Accounting Scandal Updates and Other Fraud on December 31, 2003
Bob Jensen at Trinity University


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

Many of the scandals are documented at 

There are some financial executives who do/did the right thing (e.g., blow the whistle) when confronted with an ethics issue.  There are some nice examples of real executives in real situations in the following article:
"Financial Execs Who do the Right Thing," by Jeffrey Marshall adn Ellen M. Heffes, Financial Executive, November 2003, pp. 32-38 --- 


S. Scott Voynich, Chair of the American Institute of Certified Public Accountants, has stated that further changes were necessary to regain the confidence of American investors. Voynich was the keynote speaker at the Institute’s 2003 AICPA National Conference on Current SEC Developments  .

Nothing wrong with overcharging, so long as everyone else is doing it, right?
Gretchen Morgenson"The Mutual Fund Scandal's Next Chapter," The New York Times, December 7, 2003
(See below)

Are you disgusted enough with mutual funds to raise a stink?  So far, savers don't seem nearly as outraged as they were about Enron--yet deceptive funds and sneaky "financial advisers" have swiped more money, from more people, than all the corporate scandals combined.  The House of Representatives just passed a reform bill, but in the Senate, the going looks tough.  Your legislators are scooping up money from the mutual-fund lobby, which hopes to head off any major change.  To counter the lobby, Congress needs angry protest calls from voters like you.
Jane Bryant Quinn (See Below)

One the one hand, eliminating the middleman would result in lower costs, increased sales, and greater consumer satisfaction;  on the other hand, we're the middleman.
New Yorker Cartoon, Page 29, The New Yorker Book of Business Cartoons
In the context of the recent mutual fund scandals, financial advisors have become those middlemen.

Boyer had also asked Kmart's auditors at PricewaterhouseCoopers in several cases to look into various accounting issues and was unsatisfied with the firm's work, according to the lawsuit.
"Fired From Kmart, Ex-CFO Is Key Figure in Lawsuits," SmartPros (See below)

"I believe this (mutual fund rip-off) is the worst scandal we've seen in 50 years, and I can't say I saw it coming," said Arthur Levitt, the former chairman of the Securities and Exchange Commission for nearly eight years under the Clinton administration. "I probably worried about funds less than insider trading, accounting issues and fair disclosure to investors" by public companies.
Stephen Labaton --- 

Illegal or unfair trading isn't hard for directors (or the SEC) to spot, says New York Attorney General Eliot Spitzer, who brought the first of these scandals to light.  They just have to compare their funds' total sales with total redemptions.  When the two are about the same, skimming might be going on.  I asked Lipper, a fund-tracking service, to list the larger funds where redemptions reached 90 to 110 percent of sales.  It found 229, some looking obviously churned.
Jane Bryant Quinn --- 

One thing your can count on:  When you invest, a lot of the people you trust are going to cheat.  Billions of investor dollars whirl through the system.  It's all too easy for insiders to stick their hands into that current and grab.  We're not talking about a bad apple here and there.  Cheating runs through Wall Street's very seams --- even in the sainted mutual funds.
Jane Bryant Quinn --- 

But Wall Street's Lobbyists Still Have a Firm Grip Where it Counts
While Representative Baker pushes his bill in the House, the Senate is not expected to take up a measure before next year. Some lawmakers have filed bills, but Senator Richard Shelby, the Alabama Republican who heads the Senate banking committee, has said he is not convinced of the need for new laws.
Stephen Labaton, "S.E.C. Offers Plan for Tightening Grip on Mutual Funds," The New York Times, November 19, 2003 --- 

You can read more about SEC Chairman William H. Donaldson's defense of his quick and some say marshmallow punishment of mutual fund cheaters at  

What makes this such a big scandal is that the savings of half the households in the U.S. are at stake here.  The tragedy is that now that the scandal is surfacing in the media and in state courts, the SEC is only wrist slapping mutual funds.  This is along with the continued wrist slapping of investment banking (e.g., why is Merrill Lynch still in existence after frauds dating back to Orange County ?) is the real evidence of industry power over regulators.  Sarbanes-Oxley won’t do it!  It’s still rotten to the core in Washington DC as long as industries have regulators in their well-financed  pockets --- 

As an example, see what comes of the Senate Hearings on stock option accounting.  The Senate is where industries take their last-ditch, high-lobby stances ---
November 14, 2003 Update:  
See the lobbying is already paying off --- for Senators 
"Senator Urges Caution On Accounting Reform," SmartPros, November 14, 2003 --- 

Fraud: What Starts Small Can Snowball
Paul Sweeney --- 

At a time when HealthSouth Corp.'s finances were spiraling into scandal, the company was paying its audit firm more to check for clean toilets than it was for clean books. The allegation was brought to light last week as part of a House hearing looking into HealthSouth's $2.7 billion accounting scandal.  
AccountingWeb, "HealthSouth Officials All Flush About 'Pristine Audit' Costs,"
November 13, 2003 --- 

At a time when HealthSouth Corp.’s finances were spiraling into scandal, the company was paying its audit firm Ernst & Young LLP more to check for clean toilets than it was for clean books.

The allegation was brought to light Thursday as part of a House hearing looking into HealthSouth’s $2.7 billion accounting scandal.

"By hundreds of thousands of dollars, Ernst & Young was charging more to check the magazine racks and the toilets than they were to do the audit," Rep. Cliff Stearns, R-FL, said during the House Energy and Commerce subcommittee hearing.

Former CEO and founder Richard M. Scrushy devised a program called "Pristine Audits" whereby Ernst & Young auditors were hired during 2000 and 2001 to perform inspections of the cleanliness and physical appearance of HealthSouth's approximately 1,800 surgical and rehabilitation facilities.

Scrushy was indicted earlier this week on 85 federal criminal charges, including conspiracy, securities fraud, wire fraud, mail fraud, making false statements, providing false certifications and money laundering.

The auditors were given a 50-point checklist as a guide in their examination of such features as stains on toilets and ceilings, liners in trash receptacles, and the orderliness of magazines in waiting rooms.

Ernst & Young was paid more for the Pristine Audits than for financial audits, but all of the services were categorized as audit-related fees on HealthSouth's financials. Since 2000, the SEC has required publicly held firms to identify how much is paid to audit firms for non-audit-related services.

At Thursday’s hearing, Stearns said that Ernst & Young was paid more than $2.6 million to do the pristine audits and $2.1 million in 2000 and 2001 to conduct financial audits.

Stearn confronted the company’s acting chief executive officer, chairman of the board and two current board members to find out what they knew about Ernst & Young being paid more to inspect facilities than to audit the books, the Wall Street Journal reported.

"I did not know about the total charges," said Joel Gordon, HealthSouth's acting chairman.

Note from Bob Jensen
Some people wrote and asked me why Ernst & Young would be auditing toilet cleanliness in the first place. This is part of the new assurance service offered by CPA firms called Elder Care Assurance Service --- 
(Roger Debreceny later questioned my conjecture as to whether this was Elder Care Assurance or a consulting engagement, and we are still awaiting a definitive answer from E&Y.)

Elder care assurance is one of the most successful new lines of CPA services proposed by Bob Elliott’s Committee on Assurance Services for the AICPA. It has been generating large revenues for some CPA offices as evidenced by the fact that HealthSouth paid much more for Elder Care Assurance Services from E&Y than HealthSouth paid for its E&Y financial audit.

I also tell them that the new accounting fashion trend is a green eyeshade with matching white gloves!

In an effort to cut cost, WorldCom no longer audits toilets.
WorldCom, which won a federal judge's approval for its reorganization plan earlier this month, has piled up fees at a rate of $10 million a month. 
AccountingWeb, November 13, 2003 --- 

In a new national study of nearly 200 chief executive officers, 81% expressed concern over threats to their corporate reputations, citing customer service problems, financial irregularity, negative press coverage and employee misconduct as among the issues that have the greatest potential to damage their corporate reputation. 

The Lawyers and Accountants Hit'em Hardest When Their Down
Executives from failed energy giant Enron say its total legal and accounting costs since declaring bankruptcy may top $1 billion by 2006, according to a newspaper report.

SmartPros, November 14, 2003 --- 

Tyco International Ltd., dogged by a series of scandals and eager to polish its image, is putting its entire workforce through a training program on legal and ethical issues. Can you teach someone ethics? A trend worth keeping an eye on, maybe a new service offering! 
, November 13, 2003 --- 

If PT Barnum was right when he said "There's a sucker born every minute.", there ... to use it My habit is to underestimate the weasels and overestimate the eagles ..
An ebook by Matthew Saul --- 

"Our study demonstrates that audit firms may lie to keep a profitable audit client if the expected benefits of keeping the client happy outweigh the expected costs of an audit failure if the firm gets caught," said Debra Jeter, co-author of the study and an associate professor of accounting at the Owen Graduate School of Management at Vanderbilt.
See below.)

Recall that the majority of U.S. large corporations are chartered in Delaware largely because it is easier to do there..
This is a big deal, and not just for Disney. Judge Chandler's opinion has put directors of public companies on notice that the courts in Delaware, where more than half of the FORTUNE 500 are incorporated, are inclined to hold them to a higher standard of performance than has been expected in the past. Boards have enjoyed virtually unlimited protection from lawsuits, particularly on the issue of executive pay—until now. Says Scott Spector, a partner in the corporate group of the Silicon Valley law firm of Fenwick & West: "This case has tremendous importance at a time when executive compensation is under intense media and shareholder scrutiny."
See Marc Gunther's Mickey Mouse article below.

Former HealthSouth executives gave themselves over $500,000 of company money to pay for legal fees shortly before pleading guilty to defrauding shareholders.
The Wall Street Journal, November 3, 2003 ---,,SB106781877480439600,00.html?mod=home_whats_news_us 

Fannie Mae had losses of $237 million from soured mortgage investments during the first nine months of 2003, with nearly half of the losses coming from its portfolio of manufactured-housing loans, according to a new federal filing.
Patrick Barta, The Wall Street Journal, November 17, 2003 ---,,SB106902254027452700,00.html?mod=home%5Fwhats%5Fnews%5Fus 
Bob Jensen's threads on the accounting scandals at big Fannie and her brother Freddie Mac are at 

HEIRESS IN HANDCUFFS Lea Fastow is charged with helping husband Andy orchestrate the white-collar crime of the century. Now she could be the key to nailing Enron's top dogs.
November 14, 2003 message from BusinessWeek Online's Insider []
(See below) 

Billions of dollars of life insurance cash values may be in big trouble, and most consumers don't know it because they don't check their policies like they do their stocks and bonds.
AccountingWeb, November 11, 2003 --- 

About 450 securities firms will contact mutual fund investors over the next three months about possible refunds totaling at least $85 million. 
AccountingWeb, November 11, 2003 --- 

A Million Here, A Million There:  Where's the real benefit?
TIAA-CREF CEO Allison to Get At Least $9 Million This Year
Arden Dale and Yuka Hayashi, The Wall Street Journal, November 10, 2003
Mr. Allison's compensation package at TIAA-CREF is substantially larger than that of his predecessor, John Biggs, who retired last year.  Mr. Allison's compensation includes $1 million in annual salary, a performance bonus of at least $3 million, and a long-term compensation award of $4 million, payable at the end of 2005.

University CEOs Get Peanuts in Comparison
4 Highest-Paid (Private) University Presidents Top $800,000 a Year 
by Tamar Lewin, The New York Times, November 10, 2003 --- 
Bob Jensen Note:  Detailed comparisons are impossible, because no two CEOs of colleges and universities receive the same benefits packages in terms of houses, cars, travel (such as tag along trips on private jets of members of the Boards of Trustees,, deferred compensation, etc.  There are no stock options, however, in not-for-profit organizations.

Four presidents of private universities were paid more than $800,000 last year, and the era of the million-dollar college president is fast approaching, according to an annual survey by The Chronicle of Higher Education.

Over all, 27 presidents of private universities earned at least a half-million dollars in the fiscal year, the same number as in the previous year.

The nation's highest-paid university president — Shirley Ann Jackson, who heads the Rensselaer Polytechnic Institute, in Troy, N.Y., — received $891,400 in pay and benefits in the last fiscal year, in addition to more than a half-million dollars for serving on corporate boards.

Gordon Gee of Vanderbilt University was paid $852,023, and Judith Rodin of the University of Pennsylvania received $845,474, about the same amount, including severance pay, that Arnold J. Levine earned at Rockefeller University when he stepped down last year after questions about his relationship with a female student.

At all the highest-paying universities, presidential compensation has increased at least twice as much as faculty pay over the last five years: at the University of Pennsylvania, however, from 2000-1 to 2001-2, the average professor's pay increased faster than President Rodin's compensation.

"It seems to me that the pay of faculty ought to be the benchmark," said Patrick M. Callan, president of the National Center for Public Policy and Higher Education in San Jose, Calif. "Even though the president starts at a higher level, there's no reason why the percentage increase for presidents shouldn't be the same as for faculty."

Public universities tend to pay their presidents substantially less than private universities, but the gap may be closing. According to this year's survey, 12 public university presidents — twice as many as last year — were paid more than $500,000.

"This is certainly not helpful at a time when public higher education is facing fiscal stringency, raising tuition by double-digit numbers," Mr. Callan said. "It's particularly hard for these high-paid presidents to go to the legislature and make the case for higher funding."

Mary Sue Coleman, who became president of the University of Michigan in August 2002, will get $677,500 this academic year, making her the highest-paid president of a public university. Just over a quarter of the public university presidents were paid more than $400,000, the survey found.

With many states raising tuition and slashing their budgets for higher education, legislators are showing increasing discomfort about the rising pay for college presidents. In Florida this year, legislators imposed a cap on the state's pay for public university presidents. And a bill under consideration in Ohio would limit the state contribution to university presidents' salaries to the $130,292 the governor earns. About a third of public university presidents received some of their pay from private sources, the survey found.

Presidential pay at the nation's liberal arts colleges is substantially lower. According to the survey, the highest-paid president of such colleges, Russell K. Osgood of Grinnell College, received $480,000 in pay and benefits, and only he, Larry P. Arnn of Hillsdale College and Nancy S. Dye of Oberlin College earned more than $400,000.

(Cornell's) President reports progress with faculty salaries improvement plan 
 Jacquie Powers, Cornell Chronicle, April 17, 2003 --- 

Cornell has made substantial progress in its multi-year faculty improvement plan, with salaries for continuing faculty increasing 8.1 percent in 2001-02, compared with the university's overall goal of 8 percent, President Hunter Rawlings announced April 17.

Endowed college salaries increased 7 percent in 2001-02, the single largest increase in its selected peer group, Rawlings said. The peer group average was 4.4 percent, according to preliminary data from the American Association of University Professors (AAUP).

Cornell contract college salaries increased by 6.5 percent in 2001-02, the second largest percent increase in the selected peer group, behind Texas A&M. The peer group average increased by 2.6 percent, largely attributable to very modest increases in many of the public institutions, Rawlings said.

Continued in the article

College salaries lacking in logic
Linda Conner Lambeck, Connecticut Post, November 4, 2003 --- 

If the latest published salaries of area private college presidents were based on longevity, the Rev. Aloysius P. Kelley, Fairfield University president since 1979, would be making the most instead of the least.

If based on revenues generated, John L. Lahey, president of Quinnipiac University, which grossed $113 million in 1998-99, would not have made $31,000 less than Anthony J. Cernera, president of Sacred Heart University in Fairfield, where revenues were $72 million in that year.

And if enrollment were the deciding factor, Lawrence DeNardis, president of the University of New Haven, wouldn't have made less than Julia M. McNamara, president of Albertus Magnus College in New Haven, or then-University of Bridgeport President Richard Rubenstein. Both led institutions with half the enrollment of UNH's 5,000 in 1998-99.

There are no hard-and-fast rules in setting the salary of college presidents. Generally it depends on what the board of trustees decides to pay and what the president is willing to accept.

Continued in the article.

A Billion Here, A Billion There:  Where's the real money?
An EDS accounting change over revenue booking wiped out $2.24 billion in past profits at the computer-services company.
Gary McWilliams, "EDS Cuts Profits Of $2.24 Billion For Rule Change," The Wall Street Journal, October 29=8, 2003 ---,,SB106728827489759900,00.html?mod=technology_main_whats_news 
Bob Jensen's threads on revenue accounting are at 

The General Accounting Office issued a scathing report on the federal civil rights commission, saying the director of the agency's staff flouted government guidelines while managing a $9 million budget, particularly while letting contracts worth more than $25,000.
SmartPros, November 10, 2003 --- 

Sounds Corny
Federal regulators have told Frito-Lay, Inc., Kraft Foods Inc. and Dean Foods Co. that they are considering legal action against the companies, claiming that they helped a grocery distributor that filed for bankruptcy protection earlier this year speed up the booking of revenue.
SmartPros, November 10, 2003 --- 
Bob Jensen's threads of revenue accounting frauds are at 

Vanguard also is cracking down on companies that pay their auditors less for their audit than for other services such as consulting. "We want companies to spend more for their audit than for everything else," says Glenn Booraem, who heads Vanguard's corporate-governance effort. And Vanguard voted against any directors that served on audit committees that didn't meet the firm's standard on auditor pay.
Ken Brown (see Vanguard article below)

Long Quote from Professor Steve Zeff
Few would deny that the U.S. accounting profession is in a very troubled state.  The aim of this two-part article is to explain how and why the profession evolved and changed during the 20th century, with particular emphasis on the last three decades.  It is my hope that this article will illuminate the origins and consequences of these changes that collectively brought the profession to its current condition.

This paper reviews, examines, and interprets the events and developments in the evolution of the U.S. accounting profession during the 20th century, so that one can judge "how we got where we are today."  While other historical works study the evolution of the U.S. accounting profession,1 this paper examines two issues: (1) the challenges and crises that faced the accounting profession and the big accounting firms, especially beginning in the mid-1960s, and (2) how the value shifts inside the big firms combined with changes in the earnings pressures on their corporate clients to create a climate in which serious confrontations between auditors and clients were destined to occur.  From available evidence, auditors in recent years seem to be more susceptible to accommodation and compromise on questionable accounting practices, when compared with their more stolid posture on such matters in earlier years.
"How the U.S. Accounting Profession Got Where It Is Today: Part I," by Stephen A. Zeff, Accounting Horizons, September 2003, pp. 189-205.

Note from Bob Jensen
Steve's main points are consistent with Art Wyatt's remarks at the 2003 AAA Annual Meetings in Hawaii.  However, Steve fleshes in more of the historical detail.  I am really looking forward to Steve's forthcoming Part II continuation.

I might elaborate a bit on Steve's assertion that:  "From available evidence, auditors in recent years seem to be more susceptible to accommodation and compromise on questionable accounting practices, when compared with their more stolid posture on such matters in earlier years."  Out of context, this implies that auditors of old were more moral, ethical, and professional.  But such behavior in context is relative to the changing pressures, temptations, and opportunities of a changed auditing environment.

Just because all the "stolid" male (virtually all were male before the 1970s) auditors decades earlier never committed adultery with Elizabeth Taylor does not mean that they were above temptation.  Such temptation never came their way, because Elizabeth Taylor in her prime never had any inclination toward auditors (sigh).  Along a similar vein, these "stolid" auditors only appeared to be less "susceptible to accommodation and compromise on questionable accounting practices" because temptations, pressures, and opportunities in the 1960s and earlier were totally unlike the auditing climate of the 1980s and 1990s.  My point is that auditors are human beings who have changed much less than the temptation environments and contractual complexities within which the audits take place.  The same thing has happened in the profession of journalism in the age of technology, and I highly recommend the professionalism concerns voiced at .  Journalists have not changed nearly so much as the journalism environment in the age of technology and civil strife around the world.

I also get riled when some analysts (not Steve) suggest that accounting principles today are too complex and that the simpler standards of the 1960s and earlier are all we need for current financial reporting purposes (e.g., see Scott McNealy's recommendations below ).  Those simpler standards never envisioned contractual complexities of the 1990s when newer types of derivative financial instruments (e.g., swaps), newer types of off balance sheet ploys (e.g., variable interest entities), and compound debt/equity instruments were invented.  Old standards are no more effective in modern accounting any more than battleships are effective in an age of nuclear submarines, laser-guided missiles, and satellite tracking systems.  My point here is that the FASB and IASB standards of the 1990s and later are complex because the contracts being accounted for became so complex.  There are no simple solutions to complex contracting except for simplistically naive fair value solutions that are out of touch with reality.  

November 6, 2003 reply from Gerald Trites [gtrites@STFX.CA

I recently read with great interest the Zeff paper in Horizons, the first part of a two part paper on the slow decline of the profession - or perhaps more accurately, its transition from profession to industry - during the 20th century.

Having lived through a good part of the period he covered in the first part, I can say it does a remarkable job of capturing the essence of the events during the period - a period characterized by by the inexorable forces on the profession by its publics, and the abandonment of professionalism for commercialism.

The papers should be required reading for every young person who wishes to obtain a professional accounting designation and the subject of discussion and debate in classrooms.

There was a recent cartoon in the New Yorker where an executive was sitting at a boardroom table with other executives and saying "The auditors are not team players any more." We can only hope. I hope this is the beginning of a return to professionalism. Maybe educators can help to make it so.

And congratulations to Professor Zeff.

Jerry Trites

November 6, 2003 reply from Amy Dunbar [Amy.Dunbar@BUSINESS.UCONN.EDU

Zeff's piece is great, and I look forward to the second part. The blinders came off my eyes with respect to our profession (I previously thought it was a few bad apples) when I listened to the tax shelter testimony live on Oct. 21 via Realplayer (ah, the wonder of technology). The testimony is available on . In particular, the PCAOB testimony is interesting. I now think that public accounting firms should not be able to audit clients that have purchased a "no business purpose" tax shelter from the audit firm. Perhaps the solution is to say that if the corporation is a tax client, you can't audit the company. That solution is overkill, but I no longer trust the firms to judge "business purpose." I have asked my graduate tax students to write their last memo on what Congress should do to address the tax shelter issue. The memos should be interesting reading.

Sansing, ever the terse analytic, would agree with the former IRS Chief Counsel, B. John Williams, who said the following, "One of the foundation stones of the credibility of the Service with the American public is that the Service proceed analytically rather than emotively. 'Abusive' reflects the indignation that the Service feels about a transaction, but the Service's feelings about a transaction do not state a legal basis for disallowing the tax benefits from a transaction. 'Abusive' is not an analytical term, it is an emotive term, and the mission of the Service is to apply the law fairly and impartially, not to apply the law in a manner that is biased toward a result the government wants."

Dunbar, ever the emotional observer, would encourage a little righteous indignation. Good heavens! Read the testimony of Henry Camferdam (someone said he was on 60 Minutes). When did our profession lose its way? Read Zeff!

Amy Dunbar 

November 6, 2003  Reply from Paul Williams [williamsp@COMFS1.COM.NCSU.EDU

For those of you are members of the Public Interest Section of the AAA and have free access to the section journal, Accounting and the Public Interest, there is an excellent article by Tony Tinker that sheds considerable light on this notion of the "decline of the profession." It's a myth because it presumes there was a golden era of the profession when it performed in some ideal, Durkheimian sense. But the profession of accounting was never very high up in a place it could decline from. Tom Lee documents that the first chartered accountants (ever) in Scotland (the primordial swamp from which all CPAs emerged) garnered their "charter" in order to restrain trade for their services -- they were a rather unsavory bunch whose motivation for creating the "profession" was hardly to serve the public interest. The only way accounting could ever be a profession in the classical sense in which we seem to be speaking of it as a service to mankind is that its service be performed in the employee of mankind, not in the employee of sizable private interests that are not nearly as politically and socially benign as Adam Smith's baker.

November 6 reply from Bob Jensen

Hi Paul,

With due respect, I think there was a "Golden Age" period where professionalism was quite high. I would argue that it was in the early part of the 20th Century when the large firms were formed by high integrity professionals with names like Andersen, Ernst, Haskins, Sells, Ross, Lybrand, etc. These were extremely high integrity professionals who set tough tones at the top for their employees, especially the outstanding Norwegian (my hero) named Arthur Andersen.  Read part of the eulogy for Arthur Andersen, delivered on January 13, 1947 the Rev. Dr. Duncan E. Littlefair --- 

Interestingly, the early public accounting firms may have had the highest integrity between 1900 and 1933 when auditing was not required by the U.S. Government, and CPA's did not have an auditing monopoly. I think that the early firms really believed their futures depended upon integrity and quality of service since the decision to have an audit was discretionary in the sense of agency theory where having an audit generally added value to share prices vis-à-vis not having an audit. 

As I have indicated elsewhere, however, this does not mean that "stolid" (Zeff's term) auditors of the 1950s, 1960s, and 1070s who seemingly remained highly professional would have blown the whistle on Enron, Worldcom, Xerox, Sunbeam, etc. in recent years. My comments on this are given at 

We have also had some outstanding auditors who worked public servants in government. But in the U.S., the least professional and most greedy leaders are generally in the top tiers of government (Congress, Senate, Executive Cabinet, etc.) These powerful individuals, in turn, exert pressure on agencies like the FDA, FTC, FPC, FAS, SEC, etc. to serve the interest of the companies rather than the public.

Where are the biggest crooks in most nations? Generally in high levels of government. Hence, I would prefer not to look to government for people committed to "service (as) an employee of mankind."

Where does one find an "employee of mankind?" (a Tony Tinker term) In my opinion, an employee of mankind is a high integrity professional who is driven by inner morality forces no matter where she/he happens to be employed (public or private). Public accounting in theory is neat, because the integrity is more necessary to survival of the profession than in other professions that sell more than integrity.

The problem is really not one of organizational structure. It is one of slight moral decay in the midst of enormous increases in temptation. I suspect the rise in temptation and opportunity are the main culprits.

In the next edition of New Bookmarks, I will have more to say about how this problem will be corrected. Look for the heading "1984+50: Screwed and Tattooed" in the forthcoming edition of New Bookmarks (probably around October 20).

I just finished watching the AICPA's excellent FBI Webcast today (Nov. 6). One segment that I really enjoyed was a video of Walter Pavlo, a former MCI executive who served prison time for fraud. This was a person with all intentions of being highly professional on a fast track to being in charge of collecting reseller bad debts for MCI. In that position, he just stumbled upon too much temptation for what is tantamount to a kiting scheme.

You can read details about Walter Pavlo's fraud at  This Forbes site was temporarily opened up for the AICPA Webcast viewers and will not be available very long. If you are interested in it, you should download now!

The FBI agents in the Webcast made a careful distinction between career con artists (who jump from con to con before and after prison because they seem to be inherently addicted to the game) versus others who commit fraud as a result of opportunity and temptation that exceeds their will power. These agents suggested an analogy of a bag of money being found where there appears to be no possibility of being detected. People who would never steal might succumb to "finders keepers" temptations, especially if they thought the money was lost by drug dealers who had no legitimate claim to the money in the first place and needed to somehow be punished.

Morality has not declined in the professions nearly as much as temptations and opportunities have created new environments that test morality. An analogy here is pornography. Playboy Magazine thrived in the 1960s when there was little else boys could easily get their hands on to hide under the mattress (yeah I did that). These boys were more curious than addicted. In the 21st Century with millions of free pictures of the hardest core imaginable only a few mouse clicks away, temptations and opportunities have created an entirely new addiction environment for both young people and pedophiles that prey on the young.

The obvious solutions are to do our best to convince others (e.g., auditors) not to succumb to opportunity, but it is difficult to raise the morality bar. Another solution is to reduce the temptations by increasing the probability of getting caught (e.g., better controls). At this precarious juncture in the life of our profession, we need to concentrate on both alternatives. 

But it will be a sad day when we go too far, and I will have more to say about that in the next edition of New Bookmarks.

Bob Jensen

The remainder of this thread, including long and scholarly replies from Paul Williams and David Fordham are at 

Free Corporate Fraud Hotline Initiated February 2003: 888-622-0117 

The European Union is setting up an agency to co-ordinate work to combat the rising tide of cybercrime.
BBC News, November 21, 2003 --- 

An international crackdown targets hackers, software pirates, perpetrators of credit card fraud and other cybercriminals. Authorities say they found 125,000 victims who lost more than $100 million in Internet scams ---,1367,61317,00.html?tw=newsletter_topstories_html 

Bob Jensen's helpers for reporting crimes are at 

"A Boss for the Boss," by Roger Lowenstein, The New York Times Magazine, December 14, 2003 --- 

''People being human, there will always be someone cutting corners and acting in their own self-interest,'' observes Ira Millstein, the lawyer most active in the suddenly trendy field of corporate governance. And so, regulators, investors, academics and even corporate directors are coming round to the idea that Millstein has been championing for two decades: a better way must be found to govern the corporation from within.

This intellectual ferment has upended life in that formerly cozy preserve known as the corporate boardroom. A transfer of accountability has occurred, a reapportionment of turf. ''People used to say problems were management's concern,'' Millstein says. ''When it comes to the scandals of the 90's, they are blaming the passivity of boards.'' These scandals are making plain the futility of merely blaming C.E.O.'s or even ''greedy C.E.O.'s.'' C.E.O.'s are greedy, often obscenely so. Presumably, they will be that way in 100 years. The question is not how to enlighten them, but how, and who, to restrain them.

It may seem curious that no one, until recently, thought that it was a matter for directors or fretted if a chief executive stacked his board with friends. The Disney board once included Michael Eisner's lawyer, his architect and the principal of his kids' school. With this type of oversight, C.E.O.'s could do no wrong. Consider Tyco, whose chief executive, L. Dennis Kozlowski, is now on trial for stealing from his shareholders. In 2001, shortly before his supposed crimes came to light, Kozlowski demanded a contract that guaranteed his severance, even if he committed a felony. The directors might have reasonably asked if Kozlowski were plotting a little arson or, perhaps, a discreet murder. Instead, they met his terms.

Nell Minow, a shareholder activist, says no board would grant such a blank check today, and not only because the rules for directors have changed. The culture is also changing. ''It used to be considered rude to ask a question,'' she says. ''Now they are all vying to ask the toughest question.''

Optimism must be tempered by the experience of two prior periods of activism, neither of which solved the governance riddle. There is a metaphysical sense in which the problem is irresolvable. Plato argued for a society run by perfect guardians; Juvenal is said to have replied, ''And who will guard the guardians?'' That has always been the dilemma

Continued in the article

Related issues --- 

The Institute of Management Accountants (IMA) launched its Sarbanes-Oxley Knowledge Network 

December 3, 2003 message from Colleen Sayther [

KPMG Fraud Survey
Provides detailed examination of fraud, new anti-fraud measures, and how organizations will manage this pervasive problem in the future. Over 450 U.S. business executives and government officials were interviewed to help determine how organizations are confronting fraud in the post-Sarbanes-Oxley era. The results produced several interesting insights. Click on the link for a full copy of the study.

The URL is 
This is a large file that may not download on slow modems.

Finance & Accounting Outsourcing
Challenged by an unsteady global economy, pressure to deliver more shareholder value, and hyper-scrutiny from inside and out, CFOs now bear the weight of increased accountability and liability. The need for CFOs to contribute strategic value equals the demand for timely, accurate financial information at lower cost. Outsourcing accelerates cost and process improvements while delivering best practice expertise. Cap Gemini Ernst & Young addresses these topics in their ExecutiveEdge, Reduce Costs and Improve Performance-Simultaneously. Click here to access.

The URL for various Cap Gemini downloads is at 

What does yield burning mean?



"IRS Examines Derivatives Schemes." by John Connor, The Wall Street Journal, December 4, 2003 ---,,SB107049507430505200,00.html?mod=mkts_main_news_hs_h 

The Internal Revenue Service is investigating the use of derivatives to implement suspected "yield-burning" schemes in the municipal-bond market.

In addition, the agency is seeing instances of apparent bid-rigging of derivatives, a senior IRS muni-enforcement official said.

The IRS several years ago joined with the Securities and Exchange Commission and the Justice Department in taking enforcement action against many Wall Street and regional brokerage firms for alleged yield-burning abuses -- slapping excessive markups on Treasury securities used in escrow accounts created in connection with muni advance refunding transactions. These deals were done in the early 1990s.

The new crop of transactions under scrutiny seem to be from 1998 forward, IRS officials said. The SEC also is investigating some of these transactions, according to people familiar with the matter.

A common denominator in these more recent transactions is the use of derivatives -- financial contracts whose value is designed to track the value of stocks, bonds, currencies, commodities or some other benchmark -- to divert arbitrage profits to investment bankers and lawyers, said Mark Scott, director of the IRS's tax-exempt bond program.

Arbitrage is generally barred in the muni market, where it is earned by investing tax-exempt bond proceeds in higher-yielding instruments. Arbitrage profits are supposed to be rebated to the Treasury Department. Yield-burning is a form of arbitrage abuse.

The IRS's Mr. Scott said it's not yet clear how pervasive the new, derivatives-related abuses are. But he said, "We are finding more problems than I expected." He said the agency's investigation is expanding.

One specific concern involves the use of put options in advance-refunding escrow accounts. A put option is a provision in a bond contract under which the investor has the right -- on specified dates after required notification -- to return the securities to the issuer or trustee at a predetermined price.

"Recent examinations involving advance-refunding bonds with put options in the escrow highlight increasing concerns about the use of derivative-type products as a more-sophisticated yield-burning or general abusive arbitrage scheme," said Charles Anderson, manager of the IRS's tax-exempt-bond field operations. "In the case of a put-option escrow, there is simply no reasonable need for the purchase of a put in an escrow that is already sufficient for defeasance of earlier bonds." He said that "any time people can sell products paid for with money normally rebatable to Uncle Sam, you will see the sharks circling."

Messrs. Scott and Anderson declined to comment on specific cases or securities firms or law firms.

The IRS settled at least one put-option escrow case recently and is inviting parties involved in similar deals to come forward and seek settlements through the agency's voluntary closing agreement program.

Bob Jensen's threads on derivatives are at 

Bob Jensen’s threads on “rotten to the core” are at 

"The Accounting Cycle Does Senator Enzi Support Accounting Lies? by J. Edward Ketz, SmartPros, November 24, 2003 --- 

I continue to find amazing some public statements enunciated by members of Congress. It reminds me of the witticism to be sure that your brain is engaged before putting your mouth into gear.

Consider recent comments by Senator Mike Enzi (R-Wyoming), who is holding hearings to allow small business executives to spout off against accounting reform. Specifically, these managers are yet again attempting to thwart the the Financial Accounting Standards Board's efforts to require the expensing of stock-based compensation. Of course, they covet the privilege of abusing corporate resources instead of acting as good stewards for the owners -- the stockholders of the business enterprise.

The Washington Post reports that the senator berated the chairman of the FASB Robert Herz with the comment, "I’m hoping small businesses don’t have to wage an 11th-hour campaign to get FASB to listen." He also chided Herz to contemplate the effects upon small businesses. Oddly, the senator didn’t advise Herz to ask investors and creditors about the consequences of poor and reprehensible accounting practices.

These corporate officials provide no new arguments or theories to bolster their claims, but rely on vacuous assertions. They claim that expensing options will hurt their search for talented managers, but cannot generate any evidence to that effect. Given that Microsoft now expenses stock-based compensation and appears not to have troubles hiring good people, I believe the assertion false.

Continued in the article

Bob Jensen's bottom line commentary is at 

November 19, 2003 message from Colleen Sayther [

FEI's annual Current Financial Reporting Issues conference, Integrity in Action, kicked off Monday morning with SEC Chairman William Donaldson. He focused most of his remarks on corporate governance and restoring confidence in the stock markets. The recent wave of corporate scandals, he told an overflow crowd of more than 850 financial executives at the New York Hilton, "has severely undermined the reputation of U.S. business, and represents a fundamental betrayal of American investors." At the same time, "the public sees a rigged game for insiders and the privileged."

Donaldson, who took office earlier this year, argued that a modest reform effort would be a mistake, and that the future of American business "relies on going beyond perfunctory compliance" with new rules like Sarbanes-Oxley.

The SEC chairman noted that the SEC had filed almost 700 actions in the fiscal year ending this past September, up more than 50 percent from the previous year, and that it intends to beef up enforcement and make the proceeds of fines "available to harmed investors." More than 800 professionals will be added to the current base of 3,200 staffers, he added, calling it a "major, major undertaking" to attract good people and get more synergy among the SEC's major divisions.

Key areas in the coming months, Donaldson said, would include a focus on: 1) late trading and market-timing in mutual funds; 2) monitoring corporate governance reforms at regulated institutions like the New York Stock Exchange, where a major overhaul is underway; and 3) enhancing disclosure of the nominating process for corporate directors and ensuring more shareholder input into that process.

Asked if anything can be done about the markets' unending focus on quarterly earnings, Donaldson argued that earnings management has been in a "strait-jacket" that insists on constant incremental growth. Financial managers, he said, need to "refuse to take advantage of the opportunities to conform" to those expectations -- implying that companies, and not investors, need to take the lead in creating change.

October 15, 2003 message from Thomas Buchman [

Hey Bob:

I found this web page last night, have you seen it? tb 

Thomas A. Buchman 
Associate Professor of Accounting 
Leeds School of Business 
419 UCB 
University of Colorado 
Boulder CO 80309-0419 U.S.A.

Recently at an open meeting, the Securities and Exchange Commission (SEC) adopted rules that will improve disclosure to investors regarding the nominating committee processes of public companies and the ways by which security holders may communicate with directors at the companies in which they invest. 

Hi Hossein,

Aside from my tongue in cheek fashion quip about "green eyeshades with matching white gloves," I think it should be stressed that CPA firms that offer a wider range of assurance services do not necessarily employ accountants for some of these services. In fact, accountants are probably not even trained for some assurance services in areas of elder care, computer security, city development, etc.

The theory as expounded over and over by Bob Elliott, who led the AICPA into the assurance services idea, is that the reason clients want CPA firms to deliver assurance services is the high trust those clients have in the integrity and professionalism of CPA firms. To the extent that recent and highly publicized auditing scandals have not destroyed public faith in CPA firms' integrity, there's still a glimmer of hope.

Public faith in CPA integrity is more essential for assurance services since most of these client engagements are voluntary. As long as CPA firms hold a monopoly on auditing services, it is possible to absorb more media shock of auditing scandals on the short term. CPA firms must place top priority on getting their reputations in order, however, for the long haul. A former top official of the SEC informed me privately that he anticipates the collapse of one more of the Big Five leaving us with a Big Three.

Reports that major firms have not really changed their ways in audit engagements are disturbing.

"Our study demonstrates that audit firms may lie to keep a profitable audit client if the expected benefits of keeping the client happy outweigh the expected costs of an audit failure if the firm gets caught," said Debra Jeter, co-author of the study and an associate professor of accounting at the Owen Graduate School of Management at Vanderbilt --- 

What is most disturbing to me in the recent HealthSouth revelation (that the auditing CPA firm earned much more from its Elder Care Assurance Service engagement than its audit engagement at HealthSouth) is that the magnitude of the combined revenues made the audit firm's local office more dependent upon keeping that "client happy" in the context of the above quotation from Debra Jeter. My worry is not so much the possibility of conflict of interest as it is revenue dependence from a relatively big client at the local office level.

Bob Jensen's threads on the wave of scandals can be found at 

Bob Jensen

-----Original Message----- 
From: Hossein Nouri [mailto:hnouri@TCNJ.EDU
Sent: Thursday, November 13, 2003 
Subject: Re: Are the toilets audited at Trinity University?

First of all, this not something that we can hide from students. Sooner or later they will know about it. In fact, I just sent it to my entire auditing class and told them we will discuss it in the next class!

While everybody seems to be upset about this (including myself) and looks at it in a negative way, we could also positively discuss this toilet audit. I am upset because it seems to be more of a scandal than a service audit. But, if auditors can provide services that benefits people who can be abused (like elderly people), I actually think that is a good professional service. And if you think that elderly people cannot be abused or their living conditions are good, I suggest you make a few visits, as volunteers, to some of these elderly facilities. I personally salute auditors who professionally perform the services that are to the best interest of the overall society (For your information, I am not performing such services!).

On a side note, I have not heard other professionals complain about the type of jobs they do. For example, your family doctor examine your rectum for prostate cancer. To me if this is not worse than examining toilet, it is at the same level.

If you have other positive thinking that I can tell to my class, I would like to hear from you.

Hossein Nouri, Ph.D., CPA, CFE, DABFA, 
CFSA School of Business 
The College of New Jersey 
PO Box 7718 Ewing, NJ

FAS 133 Trips Up Freddie Mac

Freddie Mac named Richard Syron, a former head of the American Stock Exchange, the Boston Fed, and tech firm Thermo Electron, as its new chairman and CEO. The executive succeeds Greg Parseghian, who was asked to step down after federal regulators determined he played a role in a string of accounting misdeeds.
See "Freddie Mac Appoints New Chief:  Syron May Bring Stability To Beleaguered Company; Toughness Is Questioned," by Patrick Barta and John D. McKinnon, The Wall Street Journal, December 8, 2003 ---,,SB107081511244443300,00.html?mod=home_whats_news_us 

Although nobody has yet to write up a case on Freddie Mac, the Appendices at this Freddie Mac site are a derivatives accounting education in and of themselves --- .  The link with the appendices is at 

"Freddie Mac hit with fine," by Marcy Gordon, The San Antonio Express News, December 11, 2003 --- 

Freddie Mac is paying a $125 million civil fine and is being threatened with possible curbs on its growth as federal regulators blame management misconduct for the mortgage giant's $5 billion misstatement of earnings. In a report issued Wednesday, regulators accused the government-sponsored company of violating its public trust.

A pliant board of directors and a system of compensating executives tied to annual earnings targets also contributed to the accounting crisis at Freddie Mac, which has brought the ouster of four top executives since early June, the Office of Federal Housing Enterprise Oversight found in its months-long investigation.

Freddie Mac agreed to pay the record fine in a settlement with the federal agency announced Wednesday.

The agency, which supervises Freddie Mac and its larger rival Fannie Mae in the multitrillion-dollar home mortgage market, cited "a pattern of inappropriate conduct and improper management of earnings" at the company and even "a disdain for appropriate disclosure standards" among former top executives.

The second-largest U.S. buyer of home mortgages "disregarded accounting rules, internal controls, disclosure standards, and ultimately, the public trust in pursuit of steady earnings growth," the agency's report found.

Its director, Armando Falcon, told reporters the agency already is considering imposing on both mortgage companies new requirements recommended in the report, including splitting the chairman and chief executive positions and limiting directors' terms.

Another recommendation is to restrain the growth of Freddie Mac's mortgage portfolio if it fails to disclose its financial situation more quickly and accurately — a prospect likely to unnerve shareholders.

Freddie Mac and Fannie Mae were created by Congress to pump money into the home mortgage market by buying home loans from banks and other lenders and bundling them into securities for sale on Wall Street.

The two corporations, whose stock is publicly traded, have grown explosively in recent years and are among the nation's largest financial institutions.

Freddie Mac's settlement with regulators still leaves to be resolved a criminal investigation by the Justice Department and a civil inquiry by the Securities and Exchange Commission.

Falcon said his agency's examination didn't find evidence of criminal misconduct. The report did cite evidence that one or more of the investment banks that engaged in transactions that Freddie Mac used to manipulate its earnings "may not have acted properly."

McLean, Va.-based Freddie Mac, with $40 billion revenue a year, has acknowledged understating its earnings by $5 billion for 2000-2002 to smooth out volatility in profits and uphold its image on Wall Street as a steady performer.

In addition, the company last month admitted inflating 2001 earnings by nearly $1 billion and said it may not be able to complete its accounting for 2003 until next June.

The company Sunday named Richard Syron, a Wall Street veteran and former Federal Reserve official, as chairman and chief executive. The board of directors in June forced out Freddie Mac's then-chairman and CEO, Leland Brendsel, and the company's president and chief financial officer.

In August, the federal regulators ordered the ouster of Brendsel's replacement, Gregory Parseghian — who had played a role in some of the company's questionable financial transactions, according to a report by attorneys hired by the board.

Parseghian earned $1 million in salary and $750,000 in bonuses in 2001.

The company didn't admit to or deny wrongdoing in the settlement, involving the first such fine in the agency's 10-year history. Freddie Mac also said it did not consent to any part of the agency's report and that it "strongly disagrees" with some of the findings.

The $125 million fine will be paid from the company's revenues, potentially reducing its bottom line.

The restatement by company auditors of Freddie Mac's 2000-2002 earnings, a massive project first announced in January and completed last month, cost the company $100 million.

Freddie Mac shares rose 25 cents to $54.25 in trading Wednesday on the New York Stock Exchange.

Under the settlement, Freddie Mac also agreed to strengthen its internal controls and accounting practices and to improve its disclosure of information to the investing public — steps the company already had undertaken after its accounting and management turmoil came to light in early June.

Also see The Wall Street Journal on December 11, 2003 ---,,SB107106680095083900,00.html?mod=mkts_main_news_hs_h 

"Freddie Regulator Seeks $100 Million In Settlement Deal," by Patrick Barta and John D. McKinnon, The Wall Street Journal, December 9. 2003 ---,,SB107092962387997400,00.html?mod=home_whats_news_us 

Federal regulators looking into Freddie Mac's accounting woes are seeking $100 million or more from the company in settlement of possible civil charges stemming from its accounting misdeeds, people familiar with the matter said.

These people stressed that the negotiations between Freddie Mac and its regulator, the Office of Federal Housing Enterprise Oversight, are continuing, and that the final settlement could be far less. However, analysts who closely follow the mortgage-finance company believe that Freddie Mac officials are eager to reach a deal quickly. The payment likely would be in settlement of charges that the regulator could bring against the company for engaging in the accounting abuses.

The company already has taken several steps in its bid to restore credibility. Late last month, Freddie Mac completed a long-delayed restatement of past earnings, concluding that it understated results through 2002 by nearly $5 billion. And on Sunday, the company said it selected a new chief executive, former American Stock Exchange head Richard Syron.

"The settlement is another big piece" that Freddie Mac needs to put its woes behind it, said Howard Glaser, a Washington, D.C., mortgage-industry consultant who has done work for Freddie Mac.

Continued in the article.

"Freddie Mac Attack Critics are calling for greater oversight -- or even a breakup," Business Week, July 7, 2003 --- 

The improper use of hedge accounting to amortize gains -- and thus smooth ragged ups and downs in quarterly earnings -- was Freddie's downfall. As a June 25 press release deadpanned: "Certain capital market transactions and accounting policies had been implemented with a view to their effect on earnings in the context of Freddie Mac's goal of achieving steady earnings growth." Translation: Steady earnings help Freddie convince investors and lenders that management has its eye on the ball. They also help ward off politicians who might point to volatility as a reason to tighten regulation or even break Freddie up. 

The company's quest for smooth earnings, plus its admitted lack of accounting expertise and weak management controls, proved to be a fateful combination. That became clear to PricewaterhouseCoopers auditors soon after they replaced longtime Freddie auditor Andersen LLC in 2002. The new audit team soon discovered suspicious hedge accounting involving Treasury securities.

Tripped Up by FAS 133
"Freddie Mac Overstated Results By as Much as $1 Billion in 2001," by Patrick Barta and John D. McKinnon, The Wall Street Journal, November 20, 2003 --- 

Freddie Mac is expected to report that it overstated earnings by as much as $1 billion in 2001 when it releases a much-anticipated restatement of past earnings in the next several days, people familiar with the situation said.

The mortgage-finance company, which has been embroiled in an accounting scandal since June, is still expected to conclude that it undercounted earnings by $4.5 billion or more during the entire three-year period of its restatement, which covers 2000, 2001 and 2002. But an overstatement during one of those years would be significant because it would further highlight the volatility of Freddie Mac's financial results, something the company had tried to hide. Freddie Mac initially reported that it earned $4.1 billion in 2001.

Some details of Freddie Mac's restatement remained in flux in advance of its release, and some people with knowledge of the situation cautioned that the numbers could change, although likely not enough to erase the troublesome overstatement. Some also believe that the overstatement could be limited to one quarter.

David Palombi, a spokesman for Freddie Mac, said he couldn't provide details on the restatement, though he noted that company officials have long stressed that it would reveal more volatile results. He said that the restatement is expected to significantly boost shareholder equity at the company.

Still, the possibility that Freddie Mac may have overstated its results in one of the years under review could make life harder for the company on Wall Street and in Washington, where legislators have been working to place Freddie Mac under stricter regulation. Companies that understate earnings are often treated more gingerly on Wall Street and elsewhere, analysts said, since correcting the errors results in more income for shareholders.

"They set up this belief that what they did was they understated earnings, and apparently they did on a cumulative basis, but it's not going to go over well that in one of the years they overstated earnings," said Mike McMahon, a financial-services industry analyst at Sandler O'Neill & Partners in San Francisco.

Freddie Mac is under investigation by several government agencies after it revealed that it used improper accounting tactics to smooth earnings to better please Wall Street. In some cases, the company pushed unwanted earnings into the future, or hid gains it thought would make the company appear to be too volatile. But an internal investigation revealed the company also used accounting gimmicks to mask some losses that resulted from accounting rules it thought were unfair.

The government-sponsored, publicly traded company exists to buy mortgages from lenders, providing needed capital to keep the U.S. mortgage market operating smoothly.

For more on the Freddie Mac macro hedge accounting fiasco that understated earnings and delayed issuance of its Year 2002 annual report and required nearly a year to restate prior year financial statements, see

FAS 133 Trips Up Fannie Mae

Fannie Mae had previously argued that it had a far better lock on its accounting than Freddie Mac, hoping to cast itself as a more responsible and sophisticated operation that didn't need much more scrutiny. Fannie Mae went so far as to hold an accounting "tutorial" earlier this month to explain derivatives accounting to investors, analysts and reporters. Yet it was in derivatives accounting that its stumble came.
Patrick Bartta and John D Mckinnon --- 

Hedging Paradox:  
In finance, there is no way to cover your Fannie without exposing your Fannie somewhere else.
Gypsy Rose Lee would've said her fan (hedge) could only cover one Fannie cheek at a time.
Gypsy Rose Lee ( ) decades ago was popular exotic dancer with high modesty tastes relative to today's riskier exposures.

The Word "Hedge" is the Most Misleading Term in Finance! FAS 133 and IAS 39 may be misleading the public into thinking that firm-wide risk is being accounted for when risk is merely being shifted about with hedging --- 

Bob Jensen's tutorials, glossaries, and cases on FAS 133 and IAS 39 are linked at 

October 29, 2003 question from Dennis Ratliff

-----Original Message----- 
From: Ratliff, Dennis J []  
Sent: Wednesday, October 29, 2003 10:16 PM 
To: Jensen, Robert 
Subject: SFAS 133

Bob, I know you are real familiar with SFAS 133, do you think the standard has had much effect on business decisions?? thanks. 

Hi Dennis,

FAS 133 is hands down the least neutral FASB standard ever issued, as is IAS 39 in the international scene.  FAS 133 has had an enormous impact upon decisions, particularly in banks where newer types of hedging instruments had to be devised in order to conform to FAS 133 accounting rules.  For example, companies used to hedge with cross-currency derivatives that were not eligible for hedge accounting under FAS 133.  They then had to hedge with more complicated concatenations of instruments (FAS 138 relieved this somewhat).  In particular you might listen to the audio laments of Mike Kogler (Chase Bank) who absolutely despises FAS 133 ---

Probably the most significant impact, however, is the loss of many former off-balance-sheet financing (OBSF) ploys.  Derivatives, particularly swaps, were among the most popular OBSF ploys used by corporations until FAS 133 went into effect.  After FAS 133, companies either could look to other on-balance sheet financing alternatives (other than derivatives) since derivatives could not be OBSF or they could seek alternate OBSF ploys, particularly SPVs ---

You might also be interested in the following message from Ira Kawaller (a member of the DIG) that I keep posted at

Message from Ira Kawaller on August 4, 2002

Hi Bob,

I posted a new article on the Kawaller & Company website: “What’s ‘ Normal ’ in Derivatives Accounting,” originally published in Financial Executive, July / August 2002. It is most relevant for financial managers of non-financial companies, who seek to avoid FAS 133 treatment for their purchase and sales contracts. The point of the article is that this treatment may mask some pertinent risks and opportunities. To view the article, click on   .

I ' d be happy to hear from you if you have any questions or comments.

Thanks for your consideration.

Ira Kawaller Kawaller & Company, LLC


Hope this helps!

Bob Jensen

Bob Jensen's tutorials, glossaries, and cases on FAS 133 and IAS 39 are linked at 

"Feds: Be Cautious of Credit Counseling Organizations," SmartPros, October 15, 2003 --- 

As consumers seek help in managing their debt or repairing damaged credit, they should be cautious when choosing a credit counseling organization, and to be wary of promised "quick fixes," regulators warned Tuesday.

Due to an increasing number of complaints to federal and state agencies, the Internal Revenue Service, the Federal Trade Commission, and state regulators issued a consumer alert for those seeking assistance from tax-exempt credit counseling organizations.

The IRS and FTC are concerned that some credit counseling organizations using questionable practices may seek tax-exempt status in order to circumvent state and federal consumer protection laws. State and federal statutes regulating credit counseling agencies often do not apply to Section 501(c)(3) tax-exempt organizations.

"Many of these groups provide a valuable service to consumers, but some use the tax code to skirt consumer-protection laws," said IRS Commissioner Mark W. Everson. "It is not fair to taxpayers struggling with financial problems to be taken advantage of by credit counseling groups exploiting gaps in the law."

"We want all consumers seeking help to take some common sense precautions," said Timothy J. Muris, Chairman of the FTC.

The IRS and FTC outlined some steps consumers can take to protect themselves from deceptive credit counseling practices:

"State charity officials are working with other state and federal agencies to remedy abuses in this area, and to assure that nonprofit credit counseling organizations operate in accordance with the charitable trust or non-profit corporation laws under which they are formed," said Mark Pacella, president of the National Association of State Charity Officials (NASCO).

To address some of the concerns, the IRS has stepped up its enforcement efforts to ensure that existing Section 501(c)(3) organizations are complying with the applicable rules and regulations. Further information and background can be found in Fact Sheet 2003-17.

Continued in the article.

Bob Jensen's threads on consumer frauds are at 

National Crime Prevention Council ---

What lawsuit is shaking up corporate governance at the moment?
Hint:  It's a Mickey Mouse lawsuit.

It's Been Mickey Mouse Corporate Governance --- Until Now

"Boards Beware! A lawsuit by Disney shareholders is shaking up much more than the Mouse House. Thanks to a Delaware court ruling, less-than-conscientious board members everywhere are running scared." 
Fortune, October 27, 2003, by Marc Gunther ---,15114,526338,00.html 

In fall 1996, Michael Eisner, the chairman and CEO of Walt Disney Co., decided he had made a big mistake. Just a year earlier he had hired Hollywood power broker Michael Ovitz as Disney's president. Ovitz had flopped, badly. The men needed to find a way to disengage without unduly embarrassing either of them.

In a three-page, handwritten letter dated Oct. 9, 1996, Eisner proposed an amicable separation to Ovitz, a friend who had literally stood by him after his coronary-bypass surgery two years earlier. "We must work together to assure a smooth transition and deal with the public relations brilliantly," Eisner wrote. "I am committed to make this a win-win situation, to keep our friendship intact, to be positive, to say and write only glowing things. You still are the only one who came to my hospital bed—and I do remember."

"This all can work out!"

It has not worked out—not even close. Ovitz, you may recall, walked away with a severance package that was generous even by entertainment-industry standards. For 15 months of labor, he got $38 million in cash, plus stock options valued at $101 million. That package caused an uproar and triggered a lawsuit by Disney shareholders, who want their money back. Since then none of them—not Ovitz, not Eisner, not the company, not shareholders—has fared very well. Ovitz's next venture failed, Eisner's reputation soured, and Disney shares currently trade at about $22 each, the same price as when Ovitz left in '96.

We revisit this unhappy moment in Hollywood history seven years later not merely for its gossip value but because the shareholder lawsuit that it provoked has, improbably, taken on enormous significance for the boards of public companies. In a ruling issued in May that has become must-reading in corporate boardrooms, Delaware judge William B. Chandler III said that the suit can go to trial. His reason: The facts, as alleged, indicate that Disney's directors failed to make a good-faith effort to do their job when they approved Ovitz's contract and once again when they allowed him such a lucrative going-away present. The $140 million package represented nearly 10% of Disney's net income in 1996.

The Disney directors who are defendants—there are 18 in all, including Eisner, Ovitz, and such well-known figures as former Senator George Mitchell, former Capital Cities CEO Thomas S. Murphy, and actor Sidney Poitier—all have been subpoenaed to testify. So have Hollywood bigwigs Sean Connery, Martin Scorsese, former Seagram chairman Edgar Bronfman, Revolution Studios chief Joe Roth, and Ron Meyer, Ovitz's former partner at Creative Artists Agency. Lawyers for the shareholders want the directors to return the money that Ovitz was paid, plus interest, to Disney's coffers. They also want Disney to radically shake up its board, stripping Eisner of his chairmanship and getting rid of the directors who, the lawsuit alleges, failed to do their jobs.

This is a big deal, and not just for Disney. Judge Chandler's opinion has put directors of public companies on notice that the courts in Delaware, where more than half of the FORTUNE 500 are incorporated, are inclined to hold them to a higher standard of performance than has been expected in the past. Boards have enjoyed virtually unlimited protection from lawsuits, particularly on the issue of executive pay—until now. Says Scott Spector, a partner in the corporate group of the Silicon Valley law firm of Fenwick & West: "This case has tremendous importance at a time when executive compensation is under intense media and shareholder scrutiny."

To be sure, the Disney case will not by itself change the way boards do business. But it's one more reason directors need to take their jobs more seriously in the aftermath of Enron, WorldCom, and Sarbanes-Oxley. Already directors are feeling multiple pressures: Institutional investors are paying more attention to governance; insurance companies are asking more questions before they write policies that protect directors and officers of public companies from liability; shareholder lawsuits are proliferating; and regulators want to give shareholders access to proxy statements so that they can vote out the directors who are no more essential than a sprig of parsley on a filet of sole.

To understand why the Disney case matters, you need to know a little about Delaware. The economy of this tiny state—it's just 30 miles across and 100 miles long—consists largely of DuPont, banking, beaches, and the business of corporate law. Companies choose to incorporate there because since 1899 the state government has made it easy for them to do so. Back then other states required a special act of the legislature to form a corporation. Delaware asked only for a few forms and a small filing fee.

Bob Jensen's threads on corporate governance are at 

What else is shaking up corporate governance?
Hint:  Vanguard is one of the largest and most ethical mutual fund companies on the planet.


Vanguard also is cracking down on companies that pay their auditors less for their audit than for other services such as consulting. "We want companies to spend more for their audit than for everything else," says Glenn Booraem, who heads Vanguard's corporate-governance effort. And Vanguard voted against any directors that served on audit committees that didn't meet the firm's standard on auditor pay.

"Vanguard Gives Corporate Chiefs A Report Card," by Ken Brown, The Wall Street Journal, November 10, 2003 ---,,SB106842052936406500,00.html?mod=your%255Fmoney%255Finvestment%255Fhs 

Vanguard Group, the nation's second-biggest mutual-fund firm behind Fidelity Investments, is turning up the heat on corporate CEOs.

In a letter sent last week to the chief executive officers at several hundred of Vanguard Group's top holdings, the fund firm said that while there has been progress in corporate governance following the scandals of the past few years, "there is much more change needed."

So, Vanguard is taking a much harder line this year, going against the managements' wishes in hundreds of proxy votes.

Vanguard's stance on three key proxy issues highlights its new standards. In voting for corporate directors, Vanguard approved just 29% of the full slates of directors proposed by companies in which it invests. Last year, Vanguard approved 90% of the full slates of directors.

In addition, Vanguard approved 79% of its companies' auditors, down from 100% last year. And the firm voted in favor of just 36% of employee-option plans, the same number as last year.

Votes like those by Vanguard are one reason why a record number of proposals from shareholders were approved this year. According to Institutional Shareholder Services Inc., which advises mutual funds and pension funds on proxy voting, 164 shareholder resolutions on everything from staggered boards to takeover defenses to executive compensation earned majorities this year. The previous record was 106 for all of last year. "It was a record year for activism any way you look at it," says Patrick McGurn, senior vice president of ISS.

Corporate governance -- which is simply how a board oversees management, makes sure the company is run well and that shareholders are treated fairly -- has been a hot-button issue since the collapse of Enron Corp., WorldCom Inc. (now MCI) and others. Since then, investors have become increasingly skeptical that board members and managements have their best interests at heart. Many have registered that displeasure by voting against proposals favored by management in the companies' annual proxy -- proposals that usually are approved with little notice.

For example, companies need to nominate some or all of their directors for re-election each year and shareholders get to vote on the names. It's rare that these nominees are voted down. But Vanguard approved only 29% of the full slates of board members nominated by companies. (Vanguard says it has to vote for all of the directors on a slate for it to count as approved.) Last year, it approved 90% of the full slates of boards.

Why the switch? In a similar letter to CEOs last year, Vanguard CEO and Chairman Jack Brennan warned that the firm would tighten its standards in response to the scandals. Vanguard now votes against directors who are on the board's audit, nominating or compensation committees, if they aren't considered independent of management. The firm also votes against board members if the committees they are on did things that Vanguard didn't like.

For example," Mr. Brennan said in an e-mail,"we now withhold votes for directors who serve on the compensation committee if the company is proposing excessive annual option grants or other compensation approaches that we are voting against." Vanguard also is cracking down on companies that pay their auditors less for their audit than for other services such as consulting. "We want companies to spend more for their audit than for everything else," says Glenn Booraem, who heads Vanguard's corporate-governance effort. And Vanguard voted against any directors that served on audit committees that didn't meet the firm's standard on auditor pay.

Corporate-governance experts say that while Vanguard has voted against management before, it never has made such a show of it. That will change next year, when fund companies must disclose their votes on individual company proxies. Vanguard opposed that shift, but experts hope it will make funds even more willing to stand up to management.

"One of the thoughts behind disclosure of voting was it would probably cause funds to vote more against management now that the votes were out in the sunlight," says Peter Clapman, chief counsel at TIAA-CREF, the big pension fund that has a history of shareholder activism.

Continued in the article.

Bob Jensen's threads on corporate governance are at 

Chances Are That Your Mutual Funds Screwed You While the SEC Knowingly Looked the Other Way 

All the corporate scandals pale in the face of the mutual fund scandals.  It’s time that all of us help spread the word or else the mutual fund lobby will continue to allow insiders to fleece investors from all over the world.

Below you will find out how you may have been cheated.  Hopefully, you will be angry enough to contact your local Senators as well as Senators Enzi, Grassley, Gregg, and Shelby in particular ---

"FIGHTING THE FUND CHEATS," by Jane Bryant Quinn, Newsweek Magazine, December 8, 2003, Page44.

Why you don't know can cost you.  A guide to what money managers hide.

Are you disgusted enough with mutual funds to raise a stink?  So far, savers don't seem nearly as outraged as they were about Enron--yet deceptive funds and sneaky "financial advisers" have swiped more money, from more people, than all the corporate scandals combined.  The House of Representatives just passed a reform bill, but in the Senate, the going looks tough.  Your legislators are scooping up money from the mutual-fund lobby, which hopes to head off any major change.  To counter the lobby, Congress needs angry protest calls from voters like you.

At least the regulators are now tailing the fund frauds that flourished right under their noses.  This week, the Securities and Exchange Commission is adopting new rules to push funds toward obeying the current laws (they don't now), as well as making it harder for them to let big investors skim off profits.  In a few weeks, the NASD (formerly the National Association of Securities Dealers) will bring enforcement actions against brokerage firms that grossly overcharged investors.  New York Attorney General Eliot Spitzer, who turned over the rock that exposed these worms, says he's likely to bring a lawsuit a week, through January, against devious mutual funds--and promises "a lot of criminal cases across the nation."

Here's how funds cheat:

 THEY MAY PAY BROKERAGE FIRMS TO GET ON A 'PREFERRED LIST': The brokers sell from that list, whether the funds are good or not.

THEY MAY PAY 'SOFT DOLLARS': That means paying the brokerage firms more than necessary to buy and sell securities.  In return, the funds get stock return, the funds get stock research, which could be useful.  They might also get "free" computers or services that, by law, should be disclosed as part of the expense ratio.  You pay soft-dollar costs without ever knowing it.

THEY DON'T DISCLOSE ALL YOUR COSTS: The prospectus shows you the upfront sales charge, if any, and the "expense ratio," which covers operating costs.  But it doesn't reveal brokerage costs or soft dollars.  Vanguard founder John Bogle estimates that expenses on taxable funds run 2 to 3 percent.  Add 0.4 percent more for brokerage costs.  All together, that's about 25 percent of the stock market's long-term, 10.4 percent return.

THEIR BOARD OF DIRECTORS HIDE: You don't even know how to contact the board with a complaint.  The whistle-blowers who outed the deceptive funds didn't go to the boards, they went to state regulators instead.

Reforms needed: The amount your fund pays in brokerage commissions and soft dollars should be disclosed.  Boards of directors, who are supposed to represent you, should put their names and a contact point into the annual report.  Morningstar managing director Don Phillips thinks they should write a yearly shareholder letter saying what they did.

BROKERS DON'T GIVE YOU REQUIRED DISCOUNTS ON SALES COMMISSIONS: If you buy A shares with a front-end load, and invest a large amount--say, more than $25,000 or $50,000 from an IRA rollover--you're entitled to a lower sales charge.  Where the discount kicks in is called a "breakpoint"--but tons of investors aren't getting the discounts they deserve.  The NASD has ordered the firms to contact clients and repay overcharges.

Some brokers sell large investors B shares, which have no breakpoints, hence no discount--and you also pay higher annual fees.  If A shares would have been cheaper, tell your broker to redo the buy.  Calculating breakpoints is more complicated than I've shown here.  For details, go to and look for its informational Investor Alerts.

THEY CHARGE YOU DOUBLE LOADS: Few investors (and brokers) know that if you're switched from one load fund to another, you usually don't have to pay the load a second time.  The rules apply even if you buy from a different broker.  Planner Rick Sabo of Money Concepts in Gibsonia, Pa., got $1,250 back for a client just by asking the new fund for a fix.

Reforms needed: Brokers should disclose how much the funds pay them to make a sale.  Costs should be shown in dollars and cents (something Vanguard has started with its funds).  "The best thing that could come out of this mess is full fee disclosure on one piece of paper," says Mary Schapiro, vice chair of the NASD.

Mutual funds are still your best investment.  To avoid crooked tactics, buy no-loads with low yearly expenses (under 0.9 percent for U.S. equity funds; under 0.6 percent for bond funds).  You want seasoned money managers who trade infrequently and with long-term performance in line with that of their peers.

Should you sell the mutual funds in trouble with the law?  Pause, if you'll pay big redemption charge or taxes.  But if the fund's fees are high, its performance mediocre and its managers cheaters, dump it for the skunk it is.

How did one of the most clever ripoffs work?

Pilgrim did it with derivatives in index funds such that when investors lost, Pilgrim won.  When investors won, Pilgrim did not lose.  This was one of the more complicated and clever ways of ripping off investors that will continue unless Congress bans 

"The Mutual Fund Scandal Unfair Fight," by Allan Sloan, Newsweek Magazine, December 8, 2003, pp. 43-46.

It's a tale of how insiders can grow fat from their stake in a fund even as regular investors are being stripped to the bone.  It turns out that Pilgrim made rich profits from investing in his PBHG Growth Fund while shareholders lost big.  PBHG Growth dropped 65 percent from March of 2000 through November of 2001, the period covered in suits filed by New York Attorney General Eliot Spitzer and the Securities and Exchange Commission.  That's a loss of 45 percent a year.  But during that same period, according to NEWSWEEK'S calculations based on information in the suits, Pilgrim made 49 percent a year on his stake in PBHG Growth.  His profit: $3.9 million.

How can this be?  Unlike regular sucker investors, Pilgrim owned his stake by investing through an outsider: a hedge fund called Appalachian Trail.  Appalachian profited by betting against Growth.  NEWSEEK has learned that Appalachian, which regulators say bought and sold Growth a total of 240 times during this period, made most or all of its profit by betting that the value of the fund's stock portfolio would fall.  Regular investors, by contrast, profited only if Growth's investments increased in value.  Pilgrim, as the fund's manager, had a legal and moral fiduciary obligation to look after his investors' money and place their interests ahead of his own.  But instead, he seems to have profited from his investors' misfortune.  It's as if a captain ran his ship into an iceberg, however inadvertently, then jumped into a private lifeboat and collected on his passengers' life insurance policies.  Pilgrim's lawyer had no comment on the regulators' suits or on NEWSWEEK'S analysis.  His defense, people involved in the case say, will apparently be that he was a passive investor in Appalachian and didn't help it bet against Growth.

The Pilgrim story is part of the almost daily revelations about mutual-fund misdeeds that are driving home a message we can no longer ignore: even when we hire professional managers to look after our money and give us a diversified portfolio, we can get (read that most likely will be) eaten alive.  We thought mutual funds were boring but safe, compared with individual stocks.  Now we're finding out that many funds weren't trustworthy.

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

"S.E.C.'s Oversight of Mutual Funds Is Said to Be Lax," by Stephen Labaton, The New York Times, November 16, 2003 --- 

The Securities and Exchange Commission failed for years to police the mutual fund industry effectively because it was captive to the industry when writing new regulations, was preoccupied by other problems on Wall Street and was severely short of staff and money, current and former officials say.

"I believe this is the worst scandal we've seen in 50 years, and I can't say I saw it coming," said Arthur Levitt, the former chairman of the Securities and Exchange Commission for nearly eight years under the Clinton administration. "I probably worried about funds less than insider trading, accounting issues and fair disclosure to investors" by public companies

Continued in the article.

What makes the mutual funds scandal such a big deal is that the life savings of half the households in the U.S. are at stake here.  There are, however, over six hundred such funds and some have been responsible ---

"Our Ethical Erosion," by Arthur Levitt, Jr. and Richard C. Breeden, The Wall Street Journal, December 3, 2003, Page A16 ---,,SB107041653779113800,00.html?mod=opinion%5Fmain%5Fcommentaries 

From the neighborhood flea market to the New York Stock Exchange, markets rely, more than anything else, on trust. Market participants must trust -- and be able to verify -- that the goods offered are what they are supposed to be; that their offer is being considered without prejudice; that their orders are being processed fairly; and that the market isn't rigged to their disadvantage.

Since Enron filed for bankruptcy two years ago this week, it has become clear that investors' trust was taken for granted and abused not just in one company or one sector, but across the breadth of our market system. High standards of integrity and character seem to have slipped to dangerous lows at many firms.

Recently, investors have learned that this ethical erosion also has infected the mutual-fund industry, apparently to a widespread degree. For 95 million mutual-fund investors, mutual funds represent the best vehicle for these individuals to access our markets and to build wealth to send their children to college, buy a new home and save for retirement. Yet, the mutual-fund industry has taken advantage of the attractiveness of mutual funds to ordinary investors:

 Investors are misled into buying funds based on past performance, even where that record actually may be very poor.

 Investors are left in the dark about the level of most fees, and about the effect that fees, expenses, sales loads and trading costs have on their actual investment returns.

 Fund directors either are stretched too thin, or are otherwise uninterested or unable to exercise effective oversight.

 Most shockingly, fund management in many instances has offered pricing and trading prerogatives to hedge funds and other large investors, with some sponsors indirectly sharing in the profits from improper trading practices. Deals of this kind, at best, turn individual investors into second-class citizens, and, at worst, into sheep to be fleeced. Apparently, $80 billion in annual fees is enough to induce a bad case of ethical myopia.

The time has come for a real clean-up. Cosmetic policy changes and compliance reviews or image campaigns won't do it. The mutual fund industry's reach and its importance to the livelihoods of millions of Americans demand not just singular enforcement actions, but a much broader overhaul of the industry itself. Anything less than swift, comprehensive action risks causing long-term damage to an investment vehicle that is important to the industry, to our markets, and to our economy as a whole.

First, we need a coordinated effort by the state attorneys general and the SEC to expose illegal activity and to prosecute it vigorously. The New York attorney general has performed an outstanding public service with his success in the Canary Capital case and in exposing other wrongdoing. But the strength of our markets rests on a national system, not on piecemeal state standards. For the future, investors need both state and federal authorities to work together in a genuine partnership to root out abusive practices, as part of a coherent and effective national effort.

Second, through legislation and regulation, Congress and the SEC should underscore the simple but critical fact that fund sponsors and directors alike have a fiduciary duty to fund investors. Fund companies are not selling soap, but a relationship based on millions of investors trusting these companies with their savings. Duties of care and loyalty are as essential in the fund industry as they are in the rest of corporate America. The first loyalty of fund-company management and directors must be to the task of enhancing the returns of ordinary fund investors, not the profitability of the fund sponsor.

Third, the SEC needs to intensify its dealings with the fund industry and improve its own capacity to be an effective overseer. It must act quickly to stop late trading, seriously curb market timing and clean up other shady practices. Today the Commission is scheduled to begin that process. More generally, fund managers must understand that the time for compliance reviews is before, not after, improper conduct occurs. For the worst offenders, sanctions need to imperil the flow of fees, and fund sponsors who believe they are above ethical concerns should see the regulatory roof cave in. When it comes to the mutual fund industry, more than a few heads need to be cracked, and the Commission shouldn't be afraid to do it.

The SEC is not waiting for a legislative prod to adopt better rules to curb market timing. If exchange limits, minimum redemption blackouts, or significant redemption fees are not adequate to stop these practices cold the agency can find other devices to allow after-hours real time pricing. The bottom line is that where a fund tells investors that they do not allow market timing, the SEC should insist that they make good on that promise.

Fourth, we must make the oversight of independent directors an effective check on mutual- fund abuses. The SEC should require fund companies to have an independent chairman without ties to the fund sponsor. That is one of the best ways to improve accountability for management practices. The SEC should also act to assure independence and competence among fund directors. Too many independent directors aren't really independent. Many directors are stretched far too thin and have served far too long.

Independent fund directorships are not supposed to be sinecures for those who won't challenge powerful fund sponsors. All fund boards should have term limits, and independent directors should have professional resources to help them develop their own independent information on fund-management performance and other issues. The SEC should increase the number of independent directors to all but one; and require that boards justify to their bosses -- the shareholders -- the choice of investment adviser and fees charged.

In egregious cases, fund sponsors could be required to appoint to their boards an investor ombudsman; or they could lose their ability to participate in nominating new fund directors or to renew advisory contracts for a defined period of time. Fund sponsors should take seriously the need to adopt meaningful governance reforms within their own organizations, not merely cosmetic trifles.

Fifth, mutual-fund companies need to show leadership in reforming themselves. Reforms may be encouraged by regulatory action, but ultimately only mutual-fund companies themselves will win back investors' trust. We need them to be a steady and loud voice for meaningful, pragmatic change. To that end, mutual-fund companies should end misleading hype and proactively ban deceptive performance advertising. Advertising should fully reflect the effect of direct and indirect fees and taxes on fund performance, as well as periods of poor and good performance.

Finally, mutual-fund companies also need to help clean up the brokerage system through which more than 80% of investors purchase their shares. Revenue sharing, sales contests and higher commissions for selling home-grown funds all damage investor interests and have no place in the industry. If they exist at all, "soft dollars" should be disclosed so that investors have a clear understanding of the relationships their mutual-fund companies and brokers have, and they should inure solely to the benefit of fund investors, not sponsors. Furthermore, Congress should consider revisiting the safe harbor it granted soft-dollar arrangements shortly after it abolished fixed brokerage commissions in 1975.

For years, mutual funds boasted that they were investors' best friends. For the health of the markets and our economy, it's time for them to prove it.

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

The primer below should have been entitled "The Mutual Fund Scandal for Dummies."  It is the best explanation of what really happened and how mutual funds versus index funds really work.

A Primer on the Mutual-Fund Scandal --- 
Stanford University  faculty member Eric Zitzewitz, "found evidence of market timing and late trading across many fund families he studied."
BusinessWeek Online, September 22, 2003

When it comes to financial scandal, the mutual-fund industry had always seemed above the fray. No longer. On Sept. 3, New York Attorney General Eliot Spitzer kicked off an industry wide probe with allegations that four prominent fund outfits allowed a hedge fund to trade in and out of mutual funds in ways that benefited the parent companies at the expense of their long-term shareholders.

By Sept. 16, Spitzer's office and the Securities & Exchange Commission had filed criminal and civil charges against a former Bank of America (BAC ) broker who allegedly facilitated illegal trading in mutual funds. More fund companies are being subpoenaed for information about their trading, and more state and federal regulators are joining the growing investigation. It's all but certain that more fund firms will be drawn into the deepening scandal.

Yet this major crisis for the fund industry has failed to inspire much fury from investors, and it has done little to halt a rising stock market. Maybe a partial explanation is that the fund companies allegedly did wrong, and why it hurt shareholders, is difficult to understand. For anyone who has read widespread coverage of the topic but wanted to scream, "Explain what the heck is going on," we provide the following discussion:

Let's start at the beginning. How is a mutual fund set up?
A mutual fund is like any other public company. It has a board of directors and shareholders. Its business is investing -- in stocks, bonds, real estate, or other assets -- using whatever strategy is set out in its prospectus, with money from individual investors. Its strategy could be to buy, say, small, fast-growing U.S. companies or to purchase the debt of firms across Europe.

A fund's board hires a portfolio manager as well as an outside firm to market and distribute the fund to investors. But funds can become big quickly, and the larger ones operate a bit differently. A fund-management company (think Fidelity or Vanguard) sets up dozens of funds, markets them to investors, hires the portfolio managers, and handles the administrative duties. It makes a profit collecting fees (usually a percentage of assets under management) from the funds it manages.

A fund company typically has in place the same board of directors (including some independent members) for its funds. The board of directors should be on the lookout for abusive practices by the fund company, but directors often have too many funds to oversee and may be too aligned with the company's portfolio managers to provide much oversight.

This case concerns mutual-fund trading. Does it involve the portfolio managers?
No, that's not what this case is about. Portfolio managers buy and sell securities for their funds. But the alleged improper trading has to do with outside investors buying and selling a fund's shares. Spitzer's complaint actually concerns the activity of one firm, Canary Capital Partners, but he alleges the same activity is far more widespread.

Portfolio managers, who are usually compensated based on their funds' performance and frequently have their own money invested in their funds, are usually shareholders' greatest defenders against trading practices that hurt long-term results.

How are mutual funds traded?
Funds can be bought and sold all day. However, unlike stocks, which are priced throughout the trading day, mutual funds are only priced once a day, usually at 4 p.m. Eastern Time. At that point the funds' price, or Net Asset Value (NAV), is determined by adding up the worth of the securities the fund owns, plus any cash it holds, and dividing that by the number of shares outstanding.

Buy a fund at 2 p.m. and you'll pay a NAV that is determined two hours later. Buy a fund at 5 p.m. and you'll pay a price that won't be set until 4 p.m. the following day. According to Spitzer's complaint, Canary Capital Partners, a hedge fund, took advantage of the way fund prices are set to effectively pick the pockets of long-term shareholders.

What's a hedge fund?
A hedge fund is like a mutual fund in that it buys and sells securities, is run by a portfolio manager, and tries to make money for its investors. But hedge funds have a very different structure (they are actually set up as partnerships) and are almost entirely unregulated, mostly because they manage money for sophisticated high net-worth individuals or companies, and have different rules governing when and how investors can liquidate their positions.

Hedge-fund managers are compensated based on a percentage of profits (often 20%), so they have a major incentive to take risks, which they often do. Selling stocks short (a way to bet they will fall in price), piling on complex financial security derivatives, and using borrowed money to leverage returns are common strategies.

So exactly what did Canary Capital allegedly do?
According to Spitzer's complaint, Canary (which settled charges, paid $40 million in fines, but didn't admit or deny guilt), had two strategies (Spitzer called them "schemes") for making money trading in mutual funds. The easiest to understand, the most serious, and clearly illegal is "late trading." The other strategy, "market timing" is far more common and not illegal, although clearly unethical.

How does late trading work?
The rule of "forward pricing" prohibits orders placed after 4 p.m. from receiving that day's price. But Canary allegedly established relationships with a few financial firms, including Bank of America, so that orders placed after 4 p.m. would still get that day's price. In return for getting to trade late, Canary placed large investments in other Bank of America funds, effectively compensating the company for the privilege of trading late.

The late-trading ability would have allowed Canary to take advantage of events that occurred after the market closed -- events that would affect the prices of securities held in a fund's portfolio when the market opened the next day.

I could use an example.
Here's a hypothetical, simplified one: Let's say the Imaginary Stock mutual fund has 5% of its assets invested in the stock of XYZ Co. After the close, XYZ announces earnings that exceed analysts' expectations. XYZ closed at 4 p.m. at $40 a share but most likely, its price will soar the next day.

The late trader buys the Imaginary Stock mutual fund at 6 p.m. after the news is announced, paying an NAV of $15 (that was calculated using the $40 share price of XYZ). The next day, when XYZ closes at $50, it helps push the fund's NAV to $15.50. The late trader sells the shares and pockets the gain. Spitzer says late trading is like "betting today on yesterday's horse races." You already know the outcome before you place your winning bet.

How do they turn this into real money? It sounds like small potatoes.
If you did this dozens of times a year in hundreds of funds investing millions of dollars at a time, it would add up.

What about market-timing? How does that work?
This strategy takes advantage of prices that are already outdated, or "stale," when a fund's NAV is set. Most often the strategy is carried out using international funds, in which prices are stale because the securities closed earlier in a different time zone.

Could you give an example?
Well, let's take the Imaginary International Stock mutual fund. One day, U.S. markets get a huge boost thanks to positive economic news and the benchmark Standard & Poor's 500 rises 5%. The market-timer steps in and buys shares of the international fund at an NAV of $15 at 4 p.m., knowing that about 75% of the time, international markets will follow what happened in the U.S. the previous trading day. Predictably, most of the time, the international fund rises in price the next day and closes at an NAV of $15.05. The market-timer then sells the shares, pocketing the gain.

If market timing isn't illegal, why would Spitzer investigate the industry for it?
Market timing (and late trading, for that matter) add to a fund's costs, which are paid by shareholders. This kind of trading activity also either dilutes long-term profits or magnifies losses depending on whether the trader is betting the fund will go up or go down. (For a more detailed example of how market-timing works, see BW Online, 12/11/02, "How Arbs Can Burn Fund Investors").

Most funds have a stated policy in place (included in the prospectus) of prohibiting market-timing. They impose redemption fees on investors that hold a fund less than 180 days. And many prospectuses give fund companies the right to kick market-timers out of the fund.

Yet Spitzer alleges that fund companies such as Janus (JNS ) and Strong got to reap extra management fees by allowing Canary to do market-timing trades in return for Canary placing large deposits of "sticky" assets (funds that are going to stay in one place for a while) in other funds. That would put it in violation of its fiduciary duty to act in its shareholders' best interests and mean it has not conformed to policies laid out in its prospectus.

Spitzer offers this analogy: "Allowing timing is like a casino saying that it prohibits loaded dice, but then allowing favored gamblers to use loaded dice, in return for a piece of the action." Janus, Strong, and the other companies named in Spitzer's complaint have promised to cooperate with him and are conducting their own internal investigations of trading practices. Several firms have promised to make restitution to shareholders if they find such deals cost shareholders money.

But wouldn't this amount to tiny losses for the shareholders in the fund?
That depends on how many traders might have used these strategies. Spitzer believes these practices are widespread and his investigation is widening to include many more fund companies.

Eric Zitzewitz, an assistant professor of economics at Stanford, has found evidence of market timing and late trading across many fund families he studied. His research shows that an investor with $10,000 in an international fund would have lost an average of $110 to market timers in 2001 and $5 a year to after-market traders. Average losses in 2003 appear to be at roughly the same level, he says. That may not sound like much, but in a three-year bear market, when the average investor was losing hundreds if not thousands of dollars on investments, it's adding the insult of abused trust to the injury of heavy losses.

What's likely to happen next?
Spitzer and other securities regulators are likely to announce the alleged involvement of more fund companies. If individual investors believe fund companies abused their trust, they are likely to call for more regulation and stiff penalties. Potentially they could pull their money out of funds en masse, forcing portfolio managers to liquidate stocks to fund redemptions. That could be very disruptive to financial markets.

Another possibility is that the stock market continues to rise on the back of a stronger economy and a jump in corporate profits. Fund investors might be willing to ignore past losses due to illegal and unethical trading practices because they're pleased with the current gains their funds are providing. For now, that's clearly what the embattled mutual-fund industry hopes will happen.

An Ethics Dilemma for Professors

Should a research professor ethically exploit his research discoveries at the expense of others?

Since I have long fantasized over this dilemma, let me note that there are two levels of ethical dilemma.

Level 1: 
A professor makes a discovery and then earns millions on it before disclosing the discovery.  This seems to me to be blatantly unethical if it entails any type of illegal or highly unethical exploitation.  However, if the activity itself is perfectly legal, then it is not blatantly unethical.  What Professor Zitzewitz (see below) did was legal for him but not necessarily legal or ethical for his broker or other fund managers who had fiduciary responsibilities to protect portfolios of clients.

Level 2: 
A professor makes a discovery and simultaneously discloses that discovery while making millions exploiting an inefficient legal/market system that has not yet caught up with the research findings.  The
Stanford University assistant professor of business in question actually was simultaneously warning the world that the mutual fund industry was ripping off the public for over $5 billion while he himself exploited his discovery by adding millions to his own personal portfolio using his discovery.  Level 2 is a real gray zone, especially if the world is just ignoring his efforts to disclose his research findings.

I recommended the above Stanford Professor Zitzewitz primer on the mutual fund scandal --- --- 
I still recommend this primer!

Here's the saddening rest of the story.

"Prof. Zitzewitz Has Good Timing And Bad Timing," by Randall Smith, The Wall Street Journal, December 9, 2003 --- 

The Stanford University business-school professor who shot to fame by warning how much aggressive mutual-fund traders using market-timing strategies cost long-term investors put his money where his mouth is.

In a widely cited research paper published last year, Eric Zitzewitz estimated that such trading costs long-term investors $5 billion annually and criticized mutual funds for allowing it. Yet Mr. Zitzewitz engaged in extensive timing trades himself during a three-month period this summer, according to people familiar with the trading.

Mr. Zitzewitz's study also concluded that investors can earn 35% to 70% annually pursuing such trading strategies in overseas mutual funds. In reality, he earned profits of more than $500,000, somewhat less than his best-case scenario, by trading with as much as $19.5 million in assets, which included funds from his wife and another academic, the same people said.

Timing trades aim to exploit stale prices of certain funds, such as foreign stock funds, which contain securities whose prices are set in overseas markets that close many hours before those in the U.S., and thus may not reflect the impact of later market-moving developments.

In a statement, Mr. Zitzewitz said, "The trading I did was based on a known pricing anomaly and was legal: No trades were placed after 4 p.m. and there were of course no quid-pro-quo arrangements with mutual funds." While he acknowledged that he has been critical of mutual funds that allow stale prices, he noted that he has no "fiduciary, regulatory or legislative role overseeing mutual fund pricing," and thus his trading wasn't a conflict of interest.

Although Mr. Zitzewitz's trades didn't necessarily violate any rules, they resulted in disciplinary action against his broker at UBS AG for alleged violation of the firm's policies against such rapid-fire fund trading. UBS fired two brokers and suspended nine others last month for alleged violations of the guidelines, which were put in place in December 2001.

However, Mr. Zitzewitz wasn't aware of the UBS policy at the time, one of the people said. And he quickly halted the activity in early September, once regulators launched a crackdown on improper mutual-fund trading. A spokeswoman for UBS said in a statement, "As a matter of policy, we do not comment on client accounts."

The 32-year-old assistant professor of strategic management, who is teaching at the Columbia Business School in Manhattan on a one-year leave from Stanford, was thrust into the spotlight in September by New York Attorney General Eliot Spitzer. After Mr. Spitzer cited the academic's cost estimates in his original complaint against Canary Capital Partners LLC, Mr. Zitzewitz was quoted in several newspaper stories and testified on the subject before a House subcommittee in November.

He isn't the first academic to test his theory in the marketplace: Two finance professors from Georgia universities who researched market-timing strategies and reached conclusions similar to those of Mr. Zitzewitz have said they took advantage of price discrepancies in international stock funds. Those academics traded in their own retirement accounts.

Still, Mr. Zitzewitz's efforts to profit from such trading flew in the face of the critical tone he took in describing mutual funds which allowed it. The title of his October 2002 paper was "Who Cares About Shareholders? Arbitrage-Proofing Mutual Funds."

And the introduction said in part, "Despite the fact that this arbitrage opportunity has been understood by the industry for 20 years and heavily exploited since at least 1998, the fund industry was still taking only limited action to protect its long-term shareholders as of mid-2002." In his congressional testimony, he said funds may have "dragged their feet" on the issue to help "favored customers."

While timing trades aren't by themselves illegal, regulators have charged some fund families with civil violations for allegedly making illegal "quid pro quo" arrangements to allow certain investors to make timing trades against the funds' stated policies. However, they aren't considered as serious a violation as a late trade, which aims to exploit events that occur after the funds are priced as of 4 p.m. There isn't any indication that Mr. Zitzewitz made any late trades or quid pro quo arrangements.

In his October 2002 research paper, Mr. Zitzewitz estimated that timing trades alone cost other investors in foreign stock funds 1.14 percentage points in annual returns in 2001. On a long-term basis, such a drag on performance could amount to roughly 10% of investors' expected returns from such funds. Mr. Zitzewitz estimated that cost had risen from 0.56 percentage point in 1998-99.

As recounted in his paper, Mr. Zitzewitz and other academics had taken their concerns about mutual funds' lack of response to the stale-price issue to the SEC. The paper described the SEC as failing to act aggressively to require funds to update stale prices, and cited mutual-fund industry pressure as one of the possible reasons.

In mid-2003, just three months before Mr. Spitzer first announced he was taking action against the practice, Mr. Zitzewitz launched his trading effort. Ironically, Mr. Spitzer's lead investigator had contacted Mr. Zitzewitz around July in an effort to learn more about the subject.

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

Nothing wrong with overcharging, so long as everyone else is doing it, right?

"The Mutual Fund Scandal's Next Chapter," by Gretchen Morgenson, The New York Times, December 7, 2003 ---  

IT'S hard to know where the ever-amazing mutual fund scandal will take investors next. But here is a clue. Regulators are setting their sights on two new areas: funds that fail to price their portfolios properly each day and those charging excessive fees.

Funds with stale pricing - net asset values that do not reflect market reality - are coming under scrutiny. "We are going to make sure that funds are priced properly even without any indication that there has been abusive market timing," said Stephen M. Cutler, director of enforcement at the Securities and Exchange Commission.

Of particular interest are corporate or municipal bond funds whose net asset values stay mysteriously inert even as the United States Treasury market is gyrating wildly. Investors in funds whose net asset values have not reacted to major moves may be paying or receiving the wrong prices. Moreover, stale prices in bond funds provide fine opportunities for market timers who jump in and out of funds to take advantage of out-of-whack prices.

A case in point is what occurred in the Treasury market last August. During the first week of the month, Treasury securities maturing in five years yielded between 3.1 percent and 3.22 percent. The following week, however, Treasuries fell and their yields moved sharply higher. By Aug. 15, yields on the 5-year Treasury had jumped to 3.4 percent.

What happens in the United States Treasury market ripples through other parts of the fixed-income world, affecting prices in corporate, mortgage-backed and municipal securities. Yet some bond funds appeared to be oddly impervious to the August moves. Consider, for example, the Franklin AGE High Income fund, which invests in speculative-grade debt. From Aug. 8 through Aug. 18, while the yields on Treasuries went from 3.18 percent to 3.4 percent, the Franklin fund's net asset value, the price at which it is bought and sold, was constant at $1.87, except for one day when it hit $1.88. And the week of Sept. 8, when Treasury yields fell from 3.34 percent to 3.14 percent, the Franklin fund's net asset value stood still at $1.95.

Here's another anomaly. For three weeks beginning on Aug. 4, the net asset value of the Quaker Intermediate Municipal Bond fund, which also invests in high-yield debt, remained at $4.91.

A Franklin spokesman declined to comment on why the fund did not move; he would say only that it was being priced correctly. A Quaker spokesman did not return a call seeking comment.

On the fees front, Mr. Cutler said his staff was looking closely at stock index funds that levy fees a lot higher than lower-cost funds like those offered by Vanguard Funds. The Vanguard 500 Index fund has an expense ratio of 0.18 percent, or 18 basis points.

While the S.E.C. is not in the business of legislating mutual fund fees, Mr. Cutler said the commission is interested in hearing how fund boards justify agreeing to pay higher fees to an adviser for what is essentially fund management on autopilot.

Consider the MainStay Equity Index fund, whose investment adviser is New York Life Investment Management. Its expense ratio is an astonishing 1.02 percent annually. Slightly less egregious but still expensive is the Northern Stock Index fund,which charges 0.55 percent annually.

A MainStay spokesman did not return a call seeking comment.

Lloyd Wennlund, a spokesman for Northern Trust, manager of the Northern Index Fund, said that it charges shareholders a fee at or below the median expense ratio of similar funds. The median expense ratio for Standard & Poor's index funds, he said, is 57.5 basis points. "We are higher than a Vanguard, sure," he said, "but our goal is to provide value to shareholders at a price that is at or below median pricing."

Nothing wrong with overcharging, so long as everyone else is doing it, right?

Apart from the breach of fiduciary responsibility in which many fund mangers help there big customers steal from their little customers, most funds charge customers much more than the value added for services.
The Wall Street Journal, December 11, 2003, Page C1 ---,,SB10710996418574900,00.html?mod=mkts_main_news_hs_h

And Fees Vary Dramatically
Among the 25 largest fund firms, the three whose stock funds have the 
highest expense ratios and the three that have the lowest expense 
stock funds.
Alliance 1.69%
Federated 1.53%
AIM 1.50%
Fidelity 0.82%
American 0.79%
Vanguard 0.28%

What is also sad is the added fee that financial advisors/brokers charge just to get into mutual funds when for most investors who want diversification in various risk categories, the funds themselves probably provide sufficient information for free.  Most of the funds like Vanguard now provide check books with their funds such that deducting is as simple as writing a check and depositing is as simple as filling out a deposit slip.

Educators can read more about TIAA/CREF mutual funds at 
TIAA/CREF charges 0.31% according to 
I could not find any information at the above Website about whether TIAA/CREF offers check writing features like Vanguard.

And the untarnished winners are:  Fidelity, Vanguard and the American Funds

Stock mutual funds took in more money in the past three months than in any period since 2000, despite the trading scandal.  The upshot: The worst mess in the history of mutual funds has become a marketing opportunity for those firms still untarnished. As cash leaves implicated firms, fund executives at major firms say their salespeople are working fervently to attract money from investors who are eager to stay invested as the stock market is again pushing strongly higher.
"Flight to Quality Benefits Three Fund Firms," by Ian McDonald, The Wall Street Journal, December 12, 2003 ---,,SB107118601050112500,00.html?mod=home_whats_news_us 

Financial planner Joseph Lyons recently moved client assets out of a Putnam Investments mutual fund whose manager allegedly made improper trades in its shares. Mr. Lyons didn't move it out of the stock market. He chose another stock mutual fund, managed by Morgan Stanley.

Like many others, he wants to avoid funds tainted by the sprawling mutual-fund trading scandal that erupted in early September, but he isn't giving up on stocks. It's hard to resist a market that seemingly keeps going up. Enthusiasm for stocks pushed the Dow Jones Industrial Average through the 10000 mark Thursday, the highest level in 18 months.

After a family discussion of the issues, 43-year-old Mr. Lyons, who works with investment firm Linsco Private Ledger, in Walnut Creek, Calif., shifted his wife's retirement holdings from several Putnam Investment funds to some Fidelity Investments portfolios. He's out to protect his clients' -- and his family's -- interests.

"As long as the stock market is doing well, people will keep investing," says Steve Henningsen, a financial adviser with the Wealth Conservancy in Boulder, Colo. "It's kind of weird this scandal hasn't chased people from funds."

Although many irate individuals and institutions have unloaded holdings of funds run by Putnam Investments, which has settled federal charges in the matter, and Strong Capital Management, which is under investigation but hasn't been charged with any wrongdoing, and other firms implicated in the scandal, money flowing into the fund industry as a whole has been surprisingly robust. From the start of September through the end of last month, stock mutual funds took in more than $63 billion, their highest three-month intake since early 2000 when stock prices peaked, according to flow-tracker AMG Data Services. This money has helped fuel the stock market's rise.

A staggering 55% of it has gone to the country's three largest fund firms as measured by assets: Fidelity Investments, Vanguard Group and American Funds. Even though the three fund groups together hold more than $1.8 trillion of the industry's $7 trillion in assets, new money is coming into Fidelity, Vanguard and American at a markedly faster pace than usual. From 1998 to the start of this year, the three firms took in a little more than a third of the industry's stock-fund flows.

While new disclosures continue to emerge almost daily in the investigations, Fidelity, Vanguard and the American Funds family run by Capital Research & Management have avoided allegations of wrongdoing in the scandal to date. And while many other firms also have a clean bill of health so far, it appears the industry's Big Three in particular are benefiting from a drastic flight to quality in the fund world.

"These firms can portray themselves as being good money managers who put the customer first," says Charles Bevis, research editor at Boston fund consultants Financial Research. "They have a very persuasive message that other firms will have a hard time delivering to customers."

Some observers find investors' reaction to the scandal news heartening. Rather than give overriding importance to the latest short-term investment returns, they appear to be casting their lot with companies that look to be more concerned about their current customers than prospective ones. "Maybe fund investors aren't so dopey after all," says Russ Kinnel, director of fund research at Morningstar.

The upshot: The worst mess in the history of mutual funds has become a marketing opportunity for those firms still untarnished. As cash leaves implicated firms, fund executives at major firms say their salespeople are working fervently to attract money from investors who are eager to stay invested as the stock market is again pushing strongly higher.

Standard & Poors:  A good place to start when looking into investment funds --- 

The more or less unmentioned scandal in the current mutual fund mess is the scandal of overcharging by many mutual funds. NBC mentioned this morning that many of the funds have been charging investors more than they are returning to investors. 

 If your fund is charging more than 1%, you should probably investigate why, and you may not get a straight answer from your broker of fund advisor.

"SEC knew about dicey fund pricing:  Agency warned of problem for nearly six years, but did little," by John W. Schoen, MSNBC, September 11, 2003 --- 

The Securities and Exchange Commission has known for nearly six years about the sloppy pricing of mutual fund shares that one study estimates is costing individual investors as much as $5 billion a year, but the agency has initiated only a handful of low-profile enforcement actions, a review of SEC statements and documents by has found.

FOLLOWING last week’s complaint against four fund companies by New York Attorney General Eliot Spitzer, the SEC announced that it would investigate mutual fund pricing practices which have been estimated to have cost tens of millions of long-term investors billions of dollars. Spitzer’s investigation found that at least four mutual fund companies — including Janus, Banc One, Strong and Bank of America’s NationsFunds — made secret deals with a hedge fund that allowed it to make rapid fire trades in fund shares at the expense of individual investors who hold the funds for the long haul.

Continued in the article

In spite of recent, criticisms of the SEC, the SEC has a great site to look at for starters along with a cost calculator ---

You might want to check out

I also recommend that you read Ric Edelman’s piece at
This is somewhat dated, but it is a concise summary of how mutual funds get money from you.  I think you can do better than the 1.5% low end that he talks about, e.g., see Vanguard at  

Time Magazine on November 17, 2003, Page 56 suggests shifting savings into low cost mutual funds "like Vanguard, Fidelity or T. Rowe Price."  Of course consideration must be given to the tax consequences if withdrawal values exceed your "cost basis."  Your present fund must disclose both the current value and the cost basis.

"The funds stank anyway:  Several funds tagged by market timers or late traders were long-term underperformers."
by Jeanne Sahadi, CNN Money November 7, 2003 --- 

If you own one of the mutual funds alleged to have been market-timed or late traded, why not channel your anger productively and realize what the scandal really has brought to light: That a lot of the funds implicated so far haven ' t been a great place for your money anyway.

At least judging by long-term performances.

To date, 39 funds have been identified either by regulators or a fund family as being targets of market timers or late traders. (Track the funds here.)

There are plenty of others, though.

In fact, the SEC has said as many as half of fund companies have had market-timing arrangements. And in cases where firms such as Prudential had brokers that were alleged to have facilitated improper trades, they had access to a broad group of funds.

Using Morningstar data, we looked at the three-, five- and 10-year performance records of the 39 funds that have been named to see how their performance compared with that of their peers.

We found that 15 of the funds ranked in the bottom half of their categories for two to three of those periods. And of those 15 funds, eight ranked in the bottom quarter for at least one of those periods.

One of the worst offenders was OneGroup LargeCap Value (OLVAX), which ranked in the 96th percentile of its category on a three-year basis; in the 76th percentile over five years; and in the 77th percentile over 10 years.


Other funds that were bottom performers for all three periods: Janus Enterprise (JAENX) (which took above-average risk and delivered three-year returns that were nearly 12 percentage points below its category average); Nations Value (NVLEX); OneGroup Diversified Equity (PAVGX) ; OneGroup Diversified Midcap (PECAX), and OneGroup Equity Income (OIEIX).

Alger SmallCap (ALSAX), meanwhile, which doesn ' t have a 10-year record yet, ranked in the 98th percentile of its peers over five years, with a return that fell more than 13 percentage points below its category average.

By contrast, only seven of the 39 funds ranked in the top half of their categories for two to three of the time periods measured. Of those, only four ranked in the top quarter for more than one time period.

The best performer in these respects was Putnam International Equity (POVSX), which was the only fund to have ranked in the top half of its category for all three periods. It ranked in the 47th percentile of its category over three years; in the 8th percentile over five years; and in the 2nd percentile over a 10-year time horizon.

"Investors First," by William H. Donaldson, The Wall Street Journal, November 18, 2003, Page A20 --- 

Among its many roles, the Securities and Exchange Commission has two critical missions. The first is to protect investors, and the second is to punish those who violate our securities laws. Last week's partial settlement of the SEC's fraud case against the Putnam mutual-fund complex does both. It offers immediate and significant protections for Putnam's current mutual-fund investors, serving as an important first step. Moreover, by its terms, it enhances our ability to obtain meaningful financial sanctions against alleged wrongdoing at Putnam, and leaves the door open for further inquiry and regulatory action.

Despite its merits, the settlement has provoked considerable discussion, and some criticism. Unfortunately, the criticism is misguided and misinformed, and it obscures the settlement's fundamental significance.

By acting quickly, the SEC required Putnam to agree to terms that produce immediate and lasting benefits for investors currently holding Putnam funds. First, we put in place a process for Putnam to make full restitution for investor losses associated with Putnam's misconduct. Second, we required Putnam to admit its violations for purposes of seeking a penalty and other monetary relief. Third, we forced immediate, tangible reforms at Putnam to protect investors from this day forward. These reforms are already being put into place, and they are working to protect Putnam investors from the sort of misconduct we found in this case.

Among the important reforms Putnam will implement is a requirement that Putnam employees who invest in Putnam funds hold those investments for at least 90 days, and in some cases for as long as one year -- putting an end to the type of short-term trading we found at Putnam. On the corporate governance front, Putnam fund boards of trustees will have independent chairmen, at least 75% of the board members will be independent, and all board actions will be approved by a majority of the independent directors.

In addition, the fund boards of trustees will have their own independent staff member who will report to and assist the fund boards in monitoring Putnam's compliance with the federal securities laws, its fiduciary duties to shareholders, and its Code of Ethics. Putnam has also committed to submit to an independent review of its policies and procedures designed to prevent and detect problems in these critical areas -- now, and every other year.

This settlement is not the end of the Commission's investigation of Putnam. We are also continuing to examine the firm's actions and to pursue additional remedies that may be appropriate, including penalties and other monetary relief. If we turn up more evidence of illegal trading, or any other prohibited activity, we will not hesitate to bring additional enforcement actions against Putnam or any of its employees. Indeed, our action in federal court charging two Putnam portfolio managers with securities fraud is pending.

There are two specific criticisms of the settlement that merit a response.

First, some have charged that it was a mistake not to force the new management at Putnam to agree that the old management had committed illegal acts. In fact, we took the unusual step of requiring Putnam to admit to liability for the purposes of determining the amount of any penalty to be imposed. We made a decision, however, that it would be better to move quickly to obtain real and practical protections for Putnam's investors, right now, rather than to pursue a blanket legal admission from Putnam. The SEC is hardly out of the mainstream in making such a decision. All other federal agencies, and many state agencies (including that of the New York attorney general), willingly and regularly forgo blanket admissions in order to achieve meaningful and timely resolutions of civil proceedings.

Second, some have criticized the Putnam settlement because it does not address how fees are charged and disclosed in the mutual fund industry. While this issue is serious, the claim is spurious. The Putnam case is about excessive short-term trading by at least six Putnam management professionals and the failure of Putnam to detect and deter that trading. The amount and disclosure of fees is not, and never has been, a part of the Putnam case, and thus it would be wholly improper to try to piggyback the fee-disclosure issue on an unrelated matter

Continued in the article.

A Message from Eliot Spitzer, Attorney General of New York , New York Times, November 17, 2003

With two decisions in the last two weeks, the Bush administration has sent its clearest message yet that it values corporate interests over the interests of average Americans. In the Securities and Exchange Commission ' s settlement with Putnam Investments, the public comes away short-changed. In the Environmental Protection Agency ' s decision to forgo enforcement of the Clean Air Act, the public comes away completely empty-handed.


The 95 million Americans who invest in mutual funds paid more than $70 billion in fees in 2002. These fees went to an industry that did not take seriously its responsibility to safeguard investors ' money. Investors are now rightly concerned about whether those mutual funds that breached their fiduciary duties will be required to refund the exorbitant fees they took, and what mechanism will be put in place to ensure that the fees charged in the future are fair.


Unfortunately, the S.E.C. ' s deal with Putnam does not provide a satisfactory answer to these questions. Instead, it raises new questions.


The commission ' s first failure is one of oversight. The mutual fund investigation began when an informant approached our office with evidence of illegal trading practices. Tipsters also approached the commission, which is supposed to be the nation ' s primary securities markets regulator, but the commission simply did not act on the information.


The commission ' s second failure was acting in haste to settle with Putnam even though the investigation is barely 10 weeks old and is yielding new and important information each day. Whether the commission recognizes it or not, the first settlement in a complex investigation always sets the tone for what follows. In this case, the bar is set too low.


The Putnam agreement does contain a useful provision mandating that the funds ' board of directors be more independent of the management companies that run its day-to-day operations. It also talks of fines and restitution, but leaves for another day the determination of the amount Putnam should pay.

Most important, the agreement does not address the manner in which the fees charged to investors are calculated. Nor does it require the fund to inform investors exactly how much they are being charged — or even provide a structure that will create market pressure to reduce those fees. Finally, there is no discussion of civil or criminal sanctions for the managers who acted improperly by engaging in or permitting market timing and late trading.


S.E.C. officials are now saying that they may be interested in additional reforms. But by settling so quickly, they have lost leverage in obtaining further measures to protect investors. After reviewing this agreement, I can say with certainty that any resolution with my office will require concessions from the industry that go far beyond what the commission obtained from Putnam.


It is not surprising that the commission would sanction a deal that ignores consumers and is unsatisfactory to state regulators. Just look at the Bush administration ' s decision to abandon pending enforcement actions and investigations of Clear Air Act violations.


Even supporters of the Bush administration ' s environmental policy were stunned when the E.P.A. announced that it was closing pending investigations into more than 100 power plants and factories for violating the Clean Air Act — and dropping 13 cases in which it had already made a determination that the law had been violated.

Regulators may disagree about what our environmental laws should look like. But we should all be able to agree that companies that violated then-existing pollution laws should be punished.

Those environmental laws were enacted to protect a public that was concerned about its health and safety. By letting companies that violated the Clean Air Act off the hook, the Environmental Protection Agency has effectively issued an industry-wide pardon. This will only embolden polluters to continue practices that harm the environment.


My office had worked with the agency to investigate polluters, and will continue to do so when possible. But today a bipartisan coalition of 14 state attorneys general will sue the agency to halt the implementation of weaker standards. In addition, we will continue to press the lawsuits that have been filed. We have also requested the E.P.A. records for the cases that have been dropped, and will file lawsuits if they are warranted by the facts.


Similarly, my office — while committed to working with the Securities and Exchange Commission in our investigation of the mutual fund industry — will not be party to settlements that fail to protect the interests of investors and let the industry off with little more than a slap on the wrist.


The public expects and deserves the protection that effective government oversight provides. Until the Bush administration shows it is willing to do the job, however, it appears the public will have to rely on state regulators and lawmakers to protect its interests.

Eliot Spitzer is attorney general of New York

"State regulators blast SEC funds deal," MSNBC, November 14, 2003 --- 

In the widening probe of mutual fund trading fraud, the fault line between the Securities & Exchange Commission and two state attorneys general widened Friday, after federal regulators blessed a partial settlement with Putnam Investments that state regulators said let the mutual fund giant off too easy. Meanwhile, the scandal spread to Charles Schwab, which said it had found some of its traders had placed “late trades” that allowed them to profit at the expense of Schwab fund customers.

THE SEC scrambled Friday to counter criticisms that its regulators have done too little, too late to clean up the $7 trillion mutual fund industry, which manages savings and retirement investments for half of all U.S. households. CNBC reported that the SEC will announce a “major enforcement action” in the scandal as soon as Monday. Sources say the action will target Morgan Stanley. At issue are payments Morgan Stanley allegedly received from mutual fund companies to sell their funds to Morgan Stanley’s customers. The customers were apparently never told about the payments. So a customer might be steered into a specific fund by his broker, not knowing that Morgan Stanley was being paid to market the fund. A source says the action will involve a significant amount of money.


But the SEC has been playing catch-up in the mutual fund trading scandal since New York Attorney General Eliot Spitzer leveled his first round of charges three months ago in a widening probe that has uncovered fraudulent mutual-fund trading practices throughout the industry. The SEC had been aware of the problem for nearly six years, issuing warnings to the industry to clean up its act as far back as 1997. But, until Spitzer moved, federal regulators failed to take significant action against the well-heeled mutual fund industry to stop the practices.

Continued in the article.

"Is the Mutual Fund Issue Abuses, or Is It Fees?" by Floyd Norris, The New York Times, November 19, 2003 --- 

The coming battle over mutual fund regulation may well end up focusing not on trading abuses, which are now the subject of regulatory action, but on the fees and costs that funds charge investors.

Much may hinge on who will make the decisions on how the rules will change.

William H. Donaldson, the chairman of the Securities and Exchange Commission, yesterday laid firm claim to mutual fund turf, and in the process voiced disapproval of the possibility that state regulators like Eliot Spitzer, the New York attorney general, might try to set new rules.

If Mr. Donaldson gets his way, the likely results will be a lowering of fees and more disclosure of what investors are paying.

That probably will reduce the profitability of the fund industry while increasing the returns for those who invest in the funds.

It is not clear if Mr. Spitzer will be content to offer suggestions and criticisms, while deferring to the S.E.C. in the end, or whether he will try to mandate reforms through negotiated settlements of civil, or even criminal charges, brought against mutual fund companies.

Nor is it clear whether Congress will be content to let the S.E.C. act, or whether legislation will be passed regarding fees.

In testimony before the Senate Banking Committee yesterday, Mr. Donaldson indicated that the commission would bring more disciplinary actions over the issue of payment for "shelf space,'' in which funds pay brokerage firms to push their funds. That was part of the case against Morgan Stanley that was settled with the S.E.C. on Monday.

"Morgan Stanley's customers did not know about these special shelf-space payments, nor in many cases did they know that the payments were coming out of the very funds into which these investors were putting their savings," Mr. Donaldson told the Senate committee.

He added that the S.E.C. was now investigating such payments at 15 brokerage firms "to determine exactly what payments are being made by funds, the form of those payments, the shelf space benefits that broker-dealers provide, and most importantly, just what these firms tell their investors about these practices." He said the commission was also "looking very closely at the mutual fund companies themselves," hinting they might face suits over the same payments.

The issue of fund fees, particularly their disclosure, had been pending at the S.E.C. for some time, with an expectation that new rules would be developed. But until the Morgan Stanley action the commission had not taken disciplinary action.

The fee issue was inserted into the debate over trading abuses by Mr. Spitzer, who criticized the commission for reaching a partial settlement with Putnam Investments without doing anything about fees.

In an Op-Ed article that appeared in The New York Times on Monday, Mr. Spitzer denounced the "exorbitant fees" that Putnam charged and said the settlement "does not address the manner in which the fees charged to investors are calculated.''

"Nor," he added, "does it require the fund to inform investors exactly how much they are being charged - or even provide a structure that will create market pressure to reduce those fees."

Mr. Donaldson responded to that argument in his own op-ed article, published in The Wall Street Journal yesterday, in which he said Putnam's violations did not involve fees.

"Those lacking rule-making authority seem to want to shoehorn the consideration of the fee-disclosure issues into the settlement of lawsuits about other subjects," Mr. Donaldson wrote. "But we should not use the threat of civil or criminal prosecution to extract concessions that have nothing to do with the alleged violations of the law."

Mr. Spitzer, in an interview yesterday, said Mr. Donaldson was taking too narrow a view in separating excessive fees from trading abuses. "They really should be viewed as a set of issues that are woven together by the common thread of failed mutual fund governance," he said. The S.E.C.'s solution, Mr. Donaldson indicated in his testimony, is likely to be much better disclosure of fees and other costs. He promised S.E.C. action next month to require better disclosure of costs in confirmation statements sent to investors when they buy fund shares, but set no date for consideration of actions on other cost-related issues, like the use of "soft-dollar" commissions to buy services or the practice of using commissions to "facilitate the sale and distribution of fund shares."

Better disclosure would probably cause some money to move to lower-cost funds, but it is worth noting that institutional investors, who presumably understand what they are doing, in recent years have put much more money into hedge funds, where fees are very high, in hopes of earning higher returns. Even well-informed individuals might make similar choices among mutual funds.

Continued in the article.

$50 Million is Peanuts at Morgan Stanley

"Morgan Stanley to Settle With SEC," by Deborah Solomon and Tom Lauriciell, The Wall Street Journal, November 17, 2003 ---,,SB106902376181774100,00.html?mod=mkts_main_news_hs_h

Morgan Stanley is expected to pay a $50 million civil penalty as part of an agreement with the Securities and Exchange Commission to settle charges relating to the way the firm sold mutual funds, according to people familiar with the matter.

In charges likely to be announced Monday, the SEC plans to accuse Morgan Stanley of conflicts of interest in the selling of funds to investors, including directing investors to certain funds based on commissions the firm received. Morgan also is expected to say it will change some of its business practices as part of the settlement.

The charges against Morgan Stanley -- which have been expected -- are likely to be only the first in a series of SEC moves stemming from its probe into mutual-fund sales practices. The SEC is examining more than 15 brokerage firms, and is looking in part at how brokers are compensated for selling funds. The agency also has been examining whether some fund companies agreed to direct orders for stock-and-bond trading to brokerage houses that in turn agreed to promote sales of the fund companies' products, according to people familiar with the probe.

(See related article.)

Continued in the article.

"Morgan Stanley Settles, But Woes Linger," by Tom Lauricella, The Wall Street Journal, November 18, 2003 ---,,SB106908566324425800,00.html?mod=2%5F1050%5F1 

Alleging significant wrongdoing in how a major Wall Street firm has sold mutual funds to investors, the Securities and Exchange Commission charged Morgan Stanley with a companywide failure to tell clients that it paid its brokers more to sell certain mutual funds that were more profitable to the firm.

In addition, in a case that was expected, the SEC said Morgan Stanley often failed to tell clients important information about the purchase of certain types of mutual-fund shares that would, in some circumstances, end up costing the investors more in fees while giving Morgan Stanley brokers a bigger commission payment.

Morgan Stanley settled the civil charges without admitting or denying wrongdoing. It will pay $50 million, which will be put aside to reimburse Morgan Stanley clients affected by the sales practices. Morgan Stanley will also have to take steps to accommodate clients who were put into inappropriate fund-share classes.

"Few things are more important to investors than receiving unbiased advice from their investment professionals -- or knowing that what they're getting may not be unbiased," Stephen Cutler, director of the SEC's enforcement division said at a news conference announcing the charges. "In plain and simple terms, Morgan Stanley's customers were not informed of the extent to which Morgan Stanley was motivated to sell them a particular fund."

Continued in the article.

"The funds stank anyway:  Several funds tagged by market timers or late traders were long-term underperformers."
by Jeanne Sahadi, CNN Money,  November 7, 2003 --- 

If you own one of the mutual funds alleged to have been market-timed or late traded, why not channel your anger productively and realize what the scandal really has brought to light: That a lot of the funds implicated so far haven't been a great place for your money anyway.

At least judging by long-term performances.

To date, 39 funds have been identified either by regulators or a fund family as being targets of market timers or late traders. (Track the funds here.)

There are plenty of others, though.

In fact, the SEC has said as many as half of fund companies have had market-timing arrangements. And in cases where firms such as Prudential had brokers that were alleged to have facilitated improper trades, they had access to a broad group of funds.

Using Morningstar data, we looked at the three-, five- and 10-year performance records of the 39 funds that have been named to see how their performance compared with that of their peers.

We found that 15 of the funds ranked in the bottom half of their categories for two to three of those periods. And of those 15 funds, eight ranked in the bottom quarter for at least one of those periods.

One of the worst offenders was OneGroup LargeCap Value (OLVAX), which ranked in the 96th percentile of its category on a three-year basis; in the 76th percentile over five years; and in the 77th percentile over 10 years.

Other funds that were bottom performers for all three periods: Janus Enterprise (JAENX) (which took above-average risk and delivered three-year returns that were nearly 12 percentage points below its category average); Nations Value (NVLEX); OneGroup Diversified Equity (PAVGX) ; OneGroup Diversified Midcap (PECAX), and OneGroup Equity Income (OIEIX).

Alger SmallCap (ALSAX), meanwhile, which doesn't have a 10-year record yet, ranked in the 98th percentile of its peers over five years, with a return that fell more than 13 percentage points below its category average.

By contrast, only seven of the 39 funds ranked in the top half of their categories for two to three of the time periods measured. Of those, only four ranked in the top quarter for more than one time period.

The best performer in these respects was Putnam International Equity (POVSX), which was the only fund to have ranked in the top half of its category for all three periods. It ranked in the 47th percentile of its category over three years; in the 8th percentile over five years; and in the 2nd percentile over a 10-year time horizon.

If you are into a mutual fund, what questions should you ask your broker or advisor?

Colleen Sayther provides a rather nice set of questions to ask your broker or advisor in the November 13, 2003 FEI Express newsletter at 
Non-members of the FEI can register for free access.

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

"Actions by Bear Stearns, SchwabBroaden Mutual-Fund Scandal," by Randall Smith, The Wall Street Journal, November 17, 2003 ---,,SB106881837539468700,00.html?mod=home_whats_news_us 

The mutual-fund trading scandals continue to spread, with Bear Stearns Cos., one of Wall Street's top trading operations, and Charles Schwab Corp., a familiar name among Main Street investors, the latest to discover possible improprieties.

Bear Stearns, a big financial company that processes trades for dozens of other brokerage firms, quietly fired four brokers and two assistants last week in an action related to mutual-fund trading activity. Charles Schwab, which popularized mutual-fund investment through a pioneering "supermarket" of funds, disclosed it had found a "limited number of instances" of questionable trading as well as other issues at its U.S. Trust Co. unit.

The involvement of Bear Stearns and Schwab underlines how big brokerage firms are now being drawn into the mutual-fund trading scandals, which once centered mainly on fund-management companies and a handful of aggressive hedge funds. Morgan Stanley, another big Wall Street firm, is expected to announce a $50 million settlement with the Securities and Exchange Commission related to the way the company sold mutual funds to individual investors, according to people familiar with the matter. In all, more than a dozen financial companies face allegations related to misconduct in selling or trading mutual funds.

Continued in the article.

"F.B.I. Agents Raid Currency Offices," The New York Times, November 18, 2003 --- 

FBI agents on Tuesday arrested about 48 Wall Street foreign exchange professionals in a sting targeting several top firms thought to have defrauded small retail investors of millions of dollars.

Federal Bureau of Investigation officers swarmed on 2 World Financial Center late on Tuesday afternoon and led out men in business suits, taking them away in vans and cars. Some of the men covered their heads with overcoats while others bowed their heads to hide from television cameras and photographers.

``It's currency fraud, securities fraud,'' said one agent at the scene of the arrests. ``It's been a long investigation. The arrests have been ongoing today.''

A Madison Deane and Associates Inc. employee, who asked not to be named, said the FBI arrested seven people at his firm, which offers currency broker services.

``We were just sitting there working, and they (FBI) just came in and stormed the place,'' the man said, adding that the FBI agents took out three partners, three vice presidents and one broker all in handcuffs at about 5.30 p.m.

``They had guns. They came in with vests and said 'Nobody move,''' the employee told Reuters.

The worker said the FBI told Madison Deane employees that $4 million had been stolen from clients and that money had been taken out of people's Individual Retirement Accounts.

A Reuters reporter on the 36th floor of 2 World Financial Center, where Madison Deane has offices, witnessed FBI agents removing about 10 boxes from one firm's office.

Madison Deane officials could not be reached for comment.

FBI agents began arresting brokers at the swank office building in downtown Manhattan shortly after 3 p.m. and for about two hours led out handcuffed people dressed in business attire. FBI sources said the Wall Street traders will be charged with money laundering and fraud for swindling retail investors out of an undisclosed amount of cash over the past year.

Among other arrested in the massive sting were three brokers at the inter-dealer brokerage ICAP (IAP.L), which operates at a different location, according to another source.

NBC television reported the defendants scammed retail investors into thinking they were buying multimillion-dollar foreign exchange trades when it is not possible for those types of investors to participate in such deals.

A spokesman for the FBI declined comment but said the agency will hold a briefing on Wednesday. Spokespeople for the U.S. Attorney's office and the Treasury Department declined comment.

Continued in the article.

"Market Timing Takes Toll On Money-Market Funds," by Allicon Bisbey Colter, The Wall Street Journal, December 3, 2003 ---,,SB107050110825510000,00.html?mod=mkts%5Fmain%5Fnews%5Fhs%5Fh 

Stock- and bond-fund managers weren't the only ones grappling with the effects of market timing at Invesco Funds Group. Managers of the firm's money-market funds, which invest in short-term debt instruments, also had to contend with large sums flowing in and out of their portfolios.

Investors who entered into special arrangements to make frequent, short-term purchases of Invesco stock and bond funds agreed to park their assets in the firm's money-market funds between transactions, allowing the firm to collect big management fees.

The arrangement was lucrative for Invesco, a unit of Amvescap PLC, which was able to attract some $900 million of assets from market timers by mid-2002. But it created havoc for portfolio managers, who were forced to keep more money in cash, undercutting the funds' performance, and generating higher trading costs and additional taxes for long-term investors.

Money-market-fund managers faced many of the same issues. In a Jan. 15 memorandum to Invesco President and Chief Executive Raymond Cunningham, the firm's compliance chief, James Lummanick, noted that timing activity at the firm was so massive that it hurt the returns of the Invesco money-market funds by forcing managers to invest in highly liquid investments to accommodate the large volume of inflows and outflows.

The kinds of instruments money-market funds invest in, such as commercial paper, banker's acceptances, repurchase agreements, government securities and certificates of deposit are all relatively liquid compared to most stocks and long-term bonds. But generally speaking, the most liquid securities, such as money that is lent overnight, pay the lowest interest rates. So keeping large sums in ultra-safe or ultra-short term debt would tend to undercut the performance of a money-market fund.

Mr. Lummanick noted in his memo to Mr. Cunningham that the firm's money-market funds were often forced to keep 50% of their total assets in overnight repurchase agreements, which currently yield around 1%.

Of course, the other kinds of securities money-market funds invest in don't offer much of a pickup in yields, and so long-term investors aren't necessarily giving up much in the way of performance when a manager keeps large sums in overnight repos.

By comparison, stock-fund managers who keep large sums of money in cash potentially sacrifice much bigger returns in a rising equity market.

Andrew Clark, a senior research analyst at fund tracker Lipper, notes that most money-market funds commit in their prospectuses to invest in securities with an average maturity of no more than 90 days. But even if they were to invest in a security with a maturity of two years, it might not yield much more than 2%.

He said long-term investors in money-market funds used by market timers to park their cash "probably get dinged more on trading costs than anything else."

Still, giving up even a small amount of return can mean the difference between making money and losing money in the current low interest-rate environment, where many money-market funds struggle to generate big enough returns to cover their management fees. Some firms have been waiving fees on money-market funds in order to keep their returns in positive territory.

The seven-day yield on the average taxable money-market fund was just 0.53% in the week ended Tuesday, according to iMoneynet. That is just 0.03 percentage point shy of the all-time low yield of 0.5% for these funds reached on Aug. 26.

IMoneynet Managing editor Peter Crane said moving large sums of money in and out of money-market funds can undercut performance in subtle ways. In addition to compelling managers to keep more money in highly liquid securities, it can force them to pay higher prices than they might otherwise have paid.

That is because the money markets are much more active in the early morning, when most managers complete the day's transactions, than in the afternoon. "As the day goes on, yields drop," Mr. Crane said. "You've got to almost pay people to take your money late in the day."

He said fund managers often know their customer base well enough to plan ahead. In fact, managers of money-market funds that cater to institutional investors will often turn new money away late in the day. But managers of retail money-market funds may not have the luxury of turning away last-minute inflows from market timers.

Who is Edward Nusbaum?

"The Future of Corporate Reporting: From The Top," by Ramona Dzinkowski, Financial Executive, November 2003, pp. 18-21--- 

Despite the recent accounting scandals and economic downturn, Edward E. Nusbaum is optimistic about the U.S. capital markets and the capitalistic system. He believes the accounting profession can improve itself, and he sees a day when there will be "plenty of public offerings and the public market system will flourish." Meanwhile, the CEO and executive partner of Grant Thornton U.S., the 5th largest accounting firm, believes that many companies - after testing the waters and finding no benfits to being a public company - will go private. Grant Thornton serves the middle market (companies with revenues between $25 million and $2 billion), with clients from both publicly and privately held firms. Nusbaum responded to questions posed by Financial Executive's Managing Editor, Ellen M. Heffes.

Continued in the article at 

Bob Jensen's threads on proposed reforms are at 

It just gets deeper and deeper for E&Y

"SEC Begins Probe Into Ernst's Pacts: Regulator to Weigh If Ties To AMR, Others Met Rules For Auditor-Independence," by Jonathan Weil, The Wall Street Journal, December 8, 2003 ---,,SB107084523554066200,00.html?mod=mkts_main_news_hs_h 

The Securities and Exchange Commission's enforcement division has begun an inquiry into Ernst & Young LLP's business relationships with three major audit clients, including American Express Co., and whether the dealings were appropriate under federal auditor-independence rules.

Ernst's contracts with American Express, AMR Corp.'s American Airlines, and Continental Airlines for travel services came to light this autumn in connection with a lawsuit in an Arkansas state circuit court where Ernst and other accounting firms are contesting allegations that they overbilled clients for travel expenses. In a court filing last week, attorneys for the plaintiff said they received a request from a federal agency for documents relating to Ernst's relationships with the three companies, which were the subject of Wall Street Journal articles on Nov. 20.

"We will fully cooperate with the SEC in its review of this matter," Ernst said in a statement, confirming the agency's identity. An SEC spokesman declined to comment.

One October 1996 contract called for American Express, as Ernst's exclusive travel agent, to receive commissions on all Ernst airfare, hotel rooms and car rentals and return a portion to Ernst. A section called "profit sharing" said Ernst would receive 53% and American Express 47% "of the net profit of Total Commission Revenue and pooled expenses." Ernst also received portions of commissions paid to American Express on leisure travel booked by Ernst employees.

Continued in article

Bob Jensen’s threads on scandals at E&Y are at 

Bob Jensen's Most Difficult Message (written December 4, 2001) --- 
The theme is how large CPA firms wear two faces like the theatrical symbol.
Bob Jensen's Commentary on the Above Message From the CEO of Andersen
     (The Most Difficult Message That I Have Perhaps Ever Written!)
     This is followed by replies from other accounting educators.

The Two Faces of Large Public Accounting Firms

When the Enron/Anderson scandals were just commencing to unfold, I wrote "The Most Difficult Message That I have Ever Written" at 
Note that you have to read the preliminaries and then scroll down to my message.

Year 2003 Update on the Same Theme of Two Faces of Public Accounting Firms

KPMG's  Smiling Face

KPMG provides a sad illustration of the two faces.  KPMG has done wonderful things in support of accounting education and accounting research.  They have helped to fund faculty, and even helped to fund my salary when I was a KPMG Professor of Accounting at Florida State University.  The KPMG Foundation has taken on a huge commitment to raise funds for supporting minority students in doctoral programs.  Some of KPMG's most wonderful programs are described at 

A recent example of KPMG's initiative to help reduce fraud.
December 3, 2003 message from Colleen Sayther [

KPMG Fraud Survey
Provides detailed examination of fraud, new anti-fraud measures, and how organizations will manage this pervasive problem in the future. Over 450 U.S. business executives and government officials were interviewed to help determine how organizations are confronting fraud in the post-Sarbanes-Oxley era. The results produced several interesting insights. Click on the link for a full copy of the study.

The URL is 
This is a large file that may not download on slow modems.

KPMG's Sad Face --- Several Recent KPMG Disclosures and a Link to Other Recent Charges

Is it unethical to commit a crime knowing that the penalties for getting caught are less than the haul from the crime?


"KPMG Didn't Register Strategy," by Cassell Bryan-Low, The Wall Street Journal, November 17, 2003, Page C1

Former Partner's Memo Says Fees Reaped From Sales of Tax Shelter Far Outweigh Potential Penalties

KPMG LLP in 1998 decided not to register a new tax-sheltering strategy for wealthy individuals after a tax partner in a memo determined the potential penalties were vastly lower than the potential fees.

The shelter, which was designed to minimize taxes owed on large capital gains such as from the sale of stock or a business, was widely marketed and has come under the scrutiny of the Internal Revenue Service. It was during the late 1990s that sales of tax shelters boomed as large accounting firms like KPMG and other advisers stepped up their marketing efforts.

Gregg W. Ritchie, then a KPMG LLP tax partner who now works for a Los Angeles-based investment firm, presented the cost-benefit analysis about marketing one of the firm's tax-shelter strategies, dubbed OPIS, in a three-page memorandum to a senior tax partner at the accounting firm in May 1998. By his calculations, the firm would reap fees of $360,000 per shelter sold and potentially pay only penalties of $31,000 if discovered, according to the internal note.

Mr. Ritchie recommended that KPMG avoid registering the strategy with the IRS, and avoid potential scrutiny, even though he assumed the firm would conclude it met the agency's definition of a tax shelter and therefore should be registered. The memo, which was reviewed by The Wall Street Journal, stated that, "The rewards of a successful marketing of the OPIS product [and the competitive disadvantages which may result from registration] far exceed the financial exposure to penalties that may arise."

The directive, addressed to Jeffrey N. Stein, a former head of tax service and now the firm's deputy chairman, is becoming a headache itself for KPMG, which currently is under IRS scrutiny for the sale of OPIS and other questionable tax strategies. The memo is expected to play a role at a hearing Tuesday by the Senate's Permanent Subcommittee on Investigations, which has been reviewing the role of KPMG and other professionals in the mass marketing of abusive tax shelters. A second day of hearings, planned for Thursday, will explore the role of lawyers, bankers and other advisers.

Richard Smith, KPMG's current head of tax services, said Mr. Ritchie's note "reflects an internal debate back and forth" about complex issues regarding IRS regulations. And the firm's ultimate decision not to register the shelter "was made based on an analysis of the law. It wasn't made on the basis of the size of the penalties" compared with fees. Mr. Ritchie, who left KPMG in 1998, declined to comment. Mr. Stein couldn't be reached for comment Sunday.

KPMG, in a statement Friday, said it has made "substantial improvements and changes in KPMG's tax practices, policies and procedures over the past three years to respond to the evolving nature of both the tax laws and regulations, and the needs of our clients. The tax strategies that will be discussed at the subcommittee hearing represent an earlier time at KPMG and a far different regulatory and marketplace environment. None of the strategies -- nor anything like these tax strategies -- is currently being offered by KPMG."

Continued in the article.

"KPMG Is Accused Of Delay Tactics: U.S. Says Accounting Firm Is Withholding Documents In IRS's Tax-Shelter Probe," by Callell Bryan-Low, The Wall Street Journal, December 11, 2003 ---,,SB107109457388263800,00.html?mod=home_whats_news_us 

The Justice Department accused KPMG LLP of improperly withholding documents from the Internal Revenue Service to hide tax-sheltering activity, signaling the government's increasing frustration with what it considers delaying tactics by the large accounting firm.

KPMG's actions "demonstrate a concerted pattern of obstruction and non-compliance, threatening the integrity of the IRS examination process," the Justice Department said in documents filed Monday in federal court in Washington, D.C., on behalf of the IRS. The filings stem from a civil investigation by the IRS into whether KPMG is liable for penalties as a promoter of potentially abusive tax shelters.

The Justice Department's comments in the latest court filings come as a further embarrassment for the accounting firm, one of the largest in the country, in its tax-shelter dealings. A continuing congressional inquiry has focused on KPMG's mass marketing of tax strategies, and the firm faces numerous suits filed by individuals who have alleged bad tax advice in the face of IRS audits.

On that front, KPMG recently agreed to settle one of the first cases from the wave of suits filed against the firm alleging improper tax advice, according to people familiar with the matter. One of these people said KPMG had agreed to pay just under $10 million to three brothers in Texas who had paid $4.5 million to participate in a KPMG-sponsored transaction that came under IRS review.

KPMG declined to comment on whether a settlement has been struck in the case, filed in December 2002 in federal court in the Southern District of Texas. In a statement, the firm said, "The court ordered the abatement of the trial date for the case."

It is unclear how such a resolution would affect the dozen or so other lawsuits alleging fraud and malpractice, among other things, that KPMG is fighting. The suits have been filed by wealthy clients mostly in Southeastern states. Edmundo Ramirez, a lawyer for the Texas brothers, declined to comment on behalf of his clients.

The IRS via the Justice Department in July 2002 asked the federal court to enforce at least 25 summonses, the rough equivalent of a subpoena, seeking KPMG records as part of an investigation into potentially abusive tax shelters. Monday's filings contain a more-confrontational tone by the Justice Department, which until now had mostly focused on legal definitions of what privileges KPMG is entitled to in seeking to not turn over certain documents.

Bob Jensen's threads on recent KPMG scandals are at 

"KPMG Insiders Questioned Shelter," by Cassell Bryan-Low, The Wall Street Journal, November 19, 2003 ---,,SB106920143767959200,00.html?mod=home%5Fwhats%5Fnews%5Fus 

Senate Panel's Report Says Firm Disregarded
Concerns From Partners on Capital Gains

KPMG LLP disregarded concerns of some of its own technical tax experts about a product to minimize capital-gains taxes that the large accounting firm sold to at least 186 wealthy individuals in 1999 and 2000, according to a report released Tuesday by a Senate panel.

The transaction, known as BLIPS, generated $50 million in fees and produced more than $1 billion of questionable tax benefits, according to the report.

The hearings by the Senate's Permanent Subcommittee on Investigations, and its accompanying 129-page report, are the results of a yearlong review into the role of KPMG and other professionals into the mass marketing of potentially abusive tax shelters. A second day of hearings, planned for Wednesday, will explore the role of lawyers, bankers and other advisers.

During the development of BLIPS, the tax partners repeatedly expressed concerns about the legitimacy of the strategy that the firm ultimately went ahead and sold, according to internal KPMG e-mails obtained by the panel.

The report names at least two of the partners who raised concerns internally. One of them, Mark Watson, who has left the firm, appeared Tuesday before the Senate panel under subpoena. Responding to a panel question Tuesday about whether the issues he had concerns about were ever resolved, Mr. Watson said: "Not to my satisfaction." He added: "I was disappointed with the decision" to go ahead and market BLIPS, but "a lot of smart partners with a lot of experience" approved it, and "there was really nothing left for me to say."

Continued in the article.

The examiner's report cited evidence that KPMG aided and abetted fiduciary breaches by Mr. Fastow and other Enron officers. KPMG "provided substantial assistance" to Mr. Fastow by issuing unqualified audit-opinion letters on the so-called LJM partnerships that he led. Enron's dealings with those partnerships played a central role in the eventual collapse of the company.


"Enron Case Examiner Criticizes Two Banks and Accounting Firms," by John R. Emshwiller and Jonathan Weil, The Wall Street Journal, December 5, 2003 ---,,SB107056450265553100,00.html?mod=mkts_main_news_hs_h 


In the latest wave of allegations of wrongdoing by major financial and accounting firms in their dealings with Enron Corp., a federal bankruptcy examiner criticized Bank of America Corp., Royal Bank of Canada, KPMG LLP and PricewaterhouseCoopers LLP.

The report by examiner Harrison Goldin also disclosed an internal e-mail written by a Royal Bank of Canada official in September 2000 that indicates there were suspicions that Enron was misstating its assets and hiding debt. This memo was written more than a year before questions began surfacing publicly about the accuracy of Enron's financial statements. Those questions helped push the Houston-based energy trader to file for bankruptcy-law protection in December 2001.

The report by Mr. Goldin was the latest in a series that have emanated from the Enron bankruptcy proceedings. Four prior ones were issued by bankruptcy examiner Neal Batson, who had the principal responsibility to review activities regarding Enron's financial and accounting activities. Mr. Batson's previous reports had been very critical of a number of major financial institutions as well as former top Enron officials and some of the company's auditors and lawyers.

In his report, Mr. Goldin looked at 10 transactions involving the Bank of America and Enron. In nine of the transactions, the examiner didn't find cause to criticize the company. In the 10th, involving a natural-gas deal, there was enough evidence to conclude that the bank was involved in "aiding and abetting certain Enron officers in breaching their fiduciary duties."

A Bank of America spokeswoman couldn't be reached to comment.

In the case of Royal Bank of Canada, Mr. Goldin found some alleged misdeeds among the roughly 15 transactions he examined. In some cases, there was evidence that Royal Bank of Canada "had actual knowledge of wrongful conduct" by Enron officers, the report said. The examiner's report quoted the September 2000 internal e-mail as saying that information received by the bank suggested that Enron's asset base "is spurious and that there are other obligations hidden" in various company-related entities.

A Bank of Canada spokeswoman said the bank feels it "did absolutely nothing wrong" in its dealings with Enron. She said that the examiner's report took the September 2000 e-mail as a "quote out of context" that "mischaracterizes the reality" of the situation.

On Enron accounting issues, much criticism has focused on the company's longtime outside auditor, Arthur Andersen LLP. Thursday's report marks the most substantive condemnation yet of the Enron-related work by PricewaterhouseCoopers and KPMG.

"PwC committed professional malpractice and was grossly negligent in preparing and providing" two fairness opinions to Enron's board of directors in 1999 and 2000, the examiner said. The opinion letters covered transactions between Enron and various partnerships controlled by its former chief financial officer, Andrew Fastow.

A PricewaterhouseCoopers spokesman said that "the examiner's criticisms of PwC have no merit. We were only engaged to perform valuation work based on unaudited assumptions provided by Enron management."

The examiner's report cited evidence that KPMG aided and abetted fiduciary breaches by Mr. Fastow and other Enron officers. KPMG "provided substantial assistance" to Mr. Fastow by issuing unqualified audit-opinion letters on the so-called LJM partnerships that he led. Enron's dealings with those partnerships played a central role in the eventual collapse of the company.

A KPMG spokesman, in a written statement, said the examiner's "assertion that KPMG aided and abetted Mr. Fastow in his breach of duty to Enron is utterly baseless and irresponsible."

Continued in the article.

Bob Jensen's threads on recent KPMG scandals are at 

Bob Jensen's threads of recent scandals in other large firms --- 

"The Secret Life of a Retirement Account," by Lynnley Browning and David Cay Johnston, The New York Times, November 11, 2003 --- 

The Internal Revenue Service, as part of a crackdown on abusive tax shelters, has been pressing an action against one of the country's biggest accounting firms, Grant Thornton, to force it to disclose the names of clients it advised to shelter millions of taxable dollars in Roth I.R.A.'s via shell corporations. How such a shelter worked and how it was promoted is vividly detailed in a lawsuit brought by a former Silicon Valley executive against Grant Thornton over the shelter he was sold.

Bob Jensen has two threads on tax controversies:

Bob Jensen's taxation bookmarks are at 

How many Vice (appropriately named VICE) Presidents were in Enron at the time of its collapse?  Take a guess!

Surprise!  Surprise!
Merrill Lynch was in the middle of the tricky dealings.

"Tiny Transaction Is Big Focus Of Prosecutors in Enron Case,"  by John R. Emshwiller and Ann Davis, The Wall Street Journal, November 10, 2003 ---,,SB106841538138102000,00.html?mod=home%5Fpage%5Fone%5Fus 

A tiny deal that initially was buried in the rubble of Enron Corp.'s collapse has turned into an important building block in the government's effort to prosecute executives at the failed energy giant.

The deal hinged on the sale of an interest in three barges, which were to produce electricity for the government of Nigeria, and generated only $12 million in profit for Enron. But it has led to indictments of eight people, more than any other Enron deal, and offers a telling glimpse into how the government investigation is evolving.

Investigators learned about the barge transaction almost immediately after they started looking at Enron's problems in late 2001. To investigators, the deal looked suspicious, in part because it was executed so quickly. But it was just one of "a host of transactions that could start unraveling," if probed hard enough, says a person familiar with the early investigation. The deal contributed about 1% to Enron's reported 1999 net income of $893 million. There were plenty of other similarly curious transactions for investigators to examine, some of which involved hundreds of millions of dollars and potentially offered more direct links to top Enron executives.

But as Justice Department lawyers slogged through the maze of Enron transactions, the barge deal started looking increasingly attractive. For one thing, some of the bigger deals were extremely complex, making them hard to explain to a jury. Also the accounting treatment for many of them had been blessed by Enron's outside auditor, Arthur Andersen LLP. Such approval makes it much harder to prosecute an executive for knowingly committing criminal acts, since the executive can argue that he or she relied in good faith on outside experts.

In the case of the barge deal, some of the evidence suggested that a crucial aspect of the transaction had been hidden from the outside auditors. It was comparatively simple and explicitly documented in internal e-mails and documents. Though small, the deal's resulting earnings had helped Enron meet its profit target for 1999 and the company had rushed to get the deal done by Dec. 31. The involvement of Merrill Lynch & Co., as the buyer of the interest in the barges, was another draw for prosecutors, particularly because the nation's biggest brokerage firm had done the deal mostly as a favor for a valued corporate client, according to congressional testimony by a Merrill official.

The focus on the Nigerian barges comes as a special task force of about half a dozen U.S. Justice Department attorneys and a platoon of FBI agents pick their way through the Enron fiasco. When the energy giant collapsed in late 2001, it left behind a labyrinth of alleged financial fraud and self-dealing involving private partnerships run and partly owned by Enron insiders.

As prosecutors sift through Enron's various deals, they have so far charged about two dozen individuals with crimes ranging from fraud and conspiracy to money laundering and insider trading. While most of those charged have pleaded not guilty and await trial, a handful have reached plea agreements with the government and are cooperating. Only one former Enron executive, Treasurer Ben Glisan Jr., is in prison. Former Chief Financial Officer Andrew Fastow has been indicted for fraud and other charges, including two counts related to the barge sale. He pleaded not guilty and is scheduled to go to trial in April.

A big unanswered question is whether prosecutors will bring charges against Enron's two former chief executive officers, Kenneth Lay and Jeffrey Skilling. The two men have denied any wrongdoing, and neither appears to be implicated in the barge case. Mr. Lay last week agreed to turn over documents to the Securities and Exchange Commission, after refusing to do so for more than a year.

In the past year, prosecutors have charged four Enron executives and four Merrill Lynch executives on conspiracy to commit wire fraud and falsifying books and records in connection with the Nigerian barge deal. Among them were Mr. Fastow and Daniel Bayly, Merrill's former head of global investment banking.

But it was the indictment of two lower-level executives that sent tremors through the ranks of the two companies. One of them was Daniel Boyle, formerly one of Enron's 650 vice presidents. By all accounts, Mr. Boyle didn't help put together the Nigerian deal. But he was one of several people who listened in on a brief conference call that the government considers key to proving that the barge transaction was fraudulent. The other executive was James Brown, a Merrill finance specialist who had actually warned Merrill executives against doing the barge deal, arguing that it might help Enron manipulate its earnings. He was overruled and told to help with the transaction, according to a report by Neal Batson, the court-appointed examiner in Enron's bankruptcy case.

To employees at Enron and Merrill, the indictments were a disturbing sign that prosecutors were willing to dive into an obscure deal and come up with lesser figures to indict. Mr. Boyle's indictment "was a scary day for lots of us," says one former Enron middle manager. The 47-year-old Mr. Boyle was known inside Enron as someone who worried about the company's aggressive, deal-making culture, according to former colleagues.

Some executives worried that they had incriminated themselves by helping investigators. Mr. Brown initially was viewed by investigators and others as something of a whistleblower because he had opposed the barge deal in its early stages. But his cooperation backfired. Besides being indicted for his role in the transaction, he was charged with perjury; Merrill attorneys found an e-mail he had sent that helped convince prosecutors that he had lied to authorities.

Continued in the article.

Bob Jensen's threads on Enron and Andersen are at 

HEIRESS IN HANDCUFFS Lea Fastow is charged with helping husband Andy orchestrate the white-collar crime of the century. Now she could be the key to nailing Enron's top dogs.
November 14, 2003 message from BusinessWeek Online's Insider [

The River Oaks Country Club in Houston sits like a plantation mansion amid a vast expanse of magnolias, dogwood, azaleas, and golf greens. Yet the club barely stands out among the equally massive estates -- the mock Taras, Pickfairs, Monticellos, and Bridesheads -- that populate the city's most prestigious neighborhood. One of these trophy properties, a three-story Gothic Revival with a small fountain in front, is where Lea Weingarten grew up.

She lived among the city's social royalty: Neighbors included art patron Dominique DeMenil, ex-Governor John Connally, and the descendants of wildcatters, ranchers, and financiers who had founded Rice University, Humble Oil, and most of the city's other major institutions. In Houston, Lea's family stood alongside these legends. The main pavilion at the Jewish Community Center of Houston was named after her grandfather, a Polish immigrant named Joseph Weingarten who built big grocery store and real estate empires in the Southwest.

There wasn't much farther up Houston's social ladder to go. And yet, as an adult, Lea W. Fastow, now 41, climbed higher. She and her ambitious husband, Andrew S. Fastow, also 41, took jobs at booming Enron Corp. (ENRNQ ) in 1990. He rocketed to the post of chief financial officer in less than eight years. She quit in 1997, after the first of her two sons was born, and proceeded to become a nationally prominent art patron -- leading Enron's art committee and enlisting hot talents to design custom projects for the company's headquarters. Jeff Koons, for instance, proposed an outdoor sculpture made of tulips -- because they were the first things ever traded on a stock market. In a vision statement e-mailed to top executives in 2000, Lea declared, "the Enron Corp. Art Collection will [reflect] Enron's corporate culture of thinking outside the lines, creating the new convention."

FIRST TO BE TRIED None of her high-concept projects ever came to be. That's too bad, because a big mound of stratospherically priced tulips would have been a perfect monument to Enron. And, in hindsight, a sculpture evoking the world's first speculative mania would have been a pretty good symbol of Lea Fastow's crash, too. On May 1, federal agents handcuffed her and charged the Houston heiress with helping Andrew orchestrate one of the most notorious white-collar crimes in history. She's accused of wire fraud, money laundering, and filing false income-tax returns.

According to the government, the socialite belonged to a small group of loyalists who executed the complex schemes devised by Andrew Fastow to inflate Enron's performance and enrich themselves. She is accused, essentially, of serving as a stand-in for her husband -- wiring money, cashing checks, and handling financial housekeeping matters that the Enron CFO didn't want his fingerprints on. Lea's story, pieced together for the first time by BusinessWeek from internal corporate documents, government investigations, and more than two dozen interviews with friends and co-workers, is unique. No heiress has ever been charged with such complex financial fraud. She and Andy, who earned more than $60 million from 1997 to 2000, are the only husband-and-wife team implicated in the current round of corporate scandals.

At the moment, Lea is front and center in the Enron Task Force investigation. She is the first former executive scheduled to go to trial, on Feb. 11. Lea has also been involved in plea bargain negotiations with the Justice Dept., according to the Houston Chronicle and other sources. She could potentially help pry open the frustrating case. Nearly two years after the company collapsed, the task force has indicted only one person who worked on the lavish 50th floor of the Enron Tower: Andrew Fastow. No criminal charges have been filed against Chairman Kenneth L. Lay, President Jeffrey K. Skilling, Chief Accounting Officer Richard A. Causey, Chief Risk Officer Rick Buy, or General Counsel Jim Derrick.

At a time of seemingly unrelenting corporate scandal, the slow pace of the Enron prosecution is causing many Americans to question whether the law reaches into the executive suite. "Skilling and Lay are iconic," says University of Texas law professor Henry T.C. Hu. "Whether they go to jail will send a terribly important message to the public, and more importantly, to managers."

Lea could potentially provide the government's first foothold on the 50th floor. The prosecutors' strategy in going after her first, most experts agree, is to pressure her husband to accept a plea bargain to minimize any punishment of the mother of his children. As part of any deal, he would be forced to testify against former Chairman Kenneth L. Lay and President Jeffrey K. Skilling. Andrew Fastow is, after all, the perfect witness to tell jurors what the top leaders knew about his own off-the-books partnerships. If Justice's gambit works, the task force could flip Andy without even having to take him to trial.

But plea bargain deals are notoriously slippery. If Justice's effort to twist Andy's arm fails, it would raise serious questions about the Enron Task Force's ability to nab Skilling and Lay (who both say they are innocent of wrongdoing). Rather than telling jurors a simple story -- that Skilling and Lay approved Fastow's dubious deals -- government lawyers would have to focus on less heinous transactions that would probably be easier to defend in court. Prosecutors would be obligated to frame the evidence as part of a broad pattern of criminal misconduct at the company. On Oct. 30, Justice secured an insider-trading guilty plea from former Enron Energy Services CEO Dave Delainey on the basis of this type of company-wide conspiracy claim. But many white-collar crime experts question whether a similar tactic could nail Skilling and Lay. "It would be a very sweeping case where they would have to prove the illegal business practices of several groups," says Houston criminal defense attorney Philip Hilder, who represents several Enron vets. "They would have a much easier time with a pinpoint bombing."

Continued in the article.

From FEI Express 132 on November 6, 2003

FASB Issues a Proposed Interpretation to Modify FIN 46
FASB continues to work to clarify the existing guidance of FIN 46, Consolidation of Variable Interest Entities, in this instance with a proposed modifying Interpretation. On Oct. 31, FASB issued a proposed interpretation to clarify some of the provisions of FIN 46 in response to input received from constituents regarding certain implementation issues. The Exposure Draft considers 17 changes/amendments to the current guidance including certain scope exceptions to limit applicability for certain companies, while also considering provisions that may broaden applicability for others. Please read the attached summary prepared by KPMG for additional information Comments are due on the proposed Exposure Draft by Dec. 1. The proposed interpretation is effective for financial statements issued for the first reporting period ending after Dec. 15, 2003.

Bob Jensen's threads on Variable Interest Entities and SPEs are at 

"Companies Finagle With Earnings Reports," SmartPros, November 10, 2003 --- 

Nov. 5, 2003 (Associated Press) — More than a boom in business pushed third-quarter corporate earnings ahead of expectations. At some companies, lowering their tax rates helped more than anything else.

So much for the recent accounting scandals putting the brakes on earnings trickery. Companies still have plenty of ways to finagle their books to boost the bottom line.

And that's where reducing tax rates come in. There's nothing illegal about it, but it surely can distort the picture of a company's health.

"There is a great amount of flexibility when it comes to tax issues," said Bill Fox, a professor of economics at the University of Tennessee. "It is an easy hole for companies to use to lift their earnings."

The third quarter is shaping up to be the best earnings period in three years. Profits for companies in the Standard & Poor's 500 stock index climbed 21 percent, ahead of the 16 percent that Wall Street analysts had been forecasting, according to earnings-tracker Thomson First Call.

Sure, the improving economy played a role in these strong results, but so did some accounting maneuvers that lowered what they owed in taxes.

U.S. companies are generally taxed on their income at a rate of 35 percent. But few end up actually paying that amount.

That's because companies don't just pay one tax rate for everything. It depends on where they do business - some states and countries have lower tax rates than others -- or what kind of investments they make.

For instance, they can get deductions on certain purchases, such as buying new equipment for their businesses, or receive tax credits for the business they do abroad. And it's often at the companies' discretion to decide when or how to account for such benefits.

The end result is a lowered effective tax rate, which reflects what is actually paid on each dollar earned.

Companies staff departments filled with tax strategists whose "primary purpose is to bring down the effective tax rate through good planning," said Henry Bubel, a tax attorney and partner at the law firm of Patterson, Bellnap, Webb & Tyler.

While this isn't a new practice, tax experts say figuring out ways to lower tax rates often becomes more prevalent when companies are having a harder time fueling earnings gains. And with the economy finally heating up this last quarter, companies might have felt additional pressures to have their profits come in ahead of expectations.

Companies often give hints about where they see their tax rates going, but they don't have to say in advance if their rates are going to differ from what they had previously forecast. That means a company can bury the news in an earnings release, making it more difficult to see how a tax-rate change is driving the bottom line.

Consider the case of Coca-Cola. The soft-drink giant reported earnings of 55 cents a share excluding one-time items, beating expectations by 3 cents a share - the exact amount Coke gained as a result of a decline in its effective tax rate thanks to a rise in sales abroad.

According to Todd Stender, an analyst at the stock research and money management firm Crowell, Weedon & Co. in Los Angeles, Coke had told analysts in July to expect its year-end tax rate to be about 24 percent. That's far from the 18.4 percent rate the company ended up using in the third quarter and the 22 percent it now expects at the end of the year.

"We didn't see this coming," said Stender, who pointed out that Coke's earnings from its core operations were flat with a year ago, while the tax-rate decline and more favorable currency conversions were the real drivers of the bottom line.

This isn't a one-time strategy for Coke. During a conference call with analysts, Coke president and chief operating officer Steve Heyer said the company would "continue to pursue tax-planning strategies which have a favorable impact on our earnings," according to a transcript provided by CCBN StreetEvents.

And Coke isn't the only company to see earnings beat estimates because of a tax-rate decline. The long list includes Kimberly-Clark, Boston Scientific and International Paper.

This kind of maneuvering is just a reminder that companies still have plenty of tools left to manage their earnings. While that might be legal, it's not necessarily right.

"Former Officials at Gateway Face SEC Fraud Charges," by Gary McWilliams, The Wall Street Journal, November 15, 2003 ---,,SB106875581966565400,00.html?mod=home_whats_news_us 

Gateway Inc. and three former executives at the personal-computer maker improperly booked revenue and profits on sham sales and other transactions rather than fall short of Wall Street estimates in 2000, the Securities and Exchange Commission charged Thursday.

The SEC accused former Chief Executive Jeffrey Weitzen, former Chief Financial Officer John J. Todd and former Controller Robert D. Manza of fraud, lying to auditors and other securities-law violations. The three executives were ousted from the company in early 2001.

An attorney said Mr. Weitzen, 47 years old, would "vigorously fight" the charges. "In bringing an enforcement action against Mr. Weitzen, the SEC's desire to appear to be pursuing corporate executives has for the moment trumped both the evidence and the law," said attorney Richard Marmaro.

Mr. Todd, 43, also will fight the charges. "It is outrageous that Mr. Todd is being sued for technical accounting issues under these circumstances," his spokesman said. "This suit is wrong."

Mr. Manza, 42, "denies these charges and intends to contest them vigorously at trial," said his attorney, James L. Sanders.

Gateway was charged with filing false statements and misleading investors in a separate administrative action Thursday, but settled by agreeing it won't violate securities laws in the future. It paid no fine. Founder and CEO Ted Waitt said the company was pleased to put the issue behind it. After resuming control of the company in early 2001, Mr. Waitt twice restated results for 2000. In a far-reaching revision covering 1999 through 2001, it reduced reported sales by $476 million.

According to a complaint filed in U.S. District Court in San Diego, the executives engaged in a series of revenue-recognition and accounting gimmicks early in 2000 to "close the gap" between analysts' expectations and the company's actual revenue and earnings.

One scheme, referred to internally as DDS, for "Deep, Deep S -- ," included contacting potential PC buyers whose credit had been previously denied and offering them preapproved financing, according to the complaint. Those sales alone pushed up revenue by $80 million, the SEC claimed.

The suit charges the executives cooked up sham sales, booked sales on equipment to be sold later or to be repurchased, and improperly booked subscriptions to Time Warner Inc.'s America Online Internet service for customers who hadn't signed up for the service.

In one such instance, the company got AOL to agree to revise a bundling agreement and retroactively adjusted revenue by $70 million, the SEC charged.

In another, it said PCs had been sold when they actually where sitting in a warehouse awaiting sale.

The SEC said Mr. Weitzen made $1.9 million in cash and bonus in 2000, tied to how the company met goals, and received $5.64 million in severance. Mr. Todd made more than $600,000 in cash and bonus and received a $1.6 million severance, while Mr. Manza made about $340,000 in 2000.

Continued in the article.

Up Up and Away in My Beautiful Pro Forma

"Little Bitty Cisco," by Jesse Eisinger, The Wall Street Journal, November 6, 2003 ---,,SB106806983279057200,00.html?mod=technology%255Ffeatured%255Fstories%255Fhs 

The way Wall Street eyes these things, including the liberal use of the words "pro forma," Cisco had an impressive fiscal first quarter.

Revenue came in better than expected and grew 5.3% compared with a year ago, topping expectations of a flat top-line thanks in part to spending from the federal government (see article). How impressive is this? Well, the country's economy grew at 7.2%, and business spending on equipment and software rose 15%. Microsoft had revenue growth of 6%, IBM 8.6%, and Dell is estimated to come in at 15% growth. So Cisco Systems, one of the big tech dogs, looks like the runt of that particular litter. Is networking a growth industry anymore, or is it doomed to be troubled by overcapacity and a lack of business demand? The next few quarters are crucial.

Earnings per share -- that is, pro forma earnings per share -- easily surpassed estimates, logging in at 17 cents a share, compared with the expectation of 15 cents a share and last year's 14 cents.

The company's shareholder equity fell in the quarter to $27.4 billion from $28 billion a year ago. Cash flow from operations fell to $973 million from $1.1 billion a year earlier. Cash on hand and investments fell from $20.7 billion to $19.7 billion, which is still mountainous but lower year-over-year, nevertheless.

Then there is the gross-margin story. Cisco has had Himalayan gross margins throughout the slowdown, because it was able to squeeze suppliers and find efficiencies. But now that revenue is finally increasing, gross margins fell. Product gross margins came in at 69%, down from 71% in the fourth quarter. Cisco is selling less profitable products, including some from its recent acquisition of Linksys. It also has outsourced much of its production. How much operating leverage does Cisco now have? That is the reason it sports its high valuation, after all.

Then there is the outlook. Deferred revenue and backlog were down. Cisco's book-to-bill ratio, a measure that reflects order momentum, was below one. When book-to-bill is below one, orders are lower than billings, suggesting a slowdown, not acceleration. True, Cisco put out a forecast for modestly higher revenue for the second quarter compared with the first. But some questions should linger.

Bob Jensen's threads on pro forma controversies are at 

David Fordham's  Gullibility Website --- 

Congratulations. You’ve been hoaxed. This happens to the best of us. I’ve been hoaxed many times. I even have a web page for my students where they can reference many of the urban legends making the rounds these days.

You can find information on this “Hotel Key Contains Personal Information” hoax at: 

As a rule of thumb, about 99% of the warnings that I receive are from paranoia-spreading anti-technologists and are little more than sensationalistic hoaxes. I have my Information Security students conduct research projects and give class presentations on a lot of these type warnings. It opens their eyes to how gullible most of the public is, having been conditioned by the media to “fear everything”. When you browse the urban legends websites, you think, “how ridiculous, who would believe this tripe?” But then when you get a new warning you’ve not seen before, it is human nature to believe it, because we all seek security.

Common sense dictates prudence. But as my student’s (and my own) research shows, most of the ** unsolicited ** warnings you get are pure bunk. I tell my students, if you want the truth, seek it out. It won’t come to you on its own anymore.

And please, don’t take my word for it, either. Everyone should cultivate the habit of collecting their own personal collection of sites they consider trustworthy for doing their research.

BTW, my gullibility website is: 

It contains links to some of the sites I consider trustworthy.

David R. Fordham
PBGH Faculty Fellow
James Madison University

Bob Jensen's threads on consumer frauds are at 

Investors also have a sense that the quality of earnings isn't high -- and they are correct. Traditionally, the difference between generally accepted accounting principles net income and operating earnings is 12% to 18%, according to S&P's number-cruncher Howard Silverblatt. After the awful track record of the bubble years when that gap blew out, earnings quality improved and the spread tightened. In the first quarter, the variance between operating earnings and net income was only 4.5%. In the second quarter it crept up to 14%, but it was still toward the low end of normal. But in this quarter, Mr. Silverblatt estimates it will be 18%. "It's on the warning track and it's a shock to go there. We've seen some pro forma, some strange items," he says.
Jesse Eisinger, The Wall Street Journal, October 27, 2003 (Ahead of the Tape Section) ---,,SB106720612223767900,00.html?mod=todays%255Fus%255Fmoneyfront%255Fhs 

FASB agrees to propose expensing stock options At its meeting yesterday (October 29, 2003), the US Financial Accounting Standards Board agreed to expose, for public comment, a standard that would require companies to expense the fair value of stock options granted to employees. The proposal would likely be issued in February 2004 and, if adopted, would take effect in 2005. The IASB published a similar proposal last year (Exposure Draft ED 2) and is expected to issue a final standard during the first quarter of 2004, also effective in 2005. Currently, companies in the United States are permitted, but not required, to recognise stock options as part of employee compensation cost. Several hundred listed companies (out of about 15,000) recognise the expense. Even if they elect not to charge the cost to expense, companies must disclose the fair values of options granted. Current IFRS require neither expensing nor disclosure of the fair values of share-based compensation. Both the FASB and IASB proposals would apply to all companies, not just publicly traded ones.
Paul Pacter, IAS Plus, October 30, 2003 --- 

Bob Jensen's threads on stock option accounting are at 

The Wall Street Journal's Mutual: Fund Scandal Scorecard: 
What companies are mixed up in the mutual-fund fiasco and how is it affecting them? As the troubles widen, keep track of the firms involved.  To read about the names and view their faces, go to the bottom to Fund Scandal Scorecard at (this is available only to WSJ electronic subscribers).

From The Wall Street Journal Accounting Educators' Reviews, October 27, 2003

TITLE: Everything You Wanted to Know About Corporate Governance . . . 
REPORTER: Judith Burns 
DATE: Oct 27, 2003 
PAGE: R5-6 
TOPICS: Corporate Governance, Internal Auditing, Sarbanes-Oxley Act, Securities and Exchange Commission, Audit Committee

SUMMARY: A special section on corporate governance in the Oct. 27 WSJ addresses the issue of corporate governance in some detail. Included is the article by Judith Burns with a primer on what corporate governance is and relating it to the parties involved. Several related articles recount why this is a topical issue and what are the prospects in the future, including the Hymowitz article detailing the duties of a corporate board member.

1.) Define corporate governance. Does it ensure superior firm performance? Why is it important to investors? Who are the major parties involved in this issue? Briefly discuss the roles each plays in it.

2.) What are the responsibilities of: the Board of Directors; the Chief Executive Officer; the internal auditors; the external auditors; the Compensation Committee; the Nominating Committee; the Auditing Committee; and the SEC? Where they apparently exist, explain potential conflicts of interest and how this "muddies the waters" where the responsibilities are concerned.

3.) What effects have this issue had on credit-rating agencies and insurance companies?

4.) Does the CEO hire the Board of Directors? Why or why not? In the Maremont and Bandler article, who failed in the governance of Tyco?

5.) How has the Sarbanes-Oxley Act affected these relationships? Have they had unintended consequences? On balance, has the Act met its intended purposes? Are more legislative changes anticipated?

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

TITLE: How to Be a Good Director 
REPORTER: Carol Hymowitz 
PAGE: R1-4 
ISSUE: Sep 27, 2002 

TITLE: Now Playing: Corporate America's Funniest Home Video 
REPORTER: Mark Maremont and James Bandler 
PAGE: A1-8 
ISSUE: Oct 29, 2003 
(See the Yawn below)

Corporate America's Funniest (read that most boring) Home Video
The Wall Street Journal, October 29, 2003 
20-minute video of an extravagant birthday party for the wife of former Tyco CEO L. Dennis Kozlowski depicts what many consider the height of corporate excess. Three videos can be downloaded from links below:


Full:   Part 1 

Full:  Part 2): 
This is a Roman Orgy without the orgy.  Actually everybody looks pretty boring and bored.  Neither video shows the life-sized naked woman birthday cake.  And the sculpture of David peeing vodka was edited out of the flicks.  The cake and the sculpture were not shown to the jury in the Kozlowski trial.  Just why these were edited out is a mystery to me since they depict the sickness of this former Tyco CEO more than the tame stuff on the jury's videos where all the bored actors in togas wore underwear.  What's left on the tape isn't worth watching except to witness a boring waste of $2 million in corporate dough.  I've attended funeral parties (e.g., for my friend John Bacon) in Pilots Grill in Bangor, Maine where the guests had more fun.
Bottom Line Conclusion:  Success of a corporate party is defined as what it cost rather than what it bought.

Has anybody read whether any partners from PwC attended the birthday bash?

An enormous mystery for the Manhattan prosecutors has been how much Tyco’s auditors knew about the about allegedly improper bonuses paid to Kozlowski and other executives along with the improper spending of corporate funds for personal expenses such as Kozlowski’s $65,000 New England golf club membership --- 

October 29, 2003 reply from Patricia Doherty [pdoherty@BU.EDU

-----Original Message----- 
From: Patricia Doherty [mailto:pdoherty@BU.EDU]  
Sent: Wednesday, October 29, 2003 9:20 AM 
Subject: Re: Corporate America's Most Boring Home Video

I suppose one interesting fact that emerged is the fact that his mistress planned his wife’s birthday party. Remarkable what some people will put up with for money. They deserve each other.

"If not this, then what?
If not now, then when?
If not you, then who?"

Patricia A. Doherty
Instructor in Accounting
Coordinator, Managerial Accounting
Boston University School of Management
595 Commonwealth Avenue
Boston, MA 02215

Bob Jensen's threads on corporate fraud --- 

I can understand why his CEO refused to listen, but why wasn't PwC willing to listen to a CFO whistleblower?

"Fired From Kmart, Ex-CFO Is Key Figure in Lawsuits," SmartPros, December 1, 2003 --- 

Nov. 24, 2003 (Detroit Free Press) — Jeffrey Boyer, Kmart's former chief financial officer, didn't publicly blow the whistle about the Troy retailer's worsening financial condition in mid-2001.

Like corporate whistle-blower Sherron Watkins at Enron , he approached his boss with his concerns. But unlike Watkins, Boyer was fired after raising issues about Kmart's financial reporting under Chuck Conaway, Kmart's former CEO and chairman, according to a civil lawsuit filed this week.

Boyer's six-month tenure at Kmart has been the center of considerable interest in the aftermath of the company's bankruptcy, the largest in U.S. retail history. His testimony has been sought by numerous investigators and regulators. Boyer has not made any public comments.

But, based on court documents, it's clear he clashed with Kmart's leadership. He even raised the issue of bankruptcy as early as August 2001 -- five months before the company filed its bankruptcy petition.

Conaway fired Boyer in November 2001, claiming that he was "concerned with his decision-making capability and particularly his state of emotional health," according to the lawsuit. Boyer, however, was told that he was being fired because supposedly he was "not a team player."

Boyer is about the only executive who was on Conaway's executive team who isn't facing allegations of wrongdoing. He was witness to most of the questionable financial practices detailed in the 116-page lawsuit filed Tuesday by the Kmart Creditor Trust in Oakland County Circuit Court.

And that makes him an ideal witness for the host of federal and other investigations that have ensnared Kmart since its Jan. 22, 2002, bankruptcy filing. The company emerged from bankruptcy on May 6 as Kmart Holding Corp.

"I think his data that he would supply to whatever source would be significant," said Joseph Whall, managing director of Auburn Hills-based forensic accounting firm the Whall Group.

"It is extremely helpful to an investigation to have an insider at an executive position that is openly discussing wrongdoing," Whall said. "He's offering a highway to a critical danger zone."

Boyer has been a key witness in several ongoing investigations of Kmart's finances including those by a federal grand jury, a congressional committee investigating corporate scandals, the U.S. Securities and Exchange Commission and Kmart's own bankruptcy lawyers.

And his legal bills are mounting. His role in the investigations has added up to about $329,799 in legal fees. Boyer has filed a claim for $1.27 million in Chicago bankruptcy court against Kmart, saying the retailer has not lived up to its obligations under his Nov. 23, 2001, separation agreement.

The bill had not been paid as of Thursday.

"Boyer has testified truthfully and endeavored to assist Kmart in these legal proceedings," his lawyer, Seth Gould, wrote in the claim. "As a result of such involvement, however, Boyer has personally incurred hundreds of thousands of dollars in legal expenses."

Neither Boyer nor Gould would comment on Thursday.

Boyer, who is now executive vice president and chief financial officer for Michaels Stores Inc. of Irving, Texas, was prominently mentioned throughout the civil lawsuit.

The lawsuit details how Boyer kept questioning things like how Kmart was accounting for vendor allowances, which companies pay retailers for space in the stores. The vendor allowances were the basis for securities fraud charges brought and recently dropped against two other former Kmart executives.

Boyer had also asked Kmart's auditors at PricewaterhouseCoopers in several cases to look into various accounting issues and was unsatisfied with the firm's work, according to the lawsuit.

Continued in the article

Bob Jensen's threads on scandals in the largest public accounting firms are at 

Bob Jensen’s threads on whistle blowing are at

He said versus she said!

"Ex-Tyco Officer Testifies Auditor Cleared Bonuses," by Chad Bray, The Wall Street Journal, December 11, 2003 ---,,SB107116795088873200,00.html?mod=mkts%5Fmain%5Fnews%5Fhs%5Fh 

The former head of Tyco International Ltd.'s finance department testified that one of its outside auditors signed off on the accounting treatment of a $96 million special bonus paid to Tyco's executives in 2000, as well as other bonuses.

During cross-examination, Mark Foley, Tyco's former senior vice president of finance, said the Bermuda conglomerate classified the special bonus paid to about 50 employees as a direct cost associated with the initial public offering of Tycom, its optical- fiber subsidiary.

. . .

Pricewaterhouse has said it never approved or authorized any of Mr. Kozlowski's or Mr. Swartz's transactions and had no reason to believe those transactions weren't fully disclosed to Tyco's board.

The Quattrone trial provoked some soul searching in Silicon Valley, as the proceedings revealed unflattering details of the cowboy culture that predominated during the tech bubble.

"Quattrone Case Aired '90s Excesses," by Ann Grimes, The Wall Street Journal, October 27, 2003 ---,,SB10671934043114400,00.html?mod=technology%255Ffeatured%255Fstories%255Fhs 

Silicon Valley breathed a sigh of relief when a federal judge declared a mistrial Friday in a trial of one of its own, former top Credit Suisse First Boston investment banker Frank Quattrone, on charges of obstruction of justice and witness tampering.

But Silicon Valley's entrepreneurs, bankers and venture capitalists might not want to break out the bubbly so fast.

While Mr. Quattrone's fate hinged narrowly on whether he intended for his staff nearly three years ago to destroy documents amid two government investigations and a grand-jury inquiry into the Credit Suisse Group unit's allocations of initial public offerings of stock, the backdrop included the excesses of the late 1990s tech-stock bubble. And the picture that emerged of Silicon Valley during the trial was of a cowboy culture, with insiders known as "Friends of Frank" receiving lucrative allocations of the hottest IPOs.

"The practices that were revealed are, frankly, not very flattering," says Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. While "the Valley always has been viewed very positively -- the innovation, the exuberant spirit" -- what emerged from the trial, he says, is a "tarnished version" of a group "that acted in economic self-interest."

Few here dispute that the homegrown scandal, following other corporate trials, has turned an uncomfortable spotlight on this codependent community of entrepreneurs, investment bankers, analysts, lawyers and venture capitalists. As a result, self-examination about how things get done here -- which began with the tech meltdown itself and gained steam with the postbubble inquiries into the IPO-allocation practices -- has reintensified.

"We, as board members and investors, need to be more proactive in addressing a myriad of topics, including diversity, governance, corporate performance and impact on the communities that we serve," says Jim Breyer, a general partner at Accel Partners in Palo Alto, Calif.

Now, amid signs of revived tech-sector investing including new initial public offerings, that mindset will be put to the test.

Mr. Quattrone's trial posed an "obvious challenge to the Silicon Valley culture of friendships, networking and partnerships," says Kirk O. Hanson, a business professor and director of the Markkula Center for Applied Ethics at Santa Clara University. That culture, widely viewed as the valley's unique strength, also is its weakness, he says, especially when "an extra portion of the wealth created is directed to insiders."

To be sure, some things have changed in the valley. As part of Wall Street's $1.4 billion settlement this past spring over too-bullish stock analysis, securities regulators formally banned "spinning," under which securities firms allocate coveted IPO shares to the personal accounts of corporate executives to induce them to direct their companies' investment-banking business to the firms.

Entrepreneurs report that venture capitalists are checking the books more thoroughly before investing in start-ups. These days, many founders are required to reach specific milestones -- either in product development or new customers -- before more money is handed over. The mantra among entrepreneurs and investors is that they are building "real companies," not just quick-exit, get-rich entities to be flipped onto an unwitting public. At search engine Google Inc., Chief Executive Eric Schmidt says the Santa Clara, Calif., company wants to send a message: "Product does matter." Google executives have said they would like to offer shares as widely as possible, people close to the situation said last week. One possibility there: the "Dutch auction" system, whereby market bids, not bankers, determine an offering price. The Financial Times reported last week that Google is considering an online auction of its shares.

Continued in the article.

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

THE SEC BLASTED the Big Board for failing to police its floor-trading firms. According to a confidential report, about 2.2 billion shares were improperly traded over the past three years, costing investors more than $150 million. The SEC is examining if Grasso engaged in "influence trading" by pressuring an NYSE floor firm to buy more AIG shares.
The Wall Street Journal, November 3, 2003 ---,,SB10678146664412100,00.html?mod=home_whats_news_us 

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

From The Wall Street Journal Accounting Educators' Reviews on October 31, 2003

TITLE: EDS Takes Charge of $2.24 Billion 
REPORTER: Gary McWilliams 
DATE: Oct 28, 2003 
TOPICS: Long-Term Contracts, Accounting, Accounting Changes and Error Corrections, Revenue Recognition

SUMMARY: Electronic Data Systems Corp. adopted a new accounting policy for the recognition of revenues for long-term contracts. The change resulted in $2.24 Billion reduction in previously recognized revenues. Questions focus on revenue recognition for long-term contracts.

1.) In general, when should revenue be recognized? List three factors that may complicate the timing of revenue recognition.

2.) Describe two general approaches for revenue recognition for long-term contracts. Discuss the advantages and disadvantages of each approach.

3.) Why did Electronic Data Systems (EDS) change its policy for revenue recognition for long-term contracts? Identify and discuss the accounting rule that prompted the change.

4.) Why did EDS adopt a retroactive treatment for the accounting change? Is it desirable for earnings and cash flows to be more closely aligned?

5.) How should the $2.24 Billion adjustment be reported in the financial statements? Will earnings from prior periods be restated?

6.) Are you surprised that stock prices rose after earnings in prior periods were revised downward? Support your answer. How will the accounting change adopted by EDS impact future earnings?

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

From the October 4, 2002 edition of The Wall Street Journal Accounting Educators' Review

TITLE: For EDS Chief, Some Gambles That Fueled Growth Turn Sour
REPORTER: Elliot Spagat, Ken Brown, and Gary McWilliams
DATE: Oct 01, 2002
TOPICS: Financial Accounting, Revenue Recognition

SUMMARY: EDS has booked "large chunks of revenue before it has been received or even billed" under long term contracts with customers. Collectibility of these receivables, and the propriety of the contract accounting, is now in question because of certain large customers' bankruprtcy filings and because of contract repricing guaratees EDS has made.

1.) Describe the nature of EDS's operations. What are they selling? Why must they invest large, up front costs when undertaking a contract?

2.) How do you think EDS is accounting for the revenue under its long term contracts with customers? (Hint: you can verify this method by going to the company financials found on its web site at .) What accounting standards and other authoritative literature establish the methods that must be used to recognize this revenue?

3.) "For one thing, though the contracts are long-term, the pricing often isn't." How does this statement impact the accounting for these contracts?

4.) What is likely to happen to EDS?'s receivables under the contracts with WorldCom and US Airways, two companies that are in bankruptcy court now? Should these circumstances with these particular companies affect the way that EDS accounts for its long term contracts with customers in general?

5.) Note that the issues regarding EDS's stock option plan that are mentioned in this article were covered in the Educators' Review dated September 27, 2002. The article that was the subject of that review is listed under Related Articles.

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

TITLE: EDS Makes Losing Bet on Stock, Raising Concern About Liquidity
REPORTERS: Elliot Spagat and Gary McWilliams
ISSUE: Sep 25, 2002

Bob Jensen's threads on revenue accounting are at 

"How Drug Directory Helps Raise Tab for Medicaid and Insurers:  They Pay for 'Off Label' Uses If Listed -- And Drugdex Lists Great Many of Them," by David Armstrong, The Wall Street Journal, October 23, 2003 ---,,SB106685564225943200,00.html?mod=todays%255Fus%255Fpageone%255Fhs 

Alarmed by surging outlays for the drug Neurontin, Oklahoma's Medicaid agency last year sifted through patient records for clues. It found widespread prescriptions of the drug for uses not approved by the Food and Drug Administration.

Ninety-four percent of prescriptions for the Pfizer Inc. medicine were for these "off label" uses, the agency estimated, tripling its bill for the drug to $3.7 million from its 1998 level. The state pondered whether to curb payments for off-label uses but quickly concluded there was little it could do.

That's because nearly all of the off-label uses for Neurontin were listed in the Drugdex Information Service -- a little-known publication that has quietly become a powerful reason for rising drug costs.

Published online by Canada's Thomson Corp., Drugdex is one of three federally recognized directories for authorizing coverage under Medicaid, the federal-state insurance program for the poor and disabled. Medicaid payment for an off-label prescription can't be denied if the condition being treated is listed under the drug's name in any of the directories. At least 31 states also compel private insurers to cover some or all of the off-label uses listed in the directories, according to health-care researcher Verispan LLC.

Drugdex's listings are far more extensive than those of the other two guides -- making it the de facto standard-setter in authorizing payment for unapproved uses of prescription drugs. Such uses, recent studies suggest, account for 40% to 50% of all drug use. That translates into significant revenue for the pharmaceutical industry, which relies heavily on government and private insurance to support the $194 billion in annual sales of prescription drugs.

As government and employers see their drug tabs surge, more concerns are being raised about the efficacy and safety of so many prescriptions for treatments the FDA has never endorsed. Critics say the broad listings in Drugdex are a boost to drug-company efforts to get doctors to prescribe brand-name medicines for off-label uses. If insurance coverage didn't exist for these uses, they add, patients might take cheaper generic drugs, over-the-counter medicines, or nothing at all, saving the health-care system huge sums.

Michael Soares, director of editorial services for Micromedex, the Thomson unit that publishes the directory, says, "It is up to Medicaid to set the policies for what is reimbursed." He acknowledges that Drugdex's listings are wider than those of the other two directories, saying that reflects its larger staff, its effort to review more of the scientific literature and its desire to reflect what doctors are actually prescribing.

Continued in the article.

"Nonsense of the Senate," The Wall Street Journal, October 23, 2003 ---,,SB106686511447081300,00.html?mod=todays%255Fus%255Fopinion%255Fhs 

Anyone who thinks a single Senator doesn't matter should take a look at yesterday's failed attempt to limit runaway class-action lawsuits. Fifty-nine Senators voted in favor of going to a floor vote on the measure, one vote short of the 60 needed to break a filibuster.

One culprit here is Alabama's Richard Shelby, the only Republican to oppose cloture and for years a wholly-owned subsidiary of the plaintiffs' bar. As usual, however, most of the opposition came from Democrats. The bill had easily passed the House earlier this year, 253-170. So Minority Leader Tom Daschle allowed just enough of his Members to vote in favor without the bill succeeding. Our sources say that Jeff Bingaman (New Mexico) and Mary Landrieu (Louisiana) had made private assurances they'd vote in favor only to bend in the end to Mr. Daschle's wishes.

Meanwhile, Arkansas's Blanche Lincoln got one of the Daschle passes and will now be able to tell the Chamber of Commerce and small business folk getting fleeced by abusive class-actions that she did what she could. At the same time, the trial lawyers won't give her too hard a time because the bill failed. As Lily Tomlin once observed, no matter how cynical you get it's hard to keep up.

Class action joins the list of other tort reforms buried by Senate Democrats. Medical malpractice (House vote, 229-196) died earlier this year after California's Dianne Feinstein walked away from a compromise. An attempt to fix the scandal that is asbestos litigation is close to expiring despite a business pledge to pay $114 billion into a trust fund.

About a decade ago, former Alabama Senator Howell Heflin explained his opposition to tort reform to his fellow Democrats by noting that "Jews, labor unions and trial lawyers" are the three main financiers of their party. Business groups aren't going to succeed in breaking that fealty to trial lawyers until they show Democrats that these votes could cost them their jobs.


The release comprises 135 pages and is available on the Board's website at .  PCAOB UpDate plans to

 publish an overview and guide to the process in an upcoming edition of PCAOB UpDate.

"Our study demonstrates that audit firms may lie to keep a profitable audit client if the expected benefits of keeping the client happy outweigh the expected costs of an audit failure if the firm gets caught," said Debra Jeter, co-author of the study and an associate professor of accounting at the Owen Graduate School of Management at Vanderbilt.

Surprise!  Surprise!
I have long contended criticisms of auditing firm ethics due to consulting practices were are overblown relative to the much larger problem of local firm dependence on the proportion of revenue generated from their largest audit clients. --- 
Also see 

This is also implied in the by Jonathon Weil's 2001 article about Andersen's dependence upon the $1 million dollar per week fees from Enron.

TITLE: Basic Principle of Accounting Tripped Enron 
REPORTER: Jonathan Weil 
DATE: Nov 12, 2001 
PAGE: C1 in The Wall Street Journal
TOPICS: Accounting, Auditing, Auditing Services, Auditor Independence

2003 Update
You might watch for a forthcoming paper in the November/December issue of the Journal of Accounting and Public Policy --- 

From the AccountingWeb on October 28, 2003

A study by Vanderbilt University researchers has found that audit firms are still likely to produce inaccurate audit opinions to benefit a big client — as long as company officials think they can get away with it.

"Our study demonstrates that audit firms may lie to keep a profitable audit client if the expected benefits of keeping the client happy outweigh the expected costs of an audit failure if the firm gets caught," said Debra Jeter, co-author of the study and an associate professor of accounting at the Owen Graduate School of Management at Vanderbilt.

However, the report also suggests that increased scrutiny over the auditing industry, brought about by the accounting scandals of the past two years, may help improve reporting as the possibility grows that wrongdoing will be discovered. Pressure brought by Securities and Exchange Commission enforcement and new rules set by the Public Company Accounting Oversight Board (PCOAB) could influence auditors’ decisions.

"If the likelihood that the firms will get caught if using questionable accounting increases," Jeter added, "their auditors, in evaluating the costs of an audit failure, will think twice and realize that their best interest lies in insisting on fair reporting."

Audit firms should rotate partners in charge of large audits, the study says, and audits should remain independent of consulting work by the same firm.

For companies being audited, Jeter advised that companies must constantly improve the internal audit function. "Top management should require managers at various levels within the firm to certify the numbers they are responsible for. Companies should make sure that most — if not all — audit committee members are financially literate and that they meet more than once a year. This is vital."

The study will be published in the November/December 2003 issue of the Journal of Accounting and Public Policy. "The Impact on the Market for Audit Services of Aggressive Competition by Auditors" is co-authored by Jeter; Paul Chaney, associate professor of accounting at the Owen School at Vanderbilt; and Pam Shaw of Tulane University.

Where were the internal and external auditors?

"AT&T Net Rises But Revenue Falls," The Wall Street Journal, October 21, 2003 ---,,SB106579114192990500,00.html?mod=technology_main_whats_news 

AT&T said Tuesday that two employees, one lower-level and one in mid-level management, "circumvented the internal controls process," resulting in an understated liability for costs incurred in 2001 and 2002. The company said the liability relates to access and other connection expense and was understated by $125 million. The company booked an after-tax expense of $77 million in the third quarter to reflect the proper amount.

"Sun CEO: Accountants Gone 'Wacko', Investors Should 'Go Nuts'," AccountingWeb, October 2, 2003 --- 

Scott McNealy, the Sun Microsystems CEO who is known in the industry as being rather colorful and blunt, reappeared on the stage of controversy by lamenting about 'wacko' accountants and calling for a return to simplicity in financial reporting. "The FASB, SEC and accountants have gone absolutely wacko on us. I'm a Stanford MBA, I went to most of my classes. I took accounting. I can't read annual reports, income statements and SEC filings any more. They are absolutely undecipherable," McNealy said on Wednesday in remarks at Toronto's Empire Club.

In an effort to simplify the reporting model, McNealy thinks that a return to cash accounting would be the best move. "If we laid [our accounts] all out with strict cash accounting, and let the analysts do the analyzing and the investors do the guessing, and stop putting the CEOs and the accountants in charge of making judgments, we'd all be a lot better off," he said.

McNealy also had nothing positive to say about the Sarbanes-Oxley Act, the federal effort intended to restore investor confidence in the marketplace. The effects of the Act were like tossing "buckets of sand in the gears of the market economy," he said. "This is an accounting full employment act, backed by the lawyers and supported by the judges," he continued, while expressing surprise that investors haven't "gone nuts" over the increased costs associated with Sarbanes-Oxley compliance.

The outspoken Sun Microsystems CEO worried openly about the effects of the Sarbanes-Oxley Act on good old-fashioned entrepreneurial risk taking, and lamented the inevitable loss of talented people from the ranks of corporate governance because of the increased liability risks.

Comment from Bob Jensen
What goes unsaid here is that old fashioned accounting just never had to deal with the complex nightmare of contracts that corporations of the world dreamed up to get around old fashioned reporting rules in order to manage earnings, achieve off balance sheet financing, and just plain screw investors.  Common McNealy --- admit where the real problem lies!

October 16, 2003 message from Roger Collins [rcollins@CARIBOO.BC.CA

An extract from an Economist article of October 16th.. 

The scandals that rocked the accountancy profession show no signs of dying away. A continuing series of arrests and regulatory censures of large accounting firms has shown that Andersen was not just one rotten apple, but that the entire barrel was tainted. Andersen's collapse should, in theory, have had a salutary effect on other auditors, serving as a stark warning of the disaster facing a firm whose eagerness to please a big client went too far. Perversely, though, Andersen's failure may have had the opposite effect. For the rest of the article, see 


Roger Collins 
UCC School of Business

From The Wall Street Journal Accounting Educators' Review on November 7, 2003

TITLE: PeopleSoft's Math: One Plus One Equals One 
REPORTER: David Bank 
DATE: Oct 31, 2003 
TOPICS: Advanced Financial Accounting

SUMMARY: PeopleSoft acquired J.D. Edwards on July 18, 2003 and has now reported third quarter results without separating out "the separate revenue contributions from J.D. Edqards and PeopleSoft in their initial qurarter as a merged company..."

1.) Why does one analyst call PeopleSoft's financial reporting "opaque"? That is, what is the problem with the fact that PeopleSoft does not separately report results from J.D. Edwards in this first full quarter after acquiring that entity? What questions and problems arise for analysts from that method of presentation?

2.) What standard requires reporting J.D. Edwards's results separately from PeopleSoft's? What information would be available in these third quarter results had that standard been followed?

3.) What requirements in the reporting standard establish whether J.D. Edwards should be reported separately from PeopleSoft? What conclusions must be reached to support the approach taken by PeopleSoft's management in the company's financial statements? Do you have any reservations about this approach? Explain.

4.) In what ways does PeopleSoft's management argue that its performance should be evaluated? How are analysts assessing the company's performance?

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

The mutual-fund scandal is spreading, as it becomes clear that players throughout the $7 trillion industry face scrutiny for improper practices that are turning out to be surprisingly common.
"For Staid Mutual-Fund Industry, Growing Probe Signals Shake-Up:  Investigators Find Indications Of Widespread Abuses Hurting Small Investors," by Tom Lauricella, The Wall Street Journal, October 20, 2003 ---,,SB106659857633625700,00.html?mod=todays%255Fus%255Fpageone%255Fhs 

The mutual-fund scandal is spreading, as it becomes clear that players throughout the $7 trillion industry could face scrutiny for improper practices that are turning out to be surprisingly common.

On Thursday, Massachusetts securities regulators signaled that they are investigating whether employees at three big mutual-fund companies -- Fidelity Investments, Morgan Stanley and Franklin Resources Inc. -- helped brokers get around prohibitions on short-term trading in their funds. The same day, state prosecutors in New York who have spearheaded a growing criminal investigation of the fund business, notched their first conviction of a mutual-fund executive: a former senior official with Fred Alger Management Inc., who pleaded guilty to obstructing the probe (See article).

New York Attorney General Eliot Spitzer, having earlier forced changes in the way analysts at brokerage firms operate, now says he intends to use the mutual-fund investigation to clean up another part of the financial world that has favored large clients at the expense of smaller ones, including millions of workers and retirees. The Securities and Exchange Commission, scrambling to keep up with him, as it did during the investigation of Wall Street analysts, is now filing civil suits of its own and is considering possible new rules aimed at preventing misbehavior in mutual-fund trading.

Industry heads have begun to roll. Top mutual-fund executives at Bank of America Corp. and Bank One Corp. have lost their jobs because of allegations of questionable rapid trading at those firms. Alliance Capital Management Holdings LP suspended a veteran portfolio manager who ran one of the country's largest technology-stock funds.

The widening debacle -- which could shake investor confidence and lead to significant changes in mutual-fund rules -- is rooted in a paradox that has dogged the industry since its birth nearly 80 years ago. The central attraction of mutual funds is that they offer the opportunity to buy shares in a single investment that reflects the composite value of dozens, or even hundreds, of individual securities

Continued in the Article

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

Must we have a down market to improve accounting rules?

"Bad Options," by Jesse Eisinger, The Wall Street Journal, October 20, 2003 ---,,SB106659977721874600,00.html?mod=todays%255Fus%255Fmoneyfront%255Fhs 

Now that stocks are rising anew and tech is back, baby, the stock-option expensing debate seems so 2002.

Nobody talks about options much any more. Like other corporate-reform efforts, could the effort to expense stock options just fade away in the bright light of a sunny market?

. . .

Take Intel, which is adamantly against expensing. In the first six months to June 28, Intel made 95 million new share-option grants. The average strike price was $18.52. On Friday, the stock closed at $31.66.

So, the intrinsic value of those options, right now, is about $1.25 billion. (They are worth more than that according to Black-Scholes, but for the sake of that model's opponents, let's leave that out of this example.) Intel had pretax profit of $4.9 billion in the first nine months of the year. So, the value of options the chip maker granted in the first half is worth just over a quarter of its profits through nine months. To keep the share count flat, Intel must spend cash to buy back stock.

If options were included as an expense item, some investors would foolishly ignore the noncash expense. But others would treat it like they treat depreciation, which is also a noncash expense. Depreciation is a proxy for how much capital spending a company needs to make to maintain its infrastructure.

When stock options are expensed, they will be just such a proxy for the cash costs to the company from employee options. That is, if the accounting watchdogs manage to do the right thing.

Continued in the article.

Bob Jensen's threads on stock option accounting are at 

Why is executive pay related to the Lake Wobegon Effect?

"Where's the stick?" The Economist, October 9, 2003 ---  
Something has gone wrong with bosses' pay. The solution has to lie with shareholders

A string of corporate scandals in recent years, from Enron to WorldCom to Tyco, have revealed senior executives apparently plundering their companies with little regard to the interests of shareholders or other employees. And even when no wrongdoing is alleged, huge pay awards are provoking growing outrage. Just ask Richard Grasso, the former chairman of the New York Stock Exchange, who went from folk hero to a symbol of excess almost overnight when it was revealed that he was due to receive $188m in accumulated benefits.

What is now causing the most indignation, in Europe as well as in America, are “golden parachutes” and other payments which reward bosses even when they fail (see article). Not only does it seem that bosses are being fed ever bigger carrots, but also that if the stick is finally applied to their backside, they walk away with yet another sackful of carrots to cushion the blow. Bugs Bunny couldn't ask for more.

The highest-profile cases of excessive pay, unfortunately, are not isolated exceptions. Bosses' pay has moved inexorably upwards, especially in America. In 1980, the average pay for the CEOs of America's biggest companies was about 40 times that of the average production worker. In 1990, it was about 85 times. Now this ratio is thought to be about 400. Profits of big firms fell last year and shares are still well down on their record high, but the average remuneration of the heads of America's companies rose by over 6%.

This one-way trend in top executives' pay has rightly raised eyebrows, on both sides of the Atlantic. The supply of good bosses may be short, but can it be that short, even during an economic slowdown and stockmarket slump? A recent poll in Britain found that 80% of people believe that top directors are overpaid. This summer customers boycotted a Dutch retailer, Ahold, to express disapproval of the pay awarded to that company's new chief executive.

Unions in America and Britain want governments to be more directly involved in regulating bosses' pay. But that cure threatens to be even worse than the disease itself. It would be much wiser to play to capitalism's strength—its flexibility—and to encourage shareholders themselves, the ostensible owners of companies, to sort the problem out. For too long the missing element in the setting of top executives' pay has been the active interest of shareholders. Only once that comes into play can the bargaining between boards and bosses become a more equitable affair.

Lavish pay-outs are not only costly in themselves but can also damage the long-term health of a company. Too many bosses have manipulated corporate results to fill their own pockets. Moreover, pay packages thought excessive or unfair can destroy morale among the rest of a company's workforce.

So what should shareholders do? For a start, big institutional investors can often make better use of the powers that they already possess. In Britain this year shareholders received the right to vote on top executives' remuneration. And yet at only one company (GlaxoSmithKline) did big investing institutions vote against an existing package—not an impressive performance if they are genuinely aggrieved.

Beyond Lake Wobegon 

The pay-setting process is characterised by what has come to be known as the Lake Wobegon effect, after the novel “Lake Wobegon Days” by Garrison Keillor. All Lake Wobegon's children are said to be “above average”. Most boards appointing a new chief executive will seek the advice of a pay consultant, who will tell them the going rate. The trouble is, no board wants to pay the average for the job. The above-average candidate which directors have just selected as CEO, they invariably reason, deserves more. And so bosses' pay spirals upwards.

If shareholders want to break this mould they need to be far more diligent. Greater transparency about executives' pay will undoubtedly help, and moves in that direction in both America and Europe are to be welcomed. And yet shareholders must also exercise more say in choosing genuinely independent directors to select and monitor the CEO. Few public companies today in either America or Europe have a majority of independent directors. This week, America's Securities and Exchange Commission took steps in the right direction by proposing an increase in the power of shareholders to nominate and appoint directors. Once they have these powers, shareholders should make use of them.

That leaves the vexed question of how, and how much, to pay top bosses. There can never be any simple, single formula for this. Much will depend on the situation of each company. The boss of a firm in a stable or declining industry should probably not be paid in the same way as one in a fast-growing high-tech market. Some corporate boards ought to at least consider a return to what was once the norm in both America and Europe (and still is in Japan) and largely ditch pay-for-performance and instead pay largely through a straight salary (most lower-level employees are paid this way).

Yet most boards will probably stick with pay-for-performance of some kind. Whether in the form of options, the outright grant of shares, bonuses tied to criteria such as earnings or revenue growth, or some other means, pay should be explicitly aligned with the long-term interests of the owners, not short-term blips in share prices or profits. Whatever formula is chosen, some bosses are bound to try to manipulate it. This is why, in future, capitalism's pillars, the shareholders who own the company, will have to become more actively involved in choosing the directors who represent them and in policing what they do. Shareholders, after all, supply the carrots.

I added the following updates to my “Rotten to the Core” segment in my running account of the accounting, finance, 
and corporate governance scandals ---
"Partners in Crime," Fortune, October 13, 2003 --- 
The untold story of how Citi, J.P. Morgan Chase, and Merrill Lynch helped Enron pull off one of the greatest scams ever. The complicity of so many highly regarded Wall Street firms in the Enron scandal is stunningly documented in internal presentations and e-mails, many of which have never before been published. It seems that the banks have gotten off easy so far.
· Firing Offense · 'A Carrot From Andy'
· The Anti-Roadshow?  

Washington DC:  The Biggest Fraud Center in the World

"My Dinner with Cheney," by Jim Hightower, The Texas Observer, Page 15, September 12, 2003 --- 

For Boeing, Inc., it was a steal of a deal, wrapped in the flag and delivered on a silver platter. The deal, initiated by Boeing lobbyists shortly after the September 11 terrorist attacks, lets the world’s largest airplane maker lease 100 of its commercial jets to the Air Force for conversion into refueling tankers. The lease pays a sweet $20 billion to Boeing–way more than the Air Force would pay simply to buy the tankers. It was a closed-door deal–done without competing bids and without Congressional hearings or a vote. It also includes a 15-percent profit for Boeing, triple what it makes selling commercial planes. How did this happen? Business Week magazine recently followed the lobbying trail. First, Boeing went to the top. Having just moved its corporate headquarters to Illinois, home state of House Speaker Dennis Hastert, its lobbyists quickly signed up Hastert, and he quietly slipped the arrangement into the Pentagon appropriations bill. But the White House budget office balked, calling the costly lease scheme "irresponsible." So, Boeing’s lobbyists, Hastert’s office, and the Air Force agreed to a bit of Enron accounting to make the lease appear less costly than it is. In other words, they rigged the numbers. Then they lobbied. Boeing spends some $6 million a year on lobbyists. It’s also a $2 million annual political contributor (including having given $100,000 to help pay for Bush’s inaugural festivities), so it has lots of insider clout.

"Former Fred Alger Official Pleads Guilty to Obstruction," The Wall Street Journal, October 17, 2003 ---,,SB106631172175567900,00.html?mod=todays%255Fus%255Fmoneyfront%255Fhs 

SEC Brings Its Own Charges; In Massachusetts, Regulators Probe a Trio of Fund Firms A former senior executive of Fred Alger Management Inc. pleaded guilty in the Supreme Court of New York State to felony criminal charges of obstructing the investigation into improper mutual-fund trading, making him the first mutual-fund executive charged in the rapidly widening investigation.

At the same time, the Securities and Exchange Commission brought civil charges against the executive, James Connelly Jr., in connection with allowing selected customers to rapidly trade, or "market time," Alger's mutual funds. The move has significance because it marks the first charges brought by the SEC in connection with market-timing, which has been a commonplace activity in the fund industry. Market-timing, or rapid trading of mutual funds, can shortchange longer-term fund holders and often is forbidden by fund policies.

The SEC action in the Alger case, on top of the criminal charges brought by New York Attorney General Eliot Spitzer, suggests that other mutual-fund management companies and their employees may face federal charges if they violated their fund's prospectus by allowing some investors to actively trade fund shares while banning others from doing the same thing.

"This certainly sends a message that market-timing can be illegal, and where it is illegal we will bring appropriate enforcement action," said Stephen Cutler, SEC enforcement chief.

Also Thursday, Massachusetts securities regulators signaled that they are investigating whether employees at three big mutual-fund companies -- Fidelity Investments, Franklin Resources Inc. and Morgan Stanley -- helped brokers circumvent rules designed to prevent rapid trading in their funds, according to people familiar with the matter.

Enron Email Messages From the Federal Energy Regulatory Commission (FERC)
Western Energy Markets: Major Issuance on March 26, 2003 - Information Released in Investigation --- 

Enron Email: 92% of the Enron emails have been returned the FERC web site. April 7, 2003 Order [PDF] | April 22, 2003 Order [PDF] | May 14, 2003 Order [PDF]

Scanned Documents: This database was created from paper documents provided to FERC during its investigation of Western energy markets. The documents were scanned and coded (indexed). Additionally, the images underwent an optical character recognition (OCR) process that created computer-readable full text. This database consists of fielded data captured during coding, full text and TIFF images. First and last Bates numbers were assigned by Aspen and any other numbers that appeared on a document were captured in a field called “Other_No”. The Aspen-assigned number is comprised of the FERC box number and a sequential number for each scanned page in a box. The value in the FirstBates field is hyper linked to the corresponding group of scanned images that comprise the database record. Database records: Over 85,000; Document images: Over 150,000

Transcript: This database was created from transcripts related to this case. Database records: 40 records

PA02-2-000 Trading Floor Audio Files - Audio files in mp3 format. Portland General Electric.

PA02-2-000 Enron Database Extracts

PA02-2-000 Portland General Electric Data

PA02-2-000 Western Sellers Submissions - Corrected and validated long-term transactions (used in regression analysis) submitted in response to the March 5, 2002 FERC letter order to all jurisdictional and non-jurisdictional sellers with wholesales sales in US portion of Western Systems Coordinating Council.

Form AccountingWeb News on October 15, 2003 --- 

Morgan Stanley, IBM Corp. and General Electric Co.’s GE Foundation will join forces and resources with Columbia University’s business school to create an academic think tank to take the lead in improving accounting standards and stock research. 

Called the Center for Excellence in Accounting and Security Analysis, the center will be chaired by Arthur Levitt, former chairman of the Securities and Exchange Commission. Trevor Harris, director of Morgan Stanley’s global valuation and accounting team for equity research, will be a co-director of the center.

"Ruling Lets Enron Workers Sue Lay, Northern Trust Over Lost Savings," by Theo Francis, The Wall Street Journal, October 2, 2003 ---,,SB106504642783044200,00.html?mod=todays%255Fus%255Fpageone%255Fhs 

A federal judge in Texas ruled that former Enron Corp. Chairman Kenneth Lay and Northern Trust Corp., trustee of Enron's 401(k) retirement plan, can be sued under federal pension law for allegedly failing to protect Enron employees.

The ruling could lead to greater protections for workers with employer stock in their 401(k) and other retirement programs. Companies using their own stock in employee-retirement plans, a widespread practice, came under increased scrutiny from Congress and government regulators after Enron's stock collapse devastated its employees' retirement savings.

The wide-ranging, 329-page ruling by U.S. District Judge Melinda Harmon in Houston came in response to motions brought in lawsuits by former employees of Enron, which filed for bankruptcy-court protection in late 2001. The ruling said Mr. Lay and Northern Trust -- along with others who oversaw Enron's retirement programs -- had a responsibility to ensure that the plans' investments were prudent. This responsibility extended to decisions about how much Enron stock employees held in their retirement accounts, the judge said.

More than 60% of Enron's $2.1 billion in 401(k) assets were invested in the company's own shares at the end of 2000. The plan covered about 20,000 Enron employees, retirees and their beneficiaries. Enron stock, which peaked at about $90 a share in 2000, currently trades for less than 10 cents a share in over-the-counter trading.

Tamar Frankel, a Boston University law professor, said she expects the ruling will put executives at other companies and financial firms on notice that they could be held accountable for decisions they make about retirement plans. That's bound to give employees an additional measure of protection, she said. "It will affect behavior," at least for a time, she said.

The ruling is the latest to underscore executives' responsibilities for their companies' retirement plans. In July, a federal judge in Oklahoma allowed employee claims to proceed against a range of defendants who made decisions about retirement plans at Williams Cos., a Tulsa, Okla., natural-gas pipeline company. In June, a U.S. District Court judge in Manhattan allowed claims to proceed in a similar case involving telecommunications company WorldCom Inc., which is reorganizing under bankruptcy-court protection and has been renamed MCI.

But benefits lawyers said rulings in some other court cases have set narrower limits on the range of company officials who employees could sue alleging breach of fiduciary duty in the administration of retirement plans.

The Enron lawsuits, which have been consolidated, accuse the company, Mr. Lay, other Enron executives, the retirement plans' administrators, Northern Trust and others of misleading company employees by encouraging and in some cases requiring them to hold Enron stock in their retirement accounts, at a time when the stock price plummeted from an artificially inflated level. Several former Enron executives have been charged with manipulating the company's financial results, ultimately driving the company into bankruptcy.

Enron contributed its own shares to employee retirement accounts and placed restrictions on when these assets could be moved to other investments.

Continued in the article.

"Former Executive Of Enron Pleads Guilty to Charge," by John R. Emshwiller, The Wall Street Journal, October 31, 2003 ---,,SB106753244927285200,00.html?mod=mkts%5Fmain%5Fnews%5Fhs%5Fh 

Federal investigators unveiled a new high-level cooperating witness in the Enron Corp. probe with the announcement that the former head of the energy company's giant North American unit had settled criminal and civil charges related to his participation in an allegedly wide-ranging fraud scheme.

As part of the settlement, David W. Delainey pleaded guilty to one criminal count of insider trading. While many of the specific allegations of misconduct against Mr. Delainey are similar to those brought in previous Enron-related cases, he is potentially a valuable catch for the government. As the former chief executive of the North American unit and Enron's highly touted retail electricity unit, called Enron Energy Services, the 37-year-old Mr. Delainey reported directly to former company President Jeffrey Skilling. He also dealt with other top-level executives, such as former Chairman Kenneth Lay.

Federal authorities have been working to determine whether there is enough evidence to bring criminal or civil charges against Messrs. Lay and Skilling and other former top officials for what the Justice Department has called "the massive fraud at Enron." Mr. Lay and Mr. Skilling, who both did stints as Enron's chief executive, have denied wrongdoing. Enron sought bankruptcy-court protection in December 2001.

So far, the Justice Department and the Securities and Exchange Commission, which are working together to investigate the company's affairs, have brought criminal or civil charges against more than 20 individuals. Most of those who have been charged criminally -- including former Chief Financial Officer Andrew Fastow, the highest-ranking officer yet indicted -- have pleaded not guilty and await trial.

Thursday, federal officials said the investigation is continuing and that Mr. Delainey is an important part of the probe. "As the chief executive of two of Enron's most important business units, Mr. Delainey has provided and will continue to provide critical insights into the inner workings of Enron," said Linda Thomsen, the SEC's deputy director for enforcement.

Besides pleading guilty to insider trading, Mr. Delainey also agreed to pay $8 million in returned stock profits and other penalties. In his plea agreement, Mr. Delainey stipulated that "Enron's executives and senior managers engaged in a wide-ranging deceive the investing public about the true nature and profitability of Enron's businesses by manipulating Enron's publicly reported financial results."

In their filings Thursday in Houston federal court, the Justice Department and SEC alleged that Mr. Delainey and other members of Enron's management manipulated company reserve accounts, improperly increased the reported value of assets and entered into improper business transactions.

Under the plea agreement, Mr. Delainey faces as many as 10 years in prison, though he could avoid incarceration. If Mr. Delainey provides "substantial assistance" to the government's Enron probe, the Justice Department has agreed to let the court know about his cooperation in order to possibly reduce his sentence.

Continued in article.
Bob Jensen's threads on the Enron scandal are at 

"Ex-Enron Accountant Cooperates, Settles With Feds," AccountingWeb, October 10, 2003 --- 
Wesley H. Cowell, the former chief accounting officer of Enron North America, has 
agreed to pay a $500,000 fine for his role in fraudulently manipulating the 
earnings of the bankrupt company's trading arm.

"Firms Reverting to by-the-Books Balance Sheets," by Thomas S. Mulligan, LA Times, February 18, 2003 ---,0,7619838.story 

As investors burned by the Enron scandal punish companies with even a whiff of accounting irregularity or other questionable behavior, some firms have found a new strategy: an old-fashioned, forthright balance sheet and income statement.

Espousing a cleaner-than-thou philosophy, corporations are turning away from finance practices that not only are legal but in other times might have won them praise for creativity.

Experts say the message these companies want to convey is "We're not Enron." Some are swearing off complex ways of reporting sales and profit that strike critics as misleading or simply difficult to understand. Some are working to bolster the independence of their boards, mindful of the tarring Enron directors have taken for apparent conflicts of interest.

The Enron debacle has given the American public a quick lesson in complex accounting, introducing such arcane terminology as synthetic leases, special purpose entities, derivatives and pro forma.

Investors are taking a microscope to accounting methods that seldom raised questions before the Enron scandal. IBM, Qwest Communications and Marriott International last week joined a list of companies whose shares have been rocked by accounting concerns, among other factors.

If companies are being punished for tangled financials, perhaps the flip side is that others will be rewarded for clarity. "Because of Enron, a premium will be attached to companies with sterling governance structures and financials that are very, very plain vanilla," said Charles Elson, who heads the University of Delaware's Center for Corporate Governance.

Much of the housecleaning is meant to reassure worried stockholders and buff firms' public image, but there is a more pressing concern: The Securities and Exchange Commission, itself criticized for missing Enron's problems, has put corporate America on notice that within the year, it will more closely examine the books of the Fortune 500, the nation's largest companies.

The SEC also has warned that adherence to the letter of accounting rules may no longer be enough; companies that produce misleading financial statements, even if they technically comply with regulations, could be punished.

Some firms are making changes on their own initiative, others only after the posse has arrived.

Krispy Kreme Doughnuts last week decided to scrap a synthetic lease it was using to finance a new factory. It didn't act, however, until it had been zinged by Forbes magazine for the arcane debt instrument and then slammed by a headline in the tabloid New York Post: "Krispy Kreme Bites."

"While this type of lease is both common and complies with the most rigorous accounting standards, the company . . . will instead use conventional, on-balance-sheet financing," Scott Livengood, Krispy Kreme's chairman and chief executive, said. "There is no reason for us to do anything that could be misinterpreted, regardless of how legal and acceptable it may be."

Although firms are anxious to calm investor fears, you aren't likely to see TV commercials touting clean balance sheets or conservative revenue recognition, communications experts say.

"An ad campaign is far too blatant," said Jerry Swerling, who runs the public relations program at USC's Annenberg School for Communication. "Besides, it's not the kind of thing you'd advertise."

Instead, companies are using their own investor relations staffs or hiring outside public relations agencies for help in delivering the we're-not-Enron message, he said.

One of the key questions raised by Enron's implosion has been, where was the board of directors? Although board members contend that key information was withheld from them, critics also have noted that seven of Enron's 14 directors either did business with the company, worked as paid consultants to it or were affiliated with organizations that received large donations from Enron or its top officers.

With board independence in the spotlight, Interpublic Group, the world's largest advertising firm, this week announced that four of its executives would step down from the board and an unaffiliated member would be added. This leaves the board with two Interpublic executives and seven outsiders, whereas the old split had been six and six.

"The interests of Interpublic shareholders will be best served by a board that is primarily made up of independent, outside directors," Chairman John Dooner said in a statement that did not mention Enron.

Procter & Gamble recently went out of its way to tell Wall Street analysts that it has "no material off-balance-sheet financing." A year ago, such a comment might have drawn blank stares, but today anyone can see it's a direct reference to a finance and accounting practice that was at the heart of the Enron collapse.

Enron used limited partnerships, some headed by former Chief Financial Officer Andrew S. Fastow, to artificially boost profit and keep large amounts of debt off its corporate balance sheet. Enron's slide toward bankruptcy became steeper Nov. 8 when it acknowledged that these arrangements were improper and reduced its previously reported profit by $586 million.

Henry Silverman, chief executive of the hotel and real estate firm Cendant, which has had serious accounting problems in the past, complained in a recent television interview that the harsh new scrutiny amounts to "the McCarthyism of guilt by association."

Nevertheless, Cendant bowed to the pressure and said that in the future it would reduce the number of special "one-time" charges it takes against earnings.

Financial watchdogs, including former SEC Chairman Arthur Levitt, have criticized firms for excessive use of such "extraordinary" charges. Many companies routinely offer separate versions of their income statements each quarter and encourage analysts to focus on the one with the better numbers.

Continued in the article.

"Deloitte Entangled in Nation's Worst Insurance Failure," AccountingWeb, October 14, 2003 --- 

The Pennsylvania Insurance Department is pointing fingers at Big Four firm Deloitte, alleging that the accounting firm contributed to the largest insurance company failure in the United States. According to a court filing, within days of Deloitte signing off on an audit of Reliance Insurance Co. indicating sufficient cash reserves in February 2000, the firm told an investment partnership of a "seriously deficient" $350 million shortfall in the insurance company.

Deloitte told the investment company about the shortfall "in exchange for millions of dollars" in accounting fees, according to the state. Deloitte "exploited the competing interests of [the investment company] and Reliance and benefited financially by receiving payments from clients on opposite sides" of the proposed deal, according to the state.

After the disclosure about the true condition of Reliance Insurance Co., the company could not be reorganized and subsequently collapsed.

The Pennsylvania Insurance Department says Deloitte knew of the true condition of the company prior to signing off on the audit, and wants Deloitte to pay for part of the $2 billion cost of Reliance's collapse.

Deloitte refuted the charges and accused the state of "serious distortion of the facts."

"Deloitte's Bermuda Affiliate Agrees to $32 Million Settlement," by Johathan Weil, The Wall Street Journal, December 10, 2003 ---,,SB107101301627587900,00.html?mod=mkts%5Fmain%5Fnews%5Fhs%5Fh 

Deloitte Touche Tomatsu's Bermuda affiliate agreed to pay $32 million to settle litigation over its audits for the Manhattan Investment Fund, nearly four years after a collapse that cost the hedge fund's investors roughly $400 million.

The settlement, which last month received preliminary approval from the federal district judge in New York presiding over the litigation, marks the latest chapter in a high-profile case that has helped spark calls for greater regulatory oversight of the hedge-fund industry. A hearing on whether the judge will grant final approval to the accord is expected sometime next year.

Continued in the article.

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

A billion here, a billion there.  Yawn.  

"Judge Proceeds In HealthSouth Sentencing Cases," by Carrick Mollenkamp and Chad Terhune, The Wall Street Journal, November 13, 2003 ---,,SB106866428454084500,00.html?mod=home_whats_news_us 

A federal judge, rejecting requests from government prosecutors, proceeded with the first sentencing hearing for former HealthSouth Corp. officials who have pleaded guilty to participating in a $2.7 billion accounting fraud at the health-care company.

U.S. District Judge Inge Johnson denied motions from Justice Department lawyers and attorneys for five former company executives to postpone sentencing until after the trial of Richard M. Scrushy, the former HealthSouth chief executive charged with directing the fraud in an 85-count indictment unsealed last week.

Mr. Scrushy has denied any wrongdoing and remains free on a $10 million bond. His trial is scheduled for Jan. 5.

Continued in the article.

October 17, 2003 message from Clikeman, Paul [pclikema@RICHMOND.EDU

60 Minutes is going to air a report this Sunday about accounting firms' promotion of "abusive" tax shelters. The synopsis from the CBS web site is below. Also, they apparently aired an interview with HealthSouth CEO Richard Scrushy last week. Did anybody see that episode and was it any good?

Gimme Shelter Oct. 17, 2003

The tax shelters the rich use to avoid an estimated $50 billion in taxes a year are the "schemes" of reputable accounting and law firms that profit immensely by selling them to their clients, says Sen. Charles Grassley (R-Iowa), chairman of the Senate Finance Committee.

He appears in Steve Kroft's report on abusive tax shelters to be broadcast on 60 Minutes, Sunday, Oct. 19, at 7 p.m. ET/PT.

"The source of the problem is the accounting firms and the law firms that peddle these schemes," says Grassley of the tax shelters, which are usually rejected by courts and the Internal Revenue Service. "You just can't write tax laws precisely enough to avoid the ingenuity of lawyers and accountants."

The "schemes" put a taxable income through elaborate financial transactions that create artificial losses to offset that income. "The products they're selling generally don't work," says Stanford University law professor Joseph Bankman, a tax shelter expert.

"If it's not illegal... it's certainly somewhat unethical, I think," says Bankman. Competitive pressure is pushing the firms into the business. "Mavericks without these moral scruples went into the business and did really well and their clients didn't get caught," adds Bankman.

But now, firms and their clients are getting caught and fined for using abusive tax shelters. Henry Camferdam blames his troubles with the IRS on the firms that sold him a $50 million tax shelter.

"Ernst and Young came to us...and said, 'Look, instead of paying all these taxes, why don't we do a tax shelter,'" says Camferdam, who was selling his business with the help of accountants Ernst and Young. "When they're a trusted advisor, you're going to listen."

The shelters are so lucrative and proprietary that Camferdam had to pay $1 million in fees and sign a strict non-disclosure agreement. He had to also pay $2 million to the law firm of Jenkins and Gilchrist for providing an "independent" legal opinion saying the shelter would work.

"You can't make $2 million a pop and be independent in any meaningful way. I would think that [Jenkins and Gilchrist] were quite interested in how many people bought that shelter," says Bankman.

Camferdam and scores of other clients bought the shelter, called the Currency Options Bring Reward Alternatives, or COBRA, but had their names turned over to the IRS by Ernst and Young when the IRS began an investigation.

"[The IRS] talked like we're the cheats...who defrauded the government," says Camferdam, who the IRS says owes it $13 million, plus interest and penalties. The IRS is auditing all the other clients who purchased the tax shelter, too.

"What I don't understand is why they have not gone after Ernst and Young, Jenkins and Gilchrist and Deutsche Bank, who designed, marketed and led us into this transaction," asks Camferdam. "That's what you use these people for. If they tell us not to do something, we don't do it. If they tell us to do something, we do it."

Ernst and Young and Jenkins and Gilchrist refused 60 Minutes' request to be interviewed on camera, but issued statements saying everything they did was completely legal. Camferdam is suing them for $1 billion, alleging they knowingly lured customers into an "illegitimate tax sham."

Paul Clikeman 
Robins School of Business 
University of Richmond Richmond, VA 23173 804-287-6575

How Ernst & Young's Controversial Tax Shelter Really Works
"Gimme Shelter," Aired by 60 Minutes on CBS Television on October 19, 2003 --- 

(CBS) If you think the rich don't pay their fair share in taxes, in some cases, you're absolutely right, especially if you're talking about big corporations and wealthy individuals who use questionable tax shelters.

These are complicated financial transactions that involve little risk and exploit technicalities and loopholes in the law for the sole purpose of avoiding taxes. They cost the federal government an estimated $50 billion a year in lost revenue -- enough to upgrade the electrical power grid or pay for the war in Iraq.

What most people don't know is that a lot of that money that is supposed to go to the government ends up in the pockets of some of the nation's biggest accounting corporations -- the most respected law firms and the richest investment banks. They're the ones who invent, legitimize and market these schemes for their wealthiest clients. Correspondent Steve Kroft reports. 

Henry Camferdam, a self-made multi-millionaire, was one of those clients. And now, much to his regret, he’s somewhat of an expert on tax shelters.

In 1999, Camferdam was running his own computer company in Indianapolis and paying himself a salary of $200,000 a year. Life was good and about to get much better. A competitor came forward and bought his company.

But he barely had time to count his money before he got a call from his longtime financial adviser, Ernst and Young, the third largest accounting firm in the country.

“They were involved in helping us sell the business, so they intimately knew what was going on,” says Camferdam. “They came to us and said, ‘Look, instead of paying all these taxes, why don't we do a tax shelter that, in essence, will eliminate all of your taxes.’ And when someone says that to you, especially when they're a trusted adviser, you're going to listen.”

At a sales pitch at their Indianapolis office, Ernst and Young told Camferdam that the tax shelter was so creative that it would cost him $1 million in fees. They also said that it was so secret that he couldn't keep any of the literature and would have to sign a non-disclosure agreement.

“Ernst and Young felt very protective of the design of this shelter. And they had a great deal of concern that someone would get this design and steal it from them,” says Camferdam, who admits he didn’t understand this tax shelter.

Quite honestly, after a half a dozen interviews, neither did we. Except that Ernst and Young called this particular tax shelter Cobra. 60 Minutes sought out Lee Sheppard, who makes her living explaining tax law for a publication called "Tax Notes."

“The tax law is complex. And people who are tax professionals like to have clients believe they're magicians. It's very flattering,” says Sheppard. “It's so complicated. You couldn't possibly understand it. And your head would explode if we had to explain it to you.” 

Here’s how it works. Ernst and Young arranged for Camferdam to buy two offsetting foreign currency options. One $50 million option bet the Euro would go up; the other a $50 million dollar bet that the Euro would go down.

Ernst and Young then began moving these two offsetting currency options through a series of hard-to-trace shell companies and partnerships -- a complicated process Sheppard calls basis bouncing.

By using a hyper-technical reading of the tax code, Ernst and Young decided that only one of the currency options had to be put on the balance sheet. Thus, it created a corporation with an artificial $50 million tax loss. That offset the $50 million profit that Camferdam made selling his business – and as a result, he owed no taxes.

But how did the accountants justify a $50 million loss on the currency transaction when in fact there really wasn't a loss?

“Ernst and Young, who are experts on the tax law, felt that there was a loophole in the tax law. And through a very complicated, expensive, accounting of this transaction you could avoid the taxes and shelter the gain on it,” says Camferdam. “And as I sit here three years from today, the discussion you and I would have on it would be very short. Because I don't fully understand it.”

Camferdam says he thought it was legal: “Absolutely. And that's what you use those people for. If they tell us not to do something, we don't do it. If they tell us to do something, we do it.”

Ernst and Young said that German financial giant Deutschebank would handle all of the currency trades and financial transactions. But that would cost Camferdam another $3 million in fees. He would also have to pay for legal advice.

“They had opinion letters from two major law firms in the country, supporting this and saying that this tax shelter was good and it would pass an audit,” says Camferdam. “So with Ernst and Young on top of the two law firms, saying that we should do this, we did it.” 

Jenkins and Gilchrist, one of the largest law firms in the country, wrote the principle legal opinion that Ernst and Young provided to Camferdam and other people who bought the Cobra tax shelter. According to court documents, they were also one of the designers of the tax shelter. That stack of papers cost Camferdam another $2 million.

But Joseph Bankman, a professor at Stanford University Law School and an expert on tax shelters, believes Jenkins and Gilchrist's legal opinion was self-serving.

“You can't make $2 million a pop and be independent in any meaningful way. I would think they were quite interested in how many people bought that shelter,” says Bankman.

But 75-100 wealthy people did. Bankman says the legal opinion may have made buyers like Camferdam feel better, but in the end it was little more than a sales tool.

“And the sad fact is it doesn't mean anything,” he says, even though Camferdam paid $2 million for it.

“It certainly improved the salability of it from Ernst and Young's perspective. But when you get in court the case is what it is,” says Bankman. “And if you're trying to take a $40 million loss on a break-even investment with no business purpose you're almost always going to lose. And that's just what courts have said for a half century now.”

And that's exactly what the IRS decided about Cobra -- it was trying to exploit an ambiguity in the tax code, while clearly violating the spirit of the law.

“The new shelters are just paper transactions. Nothing's created. There's no real investment. There's no risk. There's no possibility of upside or downside,” says Bankman.

It sounds like a fraud. “That's right,” says Bankman. “And I think 20 years ago that's what all the reputable firms thought.”

So how did they get into the business?

“Well, a few kind of mavericks without these moral scruples went into the business and they did really well. And their clients didn't get caught,” says Bankman. “And then competitive pressures pushed more and more firms and taxpayers into this arena until finally everybody lost their moral bearing or at least most people did. It became the new norm.”

Bankman says it really changed in the early 1990s, when accounting firms began charging clients a percentage of the money they saved them in taxes, instead of billing them at an hourly rate.

“If it's not illegal, it's pretty close. It's certainly somewhat unethical I think,” says Bankman.

Besides Ernst and Young, the biggest names in accounting, law and investment banking have all been caught promoting abusive tax shelters: KPMG, Price Waterhouse, Merrill Lynch, Bankers Trust, and the now defunct Arthur Anderson, among many others.

Internal promotional documents from one major accounting firm, BDO Seidman, showed just how cynical the tax shelter business has become. In a presentation for people in the in the Tax Department, who called themselves "The Wolf Pack," the firm's partners urged them to focus on one thing – money.

“These people, to the unsophisticated taxpayer, would be like a snake oil salesman 100 years ago,” says Iowa Sen. Charles Grassley, chairman of the Senate Finance Committee.

After last year's corporate scandals, he vowed to hunt down tax cheats everywhere, and he's put the promoters of what he calls "tax shelter scams" at the top of his list.

“The source of the problem are the accounting firms and the law firms that peddle these schemes,” says Grassley. “The legitimacy of it comes from the good name of the accounting firm that markets it.”

The accountants and lawyers who devise these tax shelters would say that their legitimacy comes from the ambiguity of the tax code itself -- and all they're doing is following the letter of the law, as written by Congress.

“You just can't write tax laws precisely enough to avoid the ingenuity of lawyers and accountants to find ways around it. You just can't do that,” says Grassley, who admits that he wouldn’t even attempt to explain the tax code, let alone one of these shelters. “I'm chairman of the Committee. I even pay to get my own income taxes done. But when it comes to these schemes, remember, I'm not sure that they're meant to be understandable.” 

But what people like Camferdam do understand is the bottom line. Ernst and Young told him he would save $13 million in taxes. But he ended up paying $7 million in fees -- not to the government, but to Ernst and Young, Jenkins and Gilchrist, and Deutschebank.

Now the IRS is going after him, for the $13 million in taxes it says he owes, plus interest and penalties. In response to a demand by the IRS, Ernst and Young turned his name over to the federal government, along with the names of all the other people who bought the Cobra tax shelter. They are all being audited, one by one.

“They've talked like we're the cheats, we're the ones who defrauded the government. We're the ones who maliciously went out and tried to steal tax money from them,’ says Camferdam. “What I don't understand is why they have not gone after Ernst and Young and Jenkins and Gilchrist and Deutschebank who designed, marketed and led us into this transaction.”

But that's just not the way the law works, says B. John Williams, who, until recently, was the IRS’ chief counsel and top enforcer. He says his agency's powers are limited when it comes to going after people who actually devise tax shelters.

“The law provides that we have to collect from the taxpayer who owes the money. And if that taxpayer has a beef with a professional advisor, the taxpayer can sue them and let the courts sort it out,” says Williams.

But shouldn’t they be going after the people who are devising these tax shelters and promoting them?

“Well, we have gone after them within the bounds of the law,” says Williams.

But the bounds of the law are fairly narrow. The IRS went after Ernst and Young this summer, fining them $15 million for failing to register certain tax shelters.

“The penalties are an infinitesimal piece of the pie right now. So if you compare the gross amount of billions of taxes lost, to the penalties levied, it's 1,000 to one or something,” says Bankman.  

Camferdam is suing Ernst and Young, Jenkins and Gilchrist and Deutschebank for $1 billion, alleging they knowingly lured customers into an "illegitimate tax sham."

“We didn't expect Ernst and Young to take our money and go walking down the street, never to hear from them again,” says Camferdam.

The accountants at Ernst and Young and the lawyers at Jenkins and Gilchrist gave 60 Minutes statements saying everything they did was completely legal.

Both firms refused our requests for on camera interviews. But they may have to tell their story to Sen. Grassley. He is holding hearings on the tax shelter business beginning Tuesday, and he is expected to call customers, regulators and promoters to testify.

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

From The Wall Street Journal Accounting Educators' Reviews on October 24, 2003

TITLE: Accounting Board to Look at Abuses in Tax Shelters 
REPORTER: Cassell Bryan-Low 
DATE: Oct 22, 2003 
TOPICS: Public Accounting, Sarbanes-Oxley Act, Tax Shelters, Taxation

SUMMARY: The Public Accounting Oversight Board "will focus on the profession's role in both structuring and signing off on abusive tax shelters..."

1.) From where does the Public Corporation Accounting Oversight Board (PCAOB) obtain its authority to oversee the activities of firms in the public accounting profession? As described in the article, what is the latest area into which the PCAOB will investigate?

2.) From where might a conflict of interest arise in a public accounting firm which sells personal tax planning strategies to individual clients and also audits the company for which those clients work? In your answer, you may provide any example of concerns about tax shelter strategies with which you may be familiar.

3.) What specific steps is the PCAOB saying it will undertake in order to review in more detail the tax planning strategies offered by public accounting firms?

4.) What was the political instigation for this latest increase in the level of scrutiny that the PCAOB plans to undertake?

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


"KPMG Sells DAS to Focus on Forensic Niche," SmartPros, October 23, 2003 --- 

KPMG LLP announced that it will sell its Dispute Advisory Services unit to FTI Consulting Inc. for about $89.1 million. The firm said it will channel resources to build its forensic practice.

"This proposed transaction will help KPMG meet marketplace needs in the new regulatory climate by expanding the services that offer the greatest growth opportunity for a large accounting firm's Forensic practice -- our Investigative and Integrity Advisory Services (IIAS), and Forensic Technology Services (FTS) units," said Richard Girgenti, national partner in charge of KPMG's Forensic practice. "Among our priorities is further integrating our Forensic capabilities in the audit practice."

Girgenti explained that the marketplace has changed, with the Sarbanes-Oxley Act prohibiting accounting firms from performing expert-witness work for their audit clients in the United States, and that many corporate decision-makers are hiring expert witness services from other sources to avoid any appearance of conflict.

KPMG is under no obligation to separate the DAS practice, but decided to take that step to "[reflect its] deliberate decision to lead reform," said Girgenti. He noted that the proposed transaction does not affect the DAS practices of KPMG member firms in other countries, where, because of differing regulations, the individual member firms will continue to serve their clients.

The transaction will include approximately 26 KPMG partners, 125 other billable professionals, plus support staff, who will join FTI. The transaction does not affect any other KPMG operations. More than 300 professionals remain in KPMG's Investigative and Integrity Advisory Services, and Forensic Technology Services units.

The sale transaction is expected to close during the fourth quarter of 2003.

Bob Jensen's threads on KPMG are at 

"Large Size of Travel Rebates Adds to Questions on Ernst," by Honathan Weil, The Wall Street Journal, November 20, 2003 ---,,SB106928498427833800,00.html?mod=mkts_main_news_hs_h 

Ernst & Young was awarded $98.8 million of undisclosed rebates on airline tickets from 1995 through 2000, mostly on client-related travel for which the accounting firm billed clients at full fare, internal Ernst records show.

The rebates are at the crux of a civil lawsuit here in a state circuit court, in which Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP are accused of fraudulently overbilling clients for travel expenses by hundreds of millions of dollars since the early 1990s. The tallies are the first precise annual airline-rebate figures to emerge in the case for any of the three accounting firms.

Ernst and the other defendants, in the lawsuit brought by closely held shopping-mall operator Warmack-Muskogee LP, have acknowledged retaining large rebates from travel companies without disclosing their existence to clients. But they deny that their conduct was fraudulent, saying they used the proceeds to offset costs they otherwise would have billed to clients through higher hourly rates. Confidentiality provisions in the firms' contracts, standard in the airline industry, barred parties from disclosing the contracts' existence or terms.

Court records show that Ernst had rebate agreements with three airlines: American Airlines' parent AMR Corp., Continental Airlines, and Delta Air Lines. The airline rebates soared to $36.7 million in 2000, compared with $21.2 million in 1999 and $5.2 million in 1995, reflecting a trend among major accounting firms to structure their volume discounts with select airlines as rebates rather than upfront price reductions.

A May 2001 chart by Ernst's travel department shows the firm estimated that its 2001 rebates would be $39.8 million to $44 million, including at least $21.2 million from AMR and $8.3 million from Continental.

Of Ernst's three "preferred carriers," two -- AMR and Continental -- are audit clients of the firm. Some investors say the large dollar figures, combined with a reference in one Ernst document to the firm's arrangements with AMR, Continental and seven other travel companies as "strategic partnering relationships," raise questions about how such payments mesh with Securities and Exchange Commission requirements that auditors be independent. The reference was contained in a 2001 presentation outlining the travel department's goals and objectives for the following year.

Audit firms generally aren't allowed to have partnership arrangements with clients in which the auditor would appear to be a client's advocate, rather than a watchdog for the public. SEC rules bar auditors from having direct business relationships with audit clients, with one exception: if the auditor is acting as "a consumer in the normal course of business."

The rules don't clearly spell out the full range of business relationships that would fall under that category. Ernst says its relationships with AMR and Continental qualified for the exception. Generally, auditors can buy goods and services from audit clients at volume discounts, if the prices are fair market and negotiations are arm's length. Ernst, American and Continental say theirs were. Ernst's terms with American and Continental were similar to those with Delta, which wasn't an audit client.

In a January 2000 e-mail to an Ernst consultant, Ernst's travel director explained that, within the airline industry, "point-of-sale discounts are the industry norm, not back-end rebates." Many large professional-services firms tended to prefer back-end rebates, however. A September 2000 presentation by Ernst's travel department said "the back-end rebate structure is consistent with practices in other large professional-services firms," including the other four major accounting firms and investment banks Credit Suisse First Boston and Morgan Stanley. It also said an outside consulting firm, Caldwell Associates, had deemed the competitiveness of Ernst's travel contracts "to be above average," compared with those of the other four major accounting firms.

In a statement, Ernst says: "There is no independence rule of any sort that would prohibit our receipt of rebates for volume travel in the normal course of business. As is the case with any large airline customer, we receive discounts on tickets purchased from American based on the volume of our business. ... It is entirely unrelated to our audit work for the airline."

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

The GAO issued a report on the effects of consolidation in the auditing profession, resulting in the Big Four firms which audit the majority of public companies. The GAO has issued a supplemental report, providing views of CEOs and CFOs on the consolidation of the industry. 

The GAO report can be downloaded from 

"Evaluating Internal Controls and Auditor Independence Under Sarbanes-Oxley, by Paul Munter, Financial Executive, October 2003, pp. 26-27 --- 

The issue of auditor independence has been in the spotlight for much of the past three years. Even before Enron Corp. and WorldCom Inc., the Securities and Exchange Commission (SEC) initiated major rule-making efforts focused in this area. The efforts resulted in significant modifications to its auditor independence rules, including severe restrictions on many non-audit services that an audit firm could provide to its audit clients.

However, those reforms have proven insufficient, as evidenced by the requirements of the Sarbanes-Oxley Act of 2002. It's important to note that of Sarbanes-Oxley's numerous requirements, two relate to auditor independence and assessment of the effectiveness of internal controls.

Title II of Sarbanes-Oxley directs the SEC to undertake additional rule-making on auditor independence. In particular, it specifies that an auditor is legally prohibited from providing certain non-audit services to its audit clients, among which are internal audit outsourcing and information technology design and implementation.

The performance by an auditor of any of these functions for an audit client renders the auditor no longer independent with respect to that audit client and, thus, unable to issue an audit opinion on the company's financial statements.

As audit firms and audit clients implement these requirements, there are two additional considerations that play into the decision-making process. The first is the modifying condition that exists with respect to these prohibited services. The second is the concept that an auditor can "assist but not do."

Regarding the prohibited services: the SEC determined that an auditor could provide these services to an audit client where it is reasonable to conclude that the service will not be subject to audit procedures. While these are important concepts, they are difficult to implement, and recent anecdotal evidence indicates that they are not well understood.

So, what is 'reasonable to conclude?'

The SEC's auditor independence release notes that the auditor independence rules are based on three underlying principles: 1) an auditor should not audit his/her own work; 2) an auditor should not act in the role of management; and 3) an auditor should not serve as an advocate for his/her client.

Clearly, the provision of internal audit outsourcing and information technology design and implementation violate the first two principles. However, if those services will not be subject to audit, then the SEC concluded that the threats to independence are sufficiently mitigated.

Key to understanding the "reasonable to conclude" exception is the presumption established by the SEC. The presumption is that the prohibited services cause the auditor to no longer be independent with respect to the audit client. Therefore, the burden of demonstrating that the presumption has been overcome falls squarely on the auditor. Not surprisingly, questions have been raised as to how the presumption can be overcome.

In the independence release, the SEC attempts to provide an example (in footnote 51) of when the presumption might be overcome.

More recently, the SEC staff issued frequently asked questions (FAQs) to address questions that had been raised about the independence rules. Of the 35 FAQs and responses, only Question 17 touches on the "reasonable to conclude" notion. That question and related staff response indicates that the rebuttable presumption - that the services are prohibited - cannot be overcome on the basis of materiality. Which leaves the question: What are the circumstances under which the presumption can be overcome?

Continued in the article.

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

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

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

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

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

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

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

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

Emerging Trends in Corporate Governance, PricewaterhouseCoopers (PwC) CFO DirectNetwork, September 10, 2003 --- I shortened the above link to 

"Former Freddie Mac Officer Agrees to a Civil Settlement," by John D. McKinnon, The Wall Street Journal, October 24, 2003 ---,,SB106691253032356700,00.html?mod=mkts_main_news_hs_h 

The fired president of Freddie Mac agreed to pay a civil penalty and cooperate with federal regulators, handing officials a weapon to use against the mortgage company and some former executives, as well as some of the investment firms that helped it manipulate earnings.

Political pressure on Freddie Mac and its sister company, Fannie Mae, inched up as well, as at least one lawmaker questioned the need for the government-sponsored companies.

Former President David Glenn's agreement could strengthen regulators' hand against Freddie Mac, as well as some of the firms that did business with Freddie Mac, according to several people familiar with the situation. Some of Freddie Mac's accounting manipulation was accomplished through huge structured financial transactions that effectively shifted excess earnings into future periods, to mask the company's volatility and build up reserves for lean years. Its accounting mess is expected to lead to a restatement totaling at least $4.5 billion.

Mr. Glenn's agreement to cooperate also could help the regulator, the Office of Federal Housing Enterprise Oversight, build its case against some other former Freddie officials. Agency officials said Thursday that they are getting little cooperation from ousted chairman and CEO Leland Brendsel, and are considering seeking to enforce a subpoena in court.

Amid the accounting problems in June, it fired Mr. Glenn and ousted two chief executives, a chief financial officer and its general counsel.

Continued in the article.


The executive team of CPAs Reforming Our Profession (CROP) is a vocal group of "concerned members of the AICPA" ---  

CROP has submitted recommendations to council members of the American Institute of Certified Public Accountants:

Suggestions for discussion at the October AICPA meeting:

  1. Make public acknowledgement of the shortcomings of the CPA profession and, at the same time, educate the public of management's responsibilities for illegal and unethical activities.
  2. Reform AICPA governance so that it is member-driven and more democratic.
  3. Provide better mechanisms for the voice of opposition in AICPA publications and communications and evaluate the ideas of those with thoughts contrary to the "common wisdom."
  4. Acknowledge that the CPA license IS expandable and focus on marketing the CPA brand.
  5. View auditing as an integral skill of the CPA. The audit experience should be the primary core and foundation of the education of every CPA because it teaches independence, objectivity, and professional skepticism.
  6. Utilize available and existing technology (i.e. member polling) to more effectively contact and obtain feedback from members.
  7. Create a methodology for accountability of management and volunteers to the membership.
  8. Provide for transparency and openness - there should be disclosure of all activities of the AICPA and member inquiries should be answered.
  9. Provide concrete evidence of the benefits of AICPA membership.
  10. Leverage the intellectual capital of members.
  11. Require major initiatives to have broad-based member support.
  12. Support and evaluate existing and future specialty areas and monitor their continued viability.
  13. Provide effective national and international political advocacy based on member concerns.
  14. Retain the ability to write the professional standards and protect the rule-making authority of the AICPA because it is uniquely qualified for this purpose.
  15. Provide support for all member constituencies.
  16. In addition to the reporting reforms necessary to protect shareholders of public companies, support the immediate development of an appropriate, cost effective Generally Accepted Accounting Principles for businesses who do not have outside investors and whose primary readers have direct access to management.
  17. Develop an ongoing process for the Certified Public Accounting profession to perform detailed reviews of all significant "audit" failures for the purpose of understanding the mechanism of failure and developing changes in procedures that would help avoid the same problems in the future.

September 30, 2003 message from Roger Debreceny

A few days ago Microsoft announced the forthcoming release of Office Solution Accelerators," which are "an integrated set of components, templates, and Microsoft-authored guidance designed to address key enterprise needs." Of particular interest to this list are:

"Office Solution Accelerator for Sarbanes-Oxley Provide the control and visibility you need to comply with activities related to the U.S. Securities and Exchange Commission's Sarbanes-Oxley Act of 2002. The Microsoft Office Solution Accelerator for Sarbanes-Oxley enables compliance initiatives with document and information management, automated workflow, team collaboration, and summary reporting. Using core Microsoft technologies and world-class deployment partners, the Microsoft Office Solution Accelerator for Sarbanes-Oxley is an affordable solution that uses existing software investments, is easy to deploy, familiar to users, and adaptable to changing needs.

Office Solution Accelerator for XBRL Streamline your financial reporting process by using the Microsoft Office Solution Accelerator for Extensible Business Reporting Language (XBRL). By standardizing both internal and external financial information management processes using XBRL, your organization can increase financial transparency, improve decision making, and support new financial compliance legislation."

Also of interest are:

Office Solution Accelerator for Business Scorecards Office Solution Accelerator for Six Sigma Office Solution Accelerator for Excel Reporting


The XBRL Accelerator will, as I understand it, allow users to read and write XBRL data conforming to taxonomies issued under the forthcoming XBRL 2.1 specification. I have not seen a beta version of this product yet, but expect to do so in the coming months and will report to AECM.

Roger Debreceny 
Nanyang Business School
Nanyang Technological University

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

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

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

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

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

Continued in the article.

Bob Jensen's threads on this ethics mess involving all Big Four firms are at 

From The Wall Street Journal Accounting Educators' Review, October 10, 2003

TITLE: Heard on the Street: Tyco's 'Special Bonus' on Trial 
REPORTER: Mark Maremont 
DATE: Oct 03, 2003 
TOPICS: Executive compensation, Financial Accounting, Related-party transactions

SUMMARY: Loans to Tyco executives totaling $38.5 million were treated as forgiven even though forgiving these loans was not authorized by the Board. That fact, and certain others described in the article, are expected to lead to this transaction as the critical evidence that Tyco executives looted the company with "unauthorized compensation and illicit stock sales."

1.) "In August 1999, prosecutors say Mr. Swartz, then Tyco's chief financial officer, quietly ordered a subordinate to add credits totaling $38.5 million to the employee-loan of three people..." What accounts are being credited? What would you expect would be the associated debit?

2.) Several people say the auditors never knew about the $38.5 million in forgiven loans. Did the auditors have a responsibility to know about this transaction? How would you assess this question? In your answer, cite the professional standard governing this area. As well, define materiality--both in terms of dollar amounts and in terms of the nature of the transaction, citing your source(s) for this definition.

3.) What are the requirements for financial statement disclosure of these transactions? In your answer, cite the specific accounting and reporting standard(s) enumerating these requirements.

4.) What is the significance of the facts that the forgiven loans were not included in Tyco executives' W-2's? Again, do you think the auditors should have discovered this discrepancy? What audit step might be undertaken to detect such a discrepancy?

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

Accountants are the only ones with maintaining perceptions of independence.
Who's In Control? Gartner insists that an influential VC's 38% stake in the research firm won't compromise its objectivity. 

California wins its first antispam judgment, against marketing firm PW Marketing. The company is fined $2 million under a 1998 statute; the state expects spammers will be easier to prosecute under its tougher new law ---,1367,60968,00.html 

Creative Accounting at Bank of America

"Bank of America Faces Allegations," by Carrick Mollenkamp, The Wall Street Journal, November 12, 2003 ---,,SB106859107629631400,00.html?mod=home%5Fwhats%5Fnews%5Fus 

Former Executive Charges
Use of 'Creative' Accounts,
Pressure for Contributions


A former Bank of America Corp. executive alleged in an arbitration filing that the bank used "creative accounting" in booking financial losses and that executives were inappropriately ordered to make charitable and political contributions at the behest of the bank.

The allegations are part of a claim filed Tuesday by former Bank of America executive Duncan Goldie-Morrison with the National Association of Securities Dealers, which hears employment claims and other disputes in the securities industry.

Until March, Mr. Goldie-Morrison was one of the highest-ranking executives at the bank's corporate- and investment-banking division. He ran the debt-raising business for bank clients, as well as foreign-exchange products and fixed-income research. As part of a reorganization earlier this year, Mr. Goldie-Morrison's job was eliminated.

Before the NASD, Mr. Goldie-Morrison is seeking, in addition to unspecified damages, $7.3 million, including stock options valued at $5 million that were revoked or abridged, a $2.1 million bonus he didn't receive as well as $101,000 in charitable and political contributions he made to a museum and to a political candidate in North Carolina. Bank of America is based in Charlotte, N.C.

Jeff Hershberger, a spokesman for the company, said Bank of America hadn't seen Mr. Goldie-Morrison's filing but strongly denied any wrongdoing. "His allegations have been described to us, and we are confident the company will refute and successfully defend against the allegations," Mr. Hershberger said.

Mr. Goldie-Morrison, 48 years old, said in his claim that during his nine years at Bank of America, he was a prized employee, even receiving a rare crystal hand grenade that former Chairman Hugh McColl, a former Marine, awarded to valued employees. Mr. Goldie-Morrison said he built his division into one of the biggest revenue contributors to the investment- and corporate-banking unit, which accounts for about 18% of the bank's total earnings.

Continued in the article.

"Tied to Milken, the Ride Still Can Be Bumpy," by Patrcick McGeehan, The New York Times, November 12, 2003 ---  

Investing in the second act of Michael Milken, the onetime king of junk bonds, has not been a rewarding experience for everyone. Just ask the shareholders of Nextera Enterprises, a company controlled by Mr. Milken and his brother, Lowell, and Lawrence J. Ellison, the chairman of the Oracle Corporation.

Nextera's shareholders are scheduled to meet Friday to vote on the company's proposed sale of its only operation, a corporate consulting business, to FTI Consulting for $130 million. The transaction, which is expected to close before the end of the year, would leave Nextera as a penny stock representing ownership of an empty shell whose purpose is unclear.

Compared with LeapFrog Enterprises, a company taken public by the Milken brothers and Mr. Ellison last year, Nextera has been a toad. Investors who paid $10 for their shares in Nextera's initial sale of stock in 1999 have lost more than 95 percent of their money. Yesterday, Nextera shares closed at 36 cents, down a penny on Nasdaq.

By contrast, shares of LeapFrog, which makes educational toys, hit a high of $47.30 last month before falling sharply on a disappointing third-quarter earnings report. Its shares lost $1.57 yesterday, to close at $34.37. Last week, when Michael Milken registered to sell 1 million of his 7.9 million shares of LeapFrog, they were worth about $35 each, almost triple the initial offering price 16 months ago. So far, he has sold 800,000 shares, a company official said.

According to LeapFrog's filings with the Securities and Exchange Commission, the Milkens and Mr. Ellison, as a group, owned about 29 million shares of stock. But their shares are Class B shares, each of them carrying 10 votes, giving them 90 percent of the voting power and leaving the holders of Class A shares with too little influence to affect any changes in the company.

Through a similar structure, the three men exert control of Nextera, which was intended to be a big consulting company. Their support for the sale of the consulting business, Lexecon, makes the outcome of the vote on Friday a certainty.

What is not clear is what they will do next with Nextera, which will have no operating business and will be in jeopardy of having its stock delisted. The Nasdaq stock market has notified the company that it could lose its listing on the Nasdaq small-capitalization market as soon as Nov. 30.

Michael P. Muldowney, the chief financial officer and chief operating officer, said Nextera had hired an investment bank, Harch Capital Management, to search for a private business worth $30 million to $70 million that it could acquire.

Joseph Harch, the founder of Harch Capital Management, which operates hedge funds in Boca Raton, Fla., is an old ally of Michael Milken. He was an executive at Drexel Burnham Lambert when Michael Milken ran that firm's junk-bond trading operation in the 1980's. Mr. Harch consulted with Nextera on its decision to sell Lexecon to FTI.

The sale would put an end to what began as a big idea: to build a one-stop shop for companies that need advice on staffing and technology and expert views on economic and legal matters. The company was one of the last underwritten by Donaldson, Lufkin & Jenrette, the Wall Street firm acquired in 2000 by Credit Suisse First Boston. Its prospects were trumpeted by analysts at several brokerage firms, including Banc of America Securities, Robertson Stephens and Thomas Weisel Partners.

But within two years of the company's stock sale, the market swooned and the economy faltered, curtailing demand for such advice. The share price plunged below $1 and analysts stopped recommending the stock.

"The technology spending drop-off in 2001 resulted in the company needing to revisit its strategy," Mr. Muldowney said in a telephone interview yesterday. "In part it was a realization," he added, that "technology spending was not going to rebound anytime soon."


Mr. Fischel (professor of law and economics at the University of Chicago) wrote a 1995 book that argued that Mr. Milken was not guilty of any crimes, even though he pleaded guilty to six felonies and served two years in prison. Its title is "Payback: The Conspiracy to Destroy Michael Milken and His Financial Revolution" (HarperBusiness).


"Pension Agency Warns Against Corporate Relief< by John D. McKinnon, The Wall Street Journal, November 12, 2003 ---,,SB106859371490991600,00.html?mod=home_whats_news_us 

As supporters searched for a way to make a bailout more palatable, the federal agency that backstops corporate retirement plans warned Congress against proposals to give airlines and other struggling companies a temporary, but significant, break in pension-funding requirements.

Even companies with relatively healthy retirement plans are facing higher contribution requirements because low interest rates and other economic factors are making their long-term pension obligations look larger under federal funding rules. In response, Congress is likely to pass a broad relief measure, in the form of a more generous interest-rate formula for figuring basic contribution requirements.

Continued in the article.

"Failed Pensions: A Painful Lesson in Assumptions," by Mary Williams Walsh, The New York Times, November 12, 2003 --- 

Robert M. Bowden retired from his job as accounts manager for a large trucking company with a plan to travel for himself.

But his company's pension plan collapsed this year, and his annual payout was cut to $24,000 from $48,000.

Mr. Bowden and other retirees of the company, CNF, see a culprit. In a lawsuit, they accuse the company of failing for many years to set aside enough money in the plan. The company did this, they say, by assuming they would retire much later than they really did. Though the CNF plan offered full benefits to people as young as 55, the company projected people would stick to their desks until they turned 64.

A look at documents made public in the retirees' fight at CNF and at a few other companies, including US Airways and Bethlehem Steel, shows that companies have great leeway to tweak certain crucial assumptions about the future — when their workers will retire, how long they will live, and which way interest rates will move, among others.

A year shaved off an estimate here, a decimal point's difference there can significantly reduce a company's pension obligations on paper. The company can save millions of dollars in pension contributions.

But if a company shortchanges its pension fund year after year and the company then gets into trouble, the plan that looked healthy can fail, seemingly out of nowhere, leaving workers stranded.

"I'm in a financial survival mode," Mr. Bowden said. At 59, he recently refinanced his mortgage in Lake Oswego, Ore., to conserve cash while looking for a cheaper place to live.

Assumptions that the government considers inadequate contributed to the demise of almost all of the roughly 150 pension plans that failed in the last year. Current detailed information about pension plans is not routinely disclosed, however.

The painful lesson for employees comes as companies press Congress for permanent relaxation of some provisions of the pension funding law. One measure, passed by the House in October, would allow companies to make more favorable interest rate assumptions for the next two years while a panel works on broad changes to the pension funding rules.

Two other bills, recently passed by different Senate committees, would extend the interest-rate change beyond two years, and one of them would also suspend a measure intended to punish companies that let their pension plans become severely underfunded. If Congress does not act before a stopgap measure expires at the end of the year, companies will be forced to make large mandatory contributions.

Companies generally contend that the funding requirements are out of step with the current financial environment. CNF has not filed a response to the retirees' suit, and a spokeswoman said the company could not comment on the dispute.

Continued in the article.

As you recall, the environment for fraud greatly increased with the deregulation of energy prices and the startup of energy derivatives that became an enormous source of profit and graft at Enron.  California paid a heavy price and has been lobbying for tougher regulation once again.

From Risk News on November 8, 2003

The US Senate voted down proposed legislation this week that sought to impose tighter controls on over-the-counter energy derivatives trading. Senators voted 56 to 41 against an amendment planned for inclusion in an agriculture spending bill proposed by Democrat senator for California Dianne Feinstein. It was the third time Feinstein had pushed for stricter federal regulation in the energy and commodity derivatives markets. All three efforts have failed. The International Swaps and Derivatives Association applauded the Senate's decision. “[The senators' actions] preserve the ability of American companies to use these valuable tools to manage risk, and thereby aid economic recovery," said Pickel.

Bob Jensen's threads on Enron are at 

From The Wall Street Journal Accounting Educators' Reviews on November 14, 2003

TITLE: Toyota Earnings Mask Woes in U.S. 
REPORTER: Todd Zaun 
DATE: Nov 10, 2003 
TOPICS: Accounting, Core Earnings, Earnings Quality, Financial Accounting, Financial Analysis, Financial Statement Analysis, Foreign Currency Exchange Rates

SUMMARY: Toyota Motor Corp. reported a 12% increase in operating profit and a 23% increase in net income. However, some analyst claim that a closer look at the results suggests that the performance was not as strong as it seemed.

1.) List three factors contributing to the increase in operating profit and net income at Toyota. Are these factors likely to continue into the future? Support your answer.

2.) What is earnings quality? Compare and contrast gains that should be reported as operating income and gains that should be reported as nonoperating income. How does the distinction between operating and nonoperating gains impact earnings quality?

3.) What is an interest-rate derivative? How do interest-rate derivatives generate gains and losses? How did Toyota report the gain from interest-rate derivatives? How should gains from interest-rate derivatives be reported? Support your answer using authoritative guidance.

4.) Comment on the quality of earning reported by Toyota. List three things that could improve Toyota's quality of earnings.

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


An Ethics Question for Publishers and Educators

I have an ethics question about whether marketing a rather phony "new" Edition 10E of the Garrison and Noreen Managerial Accounting textbook is being done in an ethical manner.  It is my understanding that the print version is no different than Edition 10.  The book is described at 

Reasons for requiring the new Edition 10 are given by McGraw-Hill at 

The ethics question is whether the publisher should put a "New Edition" number 10E on the cover of the print edition if content is no different than the content of millions of copies of used books with Edition 10 on the cover.

Edition 10E does comes shrink wrapped with new supplements such as a new multimedia CD that narrates some PowerPoint slides and Excel charts. However, in my viewpoint these narrations are the most boring narrations that I have ever listened to in multimedia. For example, the narration merely reads the text of very limited PowerPoint slides. I see little benefit in this if the narration does not extend beyond the bullet points.  

In fairness there are some other "benefits" that come with Edition 10E that McGraw-Hill claims add up to a $175 value.  All the Edition 10E benefits include the following:

The ethics issue is whether this is merely a cheap rip off to destroy the used book market for Edition 10. McGraw-Hill gets zero when our bookstores sell used copies of Edition 10 of the Garrison and Noreen text.  If instructors really want to use the multimedia CD, the Topic Tackler CD, and NetTutor, then the new Edition 10E is probably a good deal for students.  But my hunch is that most instructors around the world who adopt this book will not care about these new supplements and will use only the old supplements that are already available, including the Edition 10 CD with quite nice PowerPoint slides and the Edition  Study Guide) that are the same for Edition 10E as they were for Edition 10.

But many instructors may carelessly assume that a book with a new edition number on the covers has changed content inside the covers of the printed versions of the book.

This is beginning to smell like a cheap rip off of the used book market. If all McGraw-Hill added to Edition 10E are some detached supplements to the print copy Edition 10, the ethical thing to do is to market the supplements and not change the edition number on the cover a printed text that is unchanged.

November 8, 2003 reply from Ken Greene

There was a NYT article that touched on this phenomenon a few weeks ago.  Here is the abstract from the NYT website:
NATIONAL DESK | October 21, 2003, Tuesday
Students Find $100 Textbooks Cost $50, Purchased Overseas

By TAMAR LEWIN (NYT) 1667 words
Late Edition - Final , Section A , Page 1 , Column 4

ABSTRACT - American college students find that their textbooks cost far less overseas than they do in United States; more and more individual students and college bookstores are ordering textbooks from abroad; National Assn of College Bookstores has written to all leading publishers asking them to end practice they see as unfair to American students; publishing industry defends its pricing policies, saying foreign sales would be impossible if book prices were not pegged to local market conditions; textbook publishers have tried to block reimporting of American texts from overseas; Supreme Court ruled in 1998 that federal copyright law does not protect American manufacturers from having products they arrange to sell overseas at discount shipped back for sale in US; photo; chart (M

Ken Greene

November 8, 2003 reply from John Roberts [roberts_j@FIRN.EDU

I have been using this text since it came out in the Summer of 2002. When I talked to my publisher representative, my understanding was that they were just including some additional student supplements (as you outlined) with a small rise in price – about $5. I personally will not be using the new Update Edition, as they call it, since my book store will not buy back texts unless they have the same supplements in usable shape as the text being used in the next semester. These books are already expensive enough without the student losing the ability to sell the book back.

If McGraw-Hill continues this tactic of trying to eliminate the secondary market of textbooks by shortening the normal three-year edition cycle, I will find another text/publisher that is maintaining the three-year cycle. I really like the Garrison text and have used it for several years but textbooks are too similar to put up with publisher shenanigans! I can always add/delete coverage that I find insufficient/superfluous when I lecture.

John C. Roberts, Jr.
Saint Johns River Community College
283 College Drive
Orange Park, FL 32065
Phone (904) 276-6816
FAX (904) 276-6888
Suncom 890-6816


In these times
a child's eye is our only hope
and hand.
To draw a window
jump through
and erase it from the other side

A portion of the poem "Bracing Myself to Hear the Day's News," Philip Pardi, The Texas Observer, September 12, 2003, Page 21 (I don't think the poems are online) --- 
I'm reminded by Anne Murray that we need a little good news ---  
See Below!

It's fun to play on words. I'm always inspired by an Anne Murray song entitled "Little Good News" --- 
Let's play on the words a bit.

I rolled out this morning...ACEMers had email systems on 
AccountingWeb tells of an audit failure long after old Enron 
SmartPros shows us how accounting careers have grown dicey 
It's gonna get worse you see, we need a change in policy

There's a Wall Street Journal rolled up in a rubber band 
One more sad story's one more than I can stand 
Just once, how I'd like to see the headline say 
Not much to print about, can't find any frauds today


Nobody cheated on taxes owed 
No lawsuits filed, no investors got POed 
No new FASB rules, no unaccounted stock options in our pay 
We sure could use a little good news today

I'll come home this evening...I'll bet that the news will be the same 
Ernst & Young's fired a partner, PwC's been found to blame 
How I wanna hear the anchor man talk about a county fair 
And how we cleaned up the everybody's playing fair

Whoa, tell me...

Nobody was cheated by their brokers 
And the mutual funds all played square 
And everybody loves everybody in the good old USA 
We sure could use a little good news today

Nobody embezzled a widow on the lower side of town 
Nobody OD'd, only the courthouses got burned down 
Nobody failed an exam...nobody cussed out FAS 133 
Now that would really be good news for me

Sorry folks!

Bob Jensen

-----Original Message----- 
From: Richard C. Sansing [mailto:Richard.C.Sansing@DARTMOUTH.EDU]  
Sent: Wednesday, October 22, 2003 10:28 AM 
Subject: Re: An accounting parody

--- You wrote:

I am looking for an "accounting" song. I would like to be able to have a popular song and change some of the lyrics to include basic accounting principles but my creative juices do not flow in that way. Does anyone know of such a parody?

--- end of quote ---

Possibilities include "Enron-Ron-Ron" (on the Capital Steps CD, "When Bush comes to shove") and "When IRS Guys are Smilin'" (Capital Steps, "Unzippin' My Doodah"). Also, the first part of "I want to be a producer" (The Producers) deals with accounting.

Richard C. Sansing Associate Professor of Business Administration Tuck School of Business at Dartmouth 100 Tuck Hall Hanover, NH 03755

Office: Tuck 203A Phone: (603) 646-0392 Fax: (603) 646-0995 email:  URL:  
Luck is the residue of design--Branch Rickey

October 23, 2003 reply from Dan Stone [dstone@UKY.EDU

Re: songs about accountants.... Here's another: 

It's a parody of John Henry.... Called Henry the accountant

KEVIN WOODWARD Free Folksongs (audio clips) --- 
Includes part of the song "Henry the Accountant"
October 24, 2003 message from Dave Albrecht [albrecht@PROFALBRECHT.COM

A sound clip of Henry the Accountant can be found at ---

Other songs about an accountant:

The Ballad of Kenny-Boy ---

My Cat Accountant ---

Somehow, Says My Accountant ---

Bob Jensen's Enron and related humor threads are at 

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

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

Bob Jensen's Summary of Suggested Reforms --- 

Bob Jensen's Bottom Line Commentary --- 

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



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