Did Sir Isaac Newton and Gottfried Leibnitz Plagiarize?
Dr George Gheverghese Joseph from The University of Manchester says the 'Kerala School' identified the 'infinite series'- one of the basic components of calculus - in about 1350. The discovery is currently - and wrongly - attributed in books to Sir Isaac Newton and Gottfried Leibnitz at the end of the seventeenth centuries. The team from the Universities of Manchester and Exeter reveal the Kerala School also discovered what amounted to the Pi series and used it to calculate Pi correct to 9, 10 and later 17 decimal places. And there is strong circumstantial evidence that the Indians passed on their discoveries to mathematically knowledgeable Jesuit missionaries who visited India during the fifteenth century. That knowledge, they argue, may have eventually been passed on to Newton himself. Dr Joseph made the revelations while trawling through obscure Indian papers for a yet to be published third edition of his best selling book 'The Crest of the Peacock: the Non-European Roots of Mathematics' by Princeton University Press.
"Indians predated Newton 'discovery' by 250 years ," PhysOrg, August 14, 2007 --- http://physorg.com/news106238636.html

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

Question
Guess which parents most strongly object to grade inflation?
Hint: Parents Say Schools Game System, Let Kids Graduate Without Skills

The Bredemeyers represent a new voice in special education: parents disappointed not because their children are failing, but because they're passing without learning. These families complain that schools give their children an easy academic ride through regular-education classes, undermining a new era of higher expectations for the 14% of U.S. students who are in special education. Years ago, schools assumed that students with disabilities would lag behind their non-disabled peers. They often were taught in separate buildings and left out of standardized testing. But a combination of two federal laws, adopted a quarter-century apart, have made it national policy to hold almost all children with disabilities to the same academic standards as other students.
John Hechinger and Daniel Golden, "Extra Help:  When Special Education Goes Too Easy on Students," The Wall Street Journal, August 21, 2007, Page A1 ---  http://online.wsj.com/article/SB118763976794303235.html?mod=todays_us_page_one

Bob Jensen's threads on grade inflation are at http://www.trinity.edu/rjensen/Assess.htm#GradeInflation

Dirty Tricks Played on Job Seekers
Job hunters using Monster.com, the employment Web site owned by Monster Worldwide, received fake job offers by e-mail that asks for their Bank of America account information. The e-mail contains personal information collected when hackers tricked Monster.com customers into downloading a virus in a fake job-seeking tool, according to researchers at Symantec, the world's biggest maker of security software.
Rochelle Garner, "Monster.com Users Get Fake Offers And Request," The Washington Post, August 23, 2007, Page D04 --- Click Here

Question
Where are the next frontiers of installing malicious viruses on your computer?
What video sites are the most likely places to catch these bad viruses?

Answer
Since email users have become more cautious about opening email, the next frontiers are bound to be popular downloads outside of email. These include videos and wikis. The most likely place to catch these bad viruses are porn sites, particularly the many porn sites maintained by Russians and former Eastern Bloc countries. But there are many other dangerous porn sites as well.

"Online video players could become new vehicle for malicious code," MIT's Technology Review, October 2, 2007 --- http://www.technologyreview.com/Wire/19469/?nlid=578

Online videos aren't just for bloopers and rants -- some might also be conduits for malicious code that can infect your computer.

As anti-spam technology improves, hackers are finding new vehicles to deliver their malicious code. And some could be embedded in online video players, according to a report on Internet threats released Tuesday by the Georgia Tech Information Security Center as it holds its annual summit.

The summit is gathering more than 300 scholars and security experts to discuss emerging threats for 2008 -- and their countermeasures.

Among their biggest foes are the ever-changing vehicles that hackers use to deliver ''malware,'' which can silently install viruses, probe for confidential info or even hijack a computer.

''Just as we see an evolution in messaging, we also see an evolution in threats,'' said Chris Rouland, the chief technology officer for IBM Corp.'s Internet Security Systems unit and a member of the group that helped draft the report. ''As companies have gotten better blocking e-mails, we see people move to more creative techniques.''

With computer users getting wiser to e-mail scams, malicious hackers are looking for sneakier ways to spread the codes. Over the past few years, hackers have moved from sending their spam in text-based messages to more devious means, embedding them in images or disguised as Portable Document Format, or PDF, files.

''The next logical step seems to be the media players,'' Rouland said.

There have only been a few cases of video-related hacking so far.

One worm discovered in November 2006 launches a corrupt Web site without prompting after a user opens a media file in a player. Another program silently installs spyware when a video file is opened. Attackers have also tried to spread fake video links via postings on YouTube.

That reflects the lowered guard many computer users would have on such popular forums.

''People are accustomed to not clicking on messages from banks, but they all want to see videos from YouTube,'' Rouland said.

Another soft spot involves social networking sites, blogs and wikis. These community-focused sites, which are driving the next generation of Web applications, are also becoming one of the juiciest targets for malicious hackers.

Computers surfing the sites silently communicate with a Web application in the background, but hackers sometimes secretly embed malicious code when they edit the open sites, and a Web browser will unknowingly execute the code. These chinks in the armor could let hackers steal private data, hijack Web transactions or spy on users.

Tuesday's forum gathers experts from around the globe to ''try to get ahead of emerging threats rather than having to chase them,'' said Mustaque Ahamad, director of the Georgia Tech center.

They are expected to discuss new countermeasures, including tighter validation standards and programs that analyze malicious code. Ahamad also hopes the summit will be a launching pad of sorts for an informal network of security-minded programmers.

"Online Videos May Be Conduits for Viruses," by Greg Bluestein, The Washington Post, October 2, 2007 --- Click Here

Online videos aren't just for bloopers and rants _ some might also be conduits for malicious code that can infect your computer.

As anti-spam technology improves, hackers are finding new vehicles to deliver their malicious code. And some could be embedded in online video players, according to a report on Internet threats released Tuesday by the Georgia Tech Information Security Center as it holds its annual summit

The summit is gathering more than 300 scholars and security experts to discuss emerging threats for 2008 _ and their countermeasures.

Among their biggest foes are the ever-changing vehicles that hackers use to deliver "malware," which can silently install viruses, probe for confidential info or even hijack a computer.

"Just as we see an evolution in messaging, we also see an evolution in threats," said Chris Rouland, the chief technology officer for IBM Corp.'s Internet Security Systems unit and a member of the group that helped draft the report. "As companies have gotten better blocking e-mails, we see people move to more creative techniques."

With computer users getting wiser to e-mail scams, malicious hackers are looking for sneakier ways to spread the codes. Over the past few years, hackers have moved from sending their spam in text-based messages to more devious means, embedding them in images or disguised as Portable Document Format, or PDF, files.

Continued in article

Storm Worm:  The Perfect Email Storm

"The Worm That Roared," by Lev Grossman, Time Magazine, September 27, 2007 --- http://www.time.com/time/magazine/article/0,9171,1666279,00.html

During the week of Jan. 15, an innocuous-looking e-mail appeared in thousands of inboxes around the world. Its subject line read, "230 dead as storm batters Europe." The e-mail came with a file attached, bearing a plausible-sounding name like Full Story.exe or Read More.exe. Plenty of people clicked on it. After all, storms really were battering Europe at the time; that week high winds and rain had killed 14 in the U.K. alone. But all great cons have a grain of truth in them somewhere.

 

The file that arrived with the e-mail was, of course, a computer virus, immediately christened the Storm Worm by the Finnish computer security firm F-Secure, which was among the first to spot it. Since then, the Storm Worm has proved remarkably hard to kill. Nine months later, it's still out there, infecting something like a million computers worldwide. It's not the most damaging virus in history, but it may be the most sophisticated. Whoever created it is to viruses what Michelangelo was to ceilings.

The Storm Worm is a marvel of social engineering. Its subject line changes constantly. Whoever produced it--and its many later variants--has a lively feel for the seductive come-on and a thorough grounding in human nature. It preys on shock ("Saddam Hussein Alive!") and outrage ("A killer at 11, he's free at 21 and ...") and prurience ("Naked teens attack home director") and romance ("You Asked Me Why"). It mutates at a ferocious rate, constantly changing its size and tactics to evade virus filters, and finds evolving ways to exploit other online media like blogs and bulletin boards. Newer versions might contain, instead of a file, a single link to a fake YouTube page, which crashes your browser while quietly slipping the virus into your computer. "I've heard people talk about this like virus 2.0, just like people talk about Web 2.0, because it's so different from the traditional attacks," says Mikko Hypponen, chief research officer of F-Secure. "It's probably the largest collection of infected machines we've ever seen."

Like any good parasite, the Storm Worm doesn't kill its host. In fact, most of the victims--some of whom are undoubtedly reading this article--will never know their machines are infected. It doesn't cripple your computer (and can be removed once identified), but the Storm Worm does give its authors the power to quietly control your computer. What do they do with this power? Mostly they send out spam. Back in the day, computer viruses were a relatively innocent affair, written as pranks by teenagers with too much time on their hands between Star Wars sequels. Now they're written by organized criminals looking to make money from fake offers.

Nobody knows who's behind the Storm Worm. F-Secure suspects a group based in Russia, but there's no way to be sure, and recent Storm Worm subject lines referring to Labor Day and the start of the football season suggest that those involved have an American connection. What is certain is that they are very smart--prodigious innovators engaged in a cat-and-mouse game with security firms that so far they're winning. "I don't think these guys have day jobs," says Hypponen. "They're really active and really closely watching us. I don't see them stopping anytime soon."

It's also clear that they've been pulling their punches. Right now the Storm Worm gang controls a massive amount of computing power, as much as some of the world's largest supercomputers, and all they do with it is send out spam and conduct the occasional denial-of-service attack (bombarding a specific server with traffic until it shuts down). We're lucky: so far they haven't gone in for more lucrative, damaging activities like online gambling, stock scams and stealing passwords and credit-card information. Is it possible that even a worm can have a conscience?

Bob Jensen's threads on computing and networking security are at http://www.trinity.edu/rjensen/ecommerce/000start.htm

Bob Jensen's best advice at this point in time --- Buy a Mac!

Question
Why has whistleblower protection under the Sarbanes-Oxley Law failed so miserably?

Sarbox's whistleblower provisions were intended "to prevent recurrences of the Enron debacle and similar threats to the nation's financial markets" by protecting those who report fraudulent activity that could damage innocent investors. That was the intent, at least. The reality is something else. About 1,000 whistleblowing claims have been filed under Sarbox. Only 17 were determined after federal investigation to have merit and only six of this group have kept their wins after full evidentiary hearings before administrative law judges. Nevertheless, the plaintiffs bar and others have ready answers for this extremely poor batting average. Critics assert that the 90-day statute of limitation for filing whistleblower claims is too short, the burden of proof placed on complaining employees is too high, that judges are reading the law too narrowly, or even that, as one law professor testified, the whistleblower provisions have "has failed to protect the vast majority of employees who file a Sarbanes-Oxley claim" because they rarely win.
Michael Delikat, "Blowing the Whistle on Sarbox," The Wall Street Journal, August 23, 2007; Page A10 --- http://online.wsj.com/article/SB118783189154206113.html

Bob Jensen's threads on the sad state of whistleblower protections are at http://www.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

Question
Why is SAS 99 fundamentally changing the role of the external auditor in detecting and disclosing fraud, including fraud that may not pass the materiality test as far as the aggregate financial statements are concerned?

Recent professional guidance, such as SAS 99, Consideration of Fraud in a Financial Statement Audit, and Public Company Accounting Oversight Board Auditing Standard 2, has brought more attention to the auditor's responsibility to uncover the warning signs of fraud, but there is still some ambiguity about where the auditor's responsibility ends and the fraud examiner's begins.
AccountingWeb, September 2007 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=104036

Consider this scenario: A staff auditor reviewed various accrual accounts during a routine audit. He uncovered 10 manual entries made after the quarter's close that lacked sufficient supporting documentation and that significantly reduced the reserve balance for each account. The auditor reviewed the entries in the system and found the same explanation for each reduction: "reduce accrual by $1.5 million, per John Davies, corporate controller." The total amount of reductions came to $15 million, and was material to the financial statements of the company.

The auditor brought this information to the audit manager, who advised him to discuss the entries with the corporate controller. The controller provided verbal support for each entry. The auditor had no reason to disbelieve the controller, so he cited the lack of supporting documentation as an audit finding and completed the report. Six months later, news came out that the controller was adjusting various accrual accounts to manipulate earnings. The auditor was distraught about the situation, and questioned his or her conduct and the audit procedures. The audit manager was asked to explain why the audit team did not pursue the findings and press for supporting documentation. The controller was terminated, and the company underwent an investigation by the Securities and Exchange Commission (SEC). The auditor continued to wrestle with himself: "I'm an auditor, not an investigator….right?" Auditors and forensic accountants share common attributes, but their roles differ significantly. Sometimes it can be difficult for auditors to understand their responsibilities for fraud detection, investigation, and prevention. Generally, companies call in a fraud examiner to conduct an investigation once fraud is suspected, but the auditor is the person who initially finds the red flags of potential fraud.

The auditor's role in fraud detection has a long history of confusion and controversy. In 1892, the widely used auditing textbook A Practical Matter for Auditors, by Lawrence Dicksee, expressed the view that the objective of an audit was the detection of fraud, technical errors, and errors of principle. It stated, "the detection of fraud is the most important portion of the auditor's duties." Shortly thereafter, the auditor's role in fraud detection started to evolve. In an 1895 British court case (London and General Bank), the court ruled that it was the auditor's responsibility to report to shareholders all dishonest acts, but that the auditor could not be expected to uncover all fraud committed in a company, although they should conduct all audits with reasonable care. Fast-forward to the 21st Century. The nature of the auditor's responsibility to detect fraud is still the subject of confusion. For example, a 2003 study of prospective jurors conducted by Camico, a provider of CPA malpractice insurance, found that 74 percent of respondents believe audits are designed to uncover all types of fraud. In fact, according to a 2006 Association of Certified Fraud Examiners (ACFE) Report, Report to the Nation on Occupational Fraud and Abuse, only 12 percent of fraud is initially detected by external auditors, while 50 percent came from employee tips, 20 percent came from internal audits, and 19 percent was detected by internal controls.

Responsibilities

The management of public companies is required by PCAOB Auditing Standard 2 to develop and implement internal controls to prevent, detect, and deter incidents of fraud in financial reporting, and Section 404 of the Sarbanes-Oxley Act requires management to assess and report on the effectiveness of those internal controls on an annual basis.

Continued in article

Jensen Comment
External auditors are not even close to being the main source of initial detections of frauds. A much better source for early on fraud detection is a whistleblower within the organization being audited. The Sarbanes-Oxley Law in theory affords some protection for whistleblowers, but in reality SOX has been lousy at protecting whistleblowers --- http://www.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing
Also see http://www.trinity.edu/rjensen/ecommerce/eitf01.htm#BillAndHold

In general fraud examination is still fundamentally different from auditing in spite of SOX ---
http://www.amazon.com/Principles-Fraud-Examination-Joseph-Wells/dp/0471517089

Bob Jensen's threads on the professional responsibility of auditors are at http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

"The Six Signs of Internal Fraud," by Peter Goldmann --- http://accounting.smartpros.com/x59050.xml

However, we can see the signs of fraud, Albrecht said in a speech at the 18th Annual ACFE Fraud Conference. There are six signs in all organizations. By understanding them and looking for them, we significantly improve our chances of detecting and reporting fraud.

Accounting anomalies—representing such countless red flags as inventory shortages, unrecorded transactions, unusual levels of returns, etc.

Internal control weaknesses. These equate to opportunities for insiders to commit fraud. If you identify a weakness, chances are that someone will exploit it if they haven’t already.

Analytical symptoms. When a business function occurs at the wrong time, or is conducted by the wrong person or a similar operational anomaly occurs, chances are it is a sign of fraud.

Lifestyle symptoms. Employees living beyond their means is the most common. Smart internal fraudsters would steal and save. But most steal and spend. When you notice signs of extravagant lifestyle, you’re most likely looking at a sign of fraud.

Behavioral symptoms. People who stop looking you in the eye, sweat more than usual, come in earlier than usual and/or stay late should be monitored as potential fraudsters.

Tips and complaints. When employees report actual or suspected incidents of fraud among their co-workers or bosses, you’ve got good reason to start following up with a search for hard evidence.

Bob Jensen's threads on fraud detection and reporting are at http://www.trinity.edu/rjensen/FraudReporting.htm

Bill-and-Hold Revenue Recognition Tale
Anthony Menedez phoned me several times indicating that he thinks his tale would be interesting for accounting students to study. I think it would be an interesting series of events for a case writer to put into an educational case. The focus of the case, in my viewpoint, should be on a comparison of the KPMG article (quoted below) with the actual bill-in-hold transactions at Halliburton to force students to decide whether KPMG auditors and  Halliburton did or did not violate GAAP on these issues.

A financial press article is also quoted below:
Jonathan Weil, "Halliburton's Accounting Might Make You Wonder," Bloomberg News, July 21, 2007

The case has two really interesting questions:

1. What is the proper accounting (and auditing) for these transactions?
2. Is "whistleblower protection" under the Sarbanes-Oxley law an oxymoron?

June 24, 2007 message from Anthony Menendez [menendez.anthony@gmail.com]

Professor Jensen-

Hello. My name is Tony Menendez. I have enjoyed much of the information you have so generously provided on the web covering accounting issues and financial fraud. I thought you might find my Sarbanes-Oxley whistleblower case interesting. Just in case you have extra time and an interest, I am providing you with my contact information and links to some information concerning my case. I hope you are enjoying retirement but have not given up providing your insight into the ever so important area of accounting and financial fraud.

Sincerely,

Tony (713) 822 3764

Here are a few links to information you can find on the web concerning my case:

http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_weil&sid=am_McfuM6i4o 

You can read Menendez's complaint in three parts (I, II, III) on the following website:
http://www.tpmmuckraker.com/archives/003500.php

Question
In accounting, what do the following terms mean and in what context?
bill-and-hold?
Ship-in-Place?

Answer
"Bill-and-Hold Transactions in the Oilfield Services Sector," John C. Christopher, KPMG LLP --- http://www.trinity.edu/rjensen/BillandHold.pdf

Determining and defining appropriate revenue recognition has been a primary focus of companies, regulators, standard setters, and auditors in recent years. Improper revenue recognition has been one of the leading causes of financial statement restatements. Perhaps no area of revenue recognition has received as much scrutiny as "bill-and-hold" transactions. Also known as "ship-inplace" transactions, these transactions generally refer to scenarios where revenue is recognized after a seller has substantially completed its obligations under an arrangement, but prior to the buyer, or a common carrier, taking physical possession of the goods.

Background In a recent interview, former SEC Chairman Arthur Levitt referred to recognizing revenue on bill-and-hold transactions as "hocus pocus accounting." He said, "Companies try to boost revenue by manipulating the recognition of revenue. Think about a bottle of wine.You wouldn't pop the cork on that bottle until it was ready. But some companies are doing this with their revenue --- recognizing it before the sale is complete, before the product is delivered to the customer, or at a time when the customer still has options to terminate, void, or delay the sale.

Although the bill-and-hold transaction is not a GAAP violation, unfortunately it has long been associated with incidents of financial fraud. In its October 2002 Report, the General Accounting Office (GAO) said that revenue recognition is the largest single issue involved in restatements. More than half of financial reporting frauds involve the overstatement of revenue, and restatements for revenue recognition have resulted in the largest drops in market capitalization compared with any other type of restatements. There remains an intense scrutiny around a company's revenue recognition principles for these types of transactions, and management and auditors should be unusually skeptical about the appropriateness of recording revenue for these transactions.

Bill-and-hold scenarios frequently arise in the oilfield services sector. It is important to note that the form. of these transactions is neither illegal nor unethical. In fact, most have very good business or economic purposes. For example, there is currently a trend in the oil and gas industry towards developing fields in the deep waters toward the Gulf of Mexico or other more remote locations throughout the world. Development plans for these large deepwater offshore fields. as well as remote onshore fields throughout the world, will commonly have long timelines; therefore, the oilfield service companies have long lead times for delivery of equipment and products. As the development plan gets under way, many of the original timelines and milestones will change along the way as information about the reservoir becomes better. However, many of the products that the oilfield services companies manufacture and deliver are extremely capital intensive and will be manufactured and ready for their fixed delivery dates without regard to any changes in the development plan. These products are generally very large built-tosuit equipment such as wellhead connection equipment and completion products.

There are certain criteria that companies must meet in order to recognize revenue on bill-and-hold transactions. These criteria relate to the risks of ownership. the commitment and request on the part of the buyer, the business purpose of the transaction, the delivery date, and the performance obligations, among others (these criteria are discussed in more detail in the next section). As an example, an oilfield services company may complete the manufacturing of the customer's requested products, have them shipped to a company-owned warehouse, determine a fixed delivery schedule to the customer's well site, obtain a legal acknowledgement from the customer that the risk of loss has been transferred, and have no additional obligations to perform such as installation of the equipment. All of this may take place prior to the particular point in the well development plan that calls for the installation of the product. In this example, the oilfield services company might (although only based on careful analysis of the SEC and FASB guidance related to bill-and-hold transactions) be able to recognize revenue immediately upon completing the manufacturing process and meeting all of the bill-and-hold revenue recognition criteria.

SEC and FASB Guidance on Revenue Recog'nition and Bill-and-Hold Arrangements
EITf- lssue 00.21: Multiple Elements in a bill-and-hold Arrangement

Companies must first apply the separation model described in ElTF lssue 00-21 , Revenue Arrangements with Multiple Deliveries, to determine the number of units of accounting in the bill-and-hold arrangement. Bill-and-hold arrangements in this industry can include both the sale of products and the performance of certain services, such as warehousing for the product if it is shipped to a company-owned warehouse. If the SEC staff's revenue recognition criteria (discussed in the next section) are met for the product element in the bill-and-hold arrangement, revenue may be recognized on the product element when the company has completed the product only if it is a separate unit of accounting, or if there are any services involved in the transaction (e.g., warehousing), and those services are inconsequential or perfunctory to one unit of accounting. The company may need to consider whether the services are a separate unit of accounting, if they are inconsequential or perfunctory, and whether there are other performance obligations yet to be performed in determining the appropriate revenue recognition policy for the entire arrangement.

Inconsequential or Perfunctory Element

According to SAB No. 104, Revenue Recognition, if the-undelivered element is both inconsequential or perfunctory and not essential to the functionality of the delivered element, it would be appropriate to recognize revenue on the arrangement at the time of delivery and accrue the cost of providing the services related to the undelivered element. However, if the undelivered element is neither inconsequential nor perfunctory or is essential to the functionality of the delivered element, the revenue for the delivered element should be deferred and recognized based on the accounting requirements of the undelivered element. The SEC's guidance on the determination of whether an element is inconsequential or perfunctory is related to whether that element is essential to the functionality of the delivered products.

In addition, remaining activities would not be inconsequential or perfunctory if failure to complete the activities would result in the customer receiving a full or partial refund or rejecting, or a right to a refund or to reject the products delivered. The SEC provided the following factors in SAB No.104, which are not all-inclusive, as indicators that a remaining performance obligation is substantive rather than inconsequential or perfunctory:

• The seller does not have a demonstrated history of completing the remaining tasks in a timely manner and reliably estimating their costs.
• The cost or time to perform the remaining obligations for similar contracts historically has varied significantly from one instance to another.
• The skills or equipment required to complete the remaining activity are specialized or are not readily available in the marketplace.
• The cost of completing the obligation, or the fair value of that obligation, is more than insignificant in relation to such items as the contract fee, gross profit, and operating income allocable to the unit of accounting.
• The period before the remaining obligation will be extinguished is lengthy.
• T he timing of payment of a portion of the sales price is coincident with completing performance of the remaining activity.

. . .

SEC Bill-and-Hold Criteria

The SEC has established specific criteria codified in SAB No. 104 that a seller of goods or equipment must meet to recognize revenue for a bill-and-hold transaction, including:

• The risks of ownership must have passed to the buyer.
• The buyer must have a commitment to purchase, preferably in written documentation.
•  The buyer, not the seller, must originate the request that the transaction be on a bill-and-hold basis.
• The buyer must have a substantial business purpose for ordering the goods or equipment on a bill-and-hold basis.
• Delivery must be for a fixed date and on a schedule that is reasonable and consistent with the buyer's purpose (this requirement will generally be difficult for an oilfield services company to meet due to the variable nature of the movement of timelines and milestones for oilfield development).
• The seller must not retain any significant specific performance obligations under the agreement such that the earnings process is not complete. The goods or equipment must be segregated from the seller's inventory and may not be subject to being used to fill other orders.
• The goods or equipment must be complete and ready for shipment.

The SEC emphasized that that the above criteria are not a simple checklist. A transaction might meet all of the criteria and still fail the revenue recognition guidelines . . .

Continued in article

Jensen Comment
Tony Menendez, while working for Halliburton, encountered what he considered a classic violation of GAAP for bill-an-hold transactions in Halliburton's oilfield operations. He says he first confronted his superiors in the company and then a KPMG auditor, who purportedly agreed with Tony on this issue. But Halliburton countered by saying that since "title passed," revenue could be recognized. The amount in terms of dollars was material in amount.

Since Halliburton did not restate its financial statements, or purportedly, its subsequent accounting for these transactions, Tony then took the added step of blowing the whistle with the SEC. The SEC purportedly turned it back to Halliburton for further internal investigation. Soon thereafter Tony Menendez became an unemployed whistle blower

Bill-and-Hold Revenue Recognition Tale
Anthony Menedez phoned me several times indicating that he thinks his tale would be interesting for accounting students to study. I think it would be an interesting series of events for a case writer to put into an educational case. The focus of the case, in my viewpoint, should be on a comparison of the KPMG article (quoted above) with the actual bill-in-hold transactions at Halliburton to force students to decide whether KPMG auditors at Halliburton did or did not violate GAAP on these issues.

By the way, Mr. Menedez is currently still unemployed and is considering applying for doctoral study in accountancy.

August 8, 2007 message from Anthony Menendez [menendez.anthony@gmail.com]

Please see attached. The very examples described by KPMG as bill-and-hold transactions at a company like Halliburton, were the same transactions, I also believed were bill-and-hold. Interestingly, Halliburton apparantly claims, that these transactions, are not, in fact bill-and-hold and thereby avoiding the bill-and-hold hold criteria which requires that the equipment is ready for its intended use, a fixed delivery date exists for the equipment, and that there are no ongoing obligations on the part of Halliburton ( e.g. installing the equipment and performing the necessary oilfield services, the typical services provided by an "oilfield service" company. Personally, I believe that Halliburton's claim is the most absurb argument I have ever seen and worse yet, I struggle to see how KPMG allows Halliburton to deviate from the very guidance it suggests to companies that are not "Halliburton" should apply. Enjoy.

Best Regards,
Tony

You can read Menendez's complaint in three parts (I, II, III) on the following website: ---
http://www.tpmmuckraker.com/archives/003500.php

Bob Jensen's threads on whistle blowing are at
http://www.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

Bob Jensen's threads on revenue reporting and frauds can be found at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

Here's an older example of bill and hold fraud
Death by Accounting
To get companies to participate in a flu vaccine stockpile the government is dangling tons of new funding. Cash in hand is usually a very strong incentive. But a Clinton administration SEC policy prevents the vaccine makers from recognizing the revenue until the vaccine is delivered to the doctors, countering the very purpose of a stockpile. The Department of Health and Human Services' National Vaccine Advisory Committee concluded in early 2005 that for the stockpile program to be successful, "the revenue recognition issue must be resolved as soon as possible." It all began in late 1999, when the SEC issued "Staff Accounting Bulletin 101," which it painted as a modest clarification "not intended to change current guidance in the accounting literature." But in reality it was a radical change to the way companies could book revenue from "bill and hold" orders. This change would, at its least, lead to hindrances for innovative new companies. At its worst, it would discourage production of lifesaving products like vaccines.
John Berlau, "Death by Accounting?" The Wall Street Journal, October 21, 2005 --- http://online.wsj.com/article/SB112985642561675193.html?mod=opinion&ojcontent=otep

SEC SAB 101 "Revenue Recognition in Financial Statements" --- http://www.sec.gov/interps/account/sab101.htm

Anthony Menendez, who was Halliburton's director of technical accounting research and training, has accused the world's second-largest oilfield-services company of using so- called bill-and-hold accounting and other undisclosed practices to ``distort the timing of billions of dollars in revenue.'' In short, Menendez says this allowed Halliburton to book product sales improperly, before they occurred.
Jonathan Weil, "Halliburton's Accounting Might Make You Wonder," Bloomberg News, July 21, 2007 --- Click Here

The allegations are part of a 54-page complaint Menendez filed against Halliburton with a Labor Department administrative- law judge in Covington, Louisiana, who released the records in response to a Freedom of Information Act request. Menendez, who resigned last year and is seeking unspecified damages, says Halliburton retaliated against him in violation of the Sarbanes- Oxley Act's whistleblower provisions after he reported his concerns to the Securities and Exchange Commission and the company's audit committee.

Halliburton has denied the allegations. A company spokeswoman, Cathy Mann, says Halliburton's audit committee ``directed an independent investigation'' and ``concluded that the allegations were without merit.'' She declined to comment on bill-and-hold issues, and Halliburton's court filings in the case don't provide any details about its accounting practices.

Menendez, a 36-year-old former Ernst & Young LLP auditor, filed his complaint in December, shortly after a Labor Department investigator in Dallas rejected his retaliation claim. Mann says the company expects to prevail at trial.

Cause of Concern

Investors, of course, will care more about the reliability of Halliburton's numbers than whether Menendez wins. And a look at internal Halliburton documents Menendez filed with the court suggests there's reason for concern.

Here's how Menendez, who reported to Halliburton's chief accounting officer, summed up the bill-and-hold issue in his complaint:

``For example, the company recognizes revenue when the goods are parked in company warehouses, rather than delivered to the customer. Typically, these goods are not even assembled and ready for the customer. Furthermore, it is unknown as to when the goods will be ultimately assembled, tested, delivered to the customer and, finally, used by the company to perform the required oilfield services for the customer.''

If true, that would violate generally accepted accounting principles. For companies to recognize revenue before delivery, ``the risks of ownership must have passed to the buyer,'' the SEC's staff wrote in a 2003 accounting bulletin. There also ``must be a fixed schedule for delivery of the goods,'' and the product ``must be complete and ready for shipment,'' among other things.

`Terribly Flawed'

Shortly after joining Halliburton in March 2005, Menendez says he discovered a ``terribly flawed'' flow chart on the company's in-house Web site, called the Bill and Hold Decision Tree. The flow chart, a copy of which Menendez included in his complaint, walks through what to do in a situation where a ``customer has been billed for completed inventory which is being stored at a Halliburton facility.''

First, it asks: Based on the contract terms, ``has title passed to customer?'' If the answer is no -- and here's where it gets strange -- the employee is asked: ``Does transaction meet all of the `bill and hold' criteria for revenue recognition?'' If the answer to that question is yes, the decision tree says to do this: ``Recognize revenue.'' The decision tree didn't specify what the other criteria were.

At Odds

In other words, Halliburton told employees to recognize revenue even though the company still owned the product.

You don't have to be an accountant to see the problem.

``The policy in the chart is clearly at odds with generally accepted accounting principles,'' says Charles Mulford, a Georgia Institute of Technology accounting professor, who reviewed the court records. ``It's very clear cut. It's not gray.''

Bill-and-hold was at the heart of Sunbeam Corp.'s collapse in the late 1990s, and later blowups at Qwest Communications International Inc. and Nortel Networks Corp.

It is possible to use bill-and-hold and comply with the rules. But it's hard. The customer, not the seller, must request such treatment. The customer also must have a compelling reason for doing so. Customers rarely do.

SEC Inquiry

Menendez, who now works as a consultant, also accuses Halliburton of improper accounting for income taxes, off-balance- sheet entities and foreign-currency adjustments. Court records show he first alerted the SEC's enforcement division in November 2005, three months before he complained to Halliburton's audit committee.

In a Jan. 3 court filing, Halliburton said the SEC had closed its inquiry into the company's accounting practices.

Menendez told me, though, that he met with SEC investigators at the agency's Fort Worth, Texas, office as recently as March 28. He also shared a March 14 letter from an enforcement-division attorney there, which shows the travel itinerary the SEC arranged for him to attend that meeting. Mann, the Halliburton spokeswoman, declined to comment on whether the company has been notified of further SEC inquiries into Menendez's allegations.

Halliburton seemed to quell doubts about its books back in August 2004, when it paid $7.5 million to settle a two-year SEC probe. The agency faulted Halliburton's disclosures, but not its accounting. As long as investors trust a company's profits, they generally don't care how the company earns them. If they begin to suspect they shouldn't, though, look out.

Bob Jensen's threads on whistle blowing are at
http://www.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

Bob Jensen's threads on revenue reporting and frauds can be found at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

SEC SAB 101 "Revenue Recognition in Financial Statements" --- http://www.sec.gov/interps/account/sab101.htm

Question
Why doesn't Section 401 of the Sarbanes-Oxley Act apply to attestation of internal controls in the World Bank?

"World Bank Reckoning," The Wall Street Journal, September 13, 2007; Page A16 --- http://online.wsj.com/article/SB118964274677625838.html

Since we're talking about the world's second most out-of-control international bureaucracy -- no prizes for guessing the first -- we shouldn't get our hopes up. But in the past week some prominent outsiders have been forcing the World Bank to reckon with the alien concept of accountability. Now it's up to new bank President Robert Zoellick to see that their efforts bear fruit.

First up is former Federal Reserve Chairman Paul Volcker. For the past five months, Mr. Volcker and a panel of international experts have been conducting an independent review of the Department of Institutional Integrity, the bank's anticorruption unit known internally as the INT. Their report, which readers can find on OpinionJournal.com, is being released to the public today.

In sober and measured terms, Mr. Volcker's report provides a devastating indictment of what it calls the bank's "ambivalence" toward both corruption and its own anticorruption unit. "There was then, and remains now, resistance among important parts of the Bank staff and some of its leadership to the work of INT," the report says (our emphasis).

It goes on to say that, "Some resistance is more parochial. There is a natural discomfort among some line staff, who are generally encouraged by the pay and performance evaluation system to make loans for promising projects, to have those projects investigated ex post, exposed as rife with corruption, creating an awkward problem in relations with borrowing clients." To put it more plainly, the report is saying that every incentive at the bank is to push more money out the door, and bank employees hate the anticorruption effort because it interferes with that imperative.

The report endorses the work of the INT, which was created a mere six years ago and which has been under what it calls a "particularly strong" institutional attack ever since. The INT, the Volcker panel says, "is staffed by competent and dedicated investigators who work hard and long hours with professionalism" and deploy "advanced investigative methods to detect and substantiate allegations of fraud and corruption." And it goes on to recommend that the anticorruption crusaders "should be nurtured and maintained as an exemplary investigative organization" within the bank.

In a phone interview yesterday, Mr. Volcker added that he gives "high marks" to current INT director Suzanne Rich Folsom. Mr. Volcker's endorsement should stop cold the recent attempts by some in the bank's entrenched bureaucracy to run Ms. Folsom out of the bank, as they did Paul Wolfowitz.

The bank is also being put on notice by the U.S. Senate through provisions in its foreign operations appropriations bill. The provision threatens to withhold 20% of U.S. funds to the bank's International Development Association arm (which provides interest-free loans to the world's poorest countries) until it is assured that the bank "has adequately staffed and sufficiently funded the Department of Institutional Integrity." The bill also demands that the bank provide "financial disclosure forms of all senior World bank personnel." Now, that will get the bureaucracy's attention.

Notably, it's a Democrat -- Evan Bayh of Indiana -- who's taken the lead on this issue. Mr. Bayh has ordered a Government Accountability Office report on the effectiveness of IDA loans and their susceptibility to corruption, the bank's procurement procedures, as well as the legendary pay packages enjoyed by its senior management. "There's a tendency [at the bank] to say 'just give us the money and go away,'" the Senator told us by phone yesterday. "Until there are some tangible consequences, they won't take us seriously. We shouldn't let that happen."

Continued in article

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

Note that there's a pretty good summary of the Sarbanes-Oxley Act at http://en.wikipedia.org/wiki/Sarbanes-Oxley

Graft in Military Contracts Spread From Base
Less than 24 hours later Major Cockerham was behind bars, accused of orchestrating the largest single bribery scheme against the military since the start of the Iraq war. According to the authorities, the 41-year-old officer, with his wife and a sister, used an elaborate network of offshore bank accounts and safe deposit boxes to hide nearly $10 million in bribes from companies seeking military contracts. The accusations against Major Cockerham are tied to a crisis of corruption inside the behemoth bureaucracy that sustains America’s troops. Pentagon officials are investigating some $6 billion in military contracts, most covering supplies as varied as bottled water, tents and latrines for troops in Kuwait, Iraq and Afghanistan.
Ginger Thompson and Eric Schmitt, The New York Times, September 24, 2007 --- http://www.nytimes.com/2007/09/24/world/middleeast/24contractor.html

While it won't sue Apple for Nancy Heinen's alleged backdating of options, the SEC does want to talk to CEO Steve Jobs, most likely about the timing of events
Though Apple (AAPL) was given a clean bill of health by regulators over its involvement in the backdating of stock options, the investigation of a former executive continues to dog Chief Executive Steve Jobs. Securities & Exchange Commission lawyers suing former Apple General Counsel Nancy Heinen over her alleged role in the matter have issued subpoenas to Jobs. The SEC has said it won't sue Apple over the backdating of grants, praising the company for its cooperation with the investigation. Attorneys say the company and current executives are unlikely to face criminal charges from the Justice Dept. or civil charges from the SEC.
Arik Hesseldahl, "SEC Subpoenas Jobs On Backdating," Business Week, September 20, 2007 --- http://www.businessweek.com/technology/content/sep2007/tc20070920_913875.htm?link_position=link2

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

IRS "Member Satisfaction Survey" is a Scam
The Internal Revenue Service has issued a consumer alert regarding a new, two-step e-mail scam that falsely promises recipients they will receive $80 for participating in an online customer satisfaction survey. In the scam, an unsuspecting taxpayer receives an unsolicited e-mail that appears to come from the IRS. The e-mail contains a URL linking to an online "Member Satisfaction Survey."
AccountingWeb, August 31, 2007 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=103950

August 31, 2007 reply from Ganesh M. Pandit, [profgmp@HOTMAIL.COM]

Today I received an email asking me to log on to a site in order to claim my income tax "refund"...$109.30! Just for fun, I clicked on the link given and was taken to a screen that asked for my name, SSN, birthdate, debit card number, PIN, expiration date and secret 3-digit code on the back of the card! :)

Of course, if you put your cursor over the link given in the scam email message, you can see the underlying "fake" web site location.

Ganesh

Bob Jensen's threads on tax scams are at http://www.trinity.edu/rjensen/FraudReporting.htm#TaxScams

Bob Jensen's tax helpers are at http://www.trinity.edu/rjensen/Bookbob1.htm#010304Taxation

CPA auditors have always considered their primary role as attesting to full and fair corporate disclosures to investors and creditors under Generally Accepted Accounting Principles (GAAP). Now it turns out that this extends, perhaps unexpectedly, to the government as well.

"How Accounting Rule (FIN 48) Led to Probe Disclosure of Tax Savings Firms Regard as Vulnerable Leaves Senate Panel a Trail," by Jesse Drucker, The Wall Street Journal, September 11, 2007; Page A5 ---
http://online.wsj.com/article/SB118947026768923240.html?mod=todays_us_page_one

The probe, by the Senate's Permanent Subcommittee on Investigations, appears to have been sparked by an accounting rule known as FIN 48, which took effect in January. The rule for the first time requires companies to disclose how much they have set aside to pay tax authorities if certain tax-cutting transactions are successfully challenged by the government. The disclosures require companies to attach a dollar figure to tax-savings arrangements they think could be vulnerable.

Although intended to inform investors, the disclosures also serve as a kind of road map for government authorities, guiding them to companies that may have taken an aggressive stance on tax-related arrangements.

The probe, by the Senate's Permanent Subcommittee on Investigations, appears to have been sparked by an accounting rule known as FIN 48, which took effect in January. The rule for the first time requires companies to disclose how much they have set aside to pay tax authorities if certain tax-cutting transactions are successfully challenged by the government. The disclosures require companies to attach a dollar figure to tax-savings arrangements they think could be vulnerable.

Although intended to inform investors, the disclosures also serve as a kind of road map for government authorities, guiding them to companies that may have taken an aggressive stance on tax-related arrangements.

The FIN 48 disclosures generally reveal how much a company has set aside in an accounting reserve called "unrecognized tax benefits." The reserve represents the portion of the tax benefits realized on a company's tax return that also hasn't been recognized in its financial reporting.

In the letters, sent Aug. 23, Senate investigators seek to obtain more details about the underlying transactions in the FIN 48 disclosures. One letter viewed by The Wall Street Journal asks the companies to "describe any United States tax position or group of similar tax positions that represents five percent or more of your total [unrecognized tax benefit] for the period, including in the description of each whether the tax position involved foreign entities or jurisdictions."

The subcommittee, led by Sen. Carl Levin (D., Mich.), has held numerous hearings on tax shelters, tax avoidance, and the law firms and accounting firms that set up such structures.

The Senate's inquiry also includes questions about other tax-cutting arrangements. For tax-cutting transactions on which companies spent at least $1 million for legal fees or other costs, Senate investigators are asking companies to identify the amount of the tax benefit, as well as "the tax professional(s) who planned or designed the transaction or structure and the law firm(s) that authored the tax opinion or advice."

Continued in article

Tutorial:  FIN 48 from different perspectives
Financial Accounting Standards Board Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, is intended to substantially reduce uncertainty in accounting for income taxes. Its implementation and infrastructure requirements, however, generate a great deal of uncertainty. This feature provides an overview of FIN 48, addresses some of its federal and international tax issues, as well as issues arising at the state and local level.
AccountingWeb, June 2007 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=103625

From The Wall Street Journal Accounting Weekly Review on June 1, 2007

Bob Jensen's threads on FIN 48 are at http://www.trinity.edu/rjensen/Theory01.htm#FIN48

Now Here is a Sad Example of Terrible Internal Control
A small South Carolina parts supplier collected about $20.5 million over six years from the Pentagon for fraudulent shipping costs, including $998,798 for sending two 19-cent washers to a Texas base, U.S. officials said. The company also billed and was paid $455,009 to ship three machine screws costing $1.31 each to Marines in Habbaniyah, Iraq, and $293,451 to ship an 89-cent split washer to Patrick Air Force Base in Cape Canaveral, Florida, Pentagon records show. The owners of C&D Distributors in Lexington, South Carolina -- twin sisters -- exploited a flaw in an automated Defense Department...
Tony Capaccio , "Pentagon Paid $999,798 to Ship Two 19-Cent Washers to Texas," Yahoo News, August 16, 2007 --- http://news.yahoo.com/s/bloomberg/20070816/pl_bloomberg/ajkoyhuchw0m 

The company also billed and was paid $455,009 to ship three machine screws costing $1.31 each to Marines in Habbaniyah, Iraq, and $293,451 to ship an 89-cent split washer to Patrick Air Force Base in Cape Canaveral, Florida, Pentagon records show.

The owners of C&D Distributors in Lexington, South Carolina -- twin sisters -- exploited a flaw in an automated Defense Department purchasing system: bills for shipping to combat areas or U.S. bases that were labeled ``priority'' were usually paid automatically, said Cynthia Stroot, a Pentagon investigator.

C&D's fraudulent billing started in 2000, Stroot, the Defense Criminal Investigative Service's chief agent in Raleigh, North Carolina, said in an interview. ``As time went on they got more aggressive in the amounts they put in.''

The price the military paid for each item shipped rarely reached $100 and totaled just $68,000 over the six years in contrast to the $20.5 million paid for shipping, she said.

``The majority, if not all of these parts, were going to high-priority, conflict areas -- that's why they got paid,'' Stroot said. If the item was earmarked ``priority,'' destined for the military in Iraq, Afghanistan or certain other locations, ``there was no oversight.''

Scheme Detected

The scheme unraveled in September after a purchasing agent noticed a bill for shipping two more 19-cent washers: $969,000. That order was rejected and a review turned up the $998,798 payment earlier that month for shipping two 19-cent washers to Fort Bliss, Texas, Stroot said.

The Pentagon Defense Logistics Agency orders millions of parts a year. Stroot said the agency and the Defense Finance and Accounting Service, which pays contractors, have made major changes, including thorough evaluations of the priciest shipping charges.

A review of paid shipping invoices showed that fraudulent billing is ``is not a widespread problem,'' she said.

``C&D was a rogue contractor,'' Stroot said. While other questionable billing has been uncovered, nothing came close to C&D's, she said. The next-highest contractor billed $2 million in questionable transport costs, she said.

Guilty Pleas

C&D and two of its officials were barred in December from receiving federal contracts. A federal judge in Columbia, South Carolina, today accepted the guilty plea of the company and one sister, Charlene Corley, to one count of conspiracy to commit wire fraud and one count of conspiracy to launder money, Assistant U.S. Attorney Kevin McDonald said.

Corley, 46, faces a maximum prison sentence of 20 years on each count and will be sentenced in the near future, McDonald said in a telephone interview from Columbia. Stroot said her sibling died last year.

Continued in article

Jensen Comment
I would certainly verify that purported "death." She might just be living it up on some island paradise. For the past several years. the GAO has declared auditing of the Pentagon a literal impossibility.

Leader in TJX Fraud Gets 5-Year Sentence
Irving Escobar, a ring leader in a TJX Cos.-linked credit-card fraud, was sentenced to five years in prison and has been ordered to pay nearly $600,000 in restitution for damages resulting from stolen financial information, Florida officials said. The sentencing follows a guilty plea by Mr. Escobar, 19 years old, of Miami, to charges that he participated in a 10-person operation that used counterfeit cards bearing the stolen credit-card data of hundreds of TJX customers to purchase approximately $3 million in goods and gift cards. The penalty is the stiffest handed down so far in the case. The thefts were carried out at a string of Wal-Mart and Sam's Club stores in Florida during the second half of 2006, authorities said. Some of the merchandise was bought with gift cards that had previously been purchased with the fraudulent credit cards, a modern-day version of money laundering, officials said.
Joseph, Perira, The Wall Street Journal, September 14, 2007, Page B5 ---
http://online.wsj.com/article/SB118973246548127272.html?mod=todays_us_marketplace

IBM and PwC Settle With Government
International Business Machines Corp. and PricewaterhouseCoopers LLP have agreed to pay nearly $5.3 million combined to settle allegations that they made improper payments on government technology contracts, the Justice Department said Thursday.
PhysOrg, August 16, 2007 --- http://physorg.com/news106499155.html
Jensen Comment
The sad part about this is the promises made by PwC to abide by ethics and professionalism after the scandals at the end of the last century.

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

Dell to Restate Results for 4 Years as Audit Ends
Dell Inc said on Thursday it would restate four years of financial results, reducing net income for the period by as much as $150 million, after a lengthy audit found that top executives sought accounting adjustments to reach quarterly performance goals. Dell said it expects the restatements to also reduce revenue by 1 percent or less per year for the period under review.
"Dell to Restate Results for 4 Years as Audit Ends ," The New York Times, August 16, 2007 ---
http://www.nytimes.com/reuters/business/business-dell-accounting.html?_r=1&oref=slogin

Creative Accounting by Creative Michael Dell
Dell said yesterday that the Securities and Exchange Commission had started a formal investigation into its accounting practices, but provided no other details of the inquiry that began in August. As a result, the computer company said it was delaying the release of its third-quarter financial results until the end of the month. It had planned to announce them today after the markets closed. The company said the delay was not because of the new status of the investigation, but rather because of the difficulty of answering government queries, conducting its own inquiry and quickly compiling complex financial information.
Damon Darlin, "Dell Accounting Inquiry Made Formal by S.E.C.," The New York Times, November 16, 2006 --- http://www.nytimes.com/2006/11/16/technology/16dell.html?_r=1&ref=business&oref=slogin

From The Wall Street Journal Accounting Weekly Review on August 24, 2007

"Dell to Restate 4 Years of Results," by Christopher Lawton and Don Clark
The Wall Street Journal, Aug 17, 2007 Page: A3
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB118729623365900062.html?mod=djem_jiewr_ac

TOPICS: Advanced Financial Accounting, Auditing, Financial Accounting, Reserves, Restatement, Revenue Recognition, Software Industry, Vendor Allowances

SUMMARY: 'Dell Inc. said it would restate more than four years of its financial results, after a massive internal investigation found that unidentified senior executives and other employees manipulated company accounts to hit quarterly performance goals." In August 2005 the SEC informed Dell, Inc. that it was investigating the company's accounting and financial reporting practices. Dell disclosed the investigation in August 2006 with little discussion of details even as the investigation progressed through March 2007, "but a company SEC filing disclosed that the investigation uncovered issues about the way Dell recognizes revenue from selling other companies' software, amortizes revenue from some extended warranties, and accounts for reimbursement agreements with vendors." The results of the investigation indicate that various reserve and accrued-liability accounts were created or improperly adjusted-usually at the close of the quarter to give the appearance that quarterly financial goals were met.

CLASSROOM APPLICATION: The article can be used to help students consider materiality issues in terms of both dollar amounts and the nature of the item in question, indicating the problem tone set by executives at Dell because of their actions. Demonstrating understanding the accounting for risky accounts--accruals for warranties and revenue accounts--and combining that understanding with ideas on devising audit steps also is required.

QUESTIONS:
1.) Define the term "materiality". What points about Dell Inc.'s accounting issues indicate that the items in question are material? What points indicate that the issues are not material?

2.) In what areas must Dell Inc. restate its results?

3.) Define the terms "reserve accounts" and "accrued liability accounts." How do you think these accounts are used in relation to the topics of revenue recognition from sales of other companies' software and revenue from extended warranties?

4.) How might an executive or manager use the accounts described above to meet quarterly financial goals? In your answer, also comment on the types of goals that an executive would want to meet.

5.) Dell, Inc. engaged a law firm and an accounting firm who used special software to evaluate more than five million documents and then conduct extensive interviews to undertake investigation into these accounting matters. Describe one analysis procedure and one interview that you might conduct if you were part of the accounting firm's team undertaking this investigation.

Reviewed By: Judy Beckman, University of Rhode Island

"Dell to restate more than 4 years of earnings, says company manipulated results to meet goals," MIT's Technology Review, August 17, 2007 ---
http://www.technologyreview.com/Wire/19268/

Dell's independent auditor in PricewaterhouseCoopers (PwC) --- http://www.trinity.edu/rjensen/Fraud001.htm#PwC
 

Deloitte to Pay an Added $167.5M in Adelphia Case  
Officials at the trust formed after Adelphia went bankrupt claim the settlement with Deloitte & Touche is among the largest between a public accounting firm and a client.
Sarah Johnson, CFO.com August 06, 2007 --- http://www.cfo.com/article.cfm/9612110/c_2984378?f=FinanceProfessor.com

A Deloitte spokesman confirmed to CFO.com that the accounting firm has settled the case but believes it would have prevailed had the case continued. "As part of the settlement, Deloitte & Touche denies any wrongdoing," the firm said in a prepared statement, adding that Deloitte "believes ... that it was in the best interests of the firm and its clients to settle this action rather than to continue to face the burden, expense, and uncertainty of further litigation."

Deloitte served as Adelphi's audit firm from the mid-1980s to May 14, 2002, when Deloitte suspended its work on the audit for the year ended December 31, 2001, saying Adelphia's books and records had been falsified.

The Rigases were convicted in 2004 on several counts, including securities fraud, bank fraud, and conspiracy to commit bank fraud at what had been the fifth-largest cable company before its collapse. Prosecutors claimed that the two executives hid nearly $2.3 billion in Adelphia debt from stockholders to mask the company's unhealthy financial status.

Starting Monday, Timothy Rigas will serve 20 years in prison, and his father will serve 15. In an interview with USA Today published over the weekend, 82-year-old John Rigas said fraud did not occur at Adelphia. He went on to say the government's case against him was based on the business environment at the time, amid other corporate scandals like Enron, WorldCom, and Tyco. "It was a case of being in the wrong place at the wrong time," Rigas said. "If this had happened a year before, there wouldn't have been any headlines."

More than two years ago, Deloitte settled charges with the Securities and Exchange Commission, which claimed the accounting firm had "failed to detect a massive fraud perpetrated by Adelphia and certain members of the Rigas family" in its fiscal 2000 audit. Deloitte paid $50 million to settle the case.

Adelphia Communications Corp. agreed to a $715 million settlement
Adelphia Communications Corp. agreed to a $715 million settlement with the U.S. Justice Department and Securities and Exchange Commission to resolve claims stemming from the corporate looting and accounting-fraud scandal that toppled the country's fifth-largest cable-television operator.
Peter Grant and Deborah Solomon," "Adelphia to Pay $715 Million In 3-Way Settlement," The Wall Street Journal,  April 26, 2005, Page A3 --- http://online.wsj.com/article/0,,SB111445555592816193,00.html?mod=todays_us_page_one

Regas Father and Son in Club Fed at Last
In June, U.S. District Judge Leonard Sand rescinded the order allowing them to remain free, giving the father and son until Aug. 13 to report to prison. John Rigas, 82, was sentenced to 15 years and Timothy Rigas, 51, to 20 years for their role in the collapse of one of the nation's largest cable television companies (Adelphia). The pair had asked that they be allowed to serve their time together at a facility close to their homes in Coudersport, Pa. Instead, the federal Bureau of Prisons sent them to the Butner Federal Correctional Complex, located about 45 minutes northwest of Raleigh.
Martha Waggoner, "Adelphia's Rigases Report to Prison," Forbes, August 13, 2007 --- http://www.forbes.com/feeds/ap/2007/08/13/ap4014493.html

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

Delphi Settles Lawsuits Over Accounting Fraud Charges
Delphi Corp. settled fraud lawsuits by investors, including about 40,000 current and former employees and several pension funds, who contended former managers fraudulently inflated financial results to make Delphi more attractive. Participants in employee-retirement plans will get $24.5 million in allowed interest in Delphi's Chapter 11 bankruptcy case and $22.5 million in cash from insurance carriers. Buyers of Delphi's debt and equity will get $204 million in combined allowed interest and about $90 million in cash from other defendants and insurers.
"Delphi Settles Lawsuits Over Fraud Charges," The Wall Street Journal, September 4, 2007; Page A9 --- http://online.wsj.com/article/SB118887586498116651.html?mod=todays_us_page_one

Jensen Comment
I think what's important about this is that Deloitte is the only one of the Big Four that did not sell its consulting division (although those firms that did sell have started up new advisory services divisions).  It would seem that Deloitte was still auditing an information system that it once designed.  However, some other firms are probably doing the same thing even though they sold the consulting divisions that once designed the information systems being audited.

"Delphi Investors Seek Deloitte's Ouster as Auditor," by Jonathan Weil, The Wall Street Journal,  December 3, 2005; Page B13 --- http://online.wsj.com/article/SB113356891041013005.html?mod=todays_us_money_and_investing

A group of large investors has asked the judge presiding over Delphi Corp.'s bankruptcy proceedings to disqualify Big Four accounting firm Deloitte & Touche LLP from continuing to audit the auto-parts maker's financial statements.

Delphi filed for Chapter 11 bankruptcy-court protection in October, just months after disclosing a litany of accounting violations involving hundreds of millions of dollars. The disclosures prompted a series of government investigations that are continuing. Shortly after filing for bankruptcy protection, Delphi asked the court for permission to continue using Deloitte, its longtime outside auditor.

In their request Friday, the Teachers' Retirement System of Oklahoma, the Public Employees' Retirement System of Mississippi and two other large institutional investors asked U.S. Bankruptcy Judge Robert D. Drain to reject that application, arguing that Deloitte faces unmanageable conflicts of interests.

"The more Deloitte were to discover about Delphi's past accounting problems, the more it would implicate itself for having failed to detect them at the time," the funds wrote in their court filing. "In fact, Deloitte has strong incentive to conceal pre-petition accounting and auditing problems, and to minimize its own liability."

Those same investors are the lead plaintiffs in a lawsuit that seeks class-action status accusing Delphi, Deloitte and several other defendants of misleading investors. They also have filed papers before Judge Drain objecting to potentially lucrative pay packages that Delphi has proposed for certain key employees, including senior Delphi executives, while the company reorganizes.

In a statement, Deloitte spokeswoman Deborah Harrington said the accounting firm "does not believe it would be appropriate to publicly comment on a retention application that is currently pending before the federal bankruptcy court. However, any allegations that Deloitte & Touche LLP acted improperly with respect to its prior audit engagements for Delphi are untrue."

A Delphi spokesman declined to comment.

In addition to auditing Delphi's financial statements, Deloitte also designed and implemented Delphi's financial-information systems following the company's 1999 spinoff from General Motors Corp. In 2000, Delphi paid Deloitte $6.6 million for its annual audit and $50.8 million for nonaudit services, including $41.3 million for the information-systems project; it paid Deloitte an additional $12 million related to the project in 2001.

Since then, Delphi's audit fees have risen, while nonaudit fees have declined. For 2004, Delphi paid Deloitte $14 million in audit fees and $1.7 million for other services.

Continued in article

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

Sarbanes-Oxley Lowers Corporate Fraud Lawsuits
After five years, the Sarbanes-Oxley law has reduced corporate fraud. It was crafted to restore investor confidence with tighter rules for audits and forcing executives to certify financial statements. Chris Cox, chairman of the Securities and Exchange Commission, talks with Renee Montagne.
NPR, August 2, 2007 --- http://www.npr.org/templates/story/story.php?storyId=12555895

A powerful argument for Sarbox can be made simply by examining the performance of financial markets since the landmark act was passed. Though Sarbox certainly can't take full credit, the U.S. stock market (as measured by the S&P 500) has increased 67%, or about $4.2 trillion in market value, between July 30, 2002 and June 30, 2007. Even John Thain, CEO of the New York Stock Exchange (NYSE) and no great fan of Sarbox, concedes "There is no question that, broadly speaking, Sarbanes-Oxley was necessary."
Thomas J. Healey, "Sarbox Was the Right Medicine," The Wall Street Journal, August 9, 2007; Page A13 --- http://online.wsj.com/article/SB118662443703492573.html?mod=opinion&ojcontent=otep

Bob Jensen's threads on SOX/Sarbox are at http://www.trinity.edu/rjensen/FraudProposedReforms.htm

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

Internal Control Breakdown at North Carolina State University
A state audit found that $400,000 in funds from vending machines at North Carolina State University, which was supposed to go to student aid and reducing campus debt, instead went to a spending account for then-chancellor James Renick, the Associated Press reported. Renick, currently a senior official at the American Council on Education, then spent the money on art work, travel by his wife, and a $150,000 annuity for an unidentified faculty member, the audit found. The AP was unable to reach Renick but he has previously defended management at the university. The audit also found $500,000 in questionable spending by a fellowship program, supported by federal funds, for engineering faculty members. According to the AP, the audit said that the program’s manager spent 41 nights in hotels at the program’s expense in 2005-6, at an average cost of $328 a night.
Inside Higher Ed, August 27, 2007 --- http://www.insidehighered.com/news/2007/08/27/qt

Bob Jensen's threads on accountability problems in higher education are at http://www.trinity.edu/rjensen/HigherEdControversies.htm#Accountability

Home Depot Fires Employees Amid Probe of Kickbacks
Home Depot, Inc. fired four merchandise-purchasing employees who allegedly received kickbacks to ensure certain flooring products were stocked by the retailer and put in prominent positions, the company said . . . The terminations follow several months of quiet in what has been a turbulent year for the retailer. In January, Bob Nardelli resigned as chief executive amid criticism over his compensation, the strategic direction of the company and its stock price.
Ann Zimmerman, "The Wall Street Journal, August 2, 2007, Page A2 --- Click Here

Update on the ConAgra Case
Some questions were raised at a subsequent date about independence between KPMG and head of ConAgra's Audit Committee who is a former CEO of KPMG --- http://www.secinfo.com/drFan.z2d.d.htm

ConAgra Allegedly Cooks the Books
The Securities and Exchange Commission filed a civil complaint accusing three former ConAgra Foods Inc. executives of improper accounting practices that helped pump up profit statements. The SEC named former Chief Financial Officer James P. O'Donnell, former Controller Jay D. Bolding and Debra L. Keith, a former vice president of taxes, as defendants in the complaint filed in U.S. District Court. The complaint alleged improper accounting from fiscal 1999 through 2001. The SEC filed a separate complaint against former controller Kenneth W. DiFonzo, 55, of Newport Beach, Calif.
"ConAgra's Books Draw SEC Action," The Wall Street Journal, July 2, 2007; Page A10 --- Click Here

The Securities and Exchange Commission has filed civil charges against ConAgra Foods, Inc., alleging that it engaged in improper, and in certain instances fraudulent, accounting practices during its fiscal years 1999 through 2001, including the misuse of corporate reserves to manipulate reported earnings in fiscal year 1999 and a scheme at its former subsidiary, United Agri-Products (UAP), in 2000 that involved, among other things, improper and premature revenue recognition. ConAgra is a diversified international food company headquartered in Omaha, Neb. Linda Thomsen, Director of the Commission's Division of Enforcement, said, "This case again illustrates that the Commission will take strong action when a company and its officers engage in accounting fraud that distorts the company's true financial condition. The facts here are particularly troubling because of the number of different improprieties engaged in by Con Agra, the length of time over which they occurred, and the fact that senior management was involved in the misconduct."
AccountingEducation.com, August 9, 2007 --- http://accountingeducation.com/index.cfm?page=newsdetails&id=145322

You can read more about KPMG at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG

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

Another KPMG defendant pleads guilty of selling KPMG's bogus tax shelters
One of the five remaining defendants in the government's high-profile tax-shelter case against former KPMG LLP employees is expected to plead guilty ahead of a criminal trial set to begin in October, according to a person familiar with the situation. The defendant, David Amir Makov, is expected to enter his guilty plea in federal court in Manhattan this week, this person said. It is unclear how Mr. Makov's guilty plea will affect the trial for the remaining four defendants. Mr. Makov's plea deal with federal prosecutors was reported yesterday by the New York Times. A spokeswoman for the U.S. attorney in the Southern District of New York, which is overseeing the case, declined to comment. An attorney for Mr. Makov couldn't be reached. Mr. Makov would be the second person to plead guilty in the case. He is one of two people who didn't work at KPMG, but his guilty plea should give the government's case a boost. Federal prosecutors indicted 19 individuals on tax-fraud charges in 2005 for their roles in the sale and marketing of bogus shelters . . . KPMG admitted to criminal wrongdoing but avoided indictment that could have put the tax giant out of business. Instead, the firm reached a deferred-prosecution agreement that included a $456 million penalty. Last week, the federal court in Manhattan received $150,000 from Mr. Makov as part of a bail modification agreement that allows him to travel to Israel. 
Paul Davies, "KPMG Defendant to Plead Guilty," The Wall Street Journal, August 21, 2007; Page A11 --- Click Here

You can read more about the history of this case at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG

"Guilty Plea Seen," by Lynnley Brown, The New York Times, September 11, 2007 --- http://www.nytimes.com/2007/09/11/business/11kpmg.html?ref=business

The government’s criminal case against promoters of questionable tax shelters took a step forward yesterday when an investment adviser at the center of the inquiry pleaded guilty and provided new details on those involved.

The plea by David Amir Makov, 41, in Federal District Court in Manhattan is expected to bolster the government’s investigation of Deutsche Bank over its work with questionable shelters, including one known as Blips, whose workings Mr. Makov described in detail yesterday.

No charges have been filed against Deutsche Bank, and it was not named in court documents yesterday. In a statement that he read yesterday, Mr. Makov described his tax shelter work with Bank A, which people close to the case have identified as Deutsche Bank. A spokesman for the bank declined to comment.

Mr. Makov’s plea is also expected to help the government’s case against the four remaining defendants, who include three former employees of the accounting firm KPMG and an outside lawyer. Those four are scheduled to go to trial in October.

As part of the plea agreement, Mr. Makov agreed to pay a $10 million penalty; he will be sentenced at a later date. His lawyers declined to comment yesterday.

His guilty plea to conspiracy to commit tax evasion puts back on track a faltering case that had become, to the consternation of prosecutors, a referendum on the constitutional rights of white-collar defendants, rather than the largest criminal inquiry ever into abusive tax shelters.

Continued in article

Bob Jensen's threads on KPMG's roses and thorns are at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG

"U.S. Prosecutors Plan New Indictment in Tax Shelter Case (against Ernst & Young)," by Lynnley Brown, The New York Times, September 11, 2007 --- http://www.nytimes.com/2007/09/12/business/12tax.html?ref=business  

Federal prosecutors are planning a fresh indictment in a case that involves tax shelters sold by the accounting firm Ernst & Young, according to defense lawyers in the case.

Four current and former partners of Ernst & Young were indicted last May in connection with their tax shelter work from 1998 through 2004. The firm itself, which has not been charged, has been under investigation since 2004 by federal prosecutors in Manhattan, who have been looking into its creation and sale of aggressive shelters.

It was not clear whether a superseding indictment — which would include previous charges as well as new ones — would be focused on additional Ernst & Young employees, either former or current; on the firm itself; or on other firms or individuals.

Defense lawyers for two of the Ernst & Young defendants said that Deborah E. Landis, the federal prosecutor overseeing the case, told a hearing in a Federal District Court in Manhattan yesterday that the government expected to file a superseding indictment around mid-December. Any decision to file new charges requires approval of the Justice Department.

Yesterday’s hearing, before Judge Sidney H. Stein of United States District Court in Manhattan, was held to discuss the schedule of court events for the four Ernst & Young defendants. No trial date has been set.

Asked about an impending new indictment, a spokesman for Ernst & Young declined last night to comment.

Continued in article

Bob Jensen's threads on Ernst & Young roses and thorns are at http://www.trinity.edu/rjensen/Fraud001.htm#Ernst

"Big Four accounting firm KPMG LLP faces a class action lawsuit against its Canadian division," SmartPros, September 10, 2007 --- http://accounting.smartpros.com/x59025.xml

The lawsuit, filed this week in Ontario Superior Court, claims overtime compensation for non-chartered accountant KPMG employees who worked more than 44 hours in a week, were not paid overtime pay, and are not exempt under applicable regulation.

Chartered accountants, who make up the bulk of KPMG's staff, are excluded from overtime provisions.

The lead plaintiff, Toronto resident Alison Corless, was employed by KPMG as a "technician" between 2000 and 2004 and is seeking $87,000 in overtime pay for that period. The lawsuit filed this week seeks $20 million for the class.

This is the second unpaid-overtime class action lawsuit against a major company in Canada, following a lawsuit against Canadian Imperial Bank of Commerce.

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

Control Overrides in Financial Statement Fraud
Financial-statement fraud is typically a collaborative effort involving an average of seven people, according to a study conducted by the Institute for Fraud Prevention. The new study reports that those seven members can include CEOs, CFOs, COOs and other senior personnel. Study authors Robert Tillman and Michael Indergaard of St. John’s University based their analysis on a sample collected by the Government Accountability Office of 834 companies that issued restatements between Jan. 1, 1997, and June 30, 2002. The study, Control Overrides in Financial Statement Fraud, found that 374 companies, or 45%, were accused of securities fraud and subject to shareholder suits, SEC enforcement action or both. In those cases, an average of seven individuals were implicated, including CEOs, CFOs, COOs, general counsel, directors and internal and external auditors.
AccountingEducationl.com, August 1, 2007 --- http://accountingeducation.com/index.cfm?page=newsdetails&id=145287

The link in the above summary did not work. A corrected link is shown below:
http://www.theifp.org/research grants/tillman final report_revised_mac-orginal-EDITED.pdf

A federal judge on Friday sentenced Joseph P. Nacchio, the former chief executive of Qwest Communications International, to six years in prison in what prosecutors called the largest insider-trading case in history.
Dan Frosch, The New York Times, July 28, 2007 --- http://www.nytimes.com/2007/07/28/business/28qwest.html

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

More on Revenue Round Tripping Fraud

BA’s recent revenue growth and forecasts are highly impressive but scarcely credible as genuine business activity. Growth is nearly entirely based on transactions involving their Malaysian joint venture, transactions that might be described kindly as economically dubious and unkindly as appearing to be a revenue round-tripping accounting device that inflates reported sales. IBA are now forecasting a US$33.2m second half (they report on 27 August) well over half of which is likely to spring from their joint venture in Malaysia.
"IBA Health: At least Del Boy sought profit," Capital Chronicle, August 20, 2007 ---- http://alzahr.blogspot.com/2007/08/iba-health-at-least-del-boy-sought.html
This link was forwarded by Charlie Jutabha [cjutabha@primelink.co.th]

First half 2007: more of the same IBA’s 2007 half year numbers were announced on 26 February this year. IBA trumpeted 123% growth (US$12.6m) versus the prior period. The accompanying text says little of quantifiable substance to account for this. However, the only material announcements (in September, October and November 2006) to the ASX that can explain it are all related to the Malaysian JV: US$33.5m of orders from SP. That does not leave much time to install, sign-of with the customer and record the revenue before the 31 December 2006 cut-off.

However, IBA’s revenue recognition policy is such that it allows itself to book delivery and implementation revenues separately. That would provide the accounting latitude required to score these SP orders swiftly. They appear, therefore, to compose most of the 123% first half rise with the remaining US$20m or so ready to stick into the second half.

Which would look just about passable were it not for the ASX announcement in June, 3 days before full year 2007 closing, that IBA had bought the remaining 51% of the JV for US$23.2m. Thus another transaction was made completing an exercise that again bears a very striking resemblance to revenue round tripping.

In total, consideration paid into or for the SP JV in just over a year comes to US$43.8m of which cash was US$39.1m. The outright revenue value of the SP hospital concession, on IBA’s own ASX data, is US$43.3m. These are contextually interesting transactions with fortuitous timings; and spotting the economic value in the circles is not obvious. The accounting value, on the other hand, is immense and boosts the top-line on the P&L whilst masking the associated expense as an ‘investment’ in the balance sheet. Whilst it is always possible (if not probable) that the profit contribution from the SP JV is strongly positive at the 2007 full year at the half it was negative.

Looks a lot like a failure to disclose a material event In April and March 2006 IBA announced it had partnered with FSBM Holdings Berhad and won a contract (beating 22 rivals) from the University Malaya Medical Centre (UMMC). The IBA share of this was touted at US$8m.

This win was featured in ASX announcements, press releases, analyst presentations and the 2006 accounts published in August last year. An Australian Parliamentary Secretary even waxed lyrical on it. Clearly it is material, has political value and represented a prestigious reference for future IBA bids.

Unfortunately, IBA were subsequently removed from the deal by FSBM at the start of 2007 in favour of iSoft plc. Did IBA try a bait and switch, vapour-ware strategy over-promising more functionality than their suite (or that of their acquired Indian firm Medicom) actually had?

Whatever the reason, it appears IBA are neglecting to disclose a material fact to investors (find any ASX announcement on the loss if you can) and also its other Malaysian clients for, perhaps, negotiating purposes. Concurrently the company is forecasting ever-better revenue numbers. Is it conceivable that IBA hoped a successful bid for iSoft would simply buy back what they already announced and allow it an escape from its obligations to the market and customers?

Finally In light of the ASX's 10 Principles aimed at establishing corporate governance best practice one might ask what have the Audit Committee at IBA been up to. Two of its three members have strong financial backgrounds and the appropriate surnames for the role (Sherlock and Wise) whilst the other is a Professor of medicine and practicing GP. Are they content that the committee has discharged its stated duty to:

"review accounting and disclosure policies, financial and management accounting reporting practices" [p. 23, 2006 IBA Annual Report]

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

Question
Why have "new" concerns arisen over naked short selling?

From The Wall Street Journal Accounting Weekly Review on July 13, 2007

"Blame the 'Stock Vault'?" by John R. Emshwiller and Kara Scannell, The Wall Street Journal, July 5, 2007,  Page: C1
Click here to view the full article on WSJ.com

TOPICS: Accounting

SUMMARY: The Depository Trust & Clearing Corp. (DTCC) "...is the middleman [for all U.S. stock trade transactions] that helps ensure delivery of shares to buyers and money to sellers." Rather than physically exchanging shares of stock and cash for their clients' trading, brokerage houses maintain bank-like accounts of "securities entitlements" at the DTCC; "almost all stock is now kept at [the DTCC's] central depository and never leaves there." The SEC requires that trades be completed within 3 days, but "if the stock in a given transaction isn't delivered in the three-day period, the buyer, who paid his money, is routinely given electronic credit for the stock." This mechanism essentially provides cover for naked short-selling. Though it is an illegal practice, the SEC has no procedure to enforce the three-day requirement and thus eliminate the possibility of naked short-selling. "Critics contend that DTCC and the SEC have been too secretive with delivery-failure data" and thus are not upholding laws requiring "a free and transparent market."

QUESTIONS:
1.) What is the Depository Trust & Clearing Corp. (DTCC)? Why was it established?

2.) Based on the information in the article, describe the organization of the DTCC in terms of a balance sheet equation. What assets does the entity hold? What are its liabilities? Hint: think in terms similar to a bank which holds cash for its customers and which shows demand deposits on its balance sheet as liabilities.

3.) Refer to your answer to question 2 and to the statement in the article that the DTCC credits stock buyers' brokerage accounts with "securities entitlements", which then can be sold to another stock buyer. Is the term "credit" used in the same way as the description of a credit balance in a balance sheet equation? Support your answer.

4.) What is naked short-selling? Why do you think this practice is illegal?

5.) According to the description in the article, how do DTCC practices allow for naked short selling?

6.) What is "transparency" in a market? How could improvements to DTCC reporting help to improve the transparency in U.S. securities markets?

7.) How is the issue of transparency in reporting by the DTCC similar to transparency in financial reporting by corporate entities?

8.) What actions are the SEC and the DTCC considering to respond to the claim of insufficient transparency in this area?

Reviewed By: Judy Beckman, University of Rhode Island

"Blame the 'Stock Vault'?" by John R. Emshwiller and Kara Scannell, The Wall Street Journal, July 5, 2007,  Page: C1
Click here to view the full article on WSJ.com

At issue is a nefarious twist on short-selling, a legitimate practice that involves trying to profit on a stock's falling price by selling borrowed shares in hopes of later replacing them with cheaper ones. The twist is known as "naked shorting" -- selling shares without borrowing them.

Illegal except in limited circumstances, naked shorting can drive down a stock's price by effectively increasing the supply of shares for the period, some people argue.

There is no dispute that illegal naked shorting happens. The fight is over how prevalent the problem is -- and the extent to which DTCC is responsible. Some companies with falling stock prices say it is rampant and blame DTCC as the keepers of the system where it happens. DTCC and others say it isn't widespread enough to be a major concern.

The Securities and Exchange Commission has viewed naked shorting as a serious enough matter to have made two separate efforts to restrict the practice. The latest move came last month, when the SEC further tightened the rules regarding when stock has to be delivered after a sale. But some critics argue the SEC still hasn't done enough.

The controversy has put an unaccustomed spotlight on DTCC. Several companies have filed suit against DTCC regarding delivery failure. DTCC officials say the attacks are unfounded and being orchestrated by a small group of plaintiffs' lawyers and corporate executives looking to make money from lawsuits and draw attention away from problems at their companies.

Historic Roots

The naked-shorting debate is a product of the revolution that has occurred in stock trading over the past 40 years. Up to the 1960s, trading involved hundreds of messengers crisscrossing lower Manhattan with bags of stock certificates and checks. As trading volume hit 15 million shares daily, the New York Stock Exchange had to close for part of each week to clear the paperwork backlog.

That led to the creation of DTCC, which is regulated by the SEC. Almost all stock is now kept at the company's central depository and never leaves there. Instead, a stock buyer's brokerage account is electronically credited with a "securities entitlement." This electronic credit can, in turn, be sold to someone else.

Replacing paper with electrons has allowed stock-trading volume to rise to billions of shares daily. The cost of buying or selling stock has fallen to less than 3.5 cents a share, a tenth of paper-era costs.

But to keep trading moving at this pace, the system can provide cover for naked shorting, critics argue. If the stock in a given transaction isn't delivered in the three-day period, the buyer, who paid his money, is routinely given electronic credit for the stock. While the SEC calls for delivery in three days, the agency has no mechanism to enforce that guideline.

'Phantom Stock'

Some delivery failures linger for weeks or months. Until that failure is resolved, there are effectively additional shares of a company's stock rattling around the trading system in the form of the shares credited to the buyer's account, critics say. This "phantom stock" can put downward pressure on a company's share price by increasing the supply.

DTCC officials counter that for each undelivered share there is a corresponding obligation created to deliver stock, which keeps the system in balance. They also say that 80% of the delivery failures are resolved within two business weeks.

There are legitimate reasons for delivery failures, including simple clerical errors. But one illegitimate reason is naked shorting by traders looking to drive down a stock's price.

Critics contend DTCC has turned a blind eye to the naked-shorting problem.

Denver Lawsuit

In a lawsuit filed in Nevada state court, Denver-based Nanopierce Technologies Inc. contended that DTCC allowed "sellers to maintain significant open fail to deliver" positions of millions of shares of the semiconductor company's stock for extended periods, which helped push down Nanopierce's shares by more than 50%. The small company, which is now called Vyta Corp., trades on the electronic OTC Bulletin Board market. In recent trading, the stock has traded around 40 cents. A Nevada state court judge dismissed the suit, which prompted an appeal by the company.

Continued in article

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

"Fraud Cases Nab Scads of Corporate Heads," by Lara Jakes Jordan, SmartPros, July 18, 2007 --- http://accounting.smartpros.com/x58417.xml 

Hundreds of high-ranking company officials have been convicted in corporate fraud schemes since 2002, the Justice Department said Tuesday - a day after a federal judge threw out charges in one of the largest criminal tax cases in U.S. history.

Attorney General Alberto Gonzales called the U.S. District Court ruling, in favor of 13 former KPMG employees, disappointing and said he was "quite confident" the government would appeal. "Obviously, we're disappointed, and we won't be discouraged or deterred from pursuing wrongdoing where we think it exists and following the evidence where it takes us," Gonzales told reporters following the long-planned Justice Department announcement regarding its efforts to curb corporate fraud. "So we're disappointed but we're going to stay focused on this very important issue." In all, federal prosecutors have won 1,236 convictions in corporate fraud cases and reaped hundreds of millions in payback for victims over the last five years, said Deputy Attorney General Paul McNulty. At least one-third of the convictions came against company CEOs, presidents, counsel and other high-ranking officials, said McNulty, who chaired a government task force aimed at curbing corporate corruption in the aftermath of the Enron scandal that wiped out thousands of jobs, more than $60 billion in market value and more than $2 billion in employee pension plans. McNulty, who is leaving the Justice Department by summer's end, last year authored changes to rules for prosecutors in corporate fraud cases. The result, known as the "McNulty Memo," bars prosecutors from charging businesses solely for refusing to hand over corporate attorney-client communications. It also prohibits the government from penalizing firms that pay attorneys' fees for employees - except in rare cases where the payments result in blocking the investigation. Critics say that leaves open the possibility of firms that pay attorneys fees being publicly viewed as hindering investigations - a death knell in an ethics-sensitive business era. Last week, Rep. Bobby Scott, D-Va., introduced legislation to bar prosecutors from pressuring corporations against paying legal fees or demanding attorney-client information. The bill is similar to one filed last year by Sen. Arlen Specter, R-Pa. In the KPMG case Monday, U.S. District Judge Lewis A. Kaplan in New York said the government coerced the giant tax firm to limit and then cut off its payment of the employees' legal fees - stripping the 13 defendants' constitutional right to legal representation. The former KPMG employees were accused of participating in a fraud that helped the wealthy escape $2.5 billion in taxes. (Charges are still pending against several higher ranking KPMG executives.) The case was not mentioned during Tuesday's hour-long ceremony, which doubled as a public send-off for McNulty. The memo, McNulty said, should encourage firms "to engage in more robust self-assessment of their internal controls."

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

Bob Jensen's threads on why white collar crime often pays even if you know you're going to get caught are at http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

Why they do it is hypothesized at http://www.trinity.edu/rjensen/FraudEnronQuiz.htm

The case in Parma is one of several against former executives and others accused of contributing to the alleged fraud that concealed Parmalat’s mounting debt.
Eric Sylvers, "Parmalat’s Founder and Bankers Are Charged," The New York Times, July 25, 2007 --- Click Here

Bob Jensen's threads on Parmalat's auditor, Grant Thornton, are at http://www.trinity.edu/rjensen/Fraud001.htm#GrantThornton

The Controversies of Rankings of Physicians by Cost and Quality

"N.Y. Attorney General Objects to Insurer’s Ranking of Doctors by Cost and Quality," by Anthony Ramirez, The New York Times, July 14, 2007 --- http://www.nytimes.com/2007/07/14/nyregion/14healthcare.html

In a sharply worded letter, the New York State attorney general’s office asked a health insurance company yesterday to halt its planned introduction of a method for ranking doctors by quality of care and cost of service, warning of legal action if it did not comply.

. . .

It asked the company to cancel its plan to release the rankings in September, citing a furor over a similar program’s introduction in Missouri in 2005. There, physician groups, including the American Medical Association, said the cost rankings primarily reflected the cost of care to the insurer — not to patients.

Missouri doctors cited numerous objections to the pilot program, which was halted and is being redesigned. For example, most faculty members of the Washington University School of Medicine in St. Louis were initially excluded from the quality rankings because university-based care is generally more expensive. Doctors in major specialties were ranked by cost alone.

Tyler Mason, a spokesman for UnitedHealthcare, said the company had been meeting with the attorney general’s staff. He said: “We share their commitment to looking at cost and quality. That’s exactly what this is about. The assertion in the letter that sometimes higher cost equals higher quality is actually not what experts nationwide find. Sometimes lower cost means higher quality.”

Continued in article

Related Item of Controversy
Drug makers are exploring the possibility of tying pharmaceutical prices to performance
"Pricing Pills by the Results," by Andrew Pollack, The New York Times, July 14, 2007 --- Click Here 

Boston Scientific agreed to pay $195 million to settle claims related to a potentially flawed defibrillator made by its subsidiary, Guidant.
Barry Meir, "Maker Settles Suit on Device for Hearts," The New York Times, July 14, 2007 --- Click Here

Brocade Ex-CEO Convicted of Fraud
A jury in San Francisco has convicted Gregory Reyes, the former chief executive of Brocade Communications Systems, of conspiracy to defraud shareholders. The executive of the San Jose-based high-tech firm could face years in prison and millions of dollars in fines.
Scott Horsely, NPR, August 8, 2007 --- http://www.npr.org/templates/story/story.php?storyId=12586282

Fraudulent Advanced Placement (AP) Credits

"College Board Tries to Police Use of ‘Advanced Placement’ Label," by Tamar Lewin, The New York Times, July 17, 2007 --- http://www.nytimes.com/2007/07/18/education/18ap.html

When Bruce Poch, the dean of admissions at Pomona College, sees a high school transcript listing courses in AP Philosophy or AP Middle Eastern History, he knows something is wrong. There is no such thing. Neither subject is among the 37 in the College Board’s Advanced Placement program.

“Schools just slap AP on courses to tag them as high-level, even when there’s no Advanced Placement exam in the subject,” Mr. Poch said. “It was getting to be like Kleenex or Xerox.”

But now, for the first time, the College Board is creating a list of classes each school is authorized to call AP and reviewing the syllabuses for those classes. The list, expected in November, is both an effort to protect the College Board brand and an attempt to ensure that Advanced Placement classes cover what college freshmen learn, so colleges can safely award credit to students who do well on AP exams.

“We’ve heard of schools that offered AP Botany, AP Astronomy, AP Ceramics, and one Wyoming school with AP Military History,” said Trevor Packer, director of the board’s Advanced Placement program. “We don’t have those subjects. One of the reasons colleges called for the audit was that they wanted to know better what it means when they see an AP on a transcript.”

Schools seeking approval for their Advanced Placement courses must submit their syllabuses. Those found lacking are returned, but schools have two more chances to revise them.

Developed 50 years ago for gifted students in elite high schools, the Advanced Placement program now exists in almost two-thirds of American high schools. In May, about 1.5 million students took 2.5 million Advanced Placement exams, hoping to earn college credit and impress college admissions offices, which often give applicants extra points on the transcript.

But with so many more APs — real and fake — admissions officers have difficulty assessing them, especially since admission decisions are made before the May exams.

“When you look at transcripts, what you see is often not what you get,” said William Fitzsimmons, Harvard’s dean of admissions. “It could be AP Powerlifting next, who knows? In my view, it’s misleading to call something AP if it’s not a College Board AP. And even in legitimate College Board AP courses, it’s hard to know what was taught until one sees the exam results. If students are getting watered-down AP courses, this audit will help bring them up to the standard.”

As APs have spread, it has become clear that the name is no guarantee of rigor; an AP course at a wealthy suburban high school may be far more ambitious than one at a poor rural school. And in many struggling high schools, nearly all the students in Advanced Placement classes fail the exam.

The College Board concedes that the audit will do nothing to change that. “By no means do we anticipate that this will result in higher exam scores,” Mr. Packer said. “The audit allows us to know one thing only, and that is, does the AP teacher know what elements are expected in a college-level course. It’s not proof that students are prepared for college-level work.” But, he said, the audit allows the board to give teachers more guidance and practice materials, and to pinpoint areas where APs do not mirror college courses.

In AP Art History courses, the audit found, the most common flaw in the syllabuses was a narrow focus on Western art. In physics, atomic and nuclear physics were often left out. In psychology, statistical analysis and measurement needed bolstering. And in government and politics, many high schools left out Iran and Islam.

Continued in article

How to recognize and avoid Advanced Placement (AP) credits --- http://www.trinity.edu/rjensen/HigherEdControversies.htm#AP

Bob Jensen's threads on higher education controversies are at
http://www.trinity.edu/rjensen/HigherEdControversies.htm

Bob Jensen's threads on financial accountability in higher education are at http://www.trinity.edu/rjensen/HigherEdControversies.htm#Accountability

"Majoring in Credit-Card Debt:  Aggressive on-campus marketing by credit-card companies is coming under fire. What should be done to educate students about the dangers of plastic?" by Jessica Silver-Greenberg, Business Week, September 4, 2007 --- Click Here

This story is the first in a series examining the increasing use of credit cards by college students.

Seth Woodworth stood paralyzed by fear in his parents' driveway in Moses Lake, Wash. It was two years ago, during his sophomore year at Central Washington University, and on this visit, he was bringing home far more than laundry. He was carrying more than $3,000 in credit-card debt. "I was pretty terrified of listening to my voice mail because of all the messages about the money I owed," says Woodworth. He did get some help from his parents but still had to drop out of school to pay down his debts.

Over the next month, as 17 million college students flood the nation's campuses, they will be greeted by swarms of credit-card marketers. Frisbees, T-shirts, and even iPods will be used as enticements to sign up, and marketing on the Web will reinforce the message. Many kids will go for it. Some 75% of college students have credit cards now, up from 67% in 1998. Just a generation earlier, a credit card on campus was a great rarity.

For many of the students now, the cards they get will simply be an easier way to pay for groceries or books, with no long-term negative consequences. But for Seth Woodworth and a growing number like him, easy access to credit will lead to spending beyond their means and debts that will compromise their futures. The freshman 15, a fleshy souvenir of beer and late-night pizza, is now taking on a new meaning, with some freshman racking up more than $15,000 in credit-card debt before they can legally drink. "It's astonishing to me to see college students coming out of school with staggering amounts of debt and credit scores so abominable that they couldn't rent a car," says Representative Louise Slaughter (D-N.Y.).

Congressional Oversight Weighed

The role of credit-card companies in helping to build these mountains of debt is coming under great scrutiny. Critics say that as the companies compete for this important growth market, they offer credit lines far out of proportion to students' financial means, reaching $10,000 or more for youngsters without jobs. The cards often come with little or no financial education, leaving some unsophisticated students with no idea what their obligations will be. Then when students build up balances on their cards, they find themselves trapped in a maze of jargon and baffling fees, with annual interest rates shooting up to more than 30%. "No industry in America is more deserving of oversight by Congress," says Travis Plunkett, legislative director for Consumer Federation of America, a consumer advocacy group.

The oversight may be coming soon. With Democrats in control of Congress and the debt problems for college kids only growing worse, the chances of a crackdown have increased substantially. The Senate is expected to hold hearings on the credit-card industry's practices this fall. Representative Barney Frank (D-Mass.) has pledged to introduce tough legislation. And Slaughter introduced a bill in August to limit the amount of credit that could be extended to students to 20% of their income or $500 if their parents co-sign for the card. The major credit-card companies take great issue with the criticisms. Bank of America (BAC), Citibank (C), JPMorgan Chase (JPM),

American Express (AXP), and others say they are providing a valuable service to students and they work hard to ensure that their credit cards are used responsibly. Citibank and JPMorgan both offer extensive financial literacy materials for college students. Citibank, for instance, says it distributed more than 5 million credit-education pieces to students, parents, and administrators last year for free. At JPMorgan Chase, bank representative Paul Hartwick says: "Our overall approach toward college students is to help them build good financial habits and a credit history that prepares them for a lifetime of successful credit use."

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Bob Jensen's threads on the dirty secrets of credit card companies are at http://www.trinity.edu/rjensen/FraudReporting.htm#FICO