Accounting Scandal Updates and Other Fraud on September 30, 2004
Bob Jensen at Trinity University


Bob Jensen's Main Fraud Document --- 

Other Documents

Many of the scandals are documented at 

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

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

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

Updates on the leading books on the business and accounting scandals --- 

I love Infectious Greed by Frank Partnoy --- 


It's a change in philosophy for an agency that has spent the last couple of years chasing after wrongdoing uncovered by New York Attorney General Eliot Spitzer. Throughout the spate of corporate scandals, the SEC has been conducting investigations after the fact, levying fines on companies long after the abuse has occurred, and failing to spot questionable practices, such as mutual fund trading abuses.   Donaldson (SEC Chairman) wants to change that by taking a cue from Spitzer. Spitzer's strategy was to narrow his focus and concentrate on areas where small investors were being harmed. The SEC will do the same through a newly formed office of Risk Assessment, the Washington Post reported.
SEC Chairman: Find Solutions Before Problems Explode," AccountingWeb, September 30, 2004 --- 

A series of e-mails dating from the mid-1990s to 2003 show that even after KPMG was ordered by the IRS to stop pushing tax shelters considered abusive, the firm continued to promote at least a dozen new similar shelters. AccountingWeb, September2, 2004 --- 
Bob Jensen's threads on KPMG's scandals are at 

Norris said the accounting firms and the airline industry share a common struggle-never have their services been more in demand but never too has their survival been so challenged.
"Can the Big Four Save Themselves," AccounitngWeb, September 15, 2004 --- 
The above quote refers to an article by Floyd Norris in the New York Times. (See below)

The firms generally praised the board (PCOAB) and said they were working to improve their audits. James S. Turley, the chief executive of Ernst & Young, said the board would "prove to be one of the best things that ever happened to the accounting profession."
Frank Norris, The New York Times, August 27, 2004 (See below)

That some bankers have ended up in prison is not a matter of scandal, but what is outrageous is the fact that all the others are free.
Honoré de Balzac

Cyber-begging is not new, but a free web service called Dropcash has linked data from payment service PayPal with that of blogging system TypePad to make it even easier to create your own fundraising webpage - complete with progress bar.
The Guardian, September 9, 2004
Bob Jensen's threads on charity frauds are at 

The FTC said a government-funded reward system of at least $100,000 could induce people turn in those spammers who send millions of junk e-mail.  Six-figure incentives are the only way to persuade people to disclose the identity of co-workers, friends and others they know are responsible for flooding inboxes with unsolicited pitches for prescription drugs, weight loss plans and other products, according to an agency report.
The Wall Street Journal
, September 16, 2004 ---,,SB109537444890220303,00.html?mod=technology_main_whats_news 
Don't count on six-figure rewards to stop the Nigerians offshore whose scams gross hundreds of millions of dollars.  Also don't count on the rewards being funded since large numbers of legislators who will be required to appropriate funds for the rewards are in the pockets of the direct marketing industry.  Sigh!

The accounting change also could expose another weakness: In the last four quarters, Apple earned $32 million after taxes from interest on its $4.6 billion cash horde. That's nearly twice as much as the $18.5 million in operating income it would have earned under the pending FASB rules, says Albert Meyer, principal of 2nd Opinion Research. "Is it a tech company or a credit union?" Meyer asks.  If stock options had been treated as a cost, Apple's $179 million in earnings over the last four quarters ended on Mar. 27 would have fallen 69% -- significantly more than the potential drops of under 50% for other tech companies such as Dell. Out of 86 tech companies, Apple was among the 12 with the biggest hit to estimated 2005 earnings, according to Merrill Lynch (MER ).
Alex Salkever, Business Week, July 12, 2004, Page 11 (See below)

KENNETH LAY SURRENDERED to authorities in Houston to face indictment for his role in Enron's collapse. The energy giant's former CEO was charged with being part of a wide-ranging scheme to defraud investors. 
The Wall Street Journal, July 8, 2004, July 8, 2004 ---,,SB108928566380358408,00.html?mod=home_whats_news_us 
Bob Jensen's threads on the Andersen and Enron scandals are at 

Does all of this add up to a convincing indictment against the market? No. Even those economists like MIT's Paul Joskow who are most convinced that illegal market manipulation played a major role in the California meltdown continue to support the introduction of (better designed) markets to the electricity sector. Other economists are of the opinion that market design ought to be left to trial and error in the context of more complete deregulation rather than to some template drafted by experts who think they can know a priori how electricity markets could best be organized.
Jerry Taylor (See below.)

Of all the lawsuits, one filed against Mr. Winnick last October in federal court in Manhattan holds special significance. J. P. Morgan Chase and other leading banks are seeking $1.7 billion in damages from Mr. Winnick and other Global Crossing executives, contending that the group engaged in a "massive scam" to "artificially inflate" the company's performance to secure desperately needed loans. Mr. Winnick, whose lawyers dispute the accusations, declined to be interviewed for this article.  Among other things, the suit refocuses attention on exactly what Mr. Winnick knew about his company's finances during times when it was borrowing heavily and he was selling hundreds of millions of dollars in stock. It also outlines a troubling series of meetings he held with Mr. Lay and other Enron executives just months before their company crumpled.
Timothy O'Brian, "A New Legal Chapter for a 90's Flameout," The New York Times, August 15, 2004 --- 

Bye Bye Birdie
As part of an agreement with the federal government's Pension Benefit Guaranty Corporation (PBGC), beleaguered energy giant Enron Corp. has agreed to place $321 million in an escrow account in order to fully fund four defined-benefit pension plans. The money will come from proceeds of the $2.45 billion sale of the company's U.S. pipeline business. The pipeline business is considered to be Enron's most prized remaining asset.
AccounitngWeb, September 16, 2004 --- 
Bob Jensen's threads on the Enron/Andersen scandals are at 

n my view Global Crossings is the pinnacle of corporate management profiteering. I cannot believe that Justice did not prosecute this obvious case of fictitious earnings manipulation and Gary Winnick is left with over $735 million when investors had an 18 billion collapse.
Miklos A. Vasarhelyi, Rutgers University, August 15, 2004 email message

Try This Out for Mutual Fund Conflict of Interest:  Guess the Stance Taken by Fidelity's Board With Respect to Expensing of Corporate (read that Intel) Failure to Expense Employee Stock Options?
But while Fidelity funds hold almost 3 percent of Intel's shares for clients, Intel is also a big customer of Fidelity, creating the potential for a conflict at the fund giant. Fidelity is the recordkeeper for Intel's 401(k) plan, which held eight Fidelity funds worth $1 billion at the end of 2003.
Gretchen Morgenson, "A Door Opens The View Is Ugly Mutual Fund Board Voting," The New York Times,  September 12, 2004.
Bob Jensen's threads on the mutual fund scandals are at 

Bob Jensen's threads on why white collar crime still pays --- 

Turning to business, the board rapidly approved a series of transactions, according to the minutes and a report later commissioned by Hollinger. The board awarded a private company, controlled by Lord Black, $38 million in "management fees" as part of a move by Lord Black's team to essentially outsource the company's management to itself. It agreed to sell two profitable community newspapers to another private company controlled by Lord Black and Hollinger executives for $1 apiece. The board also gave Lord Black and his colleagues a cut of profits from a Hollinger Internet unit.  Finally, the directors gave themselves a raise. The meeting lasted about an hour and a half, according to the minutes and two directors who were present.
Robert Frank and Elena Cheney --- 

Bankruptcy Isn't Cheap for MCI
Lawyers, advisers and accountants who worked for MCI as it went through the biggest Chapter 11 bankruptcy case in U.S. history are seeking approval to collect about $600 million in fees, according to filings with the U.S. Bankruptcy Court for the Southern District of New York. The Ashburn, Va., telecommunications company, formerly known as WorldCom Inc., filed for bankruptcy-court protection in 2002 after an accounting fraud that ultimately totaled $11 billion. MCI emerged from Chapter 11 in April and the fees cover the entire period of the bankruptcy. Almost all the money has been paid, but the bills need final approval, according to a person familiar with the matter. MCI kept squads of lawyers from Weil, Gotshal & Manges LLP and accountants from Deloitte & Touche LLP and KPMG LLP on duty as it hurried to emerge from bankruptcy protection as soon as possible. Company officials have said that they knew fees would run into the hundreds of millions of dollars.
The Wall Street Journal,
August 17, 2004 ---,,SB109271165611793323,00.html?mod=technology%5Fmain%5Fwhats%5Fnews 


But for What Reasons?
Have accountants finally shed their dry bean-counter image? Can accounting be viewed as a "sexy" career choice? Maybe so, if the number of new accounting majors among college freshmen is any indication. Academics say the seemingly never-ending series of corporate scandals over the last few years has piqued the interest of today's students.
"Corporate Scandals Attract Students to Accounting," AccounitngWeb, August 2, 2004 --

August 2, 2004 message from Ethical Performance [

Ford Motor Company's 2003-04 Corporate Citizenship Report - which covers a wide range of topics from the Escape Hybrid sports utility vehicle to human rights and HIV/AIDS prevention - is now available.

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QWEST EX-CEO JOSEPH NACCHIO soon may face civil charges over improper accounting. The telecom firm agreed to a preliminary $250 million settlement with the SEC.
Deborah Solomon et al, The Wall Street Journal, September 13, 2004, Page A3 ---,,SB109483441282814794,00.html?mod=technology_main_whats_news 

Iwan Lost
Qwest executives massaged a deal with the Arizona School Facilities board to book the sale early and misled auditors about their actions, former Arthur Andersen auditor Mark Iwan testified Thursday.  Iwan said Grant Graham, a former Qwest finance executive, assured him the transaction would comply with accounting standards necessary to book the $33.6 million in the second quarter of 2001.

Tom McGhee, The Denver Post, March 19, 2004 ---,1413,36%257E26430%257E2027537,00.html 

Accounting rules still allow companies to classify lease obligations differently than debt, leaving billions of dollars off corporate balance sheets and relegating a big slice of corporate financing to the shadows.
Jonathan Weil, "How Leases Play A Shadowy Role In Accounting" --- 

At the FASB (Financial Accounting Standards Board), Bob Herz says he thinks "lease accounting is probably an area where people had good intentions way back when, but it evolved into a set of rules that can result in form-over substance accounting."  He cautions that an overhaul wouldn't be easy:  "Any attempts to change the current accounting in an area where people have built their business models around it become extremely controversial --- just like you see with stock options."
Jonathan Weil, "How Leases Play A Shadowy Role In Accounting" ---   
By the phrase form over substance, Bob Herz is referring to the four bright line tests of requiring leases to be booked on the balance sheet.  Over the past two decades corporations have been using these tests to skate on the edge with leasing contracts that result in hundreds of billions of dollars of debt being off balance sheets.  The leasing industry has built an enormously profitable business around financing contracts that just fall under the wire of each bright line test, particularly the 90% rule that was far too lenient in the first place.  One might read Bob's statement that after the political fight in the U.S. legislature over expensing of stock options, the FASB is a bit weary and reluctant to take on the leasing industry.  I hope he did not mean this.


When the Securities and Exchange Commission found evidence in e-mail messages that a senior partner at Andersen had participated in the fraud at Waste Management, Andersen did not fire him. Instead, it put him to work revising the firm's document-retention policy. Unsurprisingly, the new policy emphasized the need to destroy documents and did not specify that should stop if an S.E.C. investigation was threatened. It was that policy David Duncan, the Andersen partner in charge of Enron audits, claimed to be following when he shredded Andersen's reputation.

Floyd Norris (see below)


Forwarded by Miklos A. Vasarhelyi from Rutgers University
"Will Big Four Audit Firms Survive in a World of Unlimited Liability?," by Floyd Norris, The New York Times, September 10, 2004 


RE the Big Four accounting firms members of an endangered species, destined to die from litigation?

Within the accounting profession there has been growing fear ever since Arthur Andersen vanished in a sea of liability that it was only a matter of time before another firm followed. And then, the thought goes, the others would find it impossible to persuade partners to stay, lest their net worth be decimated as happened at Andersen.

Perhaps the situation is not unlike the one that confronts the major airlines. Never has there been such need and demand for the service they provide, but as commercial ventures their viability is dubious at best. The difference is that there are a host of low-cost airlines willing to take up the slack if Alitalia or United should vanish, while it is not at all clear who could replace the Big Four.

The alternative of government auditors is an unattractive one. The quality of the audits would be suspect, if only because of the difficulty in attracting good auditors at government pay, and political influence could be a problem. Consider the way technology companies got the House of Representatives to oppose reasonable accounting for stock options, or the fact that the European Commission is on the verge of overruling an international accounting rule on derivative accounting after heavy lobbying by banks.

It is easier to understand how we got to the current situation than it is to figure out how to get out of it. Over time, the big accounting firms sought growth rather than excellence. Partners were rewarded for bringing in more business and penalized for offending clients with tough audits. There was no effective regulator.

When the Securities and Exchange Commission found evidence in e-mail messages that a senior partner at Andersen had participated in the fraud at Waste Management, Andersen did not fire him. Instead, it put him to work revising the firm's document-retention policy. Unsurprisingly, the new policy emphasized the need to destroy documents and did not specify that should stop if an S.E.C. investigation was threatened. It was that policy David Duncan, the Andersen partner in charge of Enron audits, claimed to be following when he shredded Andersen's reputation.

Now there are real reforms. The Public Company Accounting Oversight Board in the United States is watching over audit quality, and other countries are following suit.

The firms appear tougher. ''We are turning down clients at an unprecedented rate,'' said James H. Quigley, the chief of Deloitte & Touche's American operations, in an interview. ''We are very rigorous in terms of who we become associated with in this world of unlimited liability.''

But better audits now will not repair poor audits of the past, and the firms yearn for legal protection. In the United States, that is so unrealistic politically that no specific proposal is pending. In Britain, their plea for a cap on damage awards was rejected by the government this week.

This may be a case of Catch-22. If auditors are doing a good job, they deserve to be protected from lawsuits that could put them out of business. But without the threat of such suits, will they do a good job?

The probable outcome is that the firms will muddle through. Plaintiffs lawyers will temper their demands, knowing they need to keep the firms in business. If Big Four managements really appear to be determined to run quality firms, governments are not likely to bring criminal charges that will put them out of business, even if individual partners committed outrageous acts.

Good auditing is essential to functioning capital markets, but in too many cases in the 1990's, auditors deemed it their job to help companies find ways to twist accounting rules and mislead investors. The reforms may have arrived just in time to save the Big Four.

Bob Jensen's threads on incompetent and corrupt audits are at 


Bob Jensen's threads on the Enron and Andersen scandals are at 


Bob Jensen's threads on scandals in the major international CPA firms are at 

"Microsoft, Amazon Unite to Battle E-Mail Scammers," by Judy Lam, The Wall Street Journal, September 29, 2004, Page D3 ---,,SB109639503163330213,00.html?mod=technology_main_whats_news Inc. and Microsoft Corp. have joined forces to combat online fraud and find the people behind e-mail scams that send millions of forged messages to consumers.

Yesterday, the two companies said they filed suits against Canadian company Gold Disk Canada Inc. and three individuals for allegedly sending millions of unsolicited e-mails using Microsoft's Hotmail services and forging the name of The suits were filed in Superior Court of the State of Washington and the U.S. District Court in Seattle.

Amazon and Microsoft said they are working to identify offenders and are collaborating to test technical solutions that would make it more difficult to send unwanted messages to consumers.

Over the past year, Microsoft has stepped up its efforts to fight spam and e-mail scams as part of a broader move to stem a range of attacks on its software. The company has had to respond to growing customer complaints about the security of Microsoft applications, prompting the company to release a host of new security software, sign new partnerships, and begin taking more legal action to thwart hackers and senders of spam.

Continued in the article

Bob Jensen's threads on computing and networking security are at



Always ask your broker or investment advisor about kickbacks!
Better yet, buy into honest mutual funds directly and leave your broker out of the picture.


"SEC to Sever a Tie Linking Mutual Funds, Brokerage Firms," by Karen Damato and Deborah Solomon, The Wall Street Journal, August 10, 2004, Page C1 ---,,SB109277224166993831,00.html?mod=home_whats_news_us 

The Securities and Exchange Commission today (August 18, 2004) is expected to ban a type of arrangement that mutual-fund companies long have used to gain favored status for their products at brokerage firms.

The agency will no longer allow fund-management companies to channel their funds' securities-trading orders and the associated commissions to brokerage firms as compensation for selling and prominently placing their fund shares, according to people familiar with the matter.

Still, the crackdown on what is known as "directed brokerage" isn't likely to alter the underlying environment in which hundreds of fund companies, all competing for "shelf space" at the brokerage firms favored by individual investors, feel obliged to pay for that access in one way or another. "If they can't pay through directed brokerage, then they will pay another way," predicts Cynthia Mayer, a fund-industry analyst at Merrill Lynch.

Regulatory scrutiny has led a number of fund managers to curtail their use of directed brokerage in recent months, and fund firms already may be making increased direct payments to brokerage firms, according to analysts including Ms. Mayer and her Merrill colleague Guy Moszkowski.

SEC officials, who declined to speak publicly because of today's vote, acknowledge that banning directed brokerage might lead to an increase in direct payments, known as "revenue sharing." But they say direct payments are preferable because they come from the fund adviser's pocket and not from assets owned by fund shareholders.

Properly disclosed revenue-sharing arrangements "present more manageable conflicts" for funds and brokerage firms than directed-brokerage deals, the SEC said in proposing the ban in February.

At the same time, the agency is investigating whether a number of fund companies are adequately disclosing these payments, which can include sponsoring seminars or other events for brokers, and fund-company executives privately complain that the rules on this practice are in flux as well.

It is legal for fund companies to consider the level of fund-share sales at a brokerage firm in allocating their trades as long as that consideration is disclosed to fund investors and the investors aren't disadvantaged.

Continued in the article

Bob Jensen's threads on the mutual fund scandals are at 

"Deloitte & Touche Launches DTect Financial Fraud Investigation Service," SmartPros, September 7, 2004 --- 

The Financial Advisory Services practice of Deloitte & Touche LLP has launched DTect, a proprietary fraud investigation service designed to help companies identify, track and analyze electronic and financial fraud indicators by sifting through large amounts of electronic data in a fraction of the time expended by using existing conventional methods.

“We involved forensic technology practitioners and forensic accountants from around the world in the development of the service. Many of these professionals are former law enforcement technologists with significant experience in the use of computers in economic crime investigations,” said Peter McLaughlin, DTect National Product Line Leader.

DTect is a procedural-driven service created to analyze mountains of historical financial transactional data such as sales, accounts payable, inventories and employee compensation. It is designed to utilize hundreds of analytical test algorithms, resulting in profiles that help identify anomalies that could indicate financial fraud. These test algorithms are executed against client-supplied data, which result in a series of profiles that are scored and ranked according to client-specific risk measurements. The higher ranking scores indicate the most probable occurrences of potential fraud, abuse, or collusion of employees and vendors.

The DTect service does not rely solely on traditional sampling techniques but enables comprehensive testing of multiple aspects of financial transactions. Anomalies and trends are identified through DTect’s unique scoring methodology, which is used to focus efforts on the highest risk transactions and entities. Other differentiators that set DTect apart from traditional software technology include the incorporation of third-party data sources, analysis of the total population of records rather than only a sampling and the ability to customize test scenarios to conform to specific client needs.

In developing DTect, Deloitte & Touche forensic professionals analyzed all types of fraud to identify distinguishing attributes. The investigators then created the tests, which can be applied to business processes such as vendor, payroll and expense disbursements, to detect the presence of fraud characteristics. Each test generates a risk score, which is assigned to each vendor, employee or job category, invoice, or transaction that fails a test. High risk scores indicate anomalies in vendors and transactions. Deloitte & Touche investigators then work with their clients to interpret and explain results, to investigate and resolve anomalies, and to identify potential incidents of fraud.

Continued in the article

Bob Jensen's threads on new assurance services are at 

Fannie Mae's regulator is set to present a report highly critical of the mortgage company's accounting practices to its board: Probe points to decisions to smooth out earnings, possibly increase bonuses

Bob Jensen's threads about fraudulent accounting at Freddie Mac and Fannie Mae are at 

The Justice Department opened a probe of possible accounting fraud at Fannie Mae. The move comes in the wake of a report by Fannie's regulator that the mortgage company may have manipulated its books to meet earnings targets.
"Fannie Criminal Probe Is Launched," by John R. Wilke et al, The Wall Street Journal, September 29, 2004 ---,,SB109649594924831762,00.html?mod=home_whats_news_us 

"Fannie Mae Overseer to Present Report Criticizing Accounting," by John D. McKinnon and James R. Hagerty, The Wall Street Journal, September 20, 2004, Page A2 ---,,SB109563119263921750,00.html?mod=home_whats_news_us 

Federal regulators are to present a report highly critical of accounting practices at Fannie Mae to the mortgage company's board today, according to several people familiar with the situation.

The company's regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo, declined to comment on the status of the eight-month probe of Fannie's accounting. But people who have been briefed on the results said Ofheo found evidence of a pattern of decisions by executives aimed at manipulating earnings to present a smoother performance. Ofheo also has been examining whether the decisions were made with an eye to beefing up bonuses to executives, they added.

Fannie's corporate cousin, Freddie Mac, agreed to pay a $125 million civil penalty for using a series of exotic financial transactions and other accounting gimmicks to smooth its earnings. A finding that Fannie Mae also manipulated its financial reports to make them look less volatile could boost efforts in Congress to tighten regulation of the two federally chartered mortgage companies.

"The smoothing problem at Freddie Mac has been determined to be present at Fannie Mae,'' said Rep. Richard Baker (R., La.), chairman of the House subcommittee that oversees government-sponsored enterprises such as Fannie and Freddie. Mr. Baker was briefed on the situation by congressional staff. He said that while the Ofheo examination continues, he believes regulators are exploring whether one

reason for the smoothing was to maximize some executives' compensation.

Stepping up the pressure on Fannie, Ofheo brought in as an adviser Washington lawyer Stanley Sporkin, a former federal judge and onetime enforcement director at the Securities and Exchange Commission. Mr. Sporkin took part last week when Ofheo presented its findings to the SEC, which also regulates Fannie, people familiar with the situation said.

By engaging such a high-powered securities lawyer, Ofheo seems determined to block Fannie from driving a wedge between it and the SEC over interpretations of accounting rules. Fannie is being advised by Wilmer Cutler Pickering Hale and Dorr LLP, known for its securities-law expertise and close contacts at the SEC.

A Fannie Mae spokesman declined to comment, as did an SEC spokesman. A spokesman for KPMG LLP, Fannie's outside auditor, said that the firm hasn't seen the Ofheo findings but that "we stand behind our audit work for Fannie Mae." Mr. Sporkin, a partner at the law firm Weil, Gotshal & Manges, couldn't be reached.

Fannie's chief executive officer, Franklin D. Raines, repeatedly has defended the company's accounting.

Ofheo announced the examination into Fannie's accounting last year following the scandal at Freddie Mac. Freddie ousted two CEOs and other senior executives in the course of that investigation. Ofheo eventually found the company had manipulated its accounting to make earnings look less volatile; steadily rising earnings are important to the companies' shareholders and debtholders, who seek reassurance that Fannie and Freddie can withstand fluctuations in interest rates and the real-estate market.

Freddie later disclosed that its accounting misdeeds led it to understate earnings by about $5 billion over several years. Investors were relieved to find that Freddie was even more profitable than it had appeared.

Continued in article

"Regulator Details a Wide Range Of Accounting Problems at Fannie," by James R. Hagerty et al, The Wall Street Journal, September 23, 2004, Page A1 ---,,SB109585616894724782,00.html?mod=home_whats_news_us 

Fannie Mae's regulator accused the mortgage-finance giant of a wide range of improper accounting practices -- including at least one instance in which executives allegedly delayed expenses in an apparent effort to hit their bonus targets.

In a 200-page report released late yesterday afternoon, the regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo, said its findings "raise concerns regarding the validity of previously reported financial results, the adequacy of regulatory capital, the quality of management supervision and the overall safety and soundness" of the company.

. . . 

Ofheo's interim report on its continuing examination also accuses Fannie of:

 Applying accounting methods and practices that don't comply with generally accepted accounting principles, or GAAP, to the company's derivatives transactions and hedging.
 Using a "cookie jar" reserve. Such reserves are used to improperly delay recognizing income so that it can be used to enhance results in later periods.
 Tolerating what it called "internal control deficiencies."
 Maintaining "a corporate culture that emphasized stable earnings at the expense of accurate financial disclosures."

Fannie's chief spokesman, Chuck Greener, declined to comment on whether the management agreed with any of the allegations but said the company's board is working with Ofheo "to resolve the issues." In a statement, the company promised to report back to Ofheo and the SEC "expeditiously" and said that the board has set up a committee composed entirely of outside directors "to take the lead on both the Ofheo report and the SEC inquiry." The statement was issued under the name of Ann McLaughlin Korologos, the presiding outside director.

Bob Jensen's threads about fraudulent accounting at Freddie Mac and Fannie Mae are at 

"Google queries provide stolen credit cards," by Robert Lemos, CNET News,  August 3, 2004 --- 

Simple queries using the Google search engine can turn up a handful of sites that have posted credit card information to the Web, CNET learned on Tuesday.

The lists of financial information include hundreds of card holders' names, addresses and phone numbers as well as their credit card data. Much of the credit card data that appears in the lists found by Google may no longer be valid, but called several people listed and verified that the credit card numbers were authentic. The query, the latest example of "Google hacking," highlights increasing concern that knowledgeable Web surfers can turn up sensitive information by mining the world's best-known search engine.

"It seems like everyone has their own trick," said Chris Wysopal, vice president of research and development for digital security firm @Stake. "This is really searching for data that should be secret but has been exposed either through misconfiguration or by someone who has stolen it."

There is no shortage of ways to search Google to find such data. Whole sites spell out how to search for financial information and describe software vulnerabilities and vulnerable configurations on Internet machines. Google is the tool of choice because its powerful search options, such as the ability to search for a range of numbers--useful in finding credit card data--is not present in other companies' search engines.

Google would not comment, citing the quiet period before the company's initial public offering. However, a company source did say that the search firm has a tool for Web masters to remove pages from the archive, if they find that parts of their site violate laws or regulations. Moreover, the company has decided to allow anyone to request the removal from search results of any document that includes a Social Security or credit card number--a note to  with a link to the page will suffice, the source said.

Continued in the article

In 2003, occupational fraud is estimated at $660 billion.


2004 Report to the Nation on Occupational Fraud and Abuse, The Association of Certified Fraud Examiners --- 


Occupational fraud and abuse is a widespread problem that affects every entity, regardless of size, location or industry. The ACFE has made it a goal to better educate the public and anti-fraud professionals about this threat.

The 2004 Report to the Nation is based on a survey that began in late 2003 and ran through the early months of 2004. Certified Fraud Examiners throughout the US were asked to provide detailed information on one fraud case he or she had personally investigated that met the following criteria:

  1. The case involved occupational fraud;
  2. The fraud occurred within the last two years;
  3. The investigation of the fraud was complete; and
  4. The CFE was reasonably sure that the perpetrator had been identified.

The end result is a comprehensive report that sheds light on occupational fraud and abuse while offering stark lessons and valuable insights about its prevention and detection.

Download the 2004 Report to the Nation * (564 kb)
Order a printed copy of the 2004 Report to the Nation
Download the 2002 Report to the Nation * (857 kb)
Download the 1996 Report to the Nation * (235 kb)

"PwC: Accounting Irregularities Cause Most Class-Action Settlements," SmartPros, August 4, 2004 --- 

The number of securities litigation cases with accounting allegations remains well above historical averages, according to a PricewaterhouseCoopers Securities Litigation Study and a preliminary analysis of the first six months of 2004.

Mega-settlements continue to drive average settlement values significantly higher than ever before. The involvement of the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) adds additional potency to the nature of securities litigation.

Accounting-Related Cases

The number of accounting-related cases remains high, totaling more than 60 percent of the 175 cases filed in 2003 and 57 percent of the 111 cases filed in the first seven months of 2004.

The number one allegation made in accounting-related cases continues to be revenue recognition, alleged in over fifty percent of these cases in 2003.

The study also finds two other allegations that are emerging in accounting-related cases: accounting estimates and internal controls. In 2003 each of these allegations appeared in over 40 percent of the accounting cases.

Settlement Values Continue to Rise

In 2003, average settlement values increased by 20 percent to $23.2 million. The increase was fueled in large part by six settlements topping $100 million each, including three settlements of $300 million or greater, with one of those settlements topping $500 million.

Excluding several partial settlements, including the recent $2.65 billion partial Worldcom settlement, the average settlement in the first six months of 2004 surged to over $32 million. So far in 2004, 14 settlements have been announced for $30 million or greater, five of which settled for $100 million or more. The average accounting case, led by five case settlements over $100 million each, settled for over $38 million. While large settlements continue to lift settlement averages to new heights, the median 2004 settlement is approximately $6.3 million and the median accounting settlement is greater than $7 million, both up from the 2003 numbers.

Triple Jeopardy Increases Potency of Cases

The dynamic of securities litigation has changed dramatically in securities litigation class actions when the SEC and DOJ are also involved.

This year for the first time, PricewaterhouseCoopers explored a phenomenon called "triple jeopardy," where companies are subject to securities class actions along with SEC and DOJ investigations. In 2002, there were an all-time high of over 40 such cases. In 2003 the study finds only 8 such instances which marks a return closer to historic norms. The preliminary 2004 research indicates that at least 13 companies are facing "triple jeopardy" this year, already surpassing the 2003 total.

"The fines and penalties meted out in recent SEC and DOJ settlements with companies also facing securities litigation have risen dramatically, and criminal prosecutions and convictions for corporate fraud offenses are ratcheting up," said Charles Hacker, Investigations and Forensic Services partner, PricewaterhouseCoopers.

Bob Jensen's threads on accounting fraud are at 


Bob Jensen's fraud conclusions are at 

From The Wall Street Journal's Accounting Weekly Review on September 17, 2004

TITLE: Letters to the Editor: Protecting Shareholders Is No "Shenanigan" 
REPORTERS: Reeves, William T., Jr. and Nicholas Maiale 
DATE: Sep 10, 2004 
PAGE: A13 
TOPICS: Accounting, Board of Directors, Corporate Governance, Dividends, Shareholder Class-Action Lawsuit

SUMMARY: Representatives of two institutional investors respond to a WSJ opinion piece on litigation against companies in which they invest. For a summary of the 1995 Securities Litigation Reform Act and related research, one good resource is a Stanford Law School web page 

1.) In general, why would institutional investors such as the Teachers' Retirement System of Louisiana (TRSL) undertake litigation against the companies in which they invest?

2.) What recent events make it particularly likely that, at this point in time, institutional investors will undertake litigation against the companies in which they invest?

3.) How can this litigation contribute to improved corporate governance? How might it detract from good governance? In your answer, define the term "corporate governance."

4.) Refer to the related article. In regards to two funds representing Pennsylvania public school teachers and state employees suing Time Warner and Royal Dutch/Shell, the author writes that "shareholders are essentially suing themselves" and, therefore, "the main winners will be the lawyers." Why does the author argue that shareholders suing a company are "suing themselves"? Explain this statement in terms of the balance sheet equation. Also, explain in detail your understanding of potential wealth impacts of the lawsuit on all company shareholders.

5.) The Teachers' Retirement System of Louisiana (TRSL) brought one legal action to stop a particular dividend payment. Why did this institutional investor want to stop this dividend payment? How are dividends typically funded? Are there any legal requirements for funding dividend payments? Cite examples and describe the source of these laws.

6.) Summarize the political tones of these letters to the editor and contrast with the political tone of the related article (the WSJ Opinion piece). How do these political perspectives influence the opinions expressed in the articles? In your discussion, also reference the political parties discussed in detail in the article.

Reviewed By: Judy Beckman, University of Rhode Island

Bob Jensen's threads on corporate governance are at 

"Big Four Get Mixed Marks From U.S. Accounting Panel," by Jonathan Weil, The Wall Street Journal, August 27, 2004 , Page C1 ---,,SB109353829914301998,00.html?mod=home_whats_news_us 

KPMG LLP said the accounting profession's federally created overseer found the firm had accepted fees from independent-audit clients based on how much money it helped them save in taxes -- a possible violation of conflict-of-interest rules that remain a major priority in the aftermath of Enron Corp.'s collapse and other corporate scandals.

That finding is included in a part of the U.S. Public Company Accounting Oversight Board's first set of annual reports on the nation's four biggest accounting firms that, under a law the Big Four firms successfully lobbied for, remains secret.

The public portions of the reports, released yesterday, identify "significant audit and accounting issues that were missed by the firms," the board said, though none of those problems caused major shareholder losses and almost none of them affected earnings.

KPMG's decision to voluntarily disclose the finding of potentially significant conflicts highlights how shrouded in secrecy the new agency's process will be. The other three firms -- PricewaterhouseCoopers LLP, Deloitte & Touche LLP and Ernst & Young LLP -- declined to specify what concerns, if any, the board raised about them in the confidential sections of their reports. In addition to findings on their compliance with auditor-independence rules, the confidential sections include critiques of the firms' risk-management practices, partner-compensation structures and disciplinary policies. Other key areas include the board's assessments of the firms' internal inspection programs and the "tone at the top" set by the firms' top executives.

In a written summary of the board's confidential findings provided by KPMG, the firm said the board had observed that its "contingent fee" arrangements "may not be consistent with the SEC's independence requirements." In a statement yesterday, KPMG's chairman and chief executive, Eugene O'Kelly, said the firm remains "confident that KPMG's system of quality control is sound and that none of the PCAOB's comments from their limited inspection represent systemic issues. Rather, we view their observations as opportunities for improvement, which we are committed to implement."

Mr. O'Kelly called the inspection process "an important part of the effort to enhance the integrity and transparency of financial reporting ... and improve the quality of audits."

KPMG said it began revising its contingent-fee policies, under which clients are charged based on a percentage of the money their accountants can save them, in May 2004 after the Securities and Exchange Commission's chief accountant issued a letter clarifying the agency's rules on the issue. KPMG said it is in the process of restructuring or settling any remaining contingent-fee arrangements and that it has initiated "discussions with audit committees about our independence relative to these arrangements." Under SEC rules, auditors are barred from entering such fee arrangements with audit clients, out of concern that they create mutual financial interests.

KPMG said, before the SEC's May letter, it had been relying on an American Institute of Certified Public Accountants interpretation of the SEC's rules, under which it thought such fee arrangements would be allowed when selling certain tax services to audit clients. In its letter, the SEC debunked the AICPA's theory.

Yesterday's reports by the accounting board, which was created by Congress in 2002 under the landmark Sarbanes-Oxley securities-overhaul legislation, mark the first time that auditors of publicly held companies have submitted to public evaluations by an independent authority. While the board's initial round of inspections was limited in scope, the fact that the reports contained any criticisms at all marks an improvement over the firms' prior system of "peer review." Under that approach, at a time when the auditing profession still was allowed to regulate itself, the major accounting firms reviewed each other every few years and refrained from criticisms.

While the reports do include lengthy citations of audit and accounting issues that all the firms missed, it will be at least another year before the public can learn from the board itself about any broader, structural deficiencies at the firms. When Congress created the board, it acceded to pressure by the Big Four firms to include a provision in the law under which the board only would disclose the existence of deficiencies in a firm's quality controls if the firm hadn't fixed them within a year.

"Unfortunately, we don't know how many more infractions were not made public as a result of Congress allowing those to remain behind closed doors," says Lynn Turner, the SEC's chief accountant from 1998 to 2001. "Congress needs to quickly bring that out into the sunshine."

The accounting firms contend that the best way to improve audit quality is through a confidential process. Spokesmen for PricewaterhouseCoopers, Ernst & Young and Deloitte declined to discuss the confidential sections of their reports. "We don't intend to depart from the process set forth by Congress, which focuses on remedial action to improve audit quality," said Steve Silber, a PricewaterhouseCoopers spokesman.

One promising development described in the public sections of the firms' reports was the inspectors' success at identifying a type of accounting violation that all four firms had failed to catch. After noticing that a client at one firm improperly had classified a certain kind of short-term debt as long-term debt, the board then asked all four firms to check other clients for the same problem. In the end, at least 20 companies had to restate their balance sheets, though the restatements didn't affect their earnings, cash flow or shareholder equity. Of those, six were KPMG clients, while eight were Deloitte clients. PricewaterhouseCoopers and Ernst each had three.

The board didn't identify the companies. A search of SEC filings turned up nearly two dozen companies, including some audited by other accounting firms, that had restated their financial reports this year because of the same issue, which centers on a 1995 rule by the Financial Accounting Standards Board's Emerging Issues Task Force. Those companies, all fairly small, included Restoration Hardware Inc., AEP Industries Inc. and Pemstar Inc. All these companies cited the need to comply with the 1995 ruling in explaining their restatements.

The board's inspections, which took place last year, were limited to 16 audits at each of the Big Four firms. The board's second round of inspections, now in progress, will expand beyond the Big Four and cover dozens of audits at each of the major accounting firms.

Without admitting fault, KPMG LLP settled a suit connected to the collapse of General American Life Insurance Co., formerly Missouri's largest insurance company. In a settlement approved last week, KPMG will pay $18 million to a General American liquidation fund. 
AccountingWeb, September 29, 2004 --- 

Bob Jensen's threads on recent KPMG scandals are at 

"Federal Regulators Find Problems at 4 Big Auditors," by Floyd Norris, The New York Times, August 27, 2004

The new regulatory body for the United States auditing industry said yesterday that its initial inspections of the Big Four accounting firms had found "significant audit and accounting issues" in work done by all four firms.

It added that it had found problems in the quality control systems at each firm but said it retained confidence in all of them.

Inspection reports on the four firms were released by the Public Company Accounting Oversight Board, which was established by Congress in 2002 in the wake of the failures of Enron and WorldCom and the collapse of Arthur Andersen, the auditing firm that had certified the books at both companies.

The board reviewed the details of 16 audits in 2003 at each firm. The versions of the reports that were made public left out large parts of the actual reports because Congress ordered that the firms be given a year to clean up many problems before negative assessments could be made public.

William J. McDonough, the board's chairman, tried to soften the blow on the firms by saying the "criticisms do not reflect any broad negative assessment of the firms' audit practices" and emphasizing that "our findings say more about the benefits of the robust, independent inspection process envisioned in the Sarbanes-Oxley Act of 2002 than they do about any infirmities in these firms' audit practices."

He added that "none of our findings has shaken our belief that these firms are capable of the highest quality auditing."

Nonetheless, the reports document cases where the four firms failed to apply one accounting rule, leading companies to understate the amount of their current liabilities - debts due within one year - and therefore overstate their working capital, an item that analysts often follow.

That rule was issued in 1995 by the Emerging Issues Task Force, a part of the Financial Accounting Standards Board, and the fact that all of the top firms had been misapplying it raised issues of just how well they know the sometimes complicated rules.

At Deloitte & Touche, the board said eight clients had restated their financial statements because of the error on the accounting rule. It said six clients of KPMG, three of Ernst & Young and three of PricewaterhouseCoopers had done the same.

Some of the errors were found by the standards board, and others by the firms.

The board also criticized Deloitte for signing agreements with one unidentified audit client that created close business relationships that seemed to violate Deloitte's own rules. It said the firm had concluded the contracts "included inappropriate language" but had not violated independence rules. Board officials said that most comments on independence issues were contained on the parts of the reports not made public.

KPMG released some information on the part of its report that was not made public, saying the standards board had concluded that some contingent fee arrangements with audit clients violated independence rules. The firm said that it had complied with the rules as it understood them but had learned in May that the S.E.C. was taking a more restrictive stance. It said it had changed agreements to comply with that interpretation and that its independence had not been compromised.

Applying accounting rules can be difficult, and in a number of other cases the staff disagreed with the way the auditing firms had applied the rules and companies ended up restating their financial statements. In one case, however, the board concluded that a client of KPMG had recorded a liability improperly, but KPMG disagreed and the staff of the Securities and Exchange Commission agreed with the accounting firm, although in the end it did force a change in the amount of the liability, according to the report.

In its response to the report, KPMG said that it showed that "three knowledgeable informed bodies" - the firm, the board and the commission - had reached three different conclusions on proper accounting, "illustrating the complex accounting issues registrants, auditors and regulators all face."

The delay on releasing some negative parts of reports has been controversial, Mr. McDonough said, but he added that he thought it was a good idea. "When it comes to quality control, any negative comments we make the firms have 12 months to correct. If they correct them, they remain confidential forever." Mr. McDonough said the delay "makes sense" because it encourages firms to improve promptly.

The firms generally praised the board and said they were working to improve their audits. James S. Turley, the chief executive of Ernst & Young, said the board would "prove to be one of the best things that ever happened to the accounting profession."

August 28, 2004 reply from David Albrecht  

The PCAOB and the American Big Four don't think the recent report is bad news. However, the Times in London has a far different take..

 David Albrecht
Bowling Green State University

August 28, 2004 reply from Dennis Beresford (University of Georgia)

All of the reports are available at the PCAOB web site. In each report, the first 15 pages or so is pretty much the same, just describing the procedures that the PCAOB staff members performed at the firm. However, the "meat" is in the remainder of each report (including the firm's response to the issues raised by the PCAOB) and they are well worth reading.

While D&T had more "errors" with respect to EITF issue 95-22, my reading of the reports would conclude that they were otherwise the least criticized by the PCAOB. And when there are so many reported problems with an accounting standard like 95-22, that may be an indication that the standard isn't working very well.

The specific matters criticized by the PCAOB were almost all judged to be immaterial and not affecting the audited financial statements. And in at least a few cases there were differences of opinion as to whether the PCAOB was even correct in its position.

On the other hand, these reports were based on looking at only 16 engagements for each firm. It will certainly be interesting to see what happens next year when the PCAOB reports the results of its first comprehensive reviews of the Big 4 firms as well as a sample of other firms.

I think these reports are very valuable information for accounting educators. They point out areas where auditors may need further schooling - both in applying accounting rules and in applying auditing standards. Rather than forming impressions based on newspaper accounts, there is a wonderful opportunity here to become much more informed about what really goes on in the auditing profession. It's certainly not perfect but few human activities are. My impression is that the firms are taking this extremely seriously and the quality of audits will be even better in the future.

Denny Beresford

"Investor Scam; Con Artists Snaring Victims Across the Country," AccountingWeb, August 20, 2004 --- 

The Securities and Exchange Commission (SEC) this week issued an investor alert designed to warn Americans about a new scam sweeping the country-answering machine "wrong number" stock touts.

Voice mail messages are appearing on home answering machines from coast to coast saying that the stock price of certain small, thinly traded companies will soon shoot up. The breezy, intimate messages sound as if a female caller mistakenly believes she has dialed a girlfriend and is confiding inside information she has learned from "that hot stock exchange guy I'm dating."

Regulators believe these voice mails are part of a "pump and dump" stock manipulation scheme, whereby the people behind the messages intend to profit by driving up the price of their targeted stocks, then selling, and leaving victims with losses. The SEC has received hundreds of complaints from investors across the country about these misdirected voice mails in recent days.

"Investors should never buy stocks on the basis of ‘hot’ tips from strangers," said SEC Investor Education Director Susan Wyderko. "We are concerned because the stock prices of companies mentioned in these calls have gone up, presumably as people listen to the messages and buy. But in all 'pump and dump' schemes, as soon as the promoter stops touting a stock, the price plummets and other investors lose their money."

The SEC is asking investors who receive these kinds of calls to let them know the company being touted, the exact date and time the call was received, the number called, and the number from which the call was made, if available. E-mail the information to, or call the SEC at 1-800-SEC-0330.


Your Government at Work


"Tech Company Settled Tax Case Without an Audit," by David Cay Johnston,  The New York Times, August 10, 2004

Remy Welling is a senior auditor for the Internal Revenue Service with 22 years' experience. But when she was handed the file on a company suspected of underpaying its taxes, it contained something she had never seen before in such a case: an agreement to close the audit before it had even begun.

Instead of being given tax returns to examine, Ms. Welling was asked to sign off on a secret deal worked out by other officials at the I.R.S. The deal, she ultimately calculated, would allow a Silicon Valley company and its top executives to escape at least $51 million in additional taxes that she was convinced they should have paid.

Moreover, the agreement required the I.R.S. to cooperate with the company, a relatively small semiconductor maker named Micrel, in keeping its shareholders uninformed on some basic terms of its stock-option plan, which Ms. Welling said enriched the four top executives by as much as $20 million in total.

For I.R.S. agents, nothing is more sacred than the privacy of a tax return. Revealing information about an audit can open an agent to criminal prosecution.

But Ms. Welling has decided to discuss what happened to her in this case, she said in an interview, because she believes that it represents a particularly striking example of how outside influence and internal obsequiousness is corrupting the integrity of the tax system.

She is willing to risk going to jail, Ms. Welling said, to bring the issue to public attention.

"Someone has to tell the public about what is going on inside the I.R.S.,'' Ms. Welling said, adding that she is about to be fired for going outside the agency by taking her complaint to the F.B.I. and the Securities and Exchange Commission.

I.R.S. officials, citing privacy concerns, declined to discuss any aspects of Ms. Welling's case or the agreement with Micrel Inc. of San Jose, Calif., which had revenue last year of $241 million.

But their handling of the case suggests that they believe that Ms. Welling has overreacted. And they insist that I.R.S. procedures have been carefully constructed to protect the corporate tax collection process against misconduct.

"It is essential that we maintain the independence and integrity of the audit process,'' Mark W. Everson, the I.R.S. commissioner, said. "The I.R.S. has long-established standards and safeguards designed to ensure that there is no undue influence over decisions by our enforcement personnel.''

Micrel's case, Ms. Welling contends, raises questions about those safeguards. The stock-option matter came to the attention of the tax agency early in 2002, when it was approached by a former top I.R.S. official, James Casimir, who represented Micrel as a partner at PricewaterhouseCoopers, the accounting firm.

Mr. Casimir, without disclosing initially whom he represented, sought help in avoiding a big tax bill that Micrel had discovered it owed because it ran its stock-option plan for several years in violation of the law.

The company, in court papers later that provided figures never reported to shareholders in official filings, estimated that its extra tax bill could have been even larger than Ms. Welling calculated - as much as $58 million, of which $14 million would be an immediate cash drain.

Stock options provide the right to buy company shares profitably at a later date at a predetermined price. To take advantage of favorable tax and accounting rules, companies are required to set the price to employees at a level no lower than the value of the stock on the day the grant is made.

Micrel's plan, however, let employees select the lowest price for the stock within 30 days, a position that made the options potentially more valuable.

Mr. Casimir, along with a lawyer working for Micrel, asked the I.R.S. to give the company and its employees relief from taxes owed and additional interest because Micrel was prepared to disclose voluntarily what it considered an unintentional mistake that had been approved by its accounting firm. Tax law includes a provision allowing companies to seek such relief, but it is typically invoked only for minor flaws like typographical errors. In most cases when companies come forward, they avoid penalties but are required to pay additional taxes.

I.R.S. lawyers, without knowing the company's identity, agreed to provide relief. Then they learned the company's name and upon checking found that Micrel had already been selected for audit on a different matter. The agreement was sent to the auditing division.

The Micrel audit - which was supposed to focus on how the company accounted for an acquisition - began in November 2002, when Ms. Welling was called into the San Jose office of her supervisor, Ron Yokoo, and handed the Micrel file.

"Usually, they just give you the tax returns to be examined," she said, "but sometimes there is a memo about looking into specific issues that have been identified. There were no tax returns in the file, and I was told they were not available.''

But then she noticed a two-page document in the file titled "Department of the Treasury-Internal Revenue Service closing agreement on final determination covering specific issues.''

Ms. Welling said she protested that the closing agreement, which would have settled the stock-option matter, could be considered only after Micrel's full tax returns had been examined.

"An auditor cannot sign off on an agreement closing an audit before the audit,'' she said. "That's just not legal, not proper.''

An article about Ms. Welling is scheduled to appear today in the electronic version of Tax Notes, a trade magazine, at www.taxanalysts .com.

Continued in the article



Forwarded on August 26, 2004 by Victor_Carrington@Countrywide.Com 


"A bit of a fizz" 
Jul 17th 2003
From The Economist print edition 

Coke faces an investigation, a cross ex-employee and an angry Burger King

From Promo Magazine, June 19, 2003 --- 

A lawsuit by a former employee has turned into a huge black eye for Coca-Cola, which this week acknowledged tampering with a promotion for frozen beverages at Burger King. Coca-Cola also revealed that the Securities and Exchange Commission made an informal request for documents related to the accusations made in the lawsuit.

In response to another allegation raised by the former employee, Matthew Whitley, the company will take a $9 million pretax write down to correct the improper valuation of some fountain dispenser equipment.


A Typical Day in Corporate Governance


Turning to business, the board rapidly approved a series of transactions, according to the minutes and a report later commissioned by Hollinger. The board awarded a private company, controlled by Lord Black, $38 million in "management fees" as part of a move by Lord Black's team to essentially outsource the company's management to itself. It agreed to sell two profitable community newspapers to another private company controlled by Lord Black and Hollinger executives for $1 apiece. The board also gave Lord Black and his colleagues a cut of profits from a Hollinger Internet unit.  Finally, the directors gave themselves a raise. The meeting lasted about an hour and a half, according to the minutes and two directors who were present.
Robert Frank and Elena Cheney (See below)



"Lord Black's Board:  A-List Cast Played Acquiescent Role," by Robert Frank and Elena Cherney, The Wall Street Journal, September 27, 2004, Page A1

On a winter afternoon four years ago, Hollinger International Inc.'s directors met with the company's chief executive, Conrad Black, for an especially busy board meeting.

Gathered around a mahogany table in a boardroom high above Manhattan's Park Avenue, eight directors of the newspaper publisher, owner of the Chicago Sun-Times and Jerusalem Post, nibbled on grilled tuna and chicken served on royal-blue Bernardaud china, according to two attendees.

Marie-Josee Kravis, wife of financier Henry Kravis, chatted about world affairs with Lord Black and A. Alfred Taubman, then chairman of Sotheby's.

Turning to business, the board rapidly approved a series of transactions, according to the minutes and a report later commissioned by Hollinger. The board awarded a private company, controlled by Lord Black, $38 million in "management fees" as part of a move by Lord Black's team to essentially outsource the company's management to itself. It agreed to sell two profitable community newspapers to another private company controlled by Lord Black and Hollinger executives for $1 apiece. The board also gave Lord Black and his colleagues a cut of profits from a Hollinger Internet unit.


Finally, the directors gave themselves a raise. The meeting lasted about an hour and a half, according to the minutes and two directors who were present.

The boards of scandal-plagued companies from Enron to Tyco have been heavily criticized for lax corporate governance and poor oversight. The board of Hollinger -- a star-studded club with whom Lord Black had longstanding social, political and business ties -- is emerging as a particularly passive watchdog. Hollinger directors openly approved more than half of the transactions that allowed Lord Black and his colleagues to improperly siphon more than $400 million from the publisher, according to a company investigation overseen by former Securities and Exchange Commission Chairman Richard Breeden.

High Society

Mr. Breeden's 500-page report, which was released earlier this month, gives a detailed picture of a board that functioned like a high-society political salon, while neglecting its oversight responsibilities. Lord Black worked hard to win his directors' loyalty, giving to their charities and holding dinners in their honor. As the scandal unfolded, director Henry Kissinger even tried to negotiate with the company on Lord Black's behalf.

According to the Breeden report, plus interviews with directors and company officials, the board rarely asked basic questions to get the facts it needed, despite warning signs. In addition to the management fees and other payments, the report says the board retroactively approved Lord Black's use of $8 million in company money to buy Franklin D. Roosevelt memorabilia, which he used to write a biography of the president. A company jet, a platoon of servants, four homes and a constant round of parties -- all partly funded by Hollinger -- were left largely unscrutinized by the board, according to the Breeden report.

Hollinger's then-corporate counsel, Mark Kipnis, told investigators there was no need to "slip" anything past the audit committee because they "routinely approved" everything, according to the Breeden report.

Several Hollinger directors say in interviews they were misled by Lord Black about some transactions. Robert Strauss, 85 years old, a former ambassador to the Soviet Union who left the board in 2002, says in an interview that he asked limited questions at board meetings because, "I relied on Mr. Black, I confess."

Some directors say it wasn't their job to police Hollinger's business. "The board doesn't run the company and I think directors are entitled to presume that they're not being lied to or that information is not being withheld," says James Thompson, the former governor of Illinois, who was a member of the board and head of its audit committee.

The Breeden report acknowledges that the board "wasn't fully and accurately" informed about a range of issues. In fact, the board ousted Lord Black as CEO last November after learning he'd received a portion of $32 million in payments it hadn't authorized. Mr. Breeden's report concludes that the board should be judged on its "entire record," including its attempt to clean up the mess.

In a statement made through a spokesman, Lord Black says none of Hollinger's senior management or directors acted improperly. He says Hollinger's management isn't aware of any "instance where directors were denied information or deliberately misinformed."

"The audit committee is being disingenuous if it is attacking payments that it knowingly approved," Lord Black continued. "The former management of Hollinger International believes that the members of the audit committee acted conscientiously, and that the absence of any dissent from them reflected their accurate judgment of management's performance."

A resolution of the scandal could prove costly for Hollinger's board. The company's ninth-largest institutional shareholder, Connecticut-based Cardinal Capital Management LLC, is suing the directors, alleging they breached their fiduciary duty. The company's independent directors are also in mediation talks with Hollinger's new management to settle potential claims the company might have against them.

The earliest outside board members were Richard Perle, an assistant secretary of defense under President Reagan, and Mr. Thompson, the former governor of Illinois. Lord Black later added his wife, Barbara Amiel Black, and recruited Ms. Kravis, an economist and the wife of financier Henry Kravis. The Kravises and Blacks socialize in New York and Palm Beach, Fla., where they both have homes, according to people familiar with the matter. Lord Black also recruited former Secretary of State Mr. Kissinger and Sotheby's Mr. Taubman.

Lord Black was able to pick all the directors slots. Even after the company went public in 1996, he retained control. As of August, he controlled 18% of Hollinger International's equity through a series of holding companies -- that figure has ranged between 30% and 60% since 1996 -- and 68% of the its voting interest. Told by a Hollinger executive he should inform Mr. Thompson of certain transactions, Lord Black retorted: "I am the controlling shareholder and I'll decide what the governor needs to know and when," the Breeden report says.

Casual Affairs

Board meetings were brief, casual affairs, according to minutes and directors. They were usually held at Hollinger's New York offices, which are hidden behind a poorly marked wooden door. From a pop-up computer screen in front of his chair, Lord Black controlled the room's lights, sound and window blinds, which he would alter during board meetings, according to one attendee. On the boardroom walls are letters written by FDR and a framed picture of mobster Al Capone that hung over Lord Black's left shoulder.

The lunch resembled a think tank as members discussed Monica Lewinsky, the future of China and the wisdom of the European Union, directors recall. Lord Black would flatter his guests. During one exchange, he invited Mr. Kissinger to weigh in by introducing him as one of the world's greatest negotiators, according to two people present.

Lord Black collected management fees for running Hollinger under an arrangement dating back to the company's founding. The fees were paid to Ravelston Corp. and Hollinger Inc., two holding companies through which Lord Black controlled Hollinger International.

Once a year, Mr. Thompson, head of the company's audit committee, would sit down over lunch or coffee with David Radler, Hollinger's chief operating officer and a Ravelston shareholder, and set the fee, according to the Breeden report. Mr. Radler announced what Ravelston wanted and after a "cursory discussion," Mr. Thompson would agree, the report says. After 1997, the fees increased by more than 20% a year, hitting $38 million in 2000, even as Hollinger shrank in size after asset sales.

"In the time needed to consume a tuna sandwich, Radler would win as much as $40 million in Hollinger revenues for Ravelston," the report states.

Some directors say they relied on the audit committee's recommendations. Members of the audit committee give contradictory accounts of how they approved the fees. Mr. Thompson says in an interview that the negotiations were "the product of the whole audit committee, not just me and Radler." Richard Burt, a former ambassador to Germany, and Ms. Kravis told investigators they "deferred entirely" to Mr. Thompson.

Ms. Kravis also told investigators she thought the compensation committee negotiated the fees, the Breeden report says. By contrast, Mr. Thompson told investigators it was Ms. Kravis's idea that he negotiate directly with Mr. Radler. Ms. Kravis didn't respond to numerous requests seeking comment. Mr. Radler declined to comment.

The board blessed another set of payments, relating to the sale of Hollinger assets, the Breeden report says. After Hollinger sold the bulk of its Canadian newspapers in 2000, Lord Black and his colleagues asked the board for a special $19.4 million "break fee" because Ravelston would see a fall in management fees because Hollinger was becoming a smaller company.

The executives also asked the board for $32.4 million in payments relating to noncompete agreements. Such agreements, in which companies agree not to compete against the assets they sell, are common in the industry. But the fees that come with these deals are typically paid to companies, not individual executives, as Lord Black and his colleagues requested.

Mr. Kipnis, the former corporate counsel, told the board that the fees were requested by the acquirer. Months after the board approved the fees, Mr. Kipnis, reversed himself, telling the board in a memo that the buyer hadn't specifically asked that individual executives get paid. He said the discrepancy was "inadvertent," the Breeden report says.

Nonetheless, Mr. Kipnis, who wasn't a beneficiary of these fees, recommended in the memo that the executives still receive the entire $52 million in fees. The board and audit committee approved the payments for a second time with only a "perfunctory examination" of the changes, according to the Breeden report.

Continued in the article

Bob Jensen's threads on corporate governance are at 

More Channel Stuffing Accounting Fraud --- 
Take This Inventory and Shove It, 
We Don't Care 'bout GAAP No More


"Bristol-Myers Nears SEC Pact of $75 Million," by Deborah Solomon, The Wall Street Journal, August 4, 2004, Page B9 ---,,SB109156697444481985,00.html?mod=home_whats_news_us 

Bristol-Myers Squibb Co. is expected to pay more than $75 million to settle Securities and Exchange Commission charges that the drug maker boosted sales through improper accounting, according to people familiar with the matter.

The settlement, which could be announced as early as today, is expected to include one of the biggest civil penalties ever levied by the SEC against an operating company. The agency plans to charge Bristol-Myers with inflating sales by more than $2.5 billion over a several-year period through the use of improper accounting techniques.

While the settlement will resolve the matter for the company, the SEC is expected to eventually file civil charges against some Bristol-Myers employees individually, people familiar with the probe said. A Bristol-Myers spokesman declined to comment.

The company also faces a Justice Department investigation and a grand jury has been impaneled to hear testimony in the case. While the company has admitted its accounting was inappropriate, a grand jury will determine whether the overstatements constituted criminal acts by either the company or individuals.

Bristol-Myers has been facing investigations for two years related to its accounting. The SEC and the Justice Department have been probing the company's use of incentives to get wholesalers to buy more drugs than they needed in an effort to post rosy financial results. Bristol-Myers announced in March 2003 that it had overstated revenue from 1999 to 2001 by $2.5 billion because of the wholesaler incentives.

The SEC has been cracking down on companies that engage in so-called channel stuffing, a practice whereby companies inflate sales by pushing unwanted products onto distributors. The agency recently fined Symbol Technologies Inc. $37 million for improper accounting practices, including channel stuffing.

The multimillion-dollar fine reflects the SEC's continued aggressiveness in punishing companies for improper revenue recognition and other accounting misdeeds. Last year, the SEC forced WorldCom Inc., now known as MCI, to pay a landmark $750 million fine related to improper accounting. While the agency has levied large fines against investment companies and securities firms, the Bristol-Myers penalty is expected to be the second-largest fine against an operating company.

The SEC settlement could help Bristol-Myers in its continuing efforts to fix its legal problems. It recently settled a shareholder lawsuit related to the accounting issues for $300 million. The plaintiffs in that case alleged that they had been hurt by "artificial inflation" of the company's stock price related to the revenue overstatements.

"Bitter Pill? Bristol-Myers Squibb Off by $900 Million:  Company says ''inappropriate accounting,'' inventory incentives with wholesalers to blame," by Stephen Taub,, March 11, 2003 ---,5309,8976,00.html?f=related 

Yesterday, Bristol-Myers Squibb Co. announced it overstated sales by about $2.5 billion over a three-year period. The inflated revenues were a result of deals with two large U.S. drug wholesalers. The rejiggering will force Bristol-Myers to restate earnings downward by $900 million.

The company's management said the restatement also reflects the correction of accounting policies to conform to generally accepted accounting principles (GAAP) and certain other adjustments to correct errors made in the application of GAAP, including certain revisions of "inappropriate accounting."

The pharmaceutical giant said it reduced net sales by more than $1.4 billion for 2001, $678 million for 2000, and $376 million for 1999. The company increased sales for the six months ended June 30, 2002 by $653 million.

It also reduced net earnings from continuing operations by $376 million, $206 million and $331 million in the years ended 2001, 2000 and 1999, while net earnings from continuing operations were increased by $201 million in the six months ended June 30, 2002.

Bristol-Myers said it experienced a substantial buildup of wholesaler inventories in its U.S. pharmaceuticals business over several years, mostly due to sales incentives offered to its wholesalers. These incentives were generally offered towards the end of a quarter to convince wholesalers to purchase enough products to help Bristol-Myers meet its quarterly sales projections, the company's management conceded.

Management also noted that in April 2002, it disclosed this substantial buildup, and undertook a plan to work down these wholesaler inventory levels. As reported at the time, the pharmaceuticals giant also announced that CFO Frederick Schiff, a 20-year veteran at the company, was leaving his post.

In June, the drug company named Andrew Bonfield its new CFO. Bonfield joined Bristol-Myers from oil company BG Group, but he spent the bulk of career at British drugmaker SmithKline Beecham.

Three months after Bonfield's arrival, Bristol-Myers indicated it would need to restate its sales and earnings to correct errors in timing of revenue recognition for certain sales to certain wholesalers. That decision was apparently triggered by advice from Bristol-Myers' independent auditors, PricewaterhouseCoopers LLP.

Since then, the company's management said it undertook an analysis of the drug-maker's transactions and incentive practices. The result? Bristol-Myer's determined that certain incentivized transactions with certain wholesalers should be accounted for under the consignment model, rather than recognizing revenue for such transactions upon shipment.

The company also decided to conform historical accounting policies to GAAP and correct errors it believed were not material to its financial statements. In addition, Bristol-Myers restaffed its controller staff after the company's accounting problems came to light.

Continued in the article

From The Wall Street Journal Accounting Educators' Review on November 1, 2002

TITLE: Bristol-Myers to Restate Results; Move Follows Insistence that Sales Accounting to Wholesalers Was Sound
REPORTER: Gardiner Harris
DATE: Oct 25, 2002
TOPICS: Earning Announcements, Financial Accounting, Pharmaceutical Industry, Restatement

Bristol-Myers Squibb Co., after insisting for months that its accounting of excessive sales to wholesalers was proper, said that it would restate sales and earnings for at least the past two years.?

1.) The question about the company's "wholesale-inventory stocking issue? "typically is referred to as "channel stuffing." Describe this problem, as you understand it from the article.

2.) Why would Bristol-Myers disclose the problem "in April when results from the first quarter plunged"? That is, what would compel them to have made a specific disclosure and why are these first quarter results indicative of a problem?

3.) Under what circumstances do companies restate previously issued financial statements? What does this indicate about the nature of the problem?

4.) Why would analysts say that "few have been able to figure out the true state of Bristol-Myers's sales and earnings" under the current circumstances? What would be the impact of this problem on the company's publicly-traded stock?

Bob Jensen's threads on channel stuffing are at 

"Shift to IASB Standards Leaves Door Open to Fraud, UK Auditors Warned," AccountingWeb, July 27, 2004 --- 

Auditors in the United Kingdom are being directed to be extra vigilant for fraud as companies may be tempted to manipulate their numbers during the transition to international accounting standards. The Institute of Chartered Accountants in England and Wales (ICAEW) is warning auditors to be on the lookout for inaccuracies and to refuse to sign off on accounts if necessary, the Financial Times of London reported.

The first set of accounts under the International Accounting Standards Board (IASB) rules may be questionable in some cases because companies must restate their opening balance sheet. Companies also have more accounting treatment options and they can make increased use of fair or market value in the valuation of assets and liabilities.

"Auditors need to ensure that their work remains of the highest quality and that they use their professional judgment and professional scepticism," said Andrew Ratcliffe, chairman of the ICAEW audit faculty.

The ICAEW is set to issue guidance on Monday for auditors and for companies about the implications of the transition to the IASB standards, which companies must use for their 2005 accounts.

Ratcliffe said companies are behind in their preparations, so auditors will most likely need to qualify some companies’ books. No doubt some companies’ 2005 annual reports would be late for the same reason, he said.

Auditors are being warned to resist pressure from management to overlook concerns because investors respond poorly to late or qualified accounts. Also, auditors are being told to maintain their independence as companies ask for help in making the move from national to international standards.

The multimillion-dollar fine reflects the SEC's continued aggressiveness in punishing companies for improper revenue recognition and other accounting misdeeds. Last year, the SEC forced WorldCom Inc., now known as MCI, to pay a landmark $750 million fine related to improper accounting. While the agency has levied large fines against investment companies and securities firms, the Bristol-Myers penalty is expected to be the second-largest fine against an operating company.

The SEC settlement could help Bristol-Myers in its continuing efforts to fix its legal problems. It recently settled a shareholder lawsuit related to the accounting issues for $300 million. The plaintiffs in that case alleged that they had been hurt by "artificial inflation" of the company's stock price related to the revenue overstatements.

Bob Jensen's threads on accounting fraud are at 

"No Wonder C.E.O.'s Love Those Mergers," by Gretchen Morgenson, The New York Times, July 18, 2004 --- 

Shareholders like it when their companies are acquired, because their stocks rise in value. Chief executives like it, too, because their severance agreements kick in. And that means they can become truly, titanically, stupefyingly rich.

Wallace R. Barr, the chief executive of Caesars Entertainment, is the latest to line up for his barrel of bucks. Last week, Harrah's announced it would acquire Caesars for $5.2 billion. Thanks to accelerated vesting of options and stock awards, Mr. Barr stands to receive almost $20 million under so-called change-of-control provisions in his contract. And if Mr. Barr resigns from Caesars "for good reason," the contract says, he is entitled to an additional $6.6 million after the two companies merge.

A spokesman for Caesars did not return a phone call seeking comment.

Then there was Wachovia's proposed acquisition of the SouthTrust Corporation last month. Equilar Inc., a compensation analysis firm in San Mateo, Calif., said the terms of the deal would give Wallace D. Malone Jr., the chief executive of SouthTrust. $59 million in termination awards, stock awards and options over the next five years if he leaves the bank. He also appears to be entitled to an annual pension of about $3.8 million.

At least Mr. Malone has said he would donate some of this bounty to charity. A spokeswoman for SouthTrust did not return a phone call seeking comment.

"In theory, change-in-control provisions make sense," said Tim Ranzetta, the president of Equilar. "They encourage executives to act in the best interests of shareholders in transactions that they anticipate will increase shareholder value, which at the same time may harm their own careers. But empirical research seems to indicate that most companies underperform relative to the market after a merger while executives benefit from these large, one-time payouts."

Amazingly few shareholders have carped about these giveaways. The California Public Employees' Retirement System, the big pension fund known as Calpers, voted against last month's merger of two health care companies, Anthem Inc. and WellPoint Health Networks, citing excessive pay. Executives stood to receive bonuses, severance payments and vested stock options totaling approximately $200 million in the deal. Leonard D. Schaeffer, WellPoint's chief executive, was entitled to $47 million in severance, stock options and enhanced retirement benefits, an Anthem spokesman said.

Nobody else seemed to mind. Shareholders approved the merger on June 28.

One reason that shareholder outrage has been muted may be that few people, beyond the executives themselves and maybe the company's compensation committee, know how costly these pay deals are. Even with all the scrutiny of corporate governance in recent years, a full tally of what executives will earn in retirement or under a change of control is simply not disclosed. Not anywhere.

Experts say that many compensation committees do not understand the size of these pay packages because they do not routinely ask their consultants for detailed lists of the various pay components.

And, my, how the list of goodies can go on. First comes the executives' severance pay, almost always nearly three times salary and bonus. Accelerated vesting of stock options and stock awards quickly follows; sometimes the options are granted with their full terms remaining - up to 10 years - giving them tremendous value.

Then there are the three additional years of pension credits that get tacked on to an executive's pay, as well as the 401(k) match, years of health care benefits and the cash value of perquisites at the time of termination - such as use of the corporate jet, country-club memberships, allowances for financial planning advice, office space and secretarial services. All in one delightfully fat lump sum.

AND don't forget that executives' pensions are often based on the unusually high severance pay, which ratchets the numbers way up.

Of course, one downside to these enormous payments is that they generate stunning tax bills for executives. Good thing their contracts almost always require the companies to pay. And how!

The so-called excise tax gross-up provisions can be so colossal that, according to one pay expert, a major merger was scuttled because the cost to cover executives' tax bills exceeded $100 million.

I view these executive compensation schemes as white collar crime, and white collar crime just does not get punished severely enough to stop the epidemic --- 

PCAOB Finds "Significant" Issues in Review of Big Four Audits

When it comes to the quality of work by Big Four accounting firms, "there's room for improvement," according to the chairman of the Public Company Accounting Oversight Board. Chairman William McDonough told lawmakers last week that limited reviews conducted last year of corporate audits found "significant" auditing and accounting issues. 

Bob Jensen's threads on Big Four auditing woes are at 

The California Board of Accountancy has taken disciplinary action against Big Four firm Ernst & Young LLP because of independence questions that arose from the firm's dealings with PeopleSoft Inc. In a related event, the New Mexico board voted 4-0 to issue notice that it "contemplated action" against E&Y for its PeopleSoft audits. AccountingWeb, September 23, 2004 --- 

"Ernst & Young's Survival Threatened by Equitable Life Case," AccountngWeb, August 16, 2004 --- 

Back in the heady days of the 1990s, it was unimaginable that the existence of even one of the Big Five accounting firms could ever be threatened. The collapse of Arthur Andersen left a Big Four and one more faces the possibility of collapse if a negligence claim against the firm is successful. Ernst & Young's battle with Equitable Life took on epic proportions in the United Kingdom this week, with Ernst & Young's chairman Nick Land writing to the Office of Fair Trading to put the office on notice that the firm's potential liability exceeds its insurance coverage.

In Land's letter to Office of Fair Trading Chairman John Vickers, Land signaled the company could collapse if Equitable Life succeeds in its £2.6bn negligence claim with Ernst & Young. Land wrote, 'our cover is not adequate to meet claims at the level we are currently facing.' The case is due to be heard at the High Court in April, the UK's Financial Director magazine reported.

A spokesman for Equitable Life said that 'the board's advice is that it has a strong claim against E&Y,' although he would not comment on whether it would seek a settlement or take the case to trial.

Meanwhile, E&Y was due to submit its response to complaints made by the Joint Disciplinary Scheme by Friday last week. Roland Foord, a partner at City law firm Stephenson Harwood, said that while the JDS findings would not influence the civil judge should a trial go ahead, it 'could have some effect in terms of settlement' decisions, Financial Director reported.

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

Ernst & Young LLP has agreed to pay $1.5 million to settle allegations that the firm's advice led nine hospitals to over bill the federal Medicare program. --- 

Bob Jensen's thread on E&Y scandals are at 

From The Wall Street Journal Accounting Educators' Review on July 16, 2004

TITLE: Auditor Independence Gets Focus 
REPORTER: Phyllis Plitch 
DATE: Jul 14, 2004 
TOPICS: Audit Committee, Audit Quality, Auditing, Regulation, Sarbanes-Oxley Act, Taxation, Accounting

SUMMARY: The Public Company Accounting Oversight Board (PCAOB) will be hosting a public roundtable on tax services and auditor independence. Questions focus on the importance of auditor independence and the role of the PCAOB.

1.) What is auditor independence? Be sure to distinguish between independence-in-fact and independence-in-appearance. Why is auditor independence important in the financial statement audit?

2.) What is the purpose of the Sarbanes-Oxley Act? What is the role of the PCAOB in financial reporting? What companies are under the jurisdiction of the PCAOB?

3.) Why are audit firms prohibited from providing certain services to their audit clients? Are any tax services currently included in the list of prohibited services?

4.) What is the role of the audit committee in financial reporting? How does the audit committee enhance auditor independence?

5.) Does providing tax services to audit clients impair auditor independence? Support your answer.

6.) What is the difference between a tax service designed to reduce tax liability and a tax service designed to achieve a financial statement result? How does each type of tax service impact auditor independence?

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

From The Wall Street Journal Accounting Educators' Review on July 16, 2004

TITLE: Possible Accounting Change May Hurt Convertible Bonds 
REPORTER: Aaron Lucchetti 
DATE: Jul 08, 2004 
TOPICS: Bonds, Convertible bonds, Earnings per share, Emerging Issues Task Force, Financial Accounting, Financial Accounting Standards Board

SUMMARY: The Emerging Issues Task Force is considering changing the requirements for including in the EPS calculation the potentially dilutive shares issuable from so-called CoCo bonds. These bonds have an interest-payment coupon and are contingently convertible, typically depending upon a specified percentage increase in the stock price.


1.) Describe the terms of CoCo Bonds. What do you think the term "CoCo" means? How do they differ from typical convertible bonds? Why do investors find typical convertible bonds attractive? Why do companies find it attractive to offer typical convertible bonds?

2.) What is the Emerging Issues Task Force (EITF)? How can the organization of that task force help to resolve issues, such as the questions surrounding CoCo bonds, more rapidly than the issues can be addressed by the FASB itself?

3.) In general, what is the accounting issue being addressed by the EITF? What is the proposed change in accounting? Does any of this have to do with the actual accounting for the bonds and their associated interest expense?

4.) Explain in detail the effect of these bonds on companies' earnings per share (EPS) calculations. Will the amount of companies' net income change under the proposed EITF resolution of this accounting issue? What will change? Is it certain that the change in treatment of these bonds will have a dilutive effect on EPS? Explain.

5.) Why might an EITF ruling require retroactive restatement of earnings by companies issuing these bonds? How else could any change in treatment of these bonds be presented in the financial statements?

6.) One investment analyst states that "the new accounting doesn't change economics, but investors [are] still likely to care." Why is this the case?

7.) Why does one analyst describe CoCo bonds as a gimmick? Why then would we "probably be better off without it"?

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 debt vs. equity are at

"Accounting Leads Rise, Making Boards Edgy," Greg Farrell, SmartPros, July 30, 2004 --- 

Two years after passage of the Sarbanes-Oxley Act, forensic accountants, corporate lawyers and the Securities and Exchange Commission are reporting a sharp increase in whistleblower complaints about accounting problems at publicly traded companies.


The law requires public companies to add costly controls in their accounting departments and holds top executives responsible for any misleading information in financial statements.

One section of the act also provides federal protection to would-be whistleblowers. As a result, warnings about accounting problems are reaching boardrooms at an unprecedented rate.

"There is increased whistle-blowing activity," said Harvey Kelly, a forensic accountant who heads fraud investigation at law firm Alix Partners. "There's an increased awareness on the part of people that Sarbanes-Oxley gives protection to individual whistleblowers."

Kelly says it's difficult to quantify the increase in whistleblower complaints. He says his firm has received a steady stream of calls from boards of directors about internal allegations of accounting fraud.

"Whistle-blowing has become almost a common feature of corporate life," said Michael Young of Willkie Farr & Gallagher, a law firm that investigated accounting fraud at Cendant. "I've been hearing it and living it."

Young says the increase in complaints has put boards of directors in a difficult spot. "In this environment, every eruption has to be seriously considered," he said. "What if somebody writes on the back of a candy wrapper that your bad debt is underfunded? Do you take it seriously? Do you have to launch an investigation?"

Kelly says that's happening at many companies. Boards are asking him to determine which complaints are unfounded grumblings from disgruntled employees and which are legitimate claims of accounting fraud.

"The concept of audit committees not wanting to get second-guessed is creating a much more robust volume of internal investigations," he said.

The SEC receives tips about possible violations of securities laws through its email complaint service ( ). Complaints jumped from 77,000 in 2001 to 180,000 last year. The SEC has received nearly 250,000 complaints this year.

More than 1,300 email complaints arrive each day, says John Stark of the SEC's enforcement division. The majority tend to be tips about accounting problems at public companies.

"It's a tremendous source of leads," Stark said.

August 3, 2004 reply from John L. Rodi [jrodi@IX.NETCOM.COM]


Did anyone else find this statement disheartening? I would have thought that the board would welcome information regarding the activities of individuals who are suspected of wrongdoing. After all isn’t safeguarding the assets of the corporation one of the responsibilities of the board of directors and anyone misappropriating assets or recording assets that don’t exist would be creating future havoc for the company.

The other thing that caught my attention is the line stating that the act was requiring the implementation of “costly controls”! Has any attempt been made to compare these costs to the billions of dollars that have been lost because of the malfeasance of officers of various corporations that have been in the news? I am reminded of the owners who use to say that they were too small to have internal controls. Subsequent defalcations made the implementation of those controls miniscule.

John Rodi

Bob Jensen's threads on whistle blowing are at 

Bank of America will pay $69 million to settle a class-action suit alleging it was among top U.S. financial firms that participated in a scheme with Enron's top executives to deceive shareholders.

"Bank of America Settles Suit Over the Collapse of Enron," by Rick Brooks and Carrick Mollekamp, The Wall Street Journal, July 4, 2004 ---,,SB108879162283854269,00.html?mod=home_whats_news_us 

Bank of America Corp. became the first bank to settle a class-action lawsuit alleging that some of the U.S.'s top financial institutions participated in a scheme with Enron Corp. executives to deceive shareholders.

The Charlotte, North Carolina, bank, the third-largest in the U.S. in assets, agreed to pay $69 million to investors who suffered billions of dollars in losses as a result of Enron's collapse amid scandal in 2001. In making the settlement, Bank of America denied that it "violated any law," adding that it decided to make the payment "solely to eliminate the uncertainties, expense and distraction of further protracted litigation," according to a statement.

The settlement with Bank of America raises the possibility that it could cost other banks and securities firms still embroiled in the suit much more to settle the allegations against them, should they decide to do so. Bank of America had relatively small-scale financial dealings with Enron compared with other banks, and was sued only for its role as an underwriter for certain Enron and Enron-related debt offerings.

In contrast with other financial institutions being pursued by Enron shareholders, led by the Regents of the University of California, which lost nearly $150 million from Enron, Bank of America wasn't accused of defrauding the energy company's shareholders. Other remaining defendants in the class-action suit, filed in 2002 in U.S. District Court in Houston, are alleged to have helped Enron with phony deals to inflate the energy company's earnings, potentially exposing those banks and securities firms to much steeper damages.

William Lerach, the lead attorney representing the University of California, predicted that the $69 million payment from Bank of America "will be the precursor of much larger ones in the future, especially with the banks that face liability for participating in the scheme to defraud Enron's common stockholders."

Still, it won't be clear until additional settlements are reached or the suit goes to trial whether Bank of America was able to negotiate a better agreement because of its willingness to strike a deal with Enron shareholders before other defendants. Bank of America's payment to settle the claims against it represents more than half its potential exposure, Mr. Lerach added.

Citigroup Inc. and J.P. Morgan Chase & Co., still defendants in the suit, declined to comment. Enron shareholders also sued Merrill Lynch & Co.; Credit Suisse First Boston, a unit of Credit Suisse Group; Deutsche Bank AG; Canadian Imperial Bank of Commerce; Barclays PLC; Toronto-Dominion Bank; and Royal Bank of Scotland PLC. Named as defendants in the class-action suit before it was amended to include the banks and securities firms were several Enron officers and directors and its former outside auditor, Arthur Andersen LLP.

The only other firm to settle allegations against it in the class-action suit is Andersen Worldwide SC, the Swiss organization that oversees Andersen Worldwide's independent partnerships. In 2002, it reached a $40 million deal with the University of California that released Andersen Worldwide from the suit. That agreement also raised questions among some other Enron claimants about whether they would recover anything more sizable from Enron's accounting firm.

The University of California's board of regents, a 26-member supervisory panel, is expected to give final approval to the settlement agreement with Bank of America later this month. A trial in the Enron class-action suit is set to start in October 2006.

Enron also triggered huge losses for Bank of America shortly after the energy company collapsed. Bank of America incurred a charge of $231 million related to its lending relationship with Enron Corp. The bulk of that stemmed from $210 million in loans that were charged off, which essentially means the bank declared them worthless. Four Bank of America employees tied to the bank's relationship with Enron left the bank in January 2002, a week after Bank of America took the Enron-related charge.

Bob Jensen's threads on the Andersen and Enron scandals are at 

Bob Jensen's threads on banking and finance scandals are at 

"KPMG Creates Ethics Global Center," SmartPros, July 14, 2004 ---

KPMG International announced the launch of the Global Center for Leadership & Business Ethics, designed to recognize those individuals who exhibit extraordinary business ethics and leadership qualities.

The establishment of the Global Center follows the announcement that KPMG International had been named the Global Founding Partner of the Nobel Peace Center in Oslo, Norway.

"As a demonstration of our fundamental commitment to the principles of leadership, integrity and ethics, KPMG is serving as a catalyst to establish an independent entity, the Global Center, that will recognize those business leaders who reflect the attributes of accomplishment and innovation," said Gene O'Kelly, chairman and chief executive of KPMG LLP, the U.S. member firm.

O'Kelly said that the separate role of Global Founding Partner of the Nobel Peace Center -- in combination with the creation of the independently operated Global Center -- as well as the Laureate & Award Medal Series comprises the "Global Initiative on Leadership & Business Ethics."

The Global Center will manage and administer the nomination process for the Laureate Award & Medal Series, which will honor those who are committed to excellence in business ethics. The processes, governance and nomination of the Laureate Award and Medal Series are modeled on Nobel.

The Laureate Award will honor a leader who best exemplifies business ethics and who has shown his or her commitment to excellence. In addition to the Laureate Award, medals will be awarded for Leadership, Corporate Governance, Reporting & Disclosure, Social Responsibility and Education.

A chairman for the Global Center will be appointed shortly, and a call for nominations for the Laureate Award & Medal Series will follow. Winners will be determined in November and the awards will be presented in December the same week that Nobel prizes are given.

"One of our highest priorities at KPMG is leading the restoration of credibility to the accounting profession," said Timothy R. Pearson, vice chair, marketing and communications, KPMG LLP. "The Global Initiative is inspired by the spirit of the Nobel Prizes and the principles and guidelines of the Nobel Foundation and the Norwegian Nobel Committee, and is aimed at recognizing outstanding business leaders."

Bob Jensen's threads on the sad and smiling faces of KPMG are at 

Figure This

Treasury taps KPMG as auditors in controversial decision while at the same time the Justice Department has a criminal investigation of KPMG for selling nearly $2 billion in illegal tax shelters.  Will KPMG employees have to be paroled to conduct the Treasury audit?

This fits perfectly into Bob Jensen's earlier theme of The Two Faces of KPMG at 

"Treasury Taps KPMG as Auditors in Controversial Decision," The AccounitngWeb, July 20, 2004 --- 

The Treasury Department is simultaneously investigating KPMG’s tax shelter practice while hiring the firm to audit its own consolidated financial statements.

Senate Finance Committee Chairman Charles E. Grassley, R-Iowa, was angered at the news, according to the Washington Post. He said Treasury is undercutting its own tax probe by awarding KPMG the contract to examine the books of Treasury’s 12 bureaus, which account for $6.9 trillion in assets and would be KPMG’s biggest audit ever.

"What signal does it send when the government is hauling one of the big accounting firms into the grand jury room over tax fraud while handing that same company millions of dollars in taxpayer-funded contracts?" Grassley asked.

Treasury Department spokesman Robert S. Nichols said the agency's independent inspector general picked KPMG. With 70 percent of the inspector general’s resources moved to the Department of Homeland Security, the office decided to seek private bids for the work.

"On the issue of tax shelters, let me affirm that the Bush administration has taken aggressive action to address the abusive tax shelter problem, more so than in any period in recent memory," he said.

KPMG said that it would not be auditing the books of the IRS, which has repeatedly demanded that the firm release the names of clients who use its tax shelters. The General Accounting Office, by statute, must conduct the IRS audit. Also, KPMG spokesman George Ledwith said that none of the firm’s employees involved in the federal investigation will be working on the Treasury audit.

The Senate Finance Committee pointed to the KPMG contract as one example of federal agencies overlooking tax abuses. The committee claims the Transportation Department has encouraged abusive leasing arrangements, the Patent and Trademark Office has issued patents for tax shelters and the Interior Department has engaged in inflating land swaps. The committee has set hearings for Wednesday on federal efforts to collect taxes owed.

"If we could just get federal agencies not to work at cross purposes, it would go a long way toward ensuring everybody pays their fair share of taxes," Grassley said. "The IRS's job would be a lot easier if other government agencies were part of the solution, not part of the problem."

This fits perfectly into Bob Jensen's earlier theme of The Two Faces of KPMG at 

FAS 133 is Not Only Complicated, It's Costly

"Cost to Fix Freddie Mac Accounting Problems: $376 Million," AccountingWeb, July 2, 2004 --- 

Freddie Mac executives told analysts Wednesday that it spent about $376 million last year to fix accounting errors that led to the ouster of three top executives and a massive financial restatement. Chief Financial Officer Martin Baumann said Freddie Mac spent $172 million last year just on its earnings restatement, which resulted in a $5.1 billion cumulative, net increase to earnings from 2000 through 2002, the Wall Street Journal reported

"That was just digging down, finding the accounting errors, fixing them, restating the results," Baumann said. Freddie Mac, the second largest U.S. mortgage buyer, spent an additional $79 million on new software in 2003. Upgrading the technology infrastructure has cost $80 million so far this year. Baumann predicted: "That number will at least double or more through the end of the year."

Freddie Mac’s new Chairman and Chief Executive Richard Syron told investors, "We have a lot of costs now that I think are a bubble, that go through dealing with a lot of the problems that I think are the result of under-investing in the past. The way you should think of this is a corporation that had some difficulties and is essentially going through a restructuring."

Observers say Freddie Mac is moving closer to fixing its accounting.

"They are seriously trying to bring it up to speed but it won't happen overnight," James McGlynn, a fund manager at Summit Investment Partners in Cincinnati, told Bloomberg. "I don't think Syron is trying to hide any facts and as long as the business holds up people should be content."

The company expects high costs to remain through 2005 in administration, technology and legal and regulatory matters.

Meanwhile, Bloomberg reported that Freddie Mac said Wednesday that its net income fell 52 percent in 2003. The decline came as rising interest rates in the second half of 2003 reduced the gains on contracts used to protect the value of its mortgage assets, said Michael Cosgrove, a Freddie Mac spokesman.

Bob Jensen's threads on Freddie and Fannie accounting woes are at 

"Ahold Inquiry in U.S. Bearing Fruit," by Anita Raghavan and Deborah Solomon, The Wall Street Journal, July 27, 2004, Page A3 --- 

Ex-Executive Pleads Guilty As Indictments Are Sought For Other Former Officials

U.S. prosecutors, intensifying a broad international investigation of the food industry, are set to unveil the first criminal charges stemming from massive accounting problems at supermarket giant Ahold NV.

A former purchasing executive at Netherlands-based Ahold's U.S. Foodservice unit pleaded guilty Friday in federal court in New York to insider trading and securities fraud, among other criminal charges, people familiar with the situation say. The plea agreement by Timothy J. Lee, 40 years old, has been sealed and is expected soon to be publicly disclosed, the people say.

The pact comes as the Manhattan U.S. attorney's office seeks to indict other U.S. Foodservice executives, including former marketing manager Mark Kaiser, former Chief Financial Officer Michael Resnick and former Vice President William Carter, as early as this week for conspiracy to commit securities fraud, which the government claims cost investors $6 billion, these people say. The figure represents the decline in Ahold's market value after the accounting irregularities came to light.

The plea agreement by Mr. Lee stemmed from allegations that he tipped off representatives of food vendors to the impending $3.5 billion sale of U.S. Foodservice to Ahold in 2000, the people say. Ahold of the Netherlands is one of the world's largest food retailers, along with Wal-Mart Stores Inc. and Carrefour SA of France.

The Securities and Exchange Commission also plans to bring civil charges of securities fraud against Messrs. Lee, Kaiser, Resnick and Carter for allegedly inflating revenue and profits by improperly booking rebates, these people say. Mr. Lee also will be charged by the SEC with civil insider trading, the people say. The investigation is continuing and the SEC is expected to bring additional charges against individuals at Ahold as well as some of the salespeople at vendor companies that helped U.S. Foodservice inflate its revenue, the people say.

Jane F. Barrett, Mr. Lee's lawyer at Blank Rome LLP in Washington, D.C., declined to comment. Richard Morvillo, a lawyer for Mr. Kaiser, said: "I'm not aware of what charges may be brought against my client by either the U.S. attorney's office or the SEC, but as we said previously, we expect to defend Mr. Kaiser vigorously and ultimately believe he will prevail." Scott B. Schreiber, an attorney for Mr. Resnick, didn't immediately return a call seeking comment. Mr. Carter couldn't be reached for comment.

The developments, in the largest investigation by U.S. prosecutors into an overseas company, underscore that the American prosecutors and securities regulators are aggressively seeking to expand their investigation into the food industry, potentially laying the groundwork to bring charges against major food vendors by putting pressure on their low-level employees.

The legal maneuvers underscore the increasing scrutiny that U.S. regulators are placing on foreign companies that trade securities such as American depositary receipts in the U.S. The U.S. attorney's office and the U.S. Securities and Exchange Commission also have been investigating whether Royal Dutch/Shell Group improperly overbooked reserves.

At issue in the Ahold matter is the hundreds of millions of dollars in rebates, "allowances" and other promotions that food makers pay to supermarket operators for coveted shelf space, and to distributors that can choose which brands to stock in their warehouses. These payments, while at times advantageous for certain big players in the market, can hurt smaller competitors and may drive up prices paid by consumers.

In recent years, these rebates and allowances appear to have been used by food distributors to help make their revenue and profits appear rosier than they actually were, regulators say.

As part of their investigation into U.S. Foodservice, prosecutors have been examining whether suppliers to the Columbia, Md., unit of Ahold signed off on inaccurate documents that could have been used to help inflate earnings at U.S. Foodservice. Last spring, Sara Lee Corp. and ConAgra Foods Inc. acknowledged that some salespeople endorsed inaccurate documents that showed the two suppliers owed more to U.S. Foodservice in rebates than they actually did.

While investigators began their probe by focusing on the accounting irregularities, the inquiry evolved into an insider-trading investigation as prosecutors started sifting through stock-trading records, say people familiar with the situation. As the probe deepened, prosecutors began scrutinizing whether Mr. Lee tipped off salesmen at vendors to curry favor, these people say.

The potential indictments come as the SEC has informed a number of food companies, including Kraft Foods Inc., Dean Foods Co. and PepsiCo Inc.'s Frito-Lay, that it is considering legal action against them in connection with accounting problems at grocery distributor Fleming Cos. These companies have received so-called Wells notices, in which the SEC discloses that its enforcement division has recommended filing a legal action.

Continued in the article

Worldwide audit failure to detect this fraud is attributed to the audit firm of Deloitte Touche Tohmatsu Internationalare --- 
Bob Jensen's threads on Deloitte's audit failures are at 

From The Wall Street Journal Accounting Educators' Review on July 9, 2004

TITLE: Accrual Accounting Can Be Costly 
REPORTER: Gene Colter 
DATE: Jul 02, 2004 
TOPICS: Earnings Management, Earnings Quality, Financial Accounting, Financial Analysis, Financial Statement Analysis, Restatement, Revenue Recognition

SUMMARY: The article discusses a research study relating the extent of accrual accounting estimates to subsequent firm performance and incidence of shareholder litigation. The study was conducted by Criterion Research Group, LLC, and the article notes that the research is of interest to insurers that offer directors and officers policies.

1.) Summarize the research study described in the article. Who performed the research? What can you understand about the relationships examined in the project? What was the motivation for the research?

2.) Define the term accrual accounting. Is it accurately compared to cash basis accounting by the description given in the article? Why must accrual accounting always involve estimates?

3.) What is the overall impression of accrual accounting that is created in the article? In your answer, comment on the statement, "Accrual accounting is common and kosher."

4.) Describe weaknesses of cash basis accounting as compared to the issues with accrual basis accounting that are presented in the article. Which basis do you think better presents information that is useful to financial statement readers? Support your answer; you may cite relevant accounting literature to do so.

5.) What basis of accounting is being described using the computer network example in the article? What accounting standards prescribe this treatment? Name at least one other industry besides computer software sales in which this accounting treatment is required.

6.) Refer again to question #5 and your answer. What alternative method must be used in this area if accrual accounting were to be avoided entirely? What are the disadvantages of this approach?

7.) Why do you think some companies must record more extensive accruals and estimates than other companies must? Do these factors themselves lead to greater likelihood of shareholder litigation as is found in the article?

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

"Accrual Accounting Can Be Costly," by Gene Colter, The Wall Street Journal, July 2, 2004, Page C1 ---,,SB108871005216853178,00.html 

Firms Booking Aggressively Are More Likely to Be Sued By Shareholders, Study Says

Book now. Pay later.

Pay the lawyers, maybe. A study to be released today suggests that companies that are most aggressive when booking noncash earnings are four times as likely to be sued by shareholders as less-aggressive peers.

At issue is so-called accrual accounting, in which companies book revenue when they earn it and expenses when they incur them rather than when they actually receive the cash or pay out the expenses. Accrual accounting is common and kosher. Problems arise, however, when companies miscalculate how much revenue they've really earned in a given period or how much in related expenses it cost to get that money.

For example, say Company A agrees to build a computer network for Company B over four years for $4 million, a job that Company A estimates it'll have to spend $1 million to complete. Company A works hard and estimates it ended up building half the computer network in the first year on the job, so it books $2 million of revenue that year. By accounting rules, it must accrue related costs in the same proportion as revenues, so it also books $500,000 of expenses in the same first year. But say it then turns out that Company A's costs to finish the network actually run to $2 million. Company A has to address that by booking $1.5 million of expenses in future years. In other words, Company A would end up increasing earnings in the first year, but at a cost to future earnings.

Getting the numbers wrong isn't a violation of generally accepted accounting principles (though intentionally misestimating is). But companies have a lot of leeway, and those that make the most aggressive assumptions when booking what the green-visor guys call accruals can end up creating a misleading picture of their financial health in any given year. When skeptics refer to a company's "revenue recognition problems," this is often what they're talking about.

The new study, based on six years of data, was conducted by Criterion Research Group LLC, an independent research firm in New York that caters primarily to institutional investors. It shows that companies that fall into what Criterion calls the highest accrual category are more likely to end up getting sued by shareholders.

The study builds on earlier research by Criterion that showed companies that use more accruals underperform companies with fewer accruals. In that report, Criterion screened 3,500 nonfinancial companies over 40 years and found that those using the most accruals had poorer forward earnings and stock returns and also had more earnings restatements and Securities and Exchange Commission enforcement actions.

None of this is to say that companies that end up in shareholder litigation set out to mislead shareholders. Rather, says Criterion Chairman Neil Baron, these companies simply run a higher risk of making mistakes with their books.

"Accruals are estimates," Mr. Baron says. "If you're a company and a much higher percentage of your earnings come from accruals or estimates, it's much more likely that you're going to be wrong more often."

Criterion screened companies involved in class-action suits from 1996 to 2003 for its new study. In each case it looked at a company's earnings for the year of the class start date, which is the year in which the alleged misbehavior began. Criterion then assigned these companies into one of 10 ranks, with those in the 10th group using the most accruals and those in 1st using the fewest. There were four times as many shareholder class-action suits among 10th group companies as there were among 1st group firms.

A number of companies in the two highest accrual categories recently settled shareholder class actions related to accounting issues, including Rite Aid Corp., Waste Management Inc., MicroStrategy Inc. and Gateway Inc. Other companies still involved in ongoing shareholder class actions involving accounting issues also turned up in the aggressive-accruals group.

Companies currently in Criterion's highest-accrual category include Chiron Corp., eBay Inc., General Motors Corp., Halliburton Co. and Yahoo Inc. -- none of which now face shareholder suits related to accounting -- among others.

EBay spokesman Hani Durzy says he doesn't think his company belongs in the high-accruals gang, noting that the company's profit-and-loss statement "closely mirrors our cash flow." He adds: "We are essentially a cash business."

A GM spokesman says, "All of GM's accounting policies and procedures are in full compliance with U.S. GAAP and are reviewed by our outside auditor and the audit committee, and we have, to the best of our knowledge, never had to restate earnings because of an accounting issue."

An e-mail from Halliburton's public-relations office notes that Halliburton follows GAAP and adds that accruals "are universally required by GAAP."

Representatives from Chiron and Yahoo said the companies had no comment.

A Criterion analyst pointed out that accruals don't necessarily relate to everyday operations. For example, a company estimating and booking tax benefits from employee stock options is also using accruals. Estimates related to pension accounting are also accruals.

Mr. Baron stresses that the vast majority of companies that book a lot of accruals are unlikely to face shareholder suits, restatements or SEC actions. Many may even outperform low-accrual companies. But he says investors should be "more scrutinizing" of financial statements from companies that make liberal use of accruals, because, statistically, they are most likely to run into these problems.

Sophisticated investors, such as fund managers, might reckon they can spot bookkeeping alarms before the broad investing public and get out of a stock before the lawyers start filing briefs. But it's possible that companies with a lot of accruals can suffer even without litigation: Mr. Baron says his firm has been contacted by insurers that offer directors and officers policies, which large companies buy to protect executives and directors against lawsuits. The insurers are asking about Criterion's research as they weigh whether to charge D&O customers higher premiums, he says.

Bob Jensen's threads on revenue accounting are at 

Bob Jensen's threads on accounting theory are at 

"Adelphia Founder And One Son Are Found Guilty," by Peter Grant and Christine Nuzum, The Wall Street Journal, July 9, 2004, Page A1 --- 

Jury Remains Deadlocked On Second Son, Acquits Former Assistant Treasurer

Notching another victory against the corporate excesses of the 1990s, prosecutors won criminal convictions against the father-and-son team of John and Timothy Rigas, former top executives at cable company Adelphia Communications Corp. However, they failed to persuade a jury that the looting involved Adelphia's former assistant treasurer.

The jury left unresolved the case against another member of the Rigas family -- Michael Rigas, former head of Adelphia operations -- remaining deadlocked on most of the counts against him.

But after deliberating for eight days, the jury found Michael Mulcahey, Adelphia's former assistant treasurer, not guilty on all 23 counts of conspiracy and fraud that he and the other defendants were facing.

The jury remained deadlocked on charges against the other son, Michael Rigas, and is scheduled to reconvene today to try to break the impasse.

The trouble at Adelphia, the nation's fifth-largest cable company, now operating in bankruptcy protection, began in March 2002 when a footnote in an otherwise routine quarterly earnings statement revealed that the Rigas family had borrowed more than $2 billion under an arrangement with Adelphia that made the family and the company responsible for each other's debts.

In the four-month trial, prosecutors called former employees, a golf pro and actress Peta Wilson to testify about the family's lavish spending habits. Ms. Wilson, the star of the show "La Femme Nikita," and the golf pro testified that they flew on Adelphia's corporate jets for no apparent business purpose. Prosecutors contended that the family treated the company like "their own ATM machine."

The jury appears to have separated Michael Rigas from his brother and father because Michael had little to do with the company's finances. His lawyer also repeatedly told jurors that his client drove an old Toyota, in contrast with Timothy and John, who had a collection of 22 cars paid for by Adelphia, according to one witness. Jurors also were shown stacks of checks written by Michael Rigas to reimburse Adelphia for personal expenses ranging from a flight to Paris to $3.45 in postage.

The verdicts were read out in a hushed and packed U.S. district courtroom in downtown Manhattan. Many family members of the defendants were in the courtroom, as well as supporters from Coudersport, Pa., the village in north-central Pennsylvania where Adelphia used to be based. Several people cried as the verdicts were read. So did Michael Mulcahey, when, after court adjourned, he was hugged by his wife, Cathy Mulcahey, who had been in court virtually every day.

Continued in the article

Bob Jensen's threads on the audit scandals at Deloitte and Touche are at 

"KPMG to Remain MCI Auditor," SmartPros, July 2, 2004 --- 

After calling a motion presented by 14 state taxing authorities a "litigation tactic," a New York judge Wednesday, June 30, denied the states' request to disqualify KPMG LLP as the accountant, auditor and tax accountant of MCI Inc.

The states, led by Massachusetts, tried to oust KPMG in April as MCI was preparing to exit bankruptcy protection. The states cited a controversial tax plan that the accounting firm designed for MCI, then known as WorldCom Inc., and said KPMG could not audit its own tax work.

"Any argument by the states that they have pursued the disqualification of KPMG to protect the public interest 'rings hollow' in light of the fact that the very conflict they allege warrants disqualification was known to them for no less than 10 months before they decided to file [the motion]," wrote Judge Arthur Gonzalez of the U.S. Bankruptcy Court for the Southern District of New York.

Throughout the dispute, KPMG and MCI maintained that the tax plan is legitimate. And even though the company exited Chapter 11 protection in April, the disqualification motion still carried serious consequences for the Ashburn, Va.-based telecom.

States have submitted about $2.75 billion in tax claims against MCI's bankruptcy estate, and disqualification of the company's adviser and auditor would have strengthened their hand in negotiations.

A ruling in favor of the states' position also could have put MCI in the tenuous position of having to find a new auditor in a post-Sarbanes-Oxley world in which Chinese walls are now supposed to exist regarding what services such firms can and can't provide.

"There are nonaudit services that auditors were providing that they cannot provide today," said one attorney not involved in the case, Morton Pierce of Dewey Ballantine LLP. "Many companies have adopted a policy that they will not use their auditor for any non-audit services.

"Given how few major firms are left, any given company probably has some nonaudit relationships with one or more of the other firms," Pierce added. "It can be a large problem."

Gonzalez's ruling helps KPMG immediately. The states had argued that KPMG should have to sacrifice all its fees during the bankruptcy case, which totaled well more than $140 million.

Even though the disqualification motion was denied, the dispute over the tax plan still simmers.

In the 37-page memorandum that accompanied his ruling, Gonzalez noted that the tax issue could figure in litigation over claims that the states have against MCI that still need to be resolved.

The Securities and Exchange Commission has requested documents related to the tax work, though the agency hasn't indicated that it will take any action. SEC lawyers could not be reached Wednesday for comment.

Charles Mulford, a professor of accounting at Georgia Institute of Technology, said the tax plan raises complex issues.

"Where I question any kind of shelter, whether it's state or federal, is when it is created simply for tax avoidance and it has no real economic basis," he said. "That's when questions should be raised."

The tax plan has been a lightning-rod issue in the MCI case for more than a year. Creditors who were dissatisfied with their recoveries under MCI's reorganization plan attacked the system in April 2003. In various motions, the dissenting creditors labeled the scheme a sham, arguing that it did nothing more than shift MCI's income from states with high taxes to those with more favorable policies.

To resolve the dispute, MCI increased recoveries to the dissenting creditors, who in return dropped their objections to the company's reorganization.

The tax minimization plan surfaced again in January, however, when Richard Thornburgh, the former U.S. attorney general who served as MCI's bankruptcy examiner, criticized KPMG at length in his final report.

"WorldCom likely avoided paying hundreds of millions of dollars in state taxes in 1998-2001," Thornburgh wrote. "The cornerstone of this program, which was designed by KPMG Peat Marwick LLP, was the classification of the 'foresight of top management' as an intangible asset, which the parent company could license to the subsidiaries in return for massive royalty charges."

In his order on Wednesday, Gonzalez called the states "dilatory" for waiting until the eve of MCI's exit from bankruptcy to protest.

Continued in the article

"KPMG's Chief Of Finance Quits As Probes Go On," by Jonathan Weil, The Wall Street Journal, July 7, 2004 ---,,SB108915179655056602,00.html?mod=home_whats_news_us 

Richard Rosenthal, KPMG LLP's chief financial officer since 2002 and the head of the firm's tax operations for two years before that, has resigned his position, the latest in a series of departures this year by top executives at the Big Four accounting firm.

KPMG Chairman Gene O'Kelly announced Mr. Rosenthal's resignation in an e-mail Monday night to the firm's partners. In the e-mail, a copy of which was reviewed by The Wall Street Journal, Mr. O'Kelly wrote that Mr. Rosenthal "has informed me of his intent to retire from the firm. After a 25-year career with the partnership, Rick has decided to seek an opportunity in the corporate community."

The e-mail didn't specify Mr. Rosenthal's reason for leaving or whether the 48-year-old had secured a job outside the firm. Mr. O'Kelly wrote that Mr. Rosenthal is expected to stay at the firm through the end of the year.

Mr. Rosenthal's resignation comes amid continuing investigations by the Internal Revenue Service and the Justice Department into KPMG's tax-shelter operations. As previously reported, a federal grand jury in Manhattan is conducting a criminal investigation into KPMG's past activities as a promoter of allegedly abusive tax shelters.

Mr. Rosenthal, who works in KPMG's Montvale, N.J., office, didn't return phone calls seeking comment. KPMG spokesman George Ledwith declined to comment and said the firm wouldn't answer questions about the reasons for Mr. Rosenthal's resignation.

Prior to becoming KPMG's finance chief, Mr. Rosenthal was KPMG's vice chairman for tax operations from 2000 through 2002, a position in which he was responsible for overseeing the marketing and development of some of KPMG's most aggressive tax shelters. He first joined the firm in 1978 after graduating from Arizona State University, starting out in the firm's Chicago office.

Mr. Rosenthal's name was mentioned several times in a November 2003 report on KPMG's tax-shelter operations written by Democratic staff members of the U.S. Senate Permanent Subcommittee on Investigations. Among other things, the report mentioned Mr. Rosenthal's participation in overseeing a KPMG tax strategy known as "SC2," which the IRS in April declared to be an abusive tax shelter.

Mr. Rosenthal's resignation comes six months after KPMG announced a shake-up of the firm's upper management, including the retirement of the firm's No. 2 executive, former Deputy Chairman Jeffrey Stein. KPMG has made clear that the January shake-up came in response to IRS and congressional scrutiny of the firm's earlier tax-shelter practices. The Senate subcommittee's November report had included several references to e-mail messages tying Mr. Stein to the promotion of controversial shelters. In addition to replacing Mr. Stein, KPMG in January also replaced its top two tax executives.

In addition to ceding his post as chief financial officer, Mr. Rosenthal also stepped down as the firm's chief administrative officer and relinquished his seat on the firm's management committee.

Mr. O'Kelly wrote that the firm expects to announce a new finance chief by Sept. 1. In the interim, Deputy Chairman Joseph Mauriello, 59, will fill the posts of chief financial officer and chief administrative officer. Mr. O'Kelly added that Mr. Rosenthal would assist Mr. Mauriello "until a successor is appointed, and then assist the new CFO" to ensure an orderly transition.

Bob Jensen's threads on KPMG woes are at 

"An 'Oops' at the Bank of 'Wow'," by Gretchen Morgenson, The New York Times, August 1, 2004 ---

VERNON W. HILL II, the founder and chief executive of Commerce Bancorp Inc., credits his "wow the customer" philosophy for taking his company from a little-known local institution in southern New Jersey to the fastest-growing retail bank in the nation. By keeping branches open weekends and evenings and by eliminating what he calls the "annoying fees'' and "stupid rules'' found at other banks, Mr. Hill has flouted industry convention. And with a stock price that is up 135 percent in the past five years, he has elicited more than a few wows from Wall Street, too.

Now, however, Mr. Hill, a former real estate executive and owner of fast-food franchises, can hear a different sort of wow from shareholders - one of shock. They recently learned that two of the bank's top executives and one of its former directors are embroiled in an influence-peddling scandal in Philadelphia. An indictment announced on June 29 by the United States attorney for the Eastern District of Pennsylvania named 12 individuals in a pay-to-play arrangement involving Corey Kemp, Philadelphia's former treasurer.

According to the indictment, Mr. Kemp handed out the city's money management and bond underwriting business to financial institutions that entertained him with restaurant meals and tickets to sporting events and that gave him sizable loans despite his abysmal credit rating. Among those indicted were Glenn K. Holck, president of Commerce Bank's Pennsylvania unit, and Stephen M. Umbrell, its regional vice president. At the heart of the scheme, the indictment says, was Ronald A. White, a lawyer who sat on a Commerce regional board until last year.

Perhaps ominously for Commerce, the indictment refers to five phone conversations taped by investigators in which Mr. Hill discussed matters relating to Mr. Kemp with the individuals named in the indictment. In an interview on Friday, Mr. Hill declined to describe the nature of the conversations.

Mr. Kemp, Mr. White, Mr. Umbrell and Mr. Holck have all pleaded not guilty.

Commerce says that the bank and its executives did nothing wrong. While Mr. Holck and Mr. Umbrell have been suspended, the bank is paying their legal expenses. In a July 13 conference call with analysts to discuss second-quarter results, Mr. Hill promised to institute new policies to increase oversight of the bank's dealings with government officials.

Continued in the article.

Bob Jensen's threads on banking, insurance, and mutual fund scandals are at 

Free Market Myths by Agency Theorists

Does all of this add up to a convincing indictment against the market? No. Even those economists like MIT's Paul Joskow who are most convinced that illegal market manipulation played a major role in the California meltdown continue to support the introduction of (better designed) markets to the electricity sector. Other economists are of the opinion that market design ought to be left to trial and error in the context of more complete deregulation rather than to some template drafted by experts who think they can know a priori how electricity markets could best be organized.
Jerry Taylor (See below.)

The Enron fiasco is exceedingly complex as a test for regulation versus free market control of resource flows and pricing.  The recent video tape disclosures of Enron's energy market creators playing an extremely unfair game with energy buyers clearly shows how naive it is to expect that players in the market will play fair without sanctions and a tone at the top that will come crashing down on unfair players.  

The question is:  "What is the top?"  Clearly when the "top" has monopoly powers in unregulated markets (i.e., markets over which there are no serious and effective government watchdogs), the system easily rots to the core --- 

Equally clear is that when industry controls the regulators in favor of suppliers, the system easily rots to the core.  We have countless examples of that in U.S. economic history.

Enron's executives were highly successful in removing government regulation of energy trading, largely due to the political clout of the all-powerful Senator Gramm whose wife Wendy eventually became a major player on Enron's Board of Directors before and after Enron declared bankruptcy.

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

What world politics has a hard time doing is constructing free markets that are truly fair in preventing monopolist sellers or buyers from taking advantage of market and/or political power to rot the fairness of market pricing.  The following editorial by Jerry Taylor is arduously in line with the Chicago/Rochester/Virginia university agency defenses of free markets.  By this I mean that any breakdown of fairness in the market is always attributed to government rather than the the somewhat inevitable evolution of markets to migrate toward monopolist exploitation similar to how Rockefeller nearly destroyed energy markets early in the 20th Century.

What Taylor fails to spell out is how to truly prevent fairness rotting and monopolist exploitation in his hallowed "free markets."  The best defense we have is an aggressive media, but media defense is by definition limited to triggering controls to capture the horse after its out of the barn and the scoundrels have safely deposited their ill-gotten fortunes in secret off-shore bank accounts that "lay" in wait for the few months that the culprits spend in Club Fed.  Even the infamous scoundrel Andy Fastow is never going to survive on a minimum wage after emerging from his new Club.

"Lay Off," by Jerry Taylor, The Wall Street Journal, July 9, 2004, Page A10 ---,,SB108932251139459024,00.html?mod=todays_us_opinion 

The grand jury indictment of former Enron CEO Ken Lay opens the final act of a political morality play that may well influence who sits in the Oval Office next January. For, in truth, the particulars of the indictment against Mr. Lay regarding the corporate governance at Enron are of little consequence compared to the particulars of the indictment against what Enron is believed to represent: unregulated markets run amuck and unrepentant corporate greed. While it's too early to say whether the indictment against Mr. Lay has merit, it's not too early to pass judgment on each of the two counts of the indictment against the economic policies of the last several years.

First, is Enron what happens when markets are unsupervised and regulators are asleep at the switch? No, Enron is what happens when politicians believe they can create robust, well-functioning markets out of whole cloth and efficiently manage competition via regulation.

California's restructured electricity market was, in fact, the furthest thing from a capitalist jungle imaginable. The government forced electric utilities to sell off most of their power plants and discouraged them from buying electricity outside of a complicated state-managed spot market. Furthermore, the electric utilities were forced to open their power lines to anyone who wanted to use them -- like Enron -- under tightly regulated terms and conditions.

The day-to-day management of the grid was likewise taken from the utilities and given to state regulators. While wholesale electricity prices were deregulated, retail prices remained tightly controlled -- a combustible combination. In sum, the state was more heavily involved in the restructured market than it was in the old system we all grew up with.

It shouldn't come as a surprise to learn that companies like Enron figured out how to game the system with colorfully named strategies such as "Death Star," "Get Shorty," "Fat Boy" and "Ricochet." All involved exploiting arbitrage opportunities offered by the fact that California's electricity market was actually four separate markets: 24 separate "day-ahead" markets (one for each hour of the day) overseen by the state managers of the spot market; a transmission congestion relief market mirroring the 24 day-ahead markets; a reserve market managed by the state grid operator; and a real-time market overseen by the same.

In a well-functioning market, the prices for day-ahead, reserve and real-time energy during each hour would be equal in all areas of the West, including California. But because of transmission congestion, price controls and the fact that each of those market auctions occurred at different times, uncertainty reigned and prices varied widely. Enron, as well as others, figured out all kinds of schemes -- most of which are perfectly legal -- to buy low and sell high within this Byzantine system.

Enron's strategies were more attractive than they otherwise might have been for two reasons. First, no matter how much they charged for power, retail prices were frozen by law and demand would thus not be affected. A market where price increases do not decrease demand is a dream walking for those selling electricity. Second, the highest-priced electricity accepted in the day-ahead market established the price for all electricity bought that hour. Because the state allowed a company's power offer to be broken down into many differentially priced increments, suppliers had an incentive to hold back some power for sale only at exorbitant prices. If the offers were rejected, fine -- the volumes of electricity typically offered at those very high prices weren't so great. If they did get their asking price for any of these small unit offers, however, it was as if everyone in that particular hourly market won the lottery.

Because Ken Lay did not eschew such strategies, most hold him out as the ultimate avatar of endemic corporate greed, the second count of the political indictment at issue. But corporate executives have a fiduciary duty to their stockholders to maximize profit. Moreover, consumers are better off in the long run when market actors exploit arbitrage opportunities because it assists in the efficient allocation of electricity assets across time and space.

Regardless, it is not clear whether Enron was either the largest or even the most aggressive firm involved in such arbitrage. It's worth noting that during the 2001-2002 crisis, Enron was charging less for electricity on average than were most of the municipally owned public utilities in the Pacific West.

No, if a charge of unconscionable greed is going to be leveled at Enron for its activities during the California electricity crisis, it ought to be leveled on two altogether different counts.

First, Enron was not a passive bystander when this bizarre market was imposed in the form of California Assembly Bill 1890. The company actively lobbied for and aggressively promoted the market structure it eventually exploited. While many well-meaning people embraced the reforms (the law, after all, passed the California legislature without a single vote in opposition and was widely embraced by academic economists and all parties to the new system), there's reason to believe that Enron at least sensed that this brave new world would provide ample profit opportunities given all its problematic imperfections.

Second, Enron apparently broke the law in pursuit of profit within the new system, but to what extent that occurred is unclear. The line between clever arbitrage and actions that violate the rules laid down for the California market is difficult to discern. Still, Enron misrepresented some of those transactions to state regulators and fraudulently reported others.

More serious is evidence found in recently released taped conversations between Enron traders suggesting that electricity was intentionally withheld from the California market to drive up wholesale prices. Now, one can make a reasonable argument that this shouldn't be against the law (if I own a power plant but can't decide when it runs and when it remains idle, who really owns the plant -- me or the government?), but the fact remains that doing so to jack up electricity prices was well understood at the time to be illegal.

Does all of this add up to a convincing indictment against the market? No. Even those economists like MIT's Paul Joskow who are most convinced that illegal market manipulation played a major role in the California meltdown continue to support the introduction of (better designed) markets to the electricity sector. Other economists are of the opinion that market design ought to be left to trial and error in the context of more complete deregulation rather than to some template drafted by experts who think they can know a priori how electricity markets could best be organized.

It's instructive to remember that the accounting shenanigans that eventually led to Enron's downfall and the indictment handed down this week were brought to light not by diligent regulators but by investors who smelled a rat. Enron survived as long as it did because those very same market forces that brought the company down were largely exiled from the California electricity market. Whether that particular narrative is as compelling as the alternative may well influence the course of politics for years to come.

Mr. Taylor is director of natural resource studies at the Cato Institute --- 

"The Case Against Ken Lay Enron's former chief claims he was out of the loop. How prosecutors aim to show otherwise" by Julie Rawe, Time Magazine, July 19, 2004 ---,9171,1101040719-662791,00.html 

Oct. 23, 2001, stands out as a particularly bad day for Ken Lay. As word circulated that the energy giant he founded was under investigation for balance-sheet shenanigans, the CEO tried to pull Enron's stock out of a tailspin by arranging a special conference call with analysts. "We're not trying to conceal anything," he told them. "I'm disclosing everything we've found." After Lay got off the phone, he gathered Enron's thousands of employees via a live webcast and video teleconference, and tried to reassure them too. "Our liquidity is fine," he said of the company that was about to flame out in one of the biggest accounting scandals in history. "As a matter of fact, it's better than fine. It's strong."

Those comments came back to haunt Lay last week in an 11-count indictment accusing him of conspiring to cook Enron's books even as he touted its tainted stock. For starters, prosecutors claim that Lay failed to mention to analysts several massive problems he knew about, including some $7 billion in hidden debts. And he neglected to tell employees that the company's liquidity hinged on an emergency billion-dollar loan Enron had just obtained by offering its precious pipelines as collateral. But one egregious comment Lay made that fateful October day could end up as his salvation. During the conference call with analysts, he professed the "highest faith and confidence" in the company's chief financial officer, Andrew Fastow, who the next day suddenly took what became a permanent leave of absence. Nearly three years later, Lay claims he was unaware of Fastow's misdeeds, a defense strategy casting Lay as the world's most clueless CEO, sincerely waving his pom-poms as his team got crushed.

Government prosecutors are patting one another on the back for finally hooking the biggest fish in an investigation into what U.S. Deputy Attorney General James Comey described last week as Enron's "spectacular fall from grace." Lay, 62, was the public face of the once stodgy pipeline firm that morphed into the seventh biggest U.S. company by trading natural gas and megawatts of power. A minister's son with a Ph.D. in economics, Lay was spared being charged with approving Enron's now famous off-the-books partnerships that hid so much debt for so long. And unlike the two former colleagues he will be tried with — Enron's onetime CEO Jeffrey Skilling and chief accounting officer Richard Causey — Lay wasn't charged with insider trading by the Justice Department (although last week the Securities and Exchange Commission did so in a separate, $90 million suit in civil court, where the standard of proof is less stringent). Instead, the bulk of the charges against Lay allege that he helped keep the deceit alive after he resumed his role as CEO in August 2001, when Skilling abruptly resigned. The remaining charges deal with an obscure bank-fraud rule involving Lay's personal-loan applications. "I have to go home and look up something called a Reg U," Lay's attorney griped. "That's a stretch."

The case won't be easy to win. Lay's claim that he believed the company stock was a good buy is bolstered by the fact that he kept purchasing more and sold shares only when forced to by margin calls. Jurors' heads will be spinning from all the byzantine financial data. And, says Houston securities litigator Thomas Ajamie, "the complexity of this case will work in the defense's favor."

Even before the Enron accounting scandal started to unravel, many people were calling for Lay's head. His company was suspected of wrongdoing in early 2001, during the California energy crisis. Last month, following the release of tapes in which Enron traders gleefully spoke of ripping off Golden State grandmothers, California's attorney general sued the firm for violating the state's unfair-competition and commodities-fraud laws. After Enron collapsed, smashing the nest eggs of rank-and-file employees, political pressure to build the case against Lay intensified. One of George W. Bush's top contributors during the 2000 campaign, Lay was nicknamed "Kenny Boy" by the President. As the months went by with no indictment, Democrats in Washington grumbled that he was being insulated by the White House.

Bob Jensen's threads on the Enron and Andersen scandals are at 

Stock Option Expensing Will Take a Bite Out of the Apple

Why Silicon Valley Hates the Impending FASB Rule to Expense Employee Stock Options
"What Could Crunch Apple Shares," by Alex Salkever, Business Week, July 12, 2004, Page 11 --- 

These are heady days for Apple (AAPL ) shareholders. Stoked in part by the success of the iPod music player, Apple shares have surged to nearly $34 recently -- the highest in four years. The runup would seem to validate a recent wave of bullish analyst reports. But Apple's earnings per share could fall dramatically if it's forced to expense stock options under new Financial Accounting Standards Board (FASB) rules.

The accounting change also could expose another weakness: In the last four quarters, Apple earned $32 million after taxes from interest on its $4.6 billion cash horde. That's nearly twice as much as the $18.5 million in operating income it would have earned under the pending FASB rules, says Albert Meyer, principal of 2nd Opinion Research. "Is it a tech company or a credit union?" Meyer asks.

If stock options had been treated as a cost, Apple's $179 million in earnings over the last four quarters ended on Mar. 27 would have fallen 69% -- significantly more than the potential drops of under 50% for other tech companies such as Dell. Out of 86 tech companies, Apple was among the 12 with the biggest hit to estimated 2005 earnings, according to Merrill Lynch (MER ).

To match its interest profits, Apple would need to double earnings from operations in the next 12 months. That could be hard when Apple says margins on its iPods will drop in the coming year. Apple declined to comment.

Bob Jensen's threads on arguments for and against the impending revised FAS 123, see 

One of the Dumbest Bills in the History of the U.S. Congress.
An obvious example of the junk compromises that lobbying money can buy.  Either stock options are booked as expenses or they are not booked as expenses.

From The Wall Street Journal Accounting Educators' Review on July 22, 2004 

TITLE: House Passes Curb on Expense Rules for Stock Options 
REPORTER: Michael Schroeder 
DATE: Jul 21, 2004 
TOPICS: Financial Accounting, Financial Accounting Standards Board, Stock Options

SUMMARY: The House approved legislation to limit expense treatment for stock options to only those granted to the top five officers of a company. This legislation responds to a standard proposed by the Financial Accounting Standards Board (FASB) requiring expense treatment for the value of all employee stock compensation. "The House vote gives the tech lobby, led by Cisco Systems Inc. and Intel Corp., a significant victory over a weighty list of policy makers who argued against Congress intruding in standard-setting...."

QUESTIONS: 1.) Describe the current accounting and reporting requirements for employee stock options. What standard establishes these requirements?

2.) Describe the changes proposed by the FASB in this area of accounting. Hint: you may verify your understanding of the proposal by reading the document on the FASB's web site at 

3.) Again reference the FASB's exposure draft via the following link  What were the FASB's reasons for proposing this change? Why hasn't this required accounting been implemented before now?

4.) What are Congress's reasons for proposing this legislation? Who supports the legislation?

5.) As a professional accountant, are you concerned about Congress passing laws regarding the development of accounting standards? Why or why not?

6.) Refer to the related article. How are the companies who support this legislation in Congress described as 'irresponsible'? How is this issue of stock compensation tied to stock buy back programs?

The House, responding to lobbying by technology companies, overwhelmingly approved a bill that would limit the required "expensing" of stock options.

The bill overrides a proposal by a national accounting-standards panel that would have required companies to expense the value of all stock options. In their 312-111 vote, the lawmakers instead approved legislation to limit the expensing rule to options granted only to the top five officers of a company. The Financial Accounting Standards Board had proposed earlier this year that companies subtract the value of all employee stock compensation from company profits.

The House vote gives the tech lobby, led by Cisco Systems Inc. and Intel Corp., a significant victory over a weighty list of policy makers who argued against Congress intruding in standard-setting in the wake of major accounting-fraud scandals beginning with Enron Corp.

Among strong supporters of stock-option expensing as a means to improve the accuracy of financial statements are Federal Reserve chairman Alan Greenspan, Treasury Secretary John Snow, and Securities and Exchange Commission William Donaldson. Mr. Greenspan warned Congress earlier this year "it would be a bad mistake for the Congress to impede FASB," because the proposed accounting for stock options "strikes me as correct."

Still, the measure faces stiff opposition in the Senate. Even though a comparable bill is pending in the Senate with 25 co-sponsors, Richard Shelby (R., Ala.), who chairs the banking committee, has pledged to block any effort by Congress to meddle in rule-making by FASB, an independent accounting-standards body based in Norwalk, Conn.

Sen. Peter G. Fitzgerald (R.,Ill.), joined by Sens. John McCain (R,., Ariz.), Carl Levin (D., Mich.) and Richard Durbin (D.,Ill), introduced a resolution to protect FASB's independence and integrity under its assault by the House. But critics of the bill say they are worried that House leadership may attempt to short-circuit the process by inserting an amendment in a must-pass appropriations bill that would derail FASB's stock-options proposal.

In approving the measure, a bipartisan roster of members argued that the proposal would cause hits to earnings, particularly for small technology companies, and hurt start-up companies that depend on stock options as an important compensation tool to attract talent. The accounting rule would mostly penalize the rank-and-file employees of small companies who depend on company stock for an important part of their compensation, bill supporters said.

TITLE: Microsoft Can Count. Intel Can't. 
REPORTER: Jesse Eisinger 
ISSUE: Jul 21, 2004 

Tech companies have a choice of two paths, and both were on display yesterday.

Microsoft Corp. -- long viewed by laymen, computer geeks and the feds as the Darth Vader of the technology world -- decided to do right by shareholders. After a long period of anticipation, the company finally figured out what it wants to do with its Olympian mound of green, and it chose wisely.

Microsoft decided to give back to shareholders even more cash than investors had been expecting. The company raised its ongoing dividend, giving the company about 1% dividend yield; said it would buy back $30 billion of stock over four years; and said it would issue a special $32 billion one-time payout. (See related article.)

And then there is the path of the irresponsible. It has been chosen by Intel Corp. and Cisco Systems Inc. and denizens of Silicon Valley. Nonetheless, these companies are celebrated by investors and accorded huge multiples. These are the companies that refuse to pay significant dividends, hoard cash and buy back stock merely to mask the massive dilution that comes from their shareholder-damaging stock-option programs.

As Microsoft was announcing its shareholder-friendly plan, Silicon Valley was sitting on the shoulders of members of Congress, whispering sweet nothings in their ears. As in, stock options cost nothing. And 312 members of the House listened.

That was the number of congressmen who voted for the Baker Bill, a measure that damages efforts of the Financial Accounting Standards Board to enact rules mandating the expensing of stock options. The bill violates FASB's independence and fights the inevitable. Hundreds of companies have moved to voluntarily expense stock options because compensation costs companies money -- no matter what Silicon Valley will have Congress believe.

Continued in the article

Bob Jensen's threads on stock option accounting controversies are at


"Morgan Stanley Is Fined Over Bad-News Delay," by Susanne Craig, The Wall Street Journal, July 30, 2004, Page C1 ---,,SB109111883749277775,00.html?mod=home_whats_news_us 

Morgan Stanley agreed to a $2.2 million fine to resolve allegations that it dragged its feet in disclosing 1,800 incidents of customer complaints and more serious misconduct involving its stockbrokers, the first of many such cases that securities cops say they plan to bring against Wall Street firms.

The National Association of Securities Dealers, which launched an investigation into the delays several months ago, charged Morgan Stanley for supervisory failures relating to the late filings and barred it from registering new brokers for one week. It also required the firm to hire an independent consultant to review its supervisory systems and procedures in this area. In settling, Morgan Stanley neither admitted nor denied the allegations.

This is the largest fine levied against a securities firm for the tardy filing of paperwork. While $2.2 million is pocket change for a big brokerage firm, the action is about more than money: It is a public embarrassment to a firm of Morgan Stanley's stature.

"A .320 batting average in baseball may be pretty good, but getting it right 32% of the time when it comes to this type of information that investors are entitled to is woefully inadequate," said Barry Goldsmith, the NASD's executive vice president for enforcement. Of the 1,800 tardy filings, more than half -- 52% -- were more than 90 days late.

The NASD said Morgan Stanley's late filings delayed several regulatory investigations and may have compromised state securities regulators' ability to review applications from brokers changing firms.

A Morgan Stanley spokeswoman said: "We began to implement a program of corrective action [on its filings] prior to finalizing this agreement and are moving quickly to conclude that process."

Continued in the article

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

"Trillion Dollar Bet"
Nobel Prize Winners (Myron Scholes from Stanford, Robert Merton from Harvard) Must Pay Millions Due to Tax Fraud

"Judge's Ruling In LTCM Case May Resonate," by Diya Gullapalli and Henny Sender, The Wall Street Journal, . August 30, 2004; Page C1

A federal judge Friday ruled against a defunct hedge fund whose name has become synonymous with the concept of "systemic risk," in a decision that singled out a Nobel Prize winner for criticism and that could have implications for other hedge funds seeking to avoid taxes.

Judge Janet Bond Arterton denied Long-Term Capital Management's attempt to reclaim $40 million in taxes, ending a monthlong civil trial involving the fund that was wound down in 1998. Her ruling upheld an Internal Revenue Service claim that the fund had filed improper deductions.

In a nearly 200-page opinion from her bench in New Haven, Conn., Judge Arterton outlined why she believed tax shelters employed by LTCM lacked the business purpose required to make them legal. She ruled that the fund engaged in at least nine complex leasing transactions that didn't have economic substance and were instead designed mainly to create losses of $106 million to offset LTCM's tax burden.

The transactions, with acronyms such as CHIPS for Computer Hardware Investment Portfolio, and TRIPS, for Trucking Investment Portfolios, began in 1996 when LTCM swapped a stake in the fund for preferred stock of five U.S. companies.

That stock was owned by Onslow Trading & Commercial LLC, an entity based in the United Kingdom that acquired the preferred stock in exchange for what are known as lease-stripping and sale-lease-back transactions.

Judge Arterton's ruling means LTCM must pay roughly $16 million in IRS penalties, or 40% of the $40 million LTCM had been trying to reclaim. Because the U.S. tax code is enforced through civil litigation, no criminal charges are anticipated against the LTCM partners, who include high-profile finance whizzes such as John Meriwether, the ex-Salomon Brothers bond boss who started the fund and Nobel Prize winner Robert Merton.

A lawyer for LTCM didn't return calls seeking comment.

The tax-shelter strategies at LTCM were run mainly by Myron Scholes, who shared the Nobel Prize with Mr. Merton. Dr. Scholes worked on option pricing captured in the Black-Scholes model widely used on Wall Street.

Dr. Scholes was cast in a harsh light in Judge Arterton's opinion.

The judge wrote that Dr. Scholes and Larry Noe, a tax director at LTCM, were "well aware of the tax requirements of economic substance and business purpose and discussed the need therefore to figure out a reason independent of taxes for Long Term to engage in a transaction."

Dr. Scholes couldn't be reached to comment.

"This ruling sends a message that cannot be mistaken that the government means business when cracking down on tax shelters," says Itzhak Shirav, an accounting professor at Columbia Business School in New York. "This was a clear-cut case where lame excuses were offered and totally rejected."

Judge Arterton's ruling is the latest criticism of tax shelters and part of the government's broader effort to crack down on such schemes.

Both the IRS and Treasury Department have issued notices criticizing transactions in which advisers used offshore insurance companies to create tax shelters for hedge-fund investments.

Some experts say the ruling could also provide ammunition for critics to demand more disclosure on how often-secretive hedge funds generate returns.

Judge Arterton's ruling was as a sober footnote to the saga of LTCM, which opened for business in February of 1994 with more than $1 billion in equity capital, $150 million of which came from 12 founding partners.

Those partners included the best and the brightest of the then Salomon Brothers bond-trading desk, led by Mr. Meriwether and Messrs. Merton and Scholes. Within several years, the fund's capital had swelled to $5 billion, making it bigger -- and more profitable -- than Salomon.

LTCM seemed to have delivered on its promise to produce stellar returns with low risk. In 1995, its first full year of operation, it returned almost 59%. By 1997, however, returns were down to about 20%, as the price discrepancies the fund looked to exploit were fast disappearing, and the Asian financial crisis was unfolding.

To compensate, the fund began using more borrowed money -- a strategy that exacerbated the impact of the fund's collapse in 1998.

By then, LTCM had assets of $100 billion but $1 trillion worth of total exposure.

Then came the Russian debt crisis, triggering a loss in the value of LTCM's leveraged positions world-wide and raising the possibility that the fund's problems could trigger a chain of losses.

That led the Federal Reserve Bank of New York to orchestrate an orderly liquidation of its trades to prevent the so-called global systemic risk.

Today, Mr. Scholes is an emeritus professor at Stanford University's Graduate School of Business in Palo Alto, Calif., while Mr. Merton is on the faculty of Harvard University's Graduate School of Business Administration.

Mr. Meriwether is a principal and co-founder of JWM Partners LLC, an investment firm in Connecticut.

You can read more about the rise and fall of Long-Term Capital Management at 

There is a tremendous (one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova video called "Trillion Dollar Bet" explaining why LTCM collapsed.  Go to 
This video is in the media libraries on most college campuses.  I highly recommend showing this video to students.  It is extremely well done and exciting to watch.

One of the more interesting summaries is the Report of The President’s Working Group on Financial Markets, April 1999 --- 

The principal policy issue arising out of the events surrounding the near collapse of LTCM is how to constrain excessive leverage. By increasing the chance that problems at one financial institution could be transmitted to other institutions, excessive leverage can increase the likelihood of a general breakdown in the functioning of financial markets. This issue is not limited to hedge funds; other financial institutions are often larger and more highly leveraged than most hedge funds.

What went wrong at Long Term Capital Management? --- 

The video and above reports, however, do not delve into the tax shelter pushed by Myron Scholes and his other LTCM partners. A nice summary of the tax shelter case with links to other documents can be found at 

The above August 27, 2004 ruling by Judge Janet Bond Arterton rounds out the "Trillion Dollar Bet."

Sharing Professor of the Week:  What He Shares is GREAT!


The Finance Professor (Jim Mahar from Penn State) --- 


NEW!!!  Mini Summaries (glorified abstracts) from past newsletters!  GREAT for class.  Note some links are no longer valid as once the articles are publish in paper format, some journals remove the link.  However, that said, the links are still worth your time!  Great way to stay abreast of what is going on! --- 


Accounting --- 

 Short Reviews of Academic Articles 
Appeared in September 25th, 2003 newsletter

OUCH, This one is going to be controversial! Just don’t blame the messenger! ;) In a hard hitting article Kane looks at the accounting profession and does not like what he finds. After laying out “an unremitting flood of accounting scams” he “traces a major part of the problem to the flawed ethics of the accounting profession” Which he claims “by designing and certifying reporting options that help troubled firms and rouge managers to conceal adverse information from outside stakeholders, the highly concentrated accounting industry manages to insulate fro serious sanctions the economic rents it can earn from cleverly abetting deceitful behavior.” Wow. This one is definitely worth reading and discussing. 

>Appeared in August 27th, 2003 newsletter

Conservatism is under attack from certain circles. For example, some (including even the FASB) are now suggesting it may be better to abandon conservatism in order to show more unbiased financial statements. In a surprisingly interesting article (NOTHING personal, but come on, it is about accounting conservatism!) Ross Watts looks at this issue and examines conservatism both from a both an historical/theoretical perspective as well as by reviewing the empirical literature on the subject. 

>Appeared in June 5th, 2003 Newsletter

What happened in the financial markets when Andersen got in trouble? Chaney and Philipich reported in the Journal of Accounting Research(2002) that stock prices of Andersen audited clients fell further than those of Non Andersen audited clients. Now Callen and Morel give lukewarm confirmation of this stock price drop by finding that over the entire 4 month period there was a price significant price decline, but they find mixed results in looking at other windows. Overall, it does look like stock prices fell for Andersen audited firms. 

In a related paper, two guys named Godbey and Mahar (yeah you may have heard of them) look at implied volatilities and found that the implied volatilities of equity options on Andersen audited firms’ stock went up. This fits the hypothesis that auditor quality can be used to reduce information asymmetry and when Andersen’s reputation suffered, the risk (as measure by implied volatility), also went up. 

>Appeared in March 3rd, 2003 newsletter

Given the many stories of aggressive practices and even fraud, here is somewhat surprising paper by Ross Watts of the University of Rochester. He finds that conservatism is still alive and well in accounting. 

>Appeared in January 22nd, 2003 newsletter

Is earnings management always bad? No, if you believe the new paper by Arya, Glover, and Sunder. They point out that Earnings management can in reduce the noise inherent in earnings and thereby reduce investor uncertainty. To quote the paper “ a smooth car ride is not only comfortable, it also assures the driver of the driver’s expertise.” Moreover, too much transparency may reduce incentives of managers. (I must say that there are some good points, but overall I would still argue on the side of more, not less transparency and therefore less earnings management.) 

>Appeared in December 3rd, 2002 newsletter

Gee, from the first two you can probably figure what my next paper (with Jonathan Godbey) is going to be on.

It is always cool when things work as financial theory (which I dare say is just economic theory) suggest. Imagine you are an auditor and your reputation is on the line when you perform an audit. Risky firms have a greater chance of hurting your reputation, so you are reluctant to perform the audit. What do you do? Charge more. (more risk, more return). That is the finding of John Lyon and Mike Maher (no relation, and he spells his name wrong ;-) ) who looked at foreign firms and found where the risk was higher, so too were the audit fees. Now the study is not conclusive (they look at risk of bribery in developing nations), but it is consistent with previously published work by Bell, Landsman and Shackelford. 

Ok, so do auditors matter? Yes. That is the conclusion of two recent papers that have looked at the stock price reactions following the Enron debacle. In each (Chaney and Philipich in the Journal of Accounting Research) and Asthana, Balsam, and Krishnan found that Andersen audited experienced a more pronounced negative stock price decline than firms audited by other accounting firms. 

>Appeared in September 3rd, 2002 newsletter

Butler, Kraft, and Weiss look at the frequency at which firms report earnings and the corresponding speed at which the information is incorporated into the stock price. Not surprisingly, those firms that reported quarterly have a faster price adjustment than those that report annually. Additionally, the paper looks at those firms that report more often voluntarily as opposed to those mandated to report more often. The results suggest that the mandatory reporters derive less benefit from the increased frequency, which suggests that the firms with high information asymmetry self-select to report more regularly. This finding may call into question the effectiveness of imposed mandates on increasing report frequency. (That said, I would still vote for more often reporting in order to shine the light on those few firms that deliberately relish in their information asymmetries.) 


Bob Jensen's threads on how to detect and report frauds --- 

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: