alleged that the former partner obstructed an examination by federal-bank regulators, and later by securities regulators, into NextCard Inc., an Internet-based credit-card issuer, by destroying work papers from its audits of the company. The auditor, prosecutors alleged, altered and deleted documents to make it appear that Ernst & Young had thoroughly considered key financial issues at the San Francisco company.

Another former E&Y employee has pleaded guilty to a criminal-obstruction charge in connection with the matter, while a third faces civil-administrative proceedings brought by the Securities and Exchange Commission.

In a statement, E&Y said that it had contacted federal authorities when it first became aware of "the violation" and also launched an internal probe. All three employees are no longer with the firm as a result of the investigation, E&Y said, and the firm is co-operating with various governmental agencies. Ed Swanson, a lawyers for the former partner, Thomas C. Trauger, 40 years old, said that his client intends to pleas not guilty and to fight the charges. "Tom is a good man and well-respected accountant and I am confident he will be exonerated," said Mr. Swanson.

Federal officials noted the investigation continues, leaving open the possibility that E&Y itself could be charged. But some accounting and legal specialists noted significant differences between the E&Y matter and the case against Arthur Andersen LLP that led to its swift downfall.

Most notably, Andersen already was on a probation of sorts with the SEC when its auditors shredded thousands of pages of documents tied to its Enron Corp. audits; E&Y isn't under any similar probation. To date, no indication has surfaced that the alleged criminal conduct at E&Y reached beyond the former auditor and the two other former Ernst employees.

The legal action takes advantage of "additional tools" provided by last year's sweeping securities reform, Sarbanes Oxley, "to aggressively prosecute this kind of conduct," said Ross Nadel, head of the criminal division in the U.S. Attorney's Office in San Francisco. Specifically, the act gives prosecutors more leeway in prosecuting those who seek to destroy, alter or falsify financial information and records.

Continued in the article.

Bob Jensen's threads on other Ernst & Young scandals can be found at 

September 19, 2003 message from Risk Waters Group [

Merrill Lynch has agreed sweeping reforms that will require all complex structured finance transactions effected by a third party with the bank to be authorized by a new Special and Structured Products Committee (SSPC). The development is the result of a deal struck with the US Department of Justice (DoJ) over charges of conspiracy with Enron. The bank has also agreed for the SSPC to be monitored for 18 months by an independent auditing firm. At the same time, a DoJ-selected attorney will review and oversee the work of the auditing firm. Merrill Lynch has declined to comment on any aspect of the deal. The co-operation agreement arose after three former Merrill executives were indicted on Wednesday by a federal grand jury on charges of conspiracy to commit wire fraud and falsify books and records. Merrill Lynch has accepted responsibility for the conduct of the three defendants - Daniel Bayly, former head of global investment banking; James Brown, head of Merrill's strategic asset lease and finance Group; and Robert Furst, the Enron relationship manager for Merrill Lynch in the investment banking division.

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

Beware of the fine print in popular gift cards issued by major stores. 
Each $50 card may decline by as much as 5% per month even though you paid full value up front.  Looks like a consumer rip off from the big chain retailers.

"Gift Cards May Bite Recipient," by Lisa Munoz, San Antonio Express News, September 22, 2003 (the article originally appeared in the Orange County Register).

Gift cards have steadily grown in popularity with both retainers and consumers since the 1990s.  But the Vinsons, and an increasing number of other consumers, have learned that gift cards can come with many strings attached.

Bob Jensen's threads on consumer frauds are at 

This Is Broken (Voice Your Consumer Complaint & Read Complaints) --- 

When I got an email with the following message, I was taken to a link that, in turn, said I had to install some Korean language software.  Beware of any site that wants to install software on your computer.  Check with your Webmaster or other expert before installing such software.

Spy on Anyone by sending them an Email-Greeting Card! Spy Software records their emails, Hotmail, Yahoo, Outlook, ACTUAL Computer Passwords, Chats, Keystrokes.  Check up on your SPOUSE, KIDS, or EMPLOYEES! 

What profession adds little to the nation's GDP, and yet has $40 billion in revenues in 2001, 50% more than Microsoft or Intel and double that of Coca-Cola?


'Trial Lawyers, Inc.,"Editorial in The Wall Street Journal, September 23, 2003, Page A24 ---,,SB106427905041783200,00.html?mod=opinion%255Fmain%255Freview%255Fand%255Foutlooks 

That's how the folks at the Manhattan Institute now refer to what may be America's only recession-proof industry: the plaintiffs' bar.

We hope the moniker catches on. For decades trial attorneys have nurtured a public image as little Davids standing up with their slingshots to America's corporate Goliaths. But as a study to be released later this morning on Capitol Hill underscores -- "Trial Lawyers, Inc.: A Report on the Lawsuit Industry in America 2003" ( -- these litigators have become an industry unto themselves

By now, most every American has his own tale about some silly lawsuit run amok, from the post-tobacco obesity suits targeting McDonald's to the $7.2 million settlement former "Tonight Show'' sidekick Ed McMahon won after suing over house mold he claimed had killed his dog. When the Manhattan Institute's researchers added it all up, the result was staggering: Not only have tort costs risen much faster than either inflation or GDP, the estimated $40 billion in revenues our tort warriors took in for 2001 was 50% more than Microsoft or Intel and double that of Coca-Cola.

One good measure of their size is their political clout: In 2002 the trial lawyers' PAC ranked third in America -- and was the Democratic Party's most generous contributor. We're not saying that there's no role for trial attorneys in the American legal system, or that they don't occasionally secure justice for a wronged individual. But with the billions its firms rake in each year putting them squarely in the category of Big Business, shouldn't their self-serving claims be treated with the same skepticism routinely directed at, say, Halliburton or Philip Morris

The Specialist Myth 

Who are the real bad guys that paid the NYSE's Richard Grasso nearly $180+ million per year to cover their evil ways?  They willingly paid this because Grasso was so darn good at his job protecting them.

The best account of the inherent corruption in the NYSE system that I have read is an editorial by John C. Bogle (founder of the huge Vanguard Group) that appears on the Editorial Page (Page A10) of the September 19, 2003 edition of The Wall Street Journal ---,,SB106393576986578400,00.html?mod=opinion%255Fmain%255Fcommentaries 


The NYSE has perpetuated myths that mislead regulators and the investing public into believing that specialists serve the public. For instance, the NYSE asserts that investors need specialists because without them, "who is going to be there to buy or sell when nobody else wants to?" The NYSE claims that the specialist reduces market volatility by acting as the buyer or seller of last resort.
SpecialistMan, by JOHN C. BOGLE 
Selected quotations are shown below:

While the NYSE bills itself as "a private company with a public purpose," there is no doubt that its chairman's most important role is to protect the interests of its members. And no interest is more important than the protection of the trading profits derived by the NYSE's floor-based specialists. Thanks in large part to Mr. Grasso's efforts, the NYSE has, until recently, enjoyed a remarkable level of prestige, providing the cover necessary to protect its inherently unfair and inefficient trading system.

Every security traded on the NYSE is assigned exclusively to a specialist firm. The specialist ultimately sees every order in its assigned stocks submitted to the exchange either electronically or through brokers on the floor. But while the NYSE grants specialists a privileged position in order to maintain a "fair and orderly market" (which, curiously, is nowhere defined), the specialist is also permitted to simultaneously trade for his own account -- an obvious conflict of interest.

NYSE rules attempt to limit the specialist's ability to improperly use inside information by limiting specialists to trading only when there is a temporary disparity between supply and demand, buying when there are no other buyers and selling when there are no other sellers. Yet if specialists really traded only when there is an absence of buyers or sellers, one would think they would lose money.

The fact is that specialists are profitable, in Samuel Johnson's words, "beyond the dreams of avarice." A forthcoming study by Precision Economics will reveal that publicly traded firms with specialist units last year enjoyed pre-tax profit margins ranging from 35% to 60%. Labranche, the largest NYSE specialist, generated more than a quarter of a billion dollars in revenues, almost entirely from trading for its own account on the floor. Pretty profitable for trading only when nobody else wants to!

. . .

The NYSE has perpetuated myths that mislead regulators and the investing public into believing that specialists serve the public. For instance, the NYSE asserts that investors need specialists because without them, "who is going to be there to buy or sell when nobody else wants to?" The NYSE claims that the specialist reduces market volatility by acting as the buyer or seller of last resort.

Think about that: Envision SpecialistMan, emerging amongst the bedlam of a fast falling stock with a giant "S" on his chest. Quickly calming the crowd, he exclaims "I will buy from every one of you because it is my duty, even though I will lose money." They sell their shares to SpecialistMan, praising him for his willingness to selflessly provide liquidity, regardless of the impact on his profits.

While this notion is ridiculous on its face, it is still put forward to defend the NYSE specialist when nearly every other major instrument is traded completely electronically without anyone being given an informational advantage. The truth is that when a stock like Enron starts falling, just like everyone else, SpecialistMan gets out of the way.

We ought to ask ourselves why we even want a specialist to manage the decline of a stock. In an efficient market, that is the last thing we should want. The market should be permitted to clear -- move to its equilibrium point -- as quickly as possible, without somebody trying to manage the process. A slowly declining stock only hurts buyers at the expense of sellers, and vice versa.

Continued in the article.

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

Bob Jensen's September 30, 2003 updates on the current accounting, finance, and corporate governance scandals can be found at 

If your company, MCI, is troubled by burdensome debt that made it difficult to compete, what can a poor company do?

Get bought out by a parent company, Worldcom that assumes all the debt and then have the parent company declare bankruptcy.  Then your company, MCI, can emerge from bankruptcy virtually debt free and have a competitive edge on the competition.  It's all part of the accounting/bankruptcy game.  At the time that Worldcom filed for protection from its creditors, WorldCom held most of the corporation's $41 billion in debt and MCI had 90 percent of the assets.

"WorldCom Tells Of Snarled Records," Christopher Stern, Washington Post, Page E1, September 16, 2003 --- 

WorldCom Inc.'s internal and external auditors testified in U.S. Bankruptcy Court today that the company's books remain a tangled mess and that it may be impossible to properly apportion close to $1 trillion in transactions between more than 200 subsidiaries.

WorldCom has argued that its books are so confused that it has little choice but to scrap much of the past three years of accounting records and begin anew on a consolidated basis.

The testimony came on the first full day of a hearing here on Ashburn-based WorldCom's plan for emerging from bankruptcy protection. Under the proposed plan, the company will combine the assets of WorldCom with MCI and other subsidiaries that have previously been held as 222 legally separate entities. It was unclear from the testimony whether the chaotic internal accounting had any impact on the $11 billion in fraudulent bookkeeping already reported by the company; witnesses did not address the subject.

Some creditors have objected to the consolidation, saying it unfairly benefits WorldCom creditors at the expense of others who own debt in subsidiaries such as MCI. U.S. Bankruptcy Court Judge Arthur J. Gonzalez is holding a hearing on the company's reorganization plan, one of the last stages in the bankruptcy process. If Gonzalez approves the plan, which among other things, establishes how much each creditor will get paid, the company could exit bankruptcy later this fall.

At the time that the company filed for protection from its creditors, WorldCom held most of the corporation's $41 billion in debt and MCI had 90 percent of the assets.

Continued in the article.

Some of these teens are good CEO candidates!

"Teens Would Act Unethically to Get Ahead," SmartPros, September 19, 2003 --- 

If there was no chance of getting caught, one-third of teens would act unethically to get ahead or to make more money, according to a poll released this week.

The Junior Achievement/Harris Interactive Poll, as part of the national roll out of a $1 million initiative of Junior Achievement and Deloitte & Touche to promote business ethics among today's young people, tapped the views of about 600 teens between the ages of 13 and 18.

While 33 percent said they would act unethically, 25 percent said they were "not sure" and 42 percent said they would not.

"Even though some of these numbers are disconcerting, the poll also showed that 56 percent of teens do believe that people who are ethical are more successful in business," said David S. Chernow, president and CEO of Junior Achievement Inc. "We have a way to go, but there is an underlying optimism among students that honesty is still the best policy. We'd like to reinforce -- and build upon -- that belief. JA is pleased to work with Deloitte & Touche to do just that."

Deloitte Ups the Ante on Ethics Education With K-12 Pilot Program --- 

Corporate Accountability: A Toolkit for Social Activists
The Stakeholder Alliance (ala our friend Ralph Estes and well-meaning social accountant) --- 

"Identity Theft Costs Businesses Nearly $48 Billion Each Year," by Sara Schaefer, The Wall Street Journal, September 4, 2003 ---,,SB106262483782072000,00.html?mod=your%255Fmoney%255Ffinancial%255Fplanning%255Fhs 

The Federal Trade Commission tallied 9.9 million consumer victims of identity theft last year, costing consumers $5 billion and businesses and financial institutions nearly $48 billion.

Victims spent a total of 297 million hours resolving problems related to the thefts, according to an FTC study released Wednesday.

"We knew there was a problem before we did this report, we just didn't have any idea of the contour of the problem," said Howard Beales, director of the commission's Bureau of Consumer Protection.

According to the study, 23% of identity theft occurred because personal information such as driver's licenses, credit cards and mail was lost or stolen. In 13% of the cases, theft occurred during transactions, including information taken from a credit card receipt during or after a purchase, or through purchases made via the Internet, mail or phone.

Also see 

Bob Jensen's threads on identity theft and how to prevent it are at 

Sarbanes-Oxley Update Forwarded by Scott Bonacker

The following is the testimony of William H Donaldson, Chairman of US Securities and Exchange Commission, before the Senate Committee on Banking, Housing and Urban Affairs, September 9, 2003. ... 

William McDonough, the head of the Public Company Accounting Oversight Board, issued his first public policy address this week, and his tone left no question about his approach to oversight. 

The PCAOB will be inspecting all accounting firms which will be auditing public companies. "We will pry into your records and your work habits, and, yes, the rules will change," McDonough said.

Mr. McDonough indicated that he is committed to helping the profession restore its reputation, which he admitted was tarnished by a few rogue members. "I would not be here as [PCAOB] chairman, if the accounting profession had not already been weighed and found wanting."

A recent survey of corporate chief financial officers found concern, confusion, and more than a little "sticker-shock." 

Auditing With SOX On!

"How Sarbanes-Oxley Will Change the Audit Process," by Donald K. McConnell, Jr. and George Y. Banks, Journal of Accountancy, September 2003, pp. 49-56 --- 

SARBANES-OXLEY WILL MEAN BIG CHANGES FOR BOTH auditors and the companies they audit. The former now will be required to certify a company’s internal controls and will no longer be able to use certain common audit strategies. Management faces the cost of implementing the new rules.

ACCORDING TO THE EXPOSURE DRAFT OF A NEW SAS, the understanding of internal controls required for CPAs to express an opinion on financial statements is not adequate for them to offer an opinion on the controls themselves. This means auditors will have to make changes to the audit process.

THE AUDITOR MUST ATTEST TO MANAGEMENT’S assessment of the effectiveness of an entity’s internal controls using standards the Public Company Accounting Oversight Board issues or adopts. The auditor will require management to identify, document and evaluate significant internal controls—management cannot delegate this function to the auditor.

AUDITORS SHOULD ADVISE COMPANIES TO BEGIN the process of assessing the effectiveness of controls as early as possible. The task will be time-consuming, requiring management to determine which locations or business units to include in its evaluation.

AUDITORS SHOULD NOT BE TOO CLOSELY INVOLVED with a company’s assessment of its controls or they risk impairing their objectivity. The auditor cannot accept management’s responsibility to reach conclusions on the effectiveness of the entity’s controls nor can management base its assertion about the controls design and operating effectiveness on the results of the auditor’s tests.

DONALD K. McCONNELL JR., CPA, CFE, PhD, is associate professor of accounting at the University of Texas at Arlington. His e-mail address is GEORGE Y. BANKS, CPA, is a partner of Grant Thornton in Dallas. His e-mail address is

From Fortune, August 11, 2003 ---,15114,474483,00.html 

A Taste of Success But the real test for Sarbanes-Oxley is still ahead. FORTUNE Monday, August 11, 2003 By Jeremy Kahn

The Securities and Exchange Commission held a small ceremony in late July to commemorate the one-year anniversary of the enactment of the Sarbanes-Oxley Corporate Responsibility Act. That same day SEC chairman William Donaldson gave a speech before the National Press Club in which he hailed Sarbanes-Oxley as the most significant piece of federal securities legislation since the securities laws were first enacted in the 1930s.

Sarbanes-Oxley has improved financial disclosure, forced executives and boards to be more vigilant, ended self-regulation of audit firms, and helped eliminate conflicts of interest in stock research. That said, it's too soon to call it a success.

"Who Does What to Whom?  Closing the Expectation Gap of Section 404, by Colleen A. Sayther (President of Financial Executives International), Financial Executive, September 2003, Page 6 --- 

Issues surrounding the various facets of Sarbanes-Oxley continue to emerge, challenging us as financial executives. Perhaps one of the thorniest areas of debate is Section 404 on Management Assessment of Internal Controls, which requires corporate managers to evaluate and report on the effectiveness of internal controls over financial reporting, identifying any "material weaknesses" they find. Further, the act requires a public company's outside auditors to attest to management's assessment of those internal controls.

And at that point, interpretations diverge. There is an ongoing debate between issuers and public accounting firms over how deeply auditors should delve. Preparers contend - and FEI agrees - that auditors should attest only to management's assessment and evaluation of internal controls. Audit firms, on the other hand, believe that auditors must attest to the actual internal control environment itself. They believe that they cannot attest to management's assessment without doing substantial work to conclude that the actual internal control environment is effective.

On July 29, I participated in a roundtable discussion held by the Public Company Accounting Oversight Board (PCAOB) to solicit views on this divisive issue - from auditors, investors, public companies, regulators and other stakeholders. I can tell you that feelings run very high on both sides of the debate.

In weighing the merits of both interpretations, it is important to remember one essential point: The internal control environment is ultimately the responsibility of management. It should not be delegated to the auditors. To do so would represent an abrogation of fiscal responsibility on the part of management and an inappropriate assumption of that responsibility by the public accounting firms.

FEI believes that the clear intent of Sarbanes-Oxley regulation in this area was to ensure that management took the necessary and appropriate responsibility for not only creating an effective internal control system, but also reviewing it on an ongoing basis. Further, we believe that Sarbanes-Oxley recognizes that independent auditors have a responsibility to understand the internal controls so that they can plan their audit. By having the independent auditor attest to management's assertion, we believe the intent of Congress - to have the independent auditors fulfill this responsibility in a manner more transparent to investors - is satisfied.

The material failures in corporate governance procedures that have rocked the corporate world lately result not from breakdowns of basic transaction controls, but from subsequent manipulations by management of the information provided by these systems. Our view remains that, based on existing attestation standards, the cost for the independent auditor to render an opinion directly on the effectiveness of an issuer's internal control system far exceeds the potential benefits for the investing public.

We believe that the focus of the auditor's work should be restricted to a review and evaluation of management's assertion on the effectiveness of its internal controls and the related documentation - not retesting and revalidating the entire internal control environment. There is a significant difference in the degree of work involved in the two approaches. This translates, not surprisingly, into a significant difference in cost.

We recognize that the auditors need to test management's assessment in order to attest, and that this work is not free. What is important, however, is striking a balance between the cost to implement and the value received. As with other aspects of Sarbanes-Oxley implementation, FEI feels strongly that the best regulation is one that accomplishes its stated objectives without placing an undue burden on businesses.

Continued in the article.

"Worry Over a New Conflict for Accounting Firms," by Jonathan D. Glater, The New York Times, September 23, 2003 

Critics worry that auditors will advise companies on their controls and then end up approving their own work.

"Designing a Section 404 Project," by Tiffany McCann and Cheryl De Mesa Graziano, Financial Executive, September 2003, pp. 44-46 --- 

Risk Areas As Section 404 implementations progress, financial managers are uncovering challenges. For example, processes and controls are not the only important pieces of information in internal control documentation. "Financial information that requires a high degree of judgment often comes from disparate sources within a company. The processes behind disparate sources, like models or assumptions, need to be identified, documented and tested. So a compliance tool needs to capture both the processes and the data flows producing financial statement amounts," says PwC's Everson.

The example he provides is the analysis for the allowance for doubtful accounts, a highly subjective number on the financial statements. A company may document its process as quarterly evaluation by the collections manager, but the information that really needs to be documented is what assumptions were used by the collections manager in the evaluation.

Another challenging area involves IT controls, a key area since so many of today's business processes are IT- driven. "One of our core team members has an IT background [to ensure IT issues are considered during implementation]," says Koen Van Loock, project leader for Section 404 at Lilly. "A general IT controls section is included in the documentation of each process and must be completed by a person with an IT background," he adds.

In the testing phase of Section 404 implementation, financial executives are finding little or no specific guidance on the extent of testing required for compliance. "Management will not get specific guidance for testing. It is management's responsibility to decide what is necessary to make the assertion that controls are operating effectively," says DeLoach. Protiviti encourages clients to consider a range of testing methods, from self-assessment to statistical sampling, depending on the nature of the risks and controls inherent to the process and the controls mitigating those risks.

Continued in the article.

From The Wall Street Journal Accounting Educators' Reviews on October 3, 2003

TITLE: BearingPoint's Auditor Faults Firm 
REPORTER: Cassell Bryan-Low and Kemba J. Dunham |
DATE: Oct 01, 2003 
TOPICS: Accounting, Auditing, Auditing Services, Internal Controls, Sarbanes-Oxley Act

SUMMARY: The Sarbanes-Oxley Act requires auditors to attest to the effectiveness of their clients' internal controls. In accordance with this increased responsibility, Pricewaterhouse Coopers LLP reported material weaknesses in internal controls at BearingPoint Inc. Questions focus on the importance of internal controls and the requirements of the Sarbanes-Oxley Act concerning internal controls.

1.) What is a system of internal controls? Who is responsible for establishing internal controls? Discuss managements' objectives for internal controls. Discuss the auditors' objectives for internal controls.

2.) What are the auditors' responsibilities for assessing internal controls in the financial statement audit? How did the Sarbanes-Oxley Act change the auditors' responsibilities for internal controls?

3.) How do internal controls impact the substantive testing required in an audit?

4.) What weaknesses in BearingPoint's internal controls are described in the article? How do these weaknesses impact control risk? How do these weaknesses impact the audit? Describe a specific audit procedure that might be utilized to overcome these weaknesses.

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

Hundreds of small accounting firms are struggling under tough new auditing rules adopted after a string of corporate scandals and regulatory probes, and several are exiting parts of the business they view as increasingly risky, according to industry experts --- 

The following was announced in the PCOAB Update newsletter for September 2003:

PCAOB Receives 349 Registrations As Deadline looms

The deadline for registration is October 22, 2003, and the Public Company Accounting Oversight Board's regulations allow the Board up to 45 days for review of applications.  This means that firms were required to submit their registration by no later than September 7, 2003.   Based upon a release posted on the Board's website, 349 firms submitted aplications for registration through September 8, 2003.  See for the up to date list of registrants.     

September 9, 2003 reply from Todd Boyle [tboyle@ROSEHILL.NET

I urge all of you to re-examine the foundations and assumptions of the corporate system in this country.

Re-examine them objectively, with an eye to improvement. Visit these three websites:

1.  and sign up for the excellent, weekly Drutman letter. 
2.  and engage with them.  
3.  and read the PDFs. Revolutionary.

There are active ACP initiative campaigns in numerous States. I think these people are on the right track.

This is not light reading. The problem is not an easy problem. CPAs have a valuable contribution to make.

Todd Boyle, CPA

In its top-to-bottom review of all aspects of the auditing business, the Public Company Accounting Oversight Board (PCAOB) has turned its attention to tax shelters. 

"Grant Thornton Ends Internal Controls Services for Audit Clients," SmartPros, September 4, 2003 --- 

Grant Thornton, the fifth largest accounting firm, announced that it will not provide a number of internal control services for its public audit clients that it believes is in keeping with the intent of the Sarbanes-Oxley Act of 2002.

"Just as we believe that the accounting industry should accept a principles versus rules based approach to accounting, we believe the same should be the case in adhering to the Sarbanes-Oxley Act," said Grant Thornton CEO Ed Nusbaum. "There are areas in the legislation that are clear, and some that might be interpreted differently by others. But the guide in gray areas should be the spirit of reform and protection of investors that the bill's authors intended."

Nusbaum said Grant Thornton will not accept engagements to document its public audit clients' internal controls, but would instead refer the client to another firm.

Also, Grant Thornton said it will not provide other services, such as design controls, design or implement processes that impact the financial reporting processes, and access to software that is used by its auditors to document and evaluate controls over financial reporting.

Grant Thornton will attest to, and report on, management's assessment of internal controls of its public audit clients under Section 404 of the Sarbanes-Oxley Act, and will continue to provide a wide array of internal controls services for public companies that are not audit clients.

From The Wall Street Journal Accounting Educators' Reviews on September 5, 2003

TITLE: More Truth-in-Labeling for Accounting Carries Liabilities 
REPORTER: Michael Rapoport and Jonathan Weil 
DATE: Aug 28, 2003 
TOPICS: Debt, Debt Covenants, Financial Accounting, Financial Accounting Standards Board

SUMMARY: FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, requires classifying mandatorily redeemable preferred stock as debt, among other things. The article discusses implications for companies' debt-to-equity ratios, referring to specific companies' financial statements, and makes comparisons to convertible bonds.

1.) Define preferred stock and common stock. How are these items classified on the balance sheet? Define mandatorily redeemable preferred stock and trust preferred stock. Prior to the issuance of SFAS 150, how were each of these items classified? What classification will they now hold following the issuance of SFAS 150?

2.) Define convertible debt. How is this item accounted for and classified in companies' balance sheets? What is the problem with this accounting treatment that the "FASB next plans to tackle"?

3.) How will the change under SFAS 150 affect companies' debt-to-equity ratios? What will they do to alleviate potential problems? Can you think of any other ratios that could be affected by this change? Name them and explain.

4.) What are the concerns with Xerox's balance sheet that are expressed in the article? Access Xerox's financial statements on the company's web site at i/ir_annualreport2002.pdf and proceeding to page 41 (numbered page 39 in the report). What amount shows as total liabilities? How can you calculate total shareholders' equity? Will this amount change under the new accounting standard?

5.) Given your assessment of Xerox's balance sheet under question #4, above, are you concerned about the company's statement that its disclosure and accounting treatment 'is consistent with the specific guidance' issued by the Securities and Exchange Commission? In general, does this guidance differ from guidance issued by the FASB?

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

In August 2003, Pricewaterhouse Coopers agreed to pay more than $50 million to settle a suit by MicroStrategy investors who alleged that the firm defrauded them when it approved MicroStrategy's financial reports.  The PwC engagement partner was banned from future audits of corporations listed with the SEC.  For some of the other PwC settlements, see 

Forwarded by David Albrecht on July 20, 2003

July 19, 2003
Business: S.E.C. Demands 6-Month Ban on New Ernst & Young Clients

Federal regulators reiterated their demand yesterday that the accounting
firm Ernst & Young be banned from accepting new audit clients for six
months as a penalty for violating conflict-of-interest rules in the 1990's.

Full Story: 

"Whistleblower Says He Just Wanted Coke to Listen," SmartPros, September 17, 2003 --- 

Matthew Whitley wanted to work for Coca-Cola Co. so much he submitted his resume 15 times. After being hired, the auditor and finance manager drank nothing but water and Coke and decorated a room in his house with company trinkets.

Eleven years later, Whitley is drinking only water. His wife sold the Coke plates, glasses and memorabilia at a garage sale. He is out of his $140,000-a-year job after accusing officials of the world's largest soft drink maker of shady accounting and fraudulent marketing practices.

Whitley, 37, was fired March 26, five days after sending his allegations to the company's top lawyer, although Coke said he was dismissed as part of a restructuring and not because he spoke up. Whitley demanded $44.4 million from Coke in exchange for his silence, but was refused, and is now suing the company for unspecified damages, charging Coke with wrongful termination, fraud, slander and intentional infliction of emotional distress.

"I'm the last one who wanted any of this to happen," Whitley said. "I wanted somebody to take what I was saying seriously."

In some ways, he's gotten his wish. Federal prosecutors are conducting a criminal investigation of claims in his suit, including allegations that Coke rigged a marketing test of Frozen Coke, a slush drink, at Burger King restaurants in Virginia in 2000. Coke has offered to pay Burger King $21 million as part of an apology.

A Superior Court judge earlier this month dismissed more than half of Whitley's claims, including allegations that Atlanta-based Coke sought to hide fraud, but ruled the lawsuit may continue. The suit also is filed in federal court; that case was not affected by the judge's decision.

E. Christopher Murray, an employment law expert in Garden City, N.Y., said the fact that the suit survived a motion to dismiss, even if it is a scaled-down version, is a victory for Whitley, who will now be able to depose Coke executives and obtain documents from the company. Most such cases are thrown out, he said.

Because the judge left intact Whitley's claims of intentional infliction of emotional distress and slander, he will be able to delve into the fraud allegations to show Coke had a motive for its actions, Murray said.

But legal tactics Coke is likely to use could prolong the case, he said.

"With the larger companies, what they normally do is fight you tooth and nail, file thousands of discovery motions, put you through the wringer, until they wear you out," Murray said. "I'm sure that's what Coca-Cola will do."

Coke has denied most of the charges but conceded that some employees improperly influenced the marketing test.

Continued in the article.

The reply from the Audit Committee at Coca Cola can be found at 

The auditing firm is Ernst & Young.

Bob Jensen's threads on whistle blowing are at 


"Former Enron Treasurer Enters Guilty Plea," by Kurt Eichenwald, The New York Times, September 11, 2003 --- 

Former Enron treasurer pleaded guilty yesterday to conspiring to commit fraud, providing the first public admission by a former executive that certain transactions at the heart of the scandal that crippled the company were used to manipulate its financial statements.

The plea, by Ben F. Glisan Jr., 37, established that a series of complex transactions known as the Raptors were knowingly constructed in ways that violated accounting rules and allowed the company to exaggerate its earnings performance.

All told, the Raptors were used to manipulate Enron's reported income by as much as $1 billion, government securities regulators said yesterday. But, until yesterday, no former executive had admitted that the Raptors were knowingly put together in violation of the rules on financial reporting.

"Beginning in the spring of 2000, I and others at Enron engaged in a conspiracy to manipulate artificially Enron's financial statements," Mr. Glisan said in Federal District Court in Houston.

He added that he had helped structure "illegal transactions" that allowed Enron to remove troubling assets from its books.

After entering his plea, Mr. Glisan was sentenced to five years in prison a fairly long sentence compared with those given in many white-collar convictions that result from pleas. With that, Mr. Glisan became the first former Enron executive to be sentenced to prison.

Continued in the article.

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

Summary of Raptor oddities: 

1.  The accounting treatment looks questionable. 

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

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


Before and After FAS 133
Although Enron was primarily a derivatives trader in futures contracts, it appears that swaps are emerging as a major component of the accounting scandal.  Interestingly enough, FAS 133 may have contributed to the problem.  Prior to FAS 133, swaps were not booked (on the ground that their historical cost is zero in an historical-cost based system).  FAS 133 imposed a requirement that all swaps be booked at zero to begin with, but that they be adjusted to fair value at least every 90 days.  If they are qualified under FAS 133 as hedges, the offsetting debit or credit does not impact upon current earnings to the extent that the hedges are effective.  How the current earnings is bypassed depends upon the nature of the hedge.  The offset goes to Other Comprehensive Income for cash flow hedges.  If the hedged item is a booked item (such as inventory) normally carried at cost, the offset goes to the booked item and, thereby, changes the accounting for the hedged item to fair value (but only during the hedging period).  If the hedged item is an unbooked item, the offset goes to an account invented in FAS 133 called "Firm Commitment" that absorbs the offsets to fair value adjustments of a derivative (such as a swap).

But in Enron, it appears that most derivatives were not qualified as hedges under FAS 133.  Prior to FAS 133, changes in swap value would not be booked to current earnings.  Subsequent to FAS 133, changes in swap values must be booked to current earnings if they are speculations rather than hedges.

Enron's CFO Andy Fastow's insider deals between his private partnership Raptor and Enron are elaborated upon in the New York Times article cited above:

Summary of Alleged Issues:

RAPTOR Entity was capitalized with LJM equity. That equity is at risk; however, the investment was completely offset by a cash fee paid to LJM. If the Raptor entities go bankrupt LJM is not affected, there is no commitment to contribute more equity.

The majority of the capitalization of the Raptor entities is some form of Enron N/P, restricted stock and stock rights.

Enron entered into several equity derivative transactions with the Raptor entities locking in our values for various equity investments we hold.

As disclosed in 2000, we recognized $500 million of revenue from the equity derivatives offset by market value changes in the underlying securities.

This year, with the value of our stock declining, the underlying capitalization of the Raptor entities is declining and credit is pushing for reserves against our MTM positions.

To avoid such a write-down or reserve in quarter one 2001, we "enhanced" the capital structure of the Raptor vehicles, committing more ENE shares.

My understanding of the third-quarter problem is that we must "enhance" the vehicles by $250 million.

I realize that we have had a lot of smart people looking at this and a lot of accountants including AA & Co. have blessed the accounting treatment. None of that will protect Enron if these transactions are ever disclosed in the bright light of day. (Please review the late 90's problems of Waste Management (news/quote) — where AA paid $130 million plus in litigation re questionable accounting practices.)

The overriding basic principle of accounting is that if you explain the "accounting treatment" to a man in the street, would you influence his investing decisions? Would he sell or buy the stock based on a thorough understanding of the facts? If so, you best present it correctly and/or change the accounting.

My concern is that the footnotes don't adequately explain the transactions. If adequately explained, the investor would know that the "entities" described in our related party footnote are thinly capitalized, the equity holders have no skin in the game, and all the value in the entities comes from the underlying value of the derivatives (unfortunately in this case, a big loss) AND Enron stock and N/P. Looking at the stock we swapped, I also don't believe any other company would have entered into the equity derivative transactions with us at the same prices or without substantial premiums from Enron. In other words, the $500 million in revenue in 2000 would have been much lower. How much lower?

Raptor looks to be a big bet if the underlying stocks did well, then no one would be the wiser. If Enron stock did well, the stock issuance to these entities would decline and the transactions would be less noticeable. All has gone against us. The stocks, most notably Hanover, the New Power Company and Avici are underwater to great or lesser degrees.

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

If it's Enron, from our shares, then I think we do not have a fact pattern that would look good to the S.E.C. or investors.

2. The equity derivative transactions do not appear to be at arms length.

a. Enron hedged New Power, Hanover and Avici with the related party at what now appears to be the peak of the market. New Power and Avici have fallen away significantly since. The related party was unable to lay off this risk. This fact pattern is once again very negative for Enron.

b. I don't think any other unrelated company would have entered into these transactions at these prices. What else is going on here? What was the compensation to the related party to induce it to enter into such transactions?

3. There is a veil of secrecy around LJM and Raptor. Employees question our accounting propriety consistently and constantly. This alone is cause for concern.

a. Jeff McMahon was highly vexed over the inherent conflicts of LJM. He complained mightily to Jeff Skilling and laid out five steps he thought should be taken if he was to remain as treasurer. Three days later, Skilling offered him the C.E.O. spot at Enron Industrial Markets and never addressed the five steps with him.

b. Cliff Baxter complained mightily to Skilling and all who would listen about the inappropriateness of our transactions with LJM.

c. I have heard one manager-level employee from the principal investments group say, "I know it would be devastating to all of us, but I wish we would get caught. We're such a crooked company." The principal investments group hedged a large number of their investments with Raptor. These people know and see a lot. Many similar comments are made when you ask about these deals. Employees quote our C.F.O. as saying that he has a handshake deal with Skilling that LJM will never lose money.

4. Can the general counsel of Enron audit the deal trail and the money trail between Enron and LJM/Raptor and its principals? Can he look at LJM? At Raptor? If the C.F.O. says no, isn't that a problem?  At Raptor? If the C.F.O. says no, isn't that a problem?

Continued at 

Bob Jensen's threads on the Enron scandal can be found at 

You can learn more technical details about Raptors in the following two links: 

The 208 Page February 2, 2002 Special Investigative Committee of the Board of Directors (Powers) Report--- 

Selected Scandals in the Largest Remaining Public Accounting Firms --- 

From The Wall Street Journal Accounting Educators' Review on August 29, 2003

TITLE: KPMG Defends Its Audit Work For Polaroid
REPORTER: James Bandler
DATE: Aug 25, 2003
TOPICS: Audit Quality, Audit Report, Auditing, Bankruptcy, Creative Accounting, Fraudulent Financial Reporting, Accounting

SUMMARY: A court appointed examiner filed a report in U.S. Bankruptcy Court in Delaware that suggests that KPMG LLP allowed Polaroid Corp. to use questionable accounting practices to hide financial distress. KPMG LLP claims that the report is biased and unfounded.

1.) What is the role of the auditor in the historical financial statement audit? Is the auditor required to provide absolute assurance that the financial statements are free from material misstatements?

2.) Distinguish between audit risk, business risk, and audit failure. When should the auditor be held liable to financial statement users? Does it appear that the situation with Polaroid Corp. is the result of audit risk, business risk, or audit failure? Support your answer.

3.) Assume that KPMG LLP followed Generally Accepted Auditing Standards in the audit of Polaroid Inc. Should KPMG LLP be required to defend the quality of the audit to financial statement users? Do allegations of substandard audit work result in a loss of reputation and significant cost to KPMG LLP? How can auditors reduce the possibility of loss of reputation and the costs of defending audit quality?

4.) What types of audit reports do auditors issue? What is the difference between a "going concern" note and a qualified opinion? When should an audit report contain a qualified opinion? When should an audit report contain a "going concern" note? Does it appear that KPMG LLP issued the correct audit opinion for Polaroid? Support your answer.

5.) What is materiality? Explain the relation between materiality and debt covenants.

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

"KPMG's Role as Spiegel Failed To Disclose Woes Is Criticized," by Matthew Karnitschnig and Cassel Bryoan-Low, The Wall Street Journal, September 12, 2003 ---,,SB106332868097474300,00.html?mod=mkts_main_news_hs_h 

A court-appointed examiner's review of the collapse of Spiegel Inc. criticizes the catalog retailer's independent auditor, KPMG LLP, for standing by as its client failed to disclose its worsening financial condition, according to people familiar with the matter.

The examiner's 214-page report, which is expected to be released publicly as early as Friday, is likely to fuel the debate that has raged since Enron Corp. about whether the Big Four auditing firms are tough enough with all of their clients. KPMG said in a statement Thursday it is "confident that it acted appropriately at all times and stands behind its actions in the Spiegel matter." But the role of KPMG, already fighting criticism from the Securities and Exchange Commission about its alleged passivity at Xerox Corp., will bring unwanted attention to the fourth-largest auditing firm in the U.S.

Spiegel of Downers Grove, Ill., filed for Chapter 11 bankruptcy-court protection in March. (See article)

The court-appointed examiner's report stems from Spiegel's failure to file with the SEC a detailed independent audit of its 2001 books, a so-called 10-K filing or annual report, until the beginning of this year. In a civil-fraud case partially resolved by Spiegel in March with the SEC, the regulators alleged that Spiegel violated securities laws by withholding material information from the public, information that should have been in the report.

Continued in the Article

Shareholders of the former Polaroid Corp. on Tuesday sued KPMG LLP, the company's former accountants, alleging the firm violated accounting guidelines when it audited the company before its bankruptcy --- 

You can also read more about KPMG's woes at 

"Inquiry of Raytheon Accounting Is Upgraded to 'Formal' by SEC," by Anne Marie Squeo and Judity Burns, The Wall Street Journal, September 3, 2003 ---,,SB106315275950222600,00.html?mod=mkts%5Fmain%5Fnews%5Fhs%5Fh 

Raytheon Co. is again under federal regulatory scrutiny after being notified by the Securities and Exchange Commission that a formal investigation has been launched into accounting practices at its commercial-aircraft unit.

The aerospace and defense company said the SEC issued the formal order in connection with an inquiry first disclosed in January. At that time, Raytheon notified investors that the government agency had opened an informal probe "primarily related to its commuter-aircraft business and the timing of revenue recognition" from 1997 through 2001. The company said it is cooperating with the investigation.


A hedge-fund manager arranged with mutual-fund firms to improperly trade fund shares, reaping millions of dollars in profits at the expense of other investors, New York Attorney General Spitzer alleged.

"Spitzer Kicks Off Fund Probe With a $40 Million Settlement," b Randall Smith and Tom Lauricella, The Wall Street Journal, September 4, 2003 ---,,SB106263200637481300,00.html?mod=todays%255Fus%255Fpageone%255Fhs 

New York Attorney General Eliot Spitzer, opening a new front in allegations of financial-market abuses, charged that a hedge-fund manager arranged with several prominent mutual-fund companies to improperly trade their fund shares -- some after the market's close -- reaping tens of millions of dollars in profits at the expense of individual investors.

Edward J. Stern, managing principal of Canary Investment Management LLC, agreed without admitting or denying wrongdoing that his company will pay a $10 million fine and $30 million in restitution. That settled civil charges that Mr. Stern violated New York state's business law against using fraud, false statements, deception and concealment in trading securities. But Mr. Spitzer said future charges were "almost certain" to be brought against mutual-fund companies themselves and possibly others. Fund companies cited, but not named as defendants, in Mr. Spitzer's complaint include Bank of America Corp., Bank One Corp., Janus Capital Corp., and Strong Capital Management Inc.

"The Market's Most Valuable Stock Is Trust," by Robert J. Shiller, The Wall Street Journal, September 26, 2003 ---,,SB106444647678083300,00.html?mod=todays%255Fus%255Fopinion%255Fhs 

New York State Attorney General Eliott Spitzer's charges of improper trading practices by several leading mutual fund families are another blow to public trust in financial institutions. Mutual funds have been the place you would advise the most unsophisticated investors to go: Mutual funds were designed for grandpa and grandma, and repeatedly recommended to them by all kinds of benevolent authorities. Thus scandals in the mutual fund sector are potentially much more damaging to public trust in our financial institutions than are scandals in other sectors -- such as the one playing out in the New York Stock Exchange right now.

Trust is a primordial form of human social cognition. We instinctively seek to surround ourselves with others we trust, and desire a stable situation where we know who we can rely on. Trust has emotional correlates. We do not "sleep easily" if we feel a lack of a basic sense of trust in those who relate to us.

Trust in investments, therefore, is something rather different from belief in earnings prospects, or even in the likelihood of high returns. Those are rational, quantitative, calculations. People's decisions to invest in stocks are related to some more basic factors, like whether they have a good feeling about investing in stocks, or, alternatively, just prefer to forget about them completely for peace of mind.

After the stock market crash of 1929, and after the sequence of financial scandals revealed from the 1920s, most U.S. investors appeared to put stocks totally out of their mind, and just forgot about them for decades. A 1954 public opinion survey commissioned by the New York Stock Exchange found that at that time only 23% of the adult population could even remember how to define a stock adequately, and only 40% knew that the NYSE does not own the stocks listed for sale to the public. Only 10% would even consider common stock as a way to invest some extra money. We do not want more people to sink back into such a backward financial state of mind in the future, but that is the direction of tendency now.

At a rational, quantitative level everything appears to be all right among investors. According to the Yale School of Management Stock Market Confidence Indexes for February through July of this year, 89% of individual investors and 87% of institutional investors expect the stock market to go up in the succeeding year. These are at close to the highest levels of optimism observed since we started collecting these data in 1989.

And yet, their quantitative expectations for the market are not necessarily going to translate into a long-term increase in demand that will promote market values. There is also a sour attitude among investors, fed by market declines and the sequence of scandals.

In 1996, near the beginning of the fastest upswing of the bull market, I noticed so many people expressing great faith that the stock market is the best long-term investment that I decided to try to tabulate, as part of my surveys of high-income Americans, how many thought this way. I asked how much they agreed with the statement: "The stock market is the best investment for long-term holders, who can buy and hold through the ups and downs of the market." The percentage of those who said they agreed strongly with this statement was already quite high, 69%, in 1996; but it rose even higher, to 76%, in 1999, right before the crash. After the market debacle, and after the scandals, the percentage who agreed strongly then fell to 60% in 2001-2 and 39% in 2003. Whatever their opinions about what the stock market will do this year, they just aren't so sanguine about it as a long-term investment.

Continued in the article.

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

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

Bob Jensen's threads on Enron-inspired humor --- 

Deloitte announces a controversial private equity service --- 

Deloitte & Touche has made a rare departure for an accounting firm by establishing a UK team to raise cash for private equity (PE) firms. The team will be led by Chris Ward, head of corporate finance advisory services and a veteran of the private equity market.

Deloitte described the typical arrangement as involving the PE firm -- as the "general partner" -- advising and investing on behalf of the limited partners, who might be a mix of pension funds, insurers, banks, and corporates. The general partners are the Big Four firm's target clients.

Weak boardrooms and weak stocks go hand in hand, a new study found, quantifying what many investors intuitively have guessed -- that companies with weak governance trail the market.

"Weak Boardrooms And Weak Stocks Go Hand in Hand," by Ken Brown, The Wall Street Journal, September 9, 2003 ---,,SB1063057056271800,00.html?mod=todays%255Fus%255Fmoneyfront%255Fhs 

Stock-market investors, not being the best-behaved group around, often have turned a blind eye to dodgy corporate behavior. Now there is evidence showing just how costly that lax attitude has been.

Many of the worst-performing stocks during the past several years -- including Enron Corp., HealthSouth Corp. and Gemstar-TV Guide International Group Ltd. -- have subpar corporate governance in common. And collectively, those stocks have done far worse than their rivals with better governance, according to a soon-to-be-released study of about 1,600 major U.S. and foreign firms.

The study, by GovernanceMetrics International Inc. in New York, quantifies what many investors intuitively have guessed -- that companies with weak governance trail the market. The new numbers, which soon will be available to big investors, could put added pressure on businesses that are governance laggards by applying statistics to an area that until now generally has been more art than science.

They also could give some needed guidance to smaller investors, many of whom have struggled to keep track of which companies are headed for trouble and which ones seem to be on the right track.

"Across the country, there's a great outrage," says New York State Comptroller Alan Hevesi, who has proposed a coalition of investors, government officials and corporate executives to push for better governance. "There's a growing sense of how costly these scandals have been."

Mr. Hevesi, who oversees New York's $106 billion public employees pension fund, says that putting numbers to governance changes could add to the incentives for companies to reform. "Corporate-governance changes may not bring in immediate -- the following week -- profits to a company, but long term they do," he said.

Continued in the article.


Insurance Company Participates in Round Tripping Accounting Fraud

"AIG Pays $10 Million Fine in Brightpoint Accounting Fraud," by Reuters, The New York Times, September 11, 2003

American International Group Inc. agreed to pay a $10 million fine to settle Securities and Exchange Commission allegations that the insurance company participated in an accounting fraud at Brightpoint Inc.

The SEC also alleged that New York-based American International, the world's largest insurer by market value, failed to cooperate with its investigation. The SEC charged Brightpoint with accounting fraud in a scheme to conceal losses by using an AIG insurance policy.

"AIG worked hand-in-hand with Brightpoint personnel to custom-design a purported insurance policy that allowed Brightpoint to overstate its earnings by a staggering 61 percent," said Wayne M. Carlin, director of SEC's Northeast Regional Office in New York.

Carlin said the transaction amounted to a "round-trip" of cash from Brightpoint to AIG and back to Brightpoint. In the past year, the SEC also has charged energy companies, such as Reliant Resources Inc. and Reliant Energy Inc., in "round-trip" arrangements that misled investors.

"By disguising the money as `insurance' AIG enabled Brightpoint to spread over several years a loss that should have been recognized immediately," Carlin said.


American International said in a statement that it "acknowledges that mistakes were made in the underwriting of this policy," which generated a profit of less than $100,000. The company said it has "taken steps to correct those mistakes."

The SEC alleged that American International fashioned and sold a purported "insurance" product for the stated purpose of "income statement smoothing" that Brightpoint used to report false and misleading financial information to the public.

"Smoothing" is when a company spreads the recognition of losses over several reporting periods.

Brightpoint, a Plainfield, Indiana-based distributor of cellular telephones and accessories, in January 2002 restated its annual financial statements for 1998 through part of 2001. The SEC said Brightpoint agreed to pay a $450,000 fine as part of today's settlement.

In settling the charges, AIG and Brightpoint neither admitted nor denied wrongdoing. Brightpoint officials didn't immediately return calls for comment.

The SEC also charged several former Brightpoint officials with wrongdoing. Former Chief Financial Officer Philip Bounsall agreed to pay a $45,000 fine; former chief accounting officer John Delaney agreed to pay $100,000, the SEC said. The SEC also charged Brightpoint's former risk management director Timothy Harcharik and former American International assistant vice president Louis Lucullo.

Continued in the article.

You can read more about round-tripping at 

Hi Roger,

When I read this article (see above), I was intrigued as to whether we need yet another amendment to FAS 133 or an entire new FASB standard.

Most insurance accounting assumes insurance against life or property loss. FAS 133 focuses on hedging cash flows, fair value, and FX. Now we must expand our thinking to insuring smoothed earnings.

What Enron taught us is that we must follow the risk trail in accountancy.

I hope you don't mind that I added your message at 

Bob Jensen

-----Original Message----- 
From: []  
ent: Friday, September 12, 2003 11:32 PM To: Jensen, Robert 
Subject: Article: Insurer Agrees to Pay Penalty in Fraud Case

Hello Bob. I was intrigued by the statement in this report that says "insurance is available to enable companies smooth the peaks and valleys from corporate earnings reports" - which seems to me to be not too far removed from income smoothing. I take it that the existence of such insurance - and the size of any payouts - is specified in the company's "Notes" - or is it? Does FASB have a policy on this that you're aware of? (I would have posted this to the AECM list but I can't access that list from this e-mail location - and besides, I'm a bit reluctant to show off my ignorance to the group as a whole).


Roger Collins 
UCC School of Business


From The Wall Street Journal Accounting Educators' Reviews on September 19, 2003

TITLE: AIG Is Charged by SEC with Fraud; Regulator Says Big Insurer Helped Client Brightpoint Overstate Its Earnings 
REPORTER: Randall Smith and Theo Francis 
DATE: Sep 12, 2003 
TOPICS: Financial Accounting

SUMMARY: AIG sold Brightpoint, Inc., a smal mobile-phone distributor, a retroactive insurance product. AIG neither admitted nor denied wrongdoing in agreeing to pay a $10 million fine in settlement of the matter, closing such probes at AIG by the SEC. The "so-called retroactive insurance policy...was allegedly designed to help Brightpoint take advantage of accounting rules allowing companies to subtrace (sic--subtract) insurance recoveries from reported losses."

1.) From Brightpoint's perspective, describe the nature of the transaction entered into with AIG. How does this transaction allow losses to be smoothed out over time?

2.) From AIG's perspective, describe the nature of the transaction they entered into. What are the costs associated with an insurance policy covering a time period already past (ignoring the SEC's findings on the propriety of the transaction)?

3.) The SEC alleges that the problem with the transaction undertaken is that no insurance policy ever actually existed. How should payments to insurers that do not involve a transfer of risk be accounted for by the paying party and by the insurer receiving the payment? Under what circumstances may an entity offset insurance recoveries against related losses? What accounting standard establishes these practices?

4.) Did the SEC find AIG guilty of fraud in selling this contract to Brightpoint?

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


Hello Nonye Opara,

I apologize for the delay in responding to your message. I was in the White Mountains of New Hampshire all summer and did not even touch a computer or read any email messages.

I was very sorry to hear that Anthony Steele passed on. He was such a good host when I was invited to lecture at your university.

It is impossible to say that new laws of most any kind cannot and do not help restrain bad behavior. It's quite another matter to assert that they are cost effective in restraining bad behavior. The new laws most certainly did not attack the basic problem that white collar crime in general is not punished severely in 99.9% of discovered crimes. Punishments most certainly are not in proportion to punishments for robbing a store at gunpoint for $100 in the front office as opposed to diverting $100 million in a top floor office. See 

I don't think the jail and fine threats do much to deter white collar crime, because the fines are relatively small and the chances of really going to jail are miniscule. What deters white collar crime is the tone at the top, potential bad publicity of investigations (the media punishments), and the threat of civil lawsuits (the tort lawyer punishments) that generally commence in seeking millions or billions in punitive damages. Media exposures and subpoenas interfere with the sleep of corporate crooks in the U.S. and elsewhere in the world.

Of all the laws that have been passed to deter fraud, probably the most important are laws to protect whistle blowers. These laws can be abused by opportunists, but some recent outcomes (e.g., the latest one giving $1 million to a Los Alamos whistle blower) make firms sit up and think about setting up policies and communication channels that take whistle blowing seriously. The only way to deter and/or discover fraud in most instances is with the help of insiders. Without informants from within, investigators are likely to overlook the entire crime. Accounting crimes are most certainly too easy to cover up.

The main deterrents to crime and ethics breakdowns are the "tones and the top." If the top executives are devils in white shirts and blouses, don't expect their followers to wear halos. The original Arthur Andersen had no trouble with his staff, because he set the stern and unfaltering tone at the very top. Eight decades later, top executives in his firm grew badly out of tune.

Bob Jensen

From: Nonye Opara []  
Sent: Wednesday, July 16, 2003 5:21 PM 
To: Jensen, Robert 
Subject: research questions

Gooday Bob Jensen , my name is Nonye Opara and i am a postgraduate student at the university of warwick in the United kingdom . I am currently conducting some research regarding post Enron reforms . I would be very grateful if you could shed some light on the following issues.

Do you think that the new laws and reforms enacted as a result of the Enron scandal are capable of preventing or deterring future Enrons from taking place and are there any shortcomings in these new laws.

And how can this be achieved i.e through criminal law or regulatory action, If criminal law do you think there will be difficulties of proof and enforcement.

You can email your response to 


Thanks for your anticipated help.

From the AccountingWeb on August 22, 2003

Two whistleblowers have found out it pays to take a chance and tell the truth. The University of California agreed to pay nearly $1 million to one former investigator who even the university admits was unfairly terminated when he helped to expose mismanagement at the university-run Los Alamos National Laboratory in New Mexico.

Glenn Walp and the university settled the case for $930,000 a month ago and announced the settlement this week. Walp was fired from his investigator job at Los Alamos in November 2002. This occurred just after he and Steve Doran, who was also an investigator, went public with their charges of mismanagement at Los Alamos. They accused top managers of protecting the university’s contract to manage the lab for the Energy Department by hiding theft and fraud. Doran settled in March, but chose to keep the settlement terms private. He continues to hold a senior law enforcement position with the university.

Also in the August 22, 2003 edition is the following book recommendation:

Book Recommendation: Communication for Accountants:  Strategies For Success, 
by Maurice L. Hirsch, Rob Anderson, and Susan L. Gabriel

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

For years, practitioners have been sending a message that technical skills are not enough; accountants must be able to communicate effectively through both writing and speech. Studies have indicated that there is dissatisfaction with the communication skills of accountants. Asserting that accountants must be able to communicate effectively through both writing and speaking, this handbook provides advice on how to gain communication skills relevant for the various financial fields accountants operate within. 


From eNewsletter on August 28, 2003


Consultants and lawyers are starting to realize that the Sarbanes-Oxley Act passed by Congress in July 2002, will not only affect public companies but will also have both direct and indirect implications for privately held businesses as well. According to the following article their are two provisions in particular that will have significant impacts for private businesses. The first relates to the so-called whistle-blower provision of the financial reporting law and the other affects private businesses who are in the process of going public or who intend to go public in the future.

Click here to read the article...

From The Wall Street Journal on August 27, 2003 --- 

In the newest sign that MCI's woes won't easily be put behind it, the Oklahoma State Attorney General plans to file criminal charges against the company, its former chief executive Bernard Ebbers and five other individuals as early as Wednesday in connection with its $11 billion accounting fraud, according to people familiar with the situation.,,SB106194366395454600,00.html?mod=todays%255Fus%255Fpageone%255Fhs 

Marketers are perfecting new ways to implant their own software into other people's computers, then barraging them with carefully targeted advertising. But consumers are catching on to this "spyware," and many of them are angry.,,SB106192877175218500,00.html?mod=todays%255Fus%255Fpageone%255Fhs

He's responsible for millions of dollars worth of damage and multimillions is time lost, but all he gets is house arrest.  It's time to throw the book at these bums!
Nabbing The Blaster Master The FBI arrested an 18-year-old from Minnesota it says is responsible for a recent version of the Blaster computer infection; he's under house arrest with orders to stay off the Internet. 

AccountingWEB has compiled a list of new books.  Browse through this selection and see if you need to add any of these books to your library. Just click on the hyper-linked titles, or on the book images to find out more  --- 

"MCI Saga Comes to a Climax," by Shawn Young, The Wall Street Journal, September 5, 2003 ---,,SB106272005425330700,00.html?mod=technology_main_whats_news 

For MCI and its powerful enemies, much comes down to a bankruptcy-court hearing that starts Monday and will determine whether the phone company that committed the biggest accounting fraud in U.S. history will be allowed out of bankruptcy protection.

The outcome is a question of survival for the Ashburn, Va., company formerly known as WorldCom Inc. If it gets out of Chapter 11 bankruptcy-court protection on schedule this autumn, MCI stands a chance of putting its $11 billion accounting fraud behind it, keeping its 50,000 workers employed, making money for new investors and recovering its full competitive might. If it is forced to remain under protection, prospects for the No. 2 long-distance carrier, after AT&T Corp., surely will continue to wither. For the company's creditors, a payout estimated at about $14 billion in cash, new MCI stock and new bonds rides on the result of the hearing. Former stockholders will get nothing.

September 8, 2003 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU


There is an even more interesting and illuminating story in today's Washington Post - 


"Hoping to Shed a Scandal WorldCom Awaits Court Ruling on Whether Overhauled Board, Accounting Are Enough," by Christopher Stone, The Washington Post, September 8, 2003, Page E01 --- 

Last month, when WorldCom Inc.'s board sat down to consider a proposal to buy the remaining shares of Digex Inc. that it did not already own, it was well prepared. It had been given a detailed due-diligence report from its investment bankers, a presentation from the corporate development team, and Digex's own chairman was on hand to answer questions. Afterward, the directors held an extensive discussion among themselves before signing off on the $18 million transaction.

The meticulous process contrasted dramatically with the last time WorldCom considered a deal involving the Laurel-based Web-hosting firm. In September 2000, the company's board approved the $6 billion acquisition of Digex's corporate parent, Intermedia Communications Inc., after just 35 minutes of discussion. The directors had no written material backing up the deal, and many were not even aware an acquisition was imminent until two hours before a hastily convened conference call. One director later lamented the cursory nature of the review: "God himself could not have made the decision in one day."

Company officials say the marked differences between the two board meetings reflect the sweeping changes that have taken place at the company since June 2002, when it first reported accounting abuses that would become the largest case of corporate fraud in history. To distance itself from its scandal-tainted past, Ashburn-based WorldCom has replaced its entire board and fired dozens of executives. It has enacted tough new accounting, financial-reporting and corporate-governance standards, and it has agreed to pay $750 million in fines and restitution. It even plans to formally take on a new name, MCI.

Today, a U.S. Bankruptcy Court is scheduled to convene a hearing to decide whether WorldCom should be given a second chance and emerge from Chapter 11 bankruptcy protection. Judge Arthur J. Gonzalez's review is likely to be unusually broad as he attempts to assess everything: the company's reorganization plans, its business prospects, its corporate ethics.

Despite the company's often avowed commitment to reform, it still has a long way to go before it regains the confidence of those who know it best. Telecommunications analyst Drake Johnstone of Davenport & Co. says he would not trust the company even if Gonzalez signs off on its reorganization plan.

"I don't see how an analyst in his right mind would follow this company given its behavior and what it did to investors," Johnstone said.

Continued in the article

"NYSE's Critics Say It Is Too Easy on Late Filers," by Jonathoan Weil, The Wall Street Journal, September 8, 2003 ---,,SB106296806586589800,00.html?mod=technology_main_whats_news 

Is it time for the New York Stock Exchange to hang up on Qwest Communications International Ltd.?

In July 2002, after months of pressure from the Securities and Exchange Commission, the Denver telecommunications company announced it would restate its accounts back to 2000, meaning investors no longer could rely on its prior audited financial statements. More than 13 months later, Qwest still hasn't released annual reports with audited financial statements for those years or 2002 -- one of the exchange's basic listing requirements. And there is no end in sight to the delay.

That hasn't kept Qwest off the exchange, notwithstanding criminal indictments for accounting fraud against some former executives. Qwest's stock still trades as "Q," the kind of one-letter ticker symbol the NYSE reserves for its most prestigious listed companies.

Receive Your Undergraduate or Graduate Diploma in Days Rather Than Years
September 22, 2003 message from Sheri Shipley [

Improve your income and your life, with increasing your earning power from a diploma within days from a prestigious non-accredited university based on life experience.

September 23, 2003 message from Octavio Bain [

There are no required tests, classes, books, or interviews!

Get a Bachelors, Masters, MBA, and Doctorate (PhD) diploma!

Receive the benefits and admiration that comes with a diploma!

No one is turned down

Bob Jensen's threads on diploma mill frauds are at 

Microsoft is discontinuing its employee stock options program!

September 19, 2003 message from Elliot Kamlet SUNY Account [mailto:ekamlet@BINGHAMTON.EDU

I would love to see the results of the research that shows what would have happened if fair value had been applied say 5 years ago in a random sample of companies. In other words, would BS or some other pricing model have worked?

Elliot Kamlet 
Binghamton University

September 19, 2003 reply from Bob Jensen

Hi Elliot,

I doubt that anything would have worked five years ago except the Wizard's Crystal Ball that always predicts "nothin' ain't worth nothin'."  Remember, Enron's "collapse" (I was tempted to use a plural "p" word with a better connotation) burst the world's equity bubble about four years ago such that every options valuation model badly overshot the mark five years ago.  In the midst of enormous valuation errors, differences in valuations most likely are just noise.

But "options are worth somethin' " according to the following essay:

"Why Stock Options Still Rule," by Michael S. Malone, Wired News, September 19, 2003 --- 

Nothing lures top talent like the chance to get really rich. Watch out, Microsoft (Microsoft dropped its stock options compensation program.)

A cabal of very strange bedfellows - federal regulators, union organizers, cynical politicians, and Microsoft - have teamed up to crush the dream of economic freedom for every working stiff in America. In the process, they may be unwittingly kicking off the next great entrepreneurial boom.

I'm talking about stock options. You remember those. Way back in the last century, options were the ticket to personal liberation; the one chance, besides organized crime and Lotto, for an everyday person to get rich. In those balmy days, options - which give the holder the right to buy or sell a company's stock at a specific price, by a specific date - were celebrated as the great egalitarian tool, spreading wealth according to hard work and merit.

They were also recognized as the fuel of entrepreneurial fire, driving the creation of new technologies, new products, and new companies. The US tech sector had perfected the use of options as a recruiting device and employee incentive, and in doing so became the fastest-growing, most innovative economic force in history.

Lately, though, options have become the bęte noire of 21st-century corporate life. Ken Lay and Frank Quattrone face prison time for abusing them. The Financial Accounting Standards Board, which sets accounting guidelines for public companies, is preparing to force US corporations to report stock options through "fair value" expensing.

Now, in what pundits are calling the final nail in the coffin, Microsoft is discontinuing its options program. No wonder it seems like the end of an era. Bill Gates may be the Prince of Darkness, but he's also a genius. If he says options are dead, who's to argue? Entrepreneurs, for starters. They want the same powerful tool at their disposal that Gates used to attract top-flight talent to a budding Microsoft. But if they're smart, they'll keep their mouths shut.

Continued in the essay.

"Warning of Pension-Plan Shortfall Raises Pressure for Financial Fix,"  by John D. McKinnon, The Wall Street Journal, September 5, 2003 ---,,SB106269876480565000,00.html?mod=your%255Fmoney%255Fretirement%255Fhs 

The government agency that insures 44 million workers' retirement benefits said the nation's pension system is in worse financial shape than previously believed, a politically charged warning at a time when economic uncertainty, unemployment and rising fears about the loss of manufacturing jobs overseas already are stoking debate in Washington.

It raises the prospect that companies could be forced to contribute more to the government insurance plan, that benefits to retirees could be reduced and even that taxpayers ultimately could have to bail out the pension-guarantee program. But some experts say the agency is overstating the problem in order to force companies to pay it higher premiums.

Pension Benefit Guaranty Corp., the agency established in 1974 to pay benefits to workers whose pension plans go bust, estimated that by the end of this month, financially troubled companies, or those with below investment-grade credit ratings, will have pension plans whose promises exceed their assets by $80 billion. The agency's previous estimate for these companies' so-called level of underfunding was $35 billion. Overall, the agency says, all private employer pension plans are $400 billion short of assets needed to keep promises they've made.


Among the various articles in Accounting Horizons that I'm catching up on after returning from my isolated summer in the White Mountains, I especially recommend the following two articles:

Title: How Chevron, Texaco, and the Indonesian Government Structured Transactions to Avoid Billions in U.S. Income Taxes  (June 2003, pp. 107-122)
Summary: (view full summary) By Jeffrey D. Gramlich and James E. Wheeler 
SYNOPSIS: This paper explains the transactions, agreements, and accounting that Chevron, Texaco, and the Government of Indonesia used to structure...

Title: The Quality of Financial Statements: Perspectives from the Recent Stock Market Bubble   (Year 2003 Special Supplement))
Summary: (view full summary) By Stephen H. Penman 
SYNOPSIS: During the recent stock market bubble, the traditional financial reporting model was assailed as a backward-looking system, out of date in the Information Age. With...

From The Wall Street Journal Accounting Educators' Reviews on September 19, 2003

TITLE: Levi Is Unable to Verify Reserves, But Defends Reporting Methods 
REPORTER: Glenn R. Simpson 
DATE: Sep 16, 2003 
PAGE: A14 
TOPICS: Accounting, Accounting Fraud, Audit Quality, Auditing, Earnings Management, Reserves, Taxation

SUMMARY: Two former employees of Levi Strauss & Co. contend that Levi misapplied tax laws and reported inappropriate tax reserves in its financial statements. Questions primarily deal with use of reserves and auditor responsibility for detecting illegal activities.

1.) Briefly explain the allegations made by the former Levi employees.

2.) Prepare the journal entry to record the income tax expense and the alleged inappropriate reserve. Omit amounts in your journal entry, but discuss the nature of the journal entry and the financial statement implications.

3.) What is earnings management? Is earnings management permitted under Generally Accepted Accounting Principles? Support your answer. How can tax reserves be used to manage earnings?

4.) Assume that Levi failed to follow the Internal Revenue Code. Also, assume that the reserve established by Levi was in violation of Generally Accepted Accounting Principles and material. Discuss the auditor's responsibilities related to these issues. What opinion should have been issued by the auditor? Support your answer.

5.) What is materiality? If the accounting reserve was inappropriate, does it matter if the amount is immaterial? Support your answer.

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

Why you should think twice about using computers at  Kinkos, libraries, airports, and other public access locations.  This also applies to having your computer serviced by someone you don't know and trust.  This link was forwarded by Glenn Gray.

From Microsoft BCentral --- 
"Danger, danger: 5 tips for using a public PC," by Kim Komando

There's a guy in New York who may have gotten into your personal business. If he did, he probably looted your online bank account.

Juju Jiang is serving time now after pleading guilty. But for a couple years, he bugged public computers at Kinko's with software that logged keystrokes. He used it to capture usernames and passwords. Some he used to steal money; others he sold on the Web.

He got caught when he manipulated a victim's home computer while she was present. She watched incredulously as he methodically searched her computer. He was using GoToMyPC, which allows travelers to manipulate their computers from afar. The victim had used GoToMyPC previously from a Kinko's machine. Jiang stole her username and password.

This raises an issue which many people haven't considered. Spying software can easily be placed on public computers, such as those not only at Kinko's stores, but in Internet cafés, airports, libraries and other public places.

With spying software, a criminal can grab your passwords and usernames. Ultimately, you could lose your money or have your identity stolen. That should tell you enough to be wary of public PC terminals.

Software is unobtrusive

Spies usually use software because it is invisible to the untutored eye. Hardware to do virtually the same thing also can be used, placing it between the keyboard and computer. But using it is too obvious in a public place.

The software programs, however, can unobtrusively make a record of a victim's every keystroke. The keystroke loggers can then e-mail the collected information on a set schedule. It also can be downloaded. Other software programs take screen shots of places you go. These, too, send their collected information via e-mail.

Continued in the article.

From The Wall Street Journal's Accounting Educators' Reviews on September 26, 2003

TITLE: Heard on the Street: Analyst Gartner Aims to Convert Mistake Into Future Success 
REPORTER: Ken Brown 
DATE: Sep 19, 2003 
TOPICS: Debt, Financial Accounting, Revenue Forecast, Revenue Recognition

SUMMARY: "Gartner, Inc. makes money by analyzing technology companies and trends." This company issued a $300 million convertible bond to Silver Lake Partners, LP, a private equity firm specializing in technology, at the height of the technology boom, in the spring of 2000. Since the technology bust, that debt has been an onerous drag on the company, because of the debt-equity implications, interest charges, and a critical aspect of the deal: Gartner was required to issue a significantly increasing number of shares under the conversion feature as its share value fell from the fallout of the technology bust. The article discusses a plethora of accounting topics in debt and equity, earnings per share, and even the company's revenue recognition procedures.

1.) What is convertible debt? Describe the provisions of the agreement between Gartner, Inc. and Silver Lake Partners, LP.

2.) "...Because of the accounting treatment of the bond payoff, Gartner's shareholders' equity will go from negative to positive." In general, what are two possible ways to account for converting bonds into common stock?

3.) Access the company's June 30, 2003, quarterly and 2002 annual financial statements via their web site at , by scrolling down the page and clicking on "investor relations." Using footnote disclosure about the convertible debt in Note 10 to the annual financial statements, the balance for the debt at 6/30/2003, and other information about the company's stock available in the financial statements, provide the journal entries that the company will record for the bond conversion under each of the two possible methods you gave in question 2. Which of these methods do you think the company will use?

4.) "For Gartner, the implications of putting the bond deal behind it could be major." Why does the author say that the company can extinguish debt without any further dilution of earnings per share beyond current disclosure? Will fully diluted earnings per share be affected by this conversion? Will basic earnings per share be affected? Explain.

5.) "Without any debt on its balance sheet, the company can use $167 million in cash...on hand" to buy back common stock. Why not just use the cash to pay off the debt? Who will receive cash under each of these alternatives? Will Silver Lake Partners receive any cash if they convert the bonds into stock? What would other stockholders' preferences be, do you think?

6.) Describe Gartner, Inc.'s business. Summarize Gartner's revenue recognition practices, as they are described late in the article. What does the author mean when he refers to "contract value"? Where in the accounting records would you find the amounts reported as "contract value" in the article?

7.) What is incremental revenue? Why do you think that "80% to 90% of each incremental dollar of research revenue can fall to the bottom line"? Why does this fact, combined with the changes in the company's capital structure, bode well for next year's earnings?

8.) The author states that revenue was down 2% in the second quarter from the first, and contract value was down 1% on the same basis. How can these results be described as "improvements over the past few quarters"? Why is appropriate to compare results for consecutive quarters, when we usually see comparisons of quarterly results to the same quarter one year earlier?

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

Bob Jensen's threads on revenue accounting are at 

"Woes at Financier Of Mortgages Spur Concerns," The Wall Street Journal, Page 1, September 26, 2003 ---,,SB106453060227968100,00.html?mod=todays%255Fus%255Fpageone%255Fhs 

Home Loan Bank of New York Takes
Mobile-Home Hit, Triggering Oversight Calls


Financial difficulties within the little-known Federal Home Loan Bank system, which provides crucial funding for the lending industry, have opened a new front in the battle over how to regulate the $6 trillion U.S. mortgage-finance market. The problems have set off a new wave of concern about the institutions that helped finance the decade-long housing boom.

For decades, the 12 Federal Home Loan Banks operated beneath investors' and lawmakers' radar screens, quietly providing capital to mostly small-town lenders so they could make more home loans. But the Federal Home Loan Bank of New York caught attention in the markets this week when it said it would have to suspend dividend payments after suffering $183 million in losses from soured investments in mobile-home loans -- losses that may have been evident as long ago as early August but weren't made public until this week. That news came on the heels of an 82% drop in second-quarter earnings at the Federal Home Loan Bank of Pittsburgh, which was stung by a sudden move in interest rates.

The home-loan banks were established by the federal government during the Depression to make funding available for home loans in local, often rural, communities. They've expanded in recent years from that low-key mission into some of the same types of mortgage business that Freddie Mac and Fannie Mae dominate, for instance buying and holding mortgages from banks. Some on Wall Street have begun to question whether the home-loan banks have moved out of their league.

The home-loan banks' surprising stumbles come at a time of rising concern about the risks coursing throughout the U.S. mortgage market as it cools down from one of the biggest housing booms in U.S. history. Lawmakers were already debating ways to boost regulation of Fannie Mae and its smaller sibling, Freddie Mac, which recently acknowledged that it used accounting gimmicks to smooth the volatility in its earnings (see related article). Thursday, the debate shifted to include the Federal Home Loan Banks, which, together, now have $809 billion in assets and $710 billion in debts, making them larger than Freddie Mac.

Continued in the article.

"Freddie Mac Again Delays Release of Restatement," by Julie Haviv, The Wall Street Journal ---,,SB106449715084396200,00.html?mod=article-outset-box 

Freddie Mac once again delayed the release of its widely anticipated reaudited and restated financial results, pushing the publication date to November rather than the end of September.

The embattled government-sponsored enterprise also said it is expecting to report that it understated earnings by $4.5 billion or more over three years. In June, the company predicted the amount would be in the range of $1.5 billion to $4.5 billion.

News of Freddie Mac's restatement delay came on the same day that executives from Freddie Mac and its competitor, Fannie Mae, were appearing on Capitol Hill. In testimony before the House Financial Services Committee, they argued against proposed legislation that would increase their capital requirements and tighten oversight of their businesses.

Freddie Mac said it extended its Sept. 30 restatement deadline because of computer-system changes, additional data processing and the timing of validation of the results. The company said the delay isn't a result of further accounting problems, noting that almost all of its new accounting policies have been finalized.

"It's obviously disappointing and it really makes you wonder what exactly is going on," said Chris Buonafede, analyst at investment bank Fox-Pitt, Kelton Inc., a unit of Swiss Reinsurance Co. "This is the third time they have delayed the release and who is to say they won't do it again?"

Freddie Mac has said it will restate its financial results for the past three years due to accounting issues. Last month, Freddie Mac jolted investors by ousting its chief executive -- for a second time in three months. That followed revelations that the company had been pushing the accounting envelope for years, hiding more than a billion dollars in profits to smooth out earnings zigzags. The company is facing multiple federal investigations.

But political headlines and accounting woes aside, Freddie Mac had some good news Thursday. The mortgage-finance company's market share grew to 41.9% in August from 35.7% in July, winning ground mainly from Fannie Mae. The August level is within Freddie Mac's historic average of 40% to 45%, according to Fox-Pitt.

Freddie Mac saw its market share shrink in the early months of the year, due to its reliance on a small number of mortgage servicers that happened to also be in a faster-prepaying market segment. Indeed, its recent gain in market share may be a result of agreements made with them regarding that issue.

In Ms Kuglin's case, it was worth the effort to refuse to pay her U.S. income taxes.  But there's not much precedent in this case for the rest of us.

Last week a female commercial pilot won a battle with the IRS over the basic tax protester issue of where it states in the law that people are required to pay income taxes. A federal court inruled in favor of Vernice Kuglin who refused to pay federal income taxes for nearly a decade. 

The issue decided by a jury was actually not whether or not Ms. Kuglin owed taxes on $920,000 of income earned in the years 1996 to 2001. While Ms. Kuglin has refused to pay tax on that money and has been subjected to criminal charges by the IRS for tax evasion and filing false W-4 forms on which she indicated that she didn't owe any income tax, the case was decided on the simple fact that the IRS did not respond to Ms. Kuglin's correspondence.


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

Bob Jensen's threads on the Enron/Andersen scandals are at  
Bob Jensen's SPE threads are at  
Bob Jensen's threads on accounting theory are at  

Bob Jensen's Summary of Suggested Reforms --- 

Bob Jensen's Bottom Line Commentary --- 

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



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